Brazil warned on policy discipline

21/03/2010 | Thierry Ogier, Taimur Ahmad

Experts sound the alarm against complacency in fiscal and monetary policy in Brazil

Warnings have been sounded against complacency in fiscal and monetary policy in Brazil.

Marcelo Carvalho, chief economist at Morgan Stanley in São Paulo, yesterday called on policy makers to rethink priorities, not to rely on the rising tax burden and set a clear fiscal framework.

“We see a strong rebound, but sustainability will be much harder unless [there is action] on some structural reforms. The risk is that policymakers confuse the two things”, Carvalho told Emerging Markets. If that happened, the result would be lower growth in the long term.

“There is not a major concern regarding debt sustainability or solvency. The problem is more related to the expansionist fiscal strategy. It may have negative implications on growth eventually,” says Carvalho.

“In the short term, the current account deficit is a more pressing issue. But in the long term, fiscal accounts are the main concern for Brazil.”

Fitch notes that the gross general government debt burden of more than 70% of GDP will remain roughly 30% above Mexico’s, hammering home the need for Brazil to unwind its expansion.

The Brazilian government has defended its fiscal strategy, saying that the net debt-to-GDP ratio will fall again after reaching 43% last year. Paulo Bernardo Silva, Brazil’s planning budget minister, has just announced sweeping budget cuts of 21.6 billion reais ($12 billion) and a freeze on hiring civil servants.

Finance minister Guido Mantega insisted in a recent interview with Emerging Markets that “we are going to be on target” fiscally.

But other observers have echoed Carvalho’s concerns. Liliana Rojas-Suarez, senior fellow at the Centre for Global Development, said the fiscal position would be compromised if expansion was not reversed. Investors “have not yet priced in the potential for a fiscal problem in Brazil. But it’s there”, she told Emerging Markets.

There are also concerns on the monetary policy front, where rising inflationary pressures leave little doubt that Brazil will soon start to raise its benchmark Selic rate. “Monetary policy tightening is necessary”, Marcelo Salomon, chief economist at Barclays Capital in São Paulo, said.

Some members of the central bank’s monetary policy council voted for an immediate hike at their March meeting, but the majority (5 against 3) decided to keep rates at 8.75%.

This has raised some concern as economic activity picks up and inflationary pressures intensify. The consumer price index may reach 2% during the first quarter of the year, even though market expectations are still within the upper range of the inflation target (below 6%). If this trend persists, the central bank will have to launch a new cycle of monetary tightening next month.

Carvalho expects interest rates to end the year at 11%.

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