MNI INTERVIEW: BCB Hurt By Fiscal ‘Blunder’ - FGV’s Goncalves

MNI (BRASILIA) - Brazil’s central bank will keep interest rates higher for longer with the government’s spending cuts announcement Wednesday seen as clumsy by the public and investors, Fundacao Getulio Vargas professor Robson Goncalves told MNI.

"There was a serious communication blunder with the spending cut package announcing the increase in income tax exemption alongside it," Goncalves, who worked as Brazil's central bank economist and researcher at the Institute of Applied Economic Research (Ipea), said in an interview. "What should have been a clear signal to the market became completely ambiguous. It was a disaster, to the point that the exchange rate is now hitting 6 reais because of it." 

Finance Minister Fernando Haddad announced BRL 70 billion in cuts over the next two years and raised income tax exemptions for individuals to BRL 5,000 per month from BRL 2,259.20. He argued the measures will have no fiscal impact because the income tax rate will increase for those earning more than BRL 50,000 per month.

"The income tax exemption issue could have been announced separately, perhaps later. Bundling everything together muddled the fiscal austerity message entirely," the FGV professor said. (See MNI INTERVIEW: BCB To Keep 50BP Pace in December -Goldenstein)

Although the government claims the income tax exemption will have a neutral fiscal impact, the market doubts the compensation will be sufficient as the revenue estimates are uncertain.

INSUFFICIENT COMPENSATION

The revenue loss is guaranteed, but the offsetting revenue is not, according to Goncalves. "The spending reduction package makes sense, but pairing it with a revenue cut complicates things. How do we measure the net effect?"

The prime-time television announcement felt more political than technical, he said, especially since the details were only clarified this morning.

The outcome for monetary policy is negative, the economist highlighted. "We are worse off than before the announcement, even from a monetary policy standpoint," he pointed out.

"Increasing the income tax exemption gives lower-income groups more disposable income for consumption, adding pressure on demand and inflation. About 50% of Brazilians earn up to five times the minimum wage," he added.

Brazil may be nearing fiscal dominance, Goncalves said. “The Treasury’s recent struggles to issue fixed-rate bonds are the clearest symptom of fiscal dominance," he said. "The government should reverse this and announce a credible fiscal governance plan." (See MNI INTERVIEW: Brazil Risks Fiscal Dominance-Ex BCB Deputy)