MNI INTERVIEW: Brazil Experiencing Confidence Crisis - Pires
MNI (BRASILIA) - Brazil is not in a fiscal dominance situation, but it is experiencing a confidence crisis along with macroeconomic disarray, Manoel Pires, former secretary of economic policy at the Ministry of Finance, told MNI.
"What is happening now seems more like a crisis of confidence combined with expectations of economic deterioration, which significantly impacts the market. But I believe this can be resolved. If we assume that no one acts to address these issues, then there is a risk of moving toward fiscal dominance," Pires, now a professor at Fundacao Getulio Vargas (FGV), said in an interview.
The contentious relationship between the government and the market caused this loss of confidence, he said. Additionally, the fiscal package included an increase in the income tax exemption threshold for individuals to BRL5,000 per month, up from the current BRL2,259.2, a measure that was poorly received by market participants.
The government stated that this should have a neutral fiscal impact, as it includes higher income tax rates for those earning over BRL50,000 per month, yet investors are not quite sure. "This issue, for example, includes investor taxation, which has now created enormous uncertainty. Nobody knows how it works, and I think it explains part of the market's reaction," Pires noted.
MONETARY POTENCY
After the Central Bank of Brazil hiked rates by 100 basis points earlier this month to 12.25% and indicated two more increases of the same size in upcoming meetings — a decision seen as more hawkish than expected — the real continued to depreciate. It reached its lowest point on Wednesday, after the release of the central bank's meeting minutes, at 6.29 per dollar.
Interest rate curves also worsened during the day, raising doubts about the potency of monetary policy and the possible beginning of fiscal dominance. (See MNI BCB WATCH: Rates Headed Above 14%, Destination Unclear)
"The government should focus on finding a solution not just for economic policy, but also for how to engage with the market. A highly adversarial relationship doesn’t help anyone," Pires opined.
The real has fallen since the late November announcement by Finance Minister Fernando Haddad of a package of BRL70 billion in spending cuts over the next two years, seen as insufficient to stabilize the public debt path.
Additionally, a hawkish tone from the U.S. Federal Reserve and an interview by President Luiz Inacio Lula da Silva over the last weekend calling for lower interest rates have fueled FX volatility.
On Friday, however, after several central bank interventions totaling BRL27.7 billion since Dec. 12, the real strengthened and traded at 6.08 per dollar. Lula also held a live session with the BCB’s new governor, Gabriel Galípolo, to calm the markets.
READINESS TO ACT
Fiscal dominance is generally understood as a situation where a country's government debt load its so high that central bank interest rate hikes can actually boost rather than alleviate inflation because of their overwhelming effect on the interest debt burden. Pires said that's not where Brazil currently finds itself.
"I am quite skeptical about fiscal dominance. These discussions typically emerge during episodes of rising interest rates but rarely materialize. Historically, governments have consistently made efforts to address this issue," the professor said.
In his view, the fiscal track record suggests that the Ministry of Finance is working to reduce the deficit, and additional measures can likely be expected in the future.
"The central bank has sent a strong signal in a stressful situation, likely indicating a terminal rate of 15%. However, these decisions are subject to change. The decision reflects readiness to act in critical economic scenarios," Pires said.
"Depending on how the market reacts, and these reactions accumulate over time as effects become evident, a stable or even appreciating exchange rate could reduce the need for further monetary action."