Brazil’s New Fiscal Framework Limits Spending Increases — 2nd Update

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By Jeffrey T. Lewis

SÃO PAULO–The Brazilian government’s proposal to limit spending increases and to balance its primary budget next year while also increasing funding to help the country’s poorest residents is a step in the right direction, despite its lack of important details, economists said.

The new fiscal framework defines the rules the administration of President Luiz Inácio Lula da Silva must follow as it works to boost economic growth and government investment while trying to keep deficits and debt under control.

The left-wing Mr. da Silva’s spending priorities have raised concern among investors and the Central Bank of Brazil over the effect they would have on inflation, though financial markets reacted calmly after details of the framework were released, with the stock market up about 1.4% in mid-afternoon trading and the Brazilian real stronger against the dollar.

Under the rules announced Thursday, once they’re approved by Congress, the government can boost spending every year by 70% of the amount that revenue increased the previous year. If the government exceeds that spending limit, the following year it would only be permitted to increase spending by 50% of the previous year’s revenue increase.

“Focusing on a spending rule is positive, that’s more important than a debt rule because debt can fluctuate” due to factors other than government spending, said Roberto Secemski, an economist at Barclays. “The general guidelines of the framework are good, but we need to see the details once the draft is introduced to Congress, to see how those mechanisms will be applied.”

Brazil’s Congress approved in December, before Mr. da Silva took office, a constitutional amendment allowing the government to boost spending above a ceiling set in a previous amendment. Since he was sworn in, Mr. da Silva has defended increased spending on education, healthcare and investment to help boost growth.

One concern is how the government will define investment, said Nicolas Borsoi, chief economist at the Nova Futura brokerage. The framework sets a floor on investment spending, which might allow the government to avoid some spending limits by classifying education or healthcare expenditures as investment, he said.

“Lula has said that he considers those segments of the budget to be an investment. In practice, that would mean there’s not much of a limit on spending,” he said, adding he has some doubts about the government’s goals for posting a primary budget surplus by 2025. “They didn’t show how they’re going to boost revenue. There’s still a lot of uncertainty.”

The primary budget balance excludes interest payments from the calculation and is a measure of a government’s ability to reduce debt. The government hopes to reduce its primary budget deficit to 0.5% of gross domestic product this year.

The primary deficit limits will have a tolerance band of 0.25% of GDP in either direction, a measure intended to increase the government’s flexibility. The administration’s goal is to have a balanced primary budget in 2024, a primary surplus of 0.5% of GDP in 2025 and a primary surplus of 1.0% of GDP in 2026, the final year of Mr. da Silva’s current term in office.

The government also set a goal of stabilizing, then reducing the level of debt as a portion of GDP. That’s a positive target, but it might not happen as quickly as the administration is hoping, said Flavio Serrano, an economist at BlueLine Asset Management.

“The framework has positive elements, such as limiting spending to less than the rise of revenue. So over time debt levels should evolve positively,” he said. “It will, in a normal economic growth situation, help stabilize the debt level. The problem is that Brazil has volatile economic growth, and that could mean that debt stabilization could take longer.”

Write to Jeffrey T. Lewis at [email protected]

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