With Brazilian inflation now above the target rate, in mid-April the central bank announced a rise in interest rates for the first time since July 2011. But the move, in the face of stubborn and diffuse pressure (over 70% of the country’s inflation basket is now affected by inflation) was dovish – just a 25 basis point increase in the face of the market expectations of 50bp. The minutes from the central bank’s monetary policy committee meeting also showed that two of the eight members voted against any rise.
Some economists read into this a likelihood that the monetary tightening will be quick and shallow. Capital Economics says: “The decision by Brazil’s central bank to raise interest rates by 25bp – as opposed to the 50bp that was priced into the market – suggests that the tightening cycle is likely to be less aggressive than many seem to expect. We think it will be the shortest and smallest tightening cycle in history.”
However, it might be that the inflationary fight will be lengthier and harder than most recognize because of the Brazilian government’s use of opaque accounting measures that assess the extent of inflationary pressures being created by fiscal easing.
It has been long acknowledged that the Brazilian government has been creative in meeting its fiscal targets, but a new report from HSBC sheds light on the government’s increasingly complex financial engineering and attempts to clarify its core fiscal balance.
The law that determines Brazil’s fiscal target gives the government considerable leeway, mainly by allowing accounting adjustments to what is considered its fiscal position. The main adjustment concerns the government’s PAC (growth acceleration plan), which is an umbrella programme covering all federal investments. The PAC dates back to the end of the administration of president Fernando Cardoso (the early 2000s); the PAC adjustment enables the government to exempt (to a limit) public investment from the fiscal targets. This adjustment was hardly used before 2012 as the government was consistently delivering the full fiscal target. “Although the government reported a primary fiscal balance for the consolidated public sector of 2.4% of GDP in 2012, the 3.1% of GDP target was met because of the PAC adjustment,” says HSBC, which also points out that in 2013 and 2014 the adjustment is being expanded to include tax-relief measures.
Also, until 2012 the treasury was required to cover any shortfall in the fiscal targets of local governments and state-owned-enterprises, but from 2014 (and the government indicated that this might be made retroactive to 2013) the treasury will no longer be required to do so. HSBC estimates that rather than meeting a target for the consolidated public sector equal to 3.1% of GDP, the government will probably now focus on the treasury delivering a surplus of 2.15%. And there’s more: to meet the fiscal targets, the government has resorted to several mechanisms that boosted dividend payments by state-owned enterprises – and in particular development bank BNDES. In 2012 dividend payments to the Brazilian treasury totalled R$28 billion ($14 billion) (R$12.9 billion from BNDES and R$7.7 billion from Caixa Econômica Federal) of which R$7 billion was anticipated dividend payments that HSBC says “are unusual because they were paid out of a cashflow that was generated by the treasury itself”, with Caixa receiving a capital injection of R$5.4 billion and a loan of $15 billion from the treasury. HSBC calculates that between 2008 and 2012 BNDES has paid the treasury dividends of R$46.9 billion, while over the same period the treasury injected R$275 billion into BNDES.
Also, questions are being asked about unpaid short-term liabilities, with suspicions that some expenditures are being shunted into the next year to postpone temporarily the increases in spending. A report by newspaper O Estado de São Paulo in January said that the NGO Contas Abertas estimates that the stock of unpaid liabilities will increase by just under R$60 billion from 2012 to 2013, up from an average increase of R$15.3 billion between 2009 and 2012.
HSBC estimates a core fiscal balance that restates the figures without the positive effect that these accounting procedures have on the adjusted rate. The bank estimates that the primary fiscal surplus actually fell from 2.8% of GDP in 2011 to 2.1% in 2012, and predicts a further decline to 1.5% in 2013 and 1.2% in 2014.
The report concludes that this off-balance-sheet fiscal expansion will neutralize the current monetary tightening: “At a time when the economy is already facing significant stress and the central bank appears to begin a tightening cycle, more fiscal easing is not the policy prescription. The [150bp] monetary tightening we predict for the coming months will probably do little more than offset the cumulative impact of fiscal easing in 2012 and 2013 and helps explain our bearish view regarding the overall inflation outlook. Specifically, although we expect some accommodation for IPCA inflation in 2013, we expect inflation to accelerate back to 6.3% in 2014.”
