How sustainable is the fiscal improvement? – 06/02/2021 – Solange Srour

This year’s fiscal scenario seems to be better than imagined. On the one hand, the stronger economic recovery generates higher tax revenue and improves estimates for this year’s primary deficit. On the other hand, high inflation, especially the very high value of the IGP-M, has increased the GDP deflator projection, reducing projections for the debt/GDP ratio.

In fact, closing this year with a smaller primary deficit reduces the fiscal adjustment needed to achieve fiscal sustainability. However, two questions are relevant: how much of this recovery can be extrapolated to subsequent years? How dependent are we on revenue growth, given the continued increase in mandatory expenditures to GDP?

The improvement in tax collection is related to greater mobility and higher prices for exports and some items with a high tax burden. There is a lot of uncertainty about how much of this recovery will persist: the impacts of the third wave, the risk of restrictions on the supply of electricity and the rise in inflation and interest rates, in addition to political and electoral insecurity.

On the expense side, there is little to celebrate. The spending ceiling has been maintained at the expense of a significant drop in discretionary spending. These fell, between 2016 and the last data for April, from 2.3% of GDP to 1.3% of GDP.

Mandatory expenditure continues to grow above inflation. Between 2017 and 2019, it grew at a pace of 1.2% in real terms. Before the ceiling, between 2010 and 2016, this rate was 5.3%! After two years of Social Security reform, the administrative discussion in Congress begins to show signs that its eventual approval may be worse than its postponement.

Expenditures on social benefits (mainly BPC, salary bonuses and unemployment insurance) remain untouched. The minimum wage that readjusts such expenses has been contained by the current government, but how long will this be possible?

To make matters worse, the pandemic has exposed the fact that the country is unable to implement a countercyclical fiscal policy: once started, it is very difficult to stop it. It is true that the second round of emergency assistance was much smaller than the first. However, there is no lack of political pressure to simply increase social spending without reviewing the effectiveness of existing programs.

Regarding the discussion on the GDP deflator, it is clear that a lower debt/GDP ratio leads to a better sustainability perspective. A more favorable starting point always makes a difference. But it gives a chill to the spine to know that we are making adjustments via inflation, a regressive and punitive tax on savers who agree to finance the government.

Discussions are common about the central bank’s supposed ability to ease fiscal indicators. Voluntary deposits were recently created to replace repo operations, which will reduce gross debt. However, the net debt will remain unchanged, and voluntary deposits must also be remunerated at the Selic rate, that is, there will be no fiscal improvement.

The possibility of purchasing government bonds is another situation that can be fallacious. If the BC acts this way in times of stress, it will be because the country risk has risen, a form of financial repression that prevents interest rates from reflecting the premium demanded by investors.

Even if the debt ends this year at close to 80% of GDP, it will still be excessively high and susceptible to the risk of spiraling out of control in less favorable scenarios. Its gradual reduction will require a fiscal effort that, depending on the parameters of interest and GDP growth, would start between 2.5% and 3.0% of GDP.

Assuming that the economic recovery and high inflation alleviate the fiscal problem, beyond the very short term, is counterproductive. It is in this environment that the political economy of fiscal management thrives on encouraging expenditure and deficit expansion. The 2022 discussion, after nine consecutive years of primary deficit, will be about loosening fiscal rules rather than tightening the spending ceiling.

Arguing that the fiscal situation is not that bad today, we will put aside the urgency of reducing the growth of mandatory expenditures — a necessary, but not sufficient, condition for the country to finally grow more sustainably.

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