Brazil’s government is under increasing pressure to loosen or lift a constitutionally mandated spending cap, alarming investors who fear a sharp deterioration in the country’s fiscal position.
Since its creation in 2016, the spending cap has been a fiscal anchor for Latin America’s largest economy. But it is under attack from forces both inside and outside the government, which want to spend in order to boost the economy, or Mr Bolsonaro’s popularity.
The debate has spooked the country’s business community, which fears a looming fiscal crisis would trigger an exodus from Brazilian assets, weaken the exchange rate, spur inflation and generate instability.
“This is the only thing we talk about. Business people understand the ceiling is imperative for Brazil’s success,” said João Sampaio Vianna, president of Ipanema Investments.
“If we don’t address the fiscal issue, international investors won’t come. If they don’t come, we won’t have money to do anything.”
After massive coronavirus crisis spending — notably on a cash transfer to Brazil’s poorest that costs about $10bn a month — the country is this year facing a primary deficit of more than $140bn, almost 13 per cent of gross domestic product. Its gross debt is forecast this year to reach 98 per cent of GDP, up from an estimated 78 per cent before the Covid-19 crisis.
“Brazil is walking on thin ice. What happened in terms of fiscal slippage was very big,” said Fernando Rocha, an economist at asset manager JGP, pointing to the growing risks for investors. “When you look at the ratio, I cannot see debt stabilising in the short term or even in 10 years ahead.”
The debate is an urgent one as the government must submit its budget for next year by the end of August. The finance ministry is legally obliged to present a budget that fits within the spending ceiling, which is calculated as the previous year’s expenses adjusted for inflation.
However, a budget that fits under the cap would provoke a fiscal contraction worth hundreds of billions of dollars next year, since the emergency coronavirus crisis funds — which are not subject to the cap — are due to be withdrawn at the end of the year despite the lingering impact of the virus.
Doing so would be likely to affect Brazil’s fragile economic recovery, a prospect that has prompted left-leaning politicians and economists — and even some officials within the Bolsonaro administration — to push to loosen or abandon the spending ceiling.
They argue that just 3 per cent of Brazil’s more than $1.4tn in debt is in foreign currency, meaning the country is less exposed to exchange rate fluctuations than in the past, and the government maintains more than $330bn in currency reserves to fend off a debt crisis.
“Without revising the spending ceiling, we have very little hope of being able to develop the country. Without the state making investments, how will the country develop?” said Maria do Rosário, a lawmaker with the opposition Workers’ party.
Paulo Guedes, the finance minister, has steadfastly defended the ceiling. But he is increasingly isolated in a cabinet that sees political dividends from spending on big-ticket items. Mr Bolsonaro has wavered on the subject, but he recently said the market needed to be more “patriotic” with Brazil.
Eduardo de Carvalho, a portfolio manager at Pacifico Asset Management in Rio de Janeiro, said what mattered was how the ceiling was adjusted, whether the government could make up the adjustments elsewhere and how those adjustments would affect total debt projections.
“If it happens in a low credibility kind of way, what would happen is very similar to the dynamics in 2015 in the last year of the Dilma Rousseff government, which was people getting rid of local assets, which is the same to say that the exchange rate would weaken and inflation would go up.”
The situation underlines Brazil’s budgetary constraints and the difficulties in changing spending rules. More than 95 per cent of Brazil’s budget is already made up of mandated spending, mostly on pensions and public sector salaries, which can only be changed via constitutional amendment.
Any attempt to alter or abandon the spending ceiling would also require a constitutional amendment and a three-fifths majority in two votes in each house of Congress — a potentially lengthy and contentious process.
“The amount of budget that the government has under its control is very small. I am not sure if the ceiling is feasible in the medium run,” said Mr Rocha. “But the market is seeing this as an important issue. If the government says ‘forget the ceiling and we are not putting anything in its place’, the market will collapse.”
A poll of 72 investors by XP, a Brazilian brokerage, found that more than half believed the government would change the ceiling to allow additional expenses.
In one sign of how jittery investors have become, Brazil’s real was briefly knocked to a three-month low against the dollar last week when the Senate voted to override Mr Bolsonaro’s veto of a costly pay rise for civil servants. The House quickly moved to assuage those fears by overruling the Senate and affirming the veto.
For Marco Cavalcanti, a former economic official who worked with Mr Guedes, the ceiling exists for moments such as this: “It is a way to convey that the government is committed to fiscal discipline. This is the moment we have to make it work.”
Additional reporting by Carolina Pulice