Brazil's economy will face a vicious circle in 2022
The Central Bank of Brazil has started a cycle of rate hikes in 2021 that could deteriorate the country's public finances, which are very sensitive to changes in monetary policy. The latest report released by Crédito y Caución highlights that Brazil was the first Central Bank in the region to initiate rate hikes and remains by far the most aggressive. According to the insurer's forecasts, further increases can be expected in the coming months, which could raise the benchmark interest rate, the Selic, above 10% in 2022. "The loss of fiscal consolidation initiated in 2016 and currency depreciation have increased inflationary pressures, forcing the central bank to raise rates further, thus creating a vicious circle," the report states.
In the years leading up to the health emergency, the spending ceiling set in 2016 and the 2019 pension reform gradually restored market confidence in Brazil's fiscal consolidation and allowed the central bank to cut the Selic from 14.25% in 2016 to a record low of 2%. However, in response to high inflation in 2021, the central bank has already raised rates several times since March to reach 7.75% in October.
Brazil's public finances are particularly dependent on this change of cycle: first, because they are financed in increasingly shorter terms, 3.6 years on average compared to 4.8 in 2016; second, because a high proportion, currently close to 30%, maintains variable rates; third, because close to 37%, compared to 25% in 2016, is directly linked to the interest rate set by the Central Bank. In addition to concerns about the effect of the Selic hike, there is also the loss of credibility of the fiscal consolidation initiated in 2016. In 2020 Brazil declared a state of calamity to cope with the economic impact of the pandemic, which allowed the public deficit to rise to 9.4%. The administration has used this clause again in 2021 to exceed the spending ceiling set in the Constitution, and the electoral cycle in the coming months makes a return to fiscal consolidation difficult. "The increase in political uncertainty in recent months has heightened market concerns that the spending ceiling may be exceeded again in 2022 for the third consecutive year, or even abolished altogether," the report explains.
With public debt equivalent to 91% of GDP, Brazil already faces one of the highest interest expenditures in the world and well above the average for emerging markets and the Americas. "To put the debt ratio on a downward trajectory, Brazil would need fiscal reforms, such as improving the highly complex tax system and reducing compulsory public spending, in particular the high wage bill, which stands at almost 14% of GDP, well above the emerging market average of 9%," the report explains.