Neither Lula nor Bolsonaro seem inclined towards irresponsible fiscal policy, says newcomer to the BC

Appointed director of Economic Policy at the Central Bank during the administration of Jair Bolsonaro (PL), the now responsible for the macroeconomics area at ASA Investments Fabio Kanczuk says that market expectations about the fiscal responsibility of Lula (PT) and the current head of the Executive, candidate for reelection, are not discrepant.

“In the past elections, it was very clear who was the darling of the market and who was the enemy of the market, and that economic policy would be very different in terms of fiscal responsibility”, he says. For the economist, this time, “neither of the two seems inclined to make a very irresponsible fiscal policy”.

Kanczuk indicates that the election period will not be a brake on interest rate escalation and projects that the basic rate (Selic, currently at 13.25%) will rise to 14.25% per year at the end of the monetary tightening cycle. But unlike other economists’ estimates, he sees room for cuts in the second quarter of 2023. That’s because inflation would fall sharply amid a recession that would hit Brazil sooner than the United States.

What can we expect for the next Copom meeting?

What came different between the last meeting [em junho] and this [agosto] it was the PEC [dos benefícios sociais], which the people at the office joke is Xuxa’s PEC, because ‘everything is possible, just believe it’. With the PEC, there was a change in the [projeção de] inflation, from 2022 it fell and from 2023 it rose, worsening the inflation situation for the relevant horizon. With that, the typical flight plan is another 0.5 percentage point increase, from 13.25% to 13.75%.

As for the next steps, how far should the BC raise interest rates?

My personal guess is that the Brazilian economy will decelerate very strongly in the fourth quarter. It won’t slow down now because it had the new aid of R$ 600, taxi vouchers, truck vouchers. In the fourth quarter, it has all the conditions for the economy to slow down sharply and even have recession in Brazil. Hence the BC sees that the monetary policy has worked and has greater confidence to stop raising interest rates. It will be 0.5 percentage point now in August, 0.25 in September, 0.25 in October and, when it arrives in December, it stops, which gives [Selic de] 14.25% [ao ano].

And from when can there be room for interest reduction?

My guess is that the BC will start to reduce interest rates in the second quarter of next year, before what economists are saying. Inflation will fall very abruptly. Inflation rose a lot because, in economists, the supply was vertical. It’s the story of missing a car chip. No one could consume services because of the pandemic, people went out consuming goods with such voluptuousness that the offer could no longer expand and became vertical. When the supply goes vertical, the price goes up a lot. The BC model made a big mistake. Now it will have the reverse of the medal. The price that has gone up too sharply will also fall too sharply.

In the opinion of many economists, the BC was wrong when it kept the Selic at the lowest historical level, at 2%, and took a while to raise the rate again. Do you think it was a mistake?

It was, I have no doubt. The BC has to put inflation in the target, if it was wrong, it doesn’t have this “look at it” thing. I place my blame. The net effect was much more inflation than we expected. We were wrong. Another error hints at what is happening in the United States. We used to say that emergency aid was holding up the economy, pushing inflation and that, when they ran out, there would be a ‘fiscal cliff’ [abismo fiscal]. What happened in practice? None of that. The rich went out consuming all the savings they generated and kept the job market warm, with wages for the poorest and the economy boomed. There are people saying that the American economy is already in recession because the poor have nothing more to consume. Our point is that no, the rich are full of money. The recession of the American economy is not for now, it will take longer to happen.

Some economists say that, along with the transparency, came some communication noises. How do you face this criticism?

I, personally, don’t buy this one so much that the market gets confused. I think you understand correctly. Other [problema] it is public humiliation. When you transparently say that you’re going to one side and it doesn’t happen, there’s crazy criticism. And you get caught a lot more, but let’s go ahead. I’m more inclined to have more transparency.

How can a recession in the US have an effect on the Brazilian economy?

Recession in the US has perverse effects, the economy suffers worldwide. The effect for Brazil is both weaker activity and a more devalued currency. This time, I think it will have a positive side. When the US slows down, there will be less inflation in Brazil. For the BC, more important than the dollar, which is a momentary thing, is world inflation, which will fall. In my mind, the recession in Brazil happens before the recession in the United States. Brazil is advanced, we started to raise interest rates much earlier, they are already very tight here. The United States is late, there [a recessão] it should happen later, if here it is at the end of the year, there it is more for the middle of next year.

On the one hand, a deceleration of the economy is expected with the lagged effects of monetary policy. On the other hand, the government has approved measures that stimulate economic activity. How much does this make the BC’s work difficult?

If it didn’t have this new stimulus, maybe the BC wouldn’t need to give 0.5 percentage point now, it might need less interest. Maybe you could see the economy slowing down in the third quarter and [o BC] I could stop too soon.

The BC is on track to break the inflation target for the second year in a row and begins to see 2023 at risk. What is your analysis of this scenario?

This year the goal is exceeded, there’s no way around it. Next year, for me, there’s still a game. For me, inflation drops very abruptly, so it’s not a given that it will burst next year.

The current context also brings back the discussion about the increase in fiscal risk. How do you see it?

Everything indicates that the fiscal risk will continue, there is a tremendous fiscal challenge for the coming year. A new format for the spending ceiling, [que] it’s going to be turned into something distinct, regardless of who wins the election. Everyone is looking forward to seeing how it goes. And the accounts on debt sustainability will be done again. It was not resolved, we will continue with this problem, with this sword over our heads, one more thing that makes the BC need more interest. With worse fiscal, neutral interest gets higher. Neutral interest was around 6% in real terms at the time of Dilma [Rousseff] and dropped to 3%. Now it has gone up again and is already at 4%.

How does the possibility of measures considered as temporary, such as the Auxílio Brasil of R$ 600, becoming permanent feed the fear of fiscal risk?

It looks like it will be permanent, regardless of the government, and it will have to be resolved for the first year as to how this R$ 600 aid will fit in the Budget. Gotta find some way to get it off the ceiling or ask for a ‘waiver’ [perdão ou licença]I don’t know what the format will be, but it doesn’t fit the original ceiling.

What is your analysis of the election and its possible risks?

In past elections, it was very clear who was the darling of the market and who was the enemy of the market, that economic policy would be very different in terms of fiscal responsibility. This time, he doesn’t have a sweetheart and an enemy. Economic policies are different, Lula is much more interventionist than Bolsonaro. But in terms of fiscal responsibility, it’s not as clear how it’s going to be. In the Lula scenario, there will be more taxes and more spending; in the Bolsonaro scenario, less tax and probably less spending. But the net is not obvious which will be better or worse. It’s not been such a crucial election for the financial market. Compared to the previous ones, it’s quieter.

Quieter perhaps because they are already two well-known names in the market?

Not because they are known, because neither of them seems inclined to make a very irresponsible fiscal policy.

Lula defended that the BC also have employment and growth goals. Do you think it’s viable?

The best way for the BC to guarantee more jobs and more growth is through the fight against inflation. It’s not that there’s an antagonism about it, it’s already in the law and it’s already being done and it doesn’t affect the way monetary policy is conducted.

In 2021, what has changed, in practice, with the BC autonomy?

The big gain is now, when perhaps the government will change from Bolsonaro to Lula, and Roberto [Campos Neto] continue as president of BC. This is a gain, for me, relevant. There could be something like ‘if Lula wins, who will he put in BC?’. In the end, I think he would put someone competent, as he did last time. But this time, there’s no noise, it’s two more years of Roberto.

X-RAY

Fabio Kanczuk, 53

Electronic engineer from the ITA (Instituto Tecnológico da Aeronáutica), with a master’s and doctorate in economics from the University of California and a postdoctoral degree at Harvard. Today, he is responsible for the macroeconomics area at ASA Investments. From 2019 to 2021, he was director of Economic Policy at the Central Bank. Previously, he served as Executive Director for Brazil and eight other countries at the World Bank, having been Secretary of Economic Policy between 2016 and 2018.