Market warns of explosive debt trajectory if president-elect overspends

The uncertainty about the size of the extra spending bill for 2023 has fueled financial market speculation and raised fears that the changes to be promoted by the elected government will put public debt on an explosive trajectory.

Both Jair Bolsonaro (PL) and Luiz Inácio Lula da Silva (PT), who are running for the second round for the Planalto, have already signaled that they intend to ask for a license for more spending next year, as well as to relax the cap rule (which limits the advance of expenses to the variation of inflation). However, neither side has detailed the numbers.

The current government’s accounts include the maintenance of the minimum benefit of BRL 600 from Auxílio Brasil (at a cost of BRL 52.5 billion), an additional BRL 200 for beneficiaries who find a job and a 13th for families headed by women (about R$ 10 billion).

Bolsonaro has also promised to undo the planned cut in spending on social programs such as Popular Pharmacy (which had a reduction of R$ 1.4 billion), in addition to having demonstrated his intention to resume public investments.

The PT members’ calculation, in turn, includes, in addition to the R$ 600 from Auxílio Brasil, an additional R$ 150 per child up to 6 years old (R$ 16.2 billion), a greater readjustment for civil servants, salary appreciation minimum and increase in investments.

With the election going to the second round, however, the row of promises only increases, in a way that is incompatible with the expectation of moderation among market economists. While there is recognition that it will be necessary to increase social spending in the midst of hunger, fears are that the dose will be exaggerated.

Measures that generate revenue waivers, such as the correction of the IRPF (Individual Income Tax) table, also worsen public debt, although they do not depend on a special authorization for more spending.

Vladimir Kuhl Teles, former secretary of Guedes and current chief economist at investment manager O3 Capital (which has businessman Abílio Diniz as a partner), calculates that gross debt would grow at an accelerated rate if incorporated into public accounts from 2023 onwards. an additional expansion of BRL 100 billion in the level of expenditure (in addition to what is already foreseen in the 2023 Budget proposal), plus an additional expansion in the ceiling of 1% above inflation from 2024.

In that case, says Teles, the ratio between gross debt and GDP (Gross Domestic Product) would rise from the current 77.5% to 91.31% in 2026 and would continue on an “explosive trajectory” from then on – and could exceed 100% of GDP ( Gross Domestic Product) in 2029.

In the case of a permanent expansion of BRL 100 billion in expenses in 2023, but a growth limited by inflation after that, indebtedness rises in the coming years and then stabilizes.

“It is essential, then, that the country be cautious and find a rule that allows intertemporal fiscal balance without having to count on the luck of a growth above expectations, for example, because the cost of an uncontrolled debt would be felt throughout the economy, as we have witnessed in the past”, says Teles.

The projections consider a GDP (Gross Domestic Product) growth of 1.3% per year, equivalent to the average observed in the three years before the pandemic. This data is relevant because a stronger economy helps to control the debt/GDP ratio, while weaker activity influences the opposite direction.

Tiago Sbardelotto, economist at XP, considers that the ceiling will be adjusted in 2023 and will continue in the following years being adjusted for inflation. “This is the only scenario in which public debt can be stabilized at the end of the period”, he says in a report.

According to him, if the increase in expenses is in line with inflation, it is possible to stabilize the debt from 2028 onwards. Otherwise, the debt tends to rise until 2030.

“A sustainable fiscal framework combined with structural reforms that increase the potential growth of the economy will be differentiating factors in achieving lower indebtedness,” he says.

Gabriel Leal de Barros, chief economist at Ryo Asset and former director of the IFI (Independent Fiscal Institution), linked to the Senate, estimates that the government’s gross debt could rise by around 5 percentage points in the wake of increased spending and also the higher interest cost on public debt – which becomes more expensive in view of the greater perception of risk in the market.

According to the economist, the market’s “acceptance” of increased spending, so that there is no panic or greater instabilities, will depend not only on the size of the bill, but on its composition – that is, what is on the spending side and the which is on the revenue side.

“On the expenditure side, accounts of around R$70 billion to R$120 billion seemed acceptable. The problem is that these R$100 billion do not solve the whole problem, they only solve the greater demand on the expenditure side. The fiscal worsening is due to the renewal of tax waivers. And when you put the two points, it’s something over R$ 200 billion, not counting the change in the tax rule itself”, he warns.

The National Treasury designs a proposal to make the spending ceiling more flexible, as anticipated by the Sheet. The reformulation authorizes real expenditure growth according to the level and trajectory of public debt, at a rate to be defined every two years. The rule also grants a bonus to increase spending in the event of an improvement in the surplus in public accounts.

The proposal has been presented to agents outside the government with milder projections for the trajectory of the public debt, even under the fiscal regime proposed by the agency. In the model, there would be an initial boost in expenses in the first year of validity, equivalent to a 2% ceiling growth above inflation.

In the different Treasury simulations, gross debt falls in the long term or, in a scenario of less vigorous activity, rises – but at a slower pace than feared by the market.

Debt would grow to a maximum of 94.3% of GDP in 2034 considering a conservative scenario for GDP growth (2% variation from 2025). In the most optimistic projection, with a more intense growth of activity (from 2.5% between 2023 and 2026, for example), the debt would rise until 2026 and fall from that year until it drops to 70.8% in 2034.

The accounts on the public debt are made at a decisive moment in the electoral campaign, while the market pressures Lula’s team to move towards the center and make more forceful nods that it will maintain the stability of public accounts. The PT campaign has also been asked to give a signal about its possible future Minister of Finance to maintain the adhesion of businessmen and investors.

The PT calculates that at least R$200 billion in extra expenses may be needed next year – although the party is studying to reduce the bill by adding expenses to the Budget gradually, not immediately. Some would even stay for 2024.

After Bolsonaro’s best performance at the polls in the 1st round, the market was optimistic – as shown by the rise of the stock market and the fall in the dollar the next day. However, there are doubts about the ability of the current government to shield itself against pressure from the center for strong increases in spending.