Opinion – Arminio Fraga: One cannot ignore the side effects of the Transition PEC

The Lula government has not yet taken office, but it has already been giving important signs about the path it will take in the economic area. In his two terms, President Lula maintained the policy of fiscal responsibility that he inherited from his predecessor. They were years of primary surpluses, except for the correct expansion policy in response to the great global crisis of 2008.

The president-elect also maintained or expanded an agenda of reforms aimed at reducing inequalities and increasing productivity. It was a good period for the economy, which grew a little more than the rest of Latin America (but much less than the average for emerging countries).

During the campaign, candidate Lula avoided going into details regarding his vision of the country’s fiscal future, mentioning only his record as a guarantee of good behavior. Two months after the elections, everything indicates that the primary surplus of 0.6% of GDP in 2022 will turn into a deficit close to 2.0% in 2023. Some fiscal deterioration was already expected, due to non-recurring factors such as the freezing of wages and the increase in commodity prices. However, it seems imprudent to me to ignore the side effects of this fiscal expansion, reinforced by explicit signs of lack of appreciation for the fiscal responsibility that did so much good for the country while it lasted. Let’s look at some.

Firstly, due to the rise in inflation from 2021 onwards, the BC (Central Bank) has been raising interest rates, in line with its primary mission. The effort has been paying off, but inflation expectations embedded in interest rates on government bonds still point to an inflation of 6.5% a year as far as the eye can see, which means that the work of the Central Bank is far from being completed. .

The economy has overcome the crisis associated with the pandemic and shows reasonable dynamism in the job market. In this context, a substantial fiscal expansion such as the one being planned would push inflation upwards and, therefore, would represent a frontal contradiction with the BC’s work, which would be forced to increase interest rates even more. In other words, a serious mistake, similar to the one committed in the Dilma government and which resulted in the deep recession of 2015-16.

Secondly (and, as a consequence of what everything indicates, there will be a clash between fiscal and monetary policies), the public debt would resume an even more accelerated growth path. Such growth would be a source of high uncertainty regarding the future of the economy, giving rise to scenarios of high inflation, depreciation of the real, high interest rates, increased tax burden, recession and unemployment.

The future Minister of Finance, Fernando Haddad, has been signaling his intention to reintroduce a fiscal anchor, which would be entirely desirable. What it is? Basically, a commitment to a fiscal policy that maintains public spending and debt at reasonable levels. A possibility raised recently in this Sheet by Marcos Mendes and me would be to recover elements of the Fiscal Responsibility Law and the spending cap. The main focus would be on controlling public spending, since the tax burden in Brazil is already quite high for a middle-income country, except in terms of eliminating regressive loopholes in the Income Tax rules.

Such an adjustment would have to occur in the most relevant items, such as payroll and Social Security. In all of them, the adjustment could and should contribute directly to a reduction in income inequality, something that certainly should be part of the plans of a center-left government in a country as unequal as ours.

There is no chance of success without facing this challenge, but the resistance will be as fierce as ever. At these times, it is up to our leaders to remember that with the major adjustment there would be a significant drop in risk premiums in the economy, an essential element for building a virtuous circle of growth and stability.

But, more important than a new anchor, which at first would lack credibility, would be to announce (and meet) targets for the primary balance and public spending for at least three years. As a suggestion, at the very least, I would suggest an immediate reduction in the primary deficit projected for next year to a maximum of 1% of GDP, followed by primary surpluses of 0.5% in 2024 and 2% in 2025. No doubt about it, I’m talking about additional expenses that are much lower than those approved in the Transition PEC or from decisions of the STF.

It would be a first step in the direction of genuinely more socially oriented public spending, without the almost certainty of the return of inflation and recession that have always brought so much suffering to the population.

Looking further ahead, the ideal would be to reach 2026 with a primary balance that causes the debt/GDP ratio to drop. This result also depends on interest rate levels (r) and the economy’s growth rate (g). The smaller the famous “r minus g” difference, the better. This difference depends on a myriad of qualitative and institutional factors that contribute to increasing productivity and reducing uncertainty in the economy.

There’s a lot of room to advance, but you can’t be too careful here. Proposals to revise the legal frameworks for sanitation and state companies for the worse signal a return to an old Brazil, unequal and incapable of growing in a sustained and inclusive manner.

Finally, there remains the argument that social responsibility is in a hurry. Gotta have it. But, as I have tried to demonstrate here, the fiscal expansion now under consideration would backfire. And it doesn’t hurt to remember that the political consequences of an economic failure would be disastrous.