Inflation leniency produced positive fiscal result in 2021, says economist

Public sector accounts should register the first positive result since 2013, according to data from the Central Bank for 2021 that will be released later this month. This supposed improvement celebrated by some analysts, however, is an illusion caused by the soaring inflation last year, says the executive director of the IFI (Independent Fiscal Institution), Felipe Salto.

For 2022, the expectation of the institution linked to the Federal Senate is that the rise in interest rates will begin to erode this gain, putting the public debt back on a growth path and leaving the task of restoring the credibility of fiscal policy to the next government.

In an interview with leaf, Salto says that society and politicians have already shown that they do not want to make a fiscal adjustment solely on the expenditure side. Therefore, it will be difficult to escape an increase in the tax burden to ensure debt stability and resources for more investment and social spending.

The IFI and most analysts estimate that public sector accounts must have closed 2021 in the black, something that was not foreseen at the beginning of last year. You recently said that this supposed improvement is an illusion. What explains this positive result? What happened was the friendly help of inflation, which appeared again, albeit to a lesser extent than in the 1980s. At the time, there was no budget deficit. Revenue evolved with inflation, and expenses were fixed from the previous year. It had a budget that did not reflect the reality of public accounts. There is a 1993 paper by Edmar Bacha warning that, when stabilization was carried out, a huge deficit would appear. What happened last year, proportionately, was the same thing.

Inflation boosted revenue. You have artificially produced a primary outcome that will not last. So much so that in 2022 it gets worse again. Debt will be at least two percentage points of GDP [Produto Interno Bruto] highest until the end of the year, it will have a primary deficit around 1.5% of GDP.

It’s not the end of the world, but it’s a very delicate situation. It is not possible to simply say that there has been an improvement in the fiscal situation. There was no structural improvement. What happened was a leniency with inflation that produced positive fiscal effects that are known in the literature. The fact is that inflation helped.

The debt/GDP ratio dropped from 89% in February to 81% in November 2021. Was this also a result of higher inflation? The main factor was high inflation. First, because it helped to raise revenue in nominal terms. The primary result (revenue minus expenditure) improved a lot. States and municipalities were also benefited by this issue and should end the year with a surplus. [a projeção da IFI para o governo central ainda é de déficit].

Rising inflation affected nominal GDP more than expected. This also helped to reduce the debt/GDP ratio.

Nobody projects debt at 83% of GDP [expectativa da IFI para dezembro], until, in July, when it began to be noticed that inflation would remain high until the end of the year and that this had already had a significant effect on nominal GDP, everyone adjusted their projections.

Of course, there were also two other important factors, which were the pension reform and the freezing of civil servants’ salaries, because the military had readjustments. But what was predominant in the fiscal improvement was inflation.​

Even if temporary, could this help from inflation be seen as welcome? It is good that the debt remains at 83% and not above 95%, as many projected, including us. It’s positive, but the interest rate is much higher. The Selic is at 9.25% per year, and the expected inflation for 2022 is 5.05% [na pesquisa Focus]. We are talking about a real interest rate of 4% to 4.2%.

This means that to stabilize a debt of 83% of GDP, if the country grows 1% in 2022, we need a primary surplus of 2.5% of GDP. The projected deficit for 2022 is around 1.5%.

The size of the fiscal challenge remains enormous. Interest will erode all that gain and will require a very high surplus to stabilize the debt. That’s why, in our projections, the debt will still grow in the coming years.

Is it possible to live with this high indebtedness? It is not an unsustainable trajectory. We project that the primary result will improve in the medium term, but the level of indebtedness in Brazil is about 30 percentage points of GDP higher than the average in developing countries. It is still a very delicate fiscal situation.

It is even worrying that you see some analysts out there praising this improvement in 2021, when it was almost entirely explained by inflation and there is still this huge fiscal challenge for the coming years. With inflation stabilizing in 2022 and 2023, interest rates decline again. So the IFI base case is not explosive for debt/GDP.

We have the pessimistic scenario. For example, if in 2023 whoever assumes the presidency fails to restore the least bit of credibility.

Whoever takes over will have to start from scratch. The spending ceiling was simply abolished. It is still valid in the letter of the Constitution, but in practice it no longer exists. Whoever wins in 2022 will have to give a new direction to fiscal policy and that has as a guideline the sustainability of the debt in the horizon of four or five years.

This challenge is not impossible, but it is also not a simple thing, as some are saying out there. If the real interest rate stays at 4% and economic growth returns to 2% in 2023 and 2024, you will still need a primary fiscal effort of up to 2% of GDP to stabilize this debt. If we are going to get out of a deficit of 1.5%, we have from 3.5 points to 4 points of GDP from fiscal effort, which gives almost R$ 400 billion of adjustment.

Representatives of pre-candidates for the presidency have mostly pointed out the need to review or even end the ceiling once and for all. What could the new fiscal anchor be? The great fear that economic agents had was that the 2022 election would lead to the choice of a political group that would abandon the spending ceiling. This has already materialized now, because the Bolsonaro government itself decided to abandon the ceiling. It is such an expressive change, in our account of R$ 112.6 billion of open space for 2022, which in practice means the invalidation of the ceiling as conceived in 2016.

The literature on this matter says that it is not enough to have norms, there must be political commitment around the rules.

The spending cap was positive while it lasted. It helped bring down the debt, improve allocative choices, approve Social Security, but it had problems since its inception. It was poorly designed. The only outlet is extraordinary credit. And he also advocated a very hard adjustment from a certain point on and none in the initial years. Therefore, it became impossible to comply with in the absence of structural changes on the expenditure side.

For 2023, there is a menu of rules that can be adopted, but the fundamental thing is that there needs to be political commitment around fiscal adjustment. If not, there’s no rule to fix it.

Is there room for fiscal adjustment and, at the same time, meeting the greater need for social spending and investments? The most important discussion for 2023 will be how to rescue fiscal responsibility, but also guarantee the necessary space for the expenses that will increase. For example, health spending and social spending are likely to increase over the next decade. OECD countries, by 2050, will increase health spending by eight percentage points of GDP, due to aging. In Brazil, there is still no study in this regard. This will have to enter into the discussion of the new fiscal rule in 2023. You will also have to take care of increasing public investment, which will play an important role in rescuing private investment.

It’s gonna be hard. I think we will not escape an adjustment also due to the increase in the tax burden. On the expense side alone, we have already seen that Congress, society and the government itself are not willing to do so. So much so that now that the ceiling was going to perform its function, the tables were turned, to spend R$ 112.6 billion more in 2022. And it’s not for social spending, which will cost from R$ 50 billion to R$ 55 billion. It is to make the expenses approved at the end of the year, amendments by the rapporteur and all that.

It is necessary to put political forces on the table and decide what form of fiscal responsibility will be, whether it will be more on the revenue or expenditure side and what kind of expenditures we are willing to cut. A comprehensive review of budget expenditures is needed. There are expenses, including tax, that have been carried for decades without an adequate review based on an impartial technical assessment. Tax waivers leave 4% of GDP on the table, something like R$300 billion.

Mauro Benevides is right in the interview he gave [para a Folha]. It’s the investment that’s paying off [com o teto de gastos]. And why are you paying? Because nobody wants to face mandatory spending.

X-RAY

Felipe Scudeler Salto, 34, executive director of the IFI (Independent Fiscal Institution) since 2016 and responsible for its implementation. Economist from FGV/EESP and Master in Public Administration and Government from FGV/EAESP. He was an economic consultant at Tendências Consultoria. He worked as a consultant for Senator José Serra (PSDB-SP). He is a professor of Public Finance in the professional master’s degree in Economics at the IDP (Instituto Brasiliense de Direito Público). Winner of the Jabuti Economics Prize in 2017 with the book “Public finance: from creative accounting to the rescue of credibility” (Record, 2016). He also organized the book “Public Accounts in Brazil”, with Josué Pellegrini (Saraiva, 2020).