(Bloomberg) -- As investors grow worried about Brazil’s fiscal outlook, selling off the real and betting on even bigger interest rate hikes, the central bank has started to signal that budget concerns are exaggerated.
The finance ministry and the monetary authority share the view that a much—anticipated plan to cut public spending will shore up investors’ confidence in Brazil’s fiscal rules and alleviate pressure for a more aggressive tightening campaign, according to a member of President Luiz Inacio Lula da Silva’s economic team.
And while fiscal woes exist, they’re not big enough to justify an interest rate increase of 75 basis points that traders threatened to price in last week, the person said, requesting anonymity to discuss the thinking of the economic team.
Brazil’s central bank kicked off a monetary tightening campaign in September to fight inflation that’s speeding up above the 3% target — largely because government spending is making consumer demand more resilient. The bank is widely expected to step up the pace next week, delivering a half-point increase that would take the benchmark Selic to 11.25%, after an initial quarter-point hike.
Yet central bank board members have adopted a more nuanced rhetoric about fiscal concerns. After months of warnings about the importance of delivering on fiscal pledges, policymakers are now saying that the risk premium priced into Brazilian assets is exaggerated and likely to be reversed by a positive fiscal shock. Governor Roberto Campos Neto went as far as telling investors to wait for good news on spending cuts following October’s municipal elections.
“The central bank is making an effort to give a vote of confidence to the finance ministry,” said Guilherme Abbud, the CEO of Persevera Asset Management in Sao Paulo.
Lula has increased spending since taking office in 2023 to fulfill campaign pledges of improving living standards for poor Brazilians. Public coffers have come under additional pressure this year as the administration responds to disasters including historic floods in May, followed by widespread forest fires and record drought.
The message that Finance Minister Fernando Haddad is now conveying to Lula is that the government needs to rein in mandatory spending in coming months, said a person familiar with the minister’s thinking. The growth of some of those expenditures beyond the limit allowed by fiscal rules - 2.5% above inflation - will only create more pressure on the budget and spur public debt as time goes by.
Regardless, Brazil’s central bank will keep its guard up. Economic Policy Director Diogo Guillen said in Washington, during the meeting of the International Monetary Fund last week, that board members won’t be passive, and the role of monetary policy is to bring inflation back to target.
Guillen also presented a study on the impacts of government transfers equivalent to 1% of gross domestic product. His conclusion was that, even if fiscal policy doesn’t boost economic growth, it can still be inflationary.
Planning Minister Simone Tebet said this month the government will unveil “as many measures as possible” to cut spending this year. One proposal alone could save some 20 billion reais ($3.5 billion), she said, without providing details.
Spending that’s mandated by the constitution accounts for 90% of total government outlays. Brazil will end 2024 with a 68.8 billion-real primary fiscal deficit, which excludes interest payments, according to a budget report released in September.
For 2025, the government plans to eliminate that gap with the help of 166.4 billion reais in extraordinary revenue. The administration had previously backed off its pledge for a surplus next year, sparking a wave of investor angst.
--With assistance from Barbara Nascimento.
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