Brazil on a suicidal path
Pedro Jobim and Leonardo De Paoli
The Brazilian economy is currently experiencing a favorable moment. Propelled by a substantial fiscal stimulus initiated in 2022 and amplified by approximately R$ 180 billion through the "Transition bill" in 2023—alongside the significant payment of judicial debts, the reindexation of the minimum wage to nominal GDP, and the expansion of social security benefits, among other factors—the GDP growth rate is projected to reach approximately 3.5% in 2024. This follows similar growth rates in the preceding two years. The labor market remains robust, with unemployment rates at their lowest in a decade. Additionally, the continued expansion of bank credit concessions to households has bolstered consumption growth.
However, even amidst this rapid economic expansion—an inherently cyclical phenomenon that will soon exhaust itself—the public debt-to-GDP ratio continues to increase at an annual rate of 4 to 5 percentage points. The fiscal "framework" introduced by the government relies on the continuous increase of the tax burden and fails to chart a trajectory toward public debt convergence. The content of the recently announced "expenditure control package" confirms that the government has no intention of curbing the rapid growth of public spending, which currently constitutes the primary source of macroeconomic instability.
Confronted with budgetary constraints imposed by its own fiscal framework—designed with presumed flexibility to allow unimpeded spending over the four-year term—the government has sought to maintain fiscal momentum through extrabudgetary measures. These include leveraging public funds to obscure primary expenditures, reactivating the pace of BNDEs concessions, and increasing expenditures by state-owned enterprises, among other strategies.
Inflation, as measured by the moving average of its core indices, currently hovers around 6%, significantly exceeding the upper limit of the target range. The government's evident lack of commitment to curbing the growth of expenditures, coupled with uncertainty surrounding the fiscal neutrality and scope of the recently announced reform on financial income instruments, has triggered a new wave of asset price declines in Brazilian markets. This erosion of confidence has led to heightened inflation expectations, prompting the Central Bank to signal an upward adjustment of interest rates in its latest policy decision.
However, the Central Bank alone cannot restore economic stability or revive confidence in the government's economic policies, which are undermined by unsustainable spending levels. While necessary to prevent further economic disarray, the new, higher interest rate level will inevitably slow economic activity and accelerate the divergence of public debt dynamics.
As always, the most vulnerable segments of the population—those with lower incomes—will bear the brunt of high inflation. Ironically, these are the very individuals whom the government ostensibly seeks to support with its policies.
Equally concerning is the substantial depletion of foreign reserves in recent weeks, nearing $17 billion. If the current trajectory of deteriorating expectations persists, discussions of the "pace" of interest rate hikes will soon become irrelevant, and much of the Central Bank's communication strategy will prove ineffectual. In times of acute crisis, the critical signals from the Central Bank are reduced to nominal interest rate levels and its willingness to deplete reserves—an inclination that recent actions suggest is far from minimal.
It is essential to emphasize that the acceleration of government spending, the reindexation of the minimum wage to nominal GDP, the income tax exemption for earnings up to R$ 5,000, the proliferation of ministries, and the resurgence of BNDES concessions and investments by Petrobras and other state-owned enterprises were all campaign promises of the current administration. These initiatives were endorsed by several prominent economists. In a 2022 article, we highlighted the potential economic disaster of another PT-led government, referencing policies implemented between 2006 and 2015 and their devastating consequences, including the worst recession in Brazilian history and the destruction of five million jobs.
After two years of theatrics and good fortune, the government's intentions have become transparent, leaving fools and cynics alike exposed. The former cannot claim ignorance; the latter must choose between silence or continuing their cynicism by "warning" society and the government about the consequences of the reckless economic course.
Our challenges extend beyond the unchecked growth of public spending, the prospect of sustained and rising inflation, and the premature depletion of reserves. Institutional deterioration—worsening year after year—exacerbates the crisis.
The government appears committed to steering Brazil toward inflation and fiscal unsustainability, rendering the economy vulnerable to a global economic cycle downturn. Adding to this volatile environment are polarization, legal uncertainty, the suppression of constitutional guarantees and individual freedoms, an overreaching judiciary, resentment, and fear. These elements, already pervasive in today's Brazil, significantly heighten the risk of a severe crisis.