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Spending-Cap Bill Reaches Congress

July 1, 2016

The government has submitted its public spending-cap bill to Congress and concluded renegotiations of state debts.

The Brazilian economy in June 2016

The government has submitted its public spending-cap bill to Congress and concluded renegotiations of state debts. So far, the administration has managed to advance its legislative agenda, though still not the more controversial measures. The government has now seen its third minister step down. The Copom (Monetary Policy Committee) signaled it will be aiming for the center of the inflation target in 2017 and the CMN (National Monetary Council) kept the target for 2018 at 4.5%. The exchange rate appreciated, and the central bank resumed intervention at the end of the month. The economy remained in recession and unemployment rose again, but confidence indicators have improved. Inflation once again showed signs of slowing. Fiscal accounts continued to deteriorate, while the balance of payments kept getting stronger.

Government submits public spending-cap proposal and renegotiates state debts…

The government has submitted a constitutional amendment bill to Congress setting a cap on public spending growth, limiting it to the previous year’s inflation level. This is a positive step in efforts to reach fiscal equilibrium because, if approved, spending as a percentage of GDP will fall over time. In another major initiative, the administration renegotiated state debts with the federal government. So far, the interim administration has been able to push its agenda through Congress, although still not the more controversial measures.

... but sees another minister stepping down.

Henrique Alves, the Minister of Tourism, resigned after being mentioned by Sergio Machado, the former president of Transpetro, in his plea bargain testimony. Romero Jucá, Planning Minister, and Fabiano Silveira, Transparency, Enforcement and Control Minister, resigned in May when recordings of telephone conversations linked to Operation Carwash investigations were published.

The central bank will aim for the center of the inflation target in 2017.

At Alexandre Tombini’s last meeting as president, the central bank voted unanimously to hold the Selic benchmark rate stable at 14.25%. Subsequently, in the first Inflation Report published by the central bank under Ilan Goldfajn as president, the Copom highlighted its goal of inflation convergence towards the center of the target in 2017, commenting that under current conditions, there is no room for a cut in interest rates. The report’s forecasts suggest inflation convergence in the benchmark scenario (assuming a constant rate of interest), but it stabilizes above the inflation target level in the market scenario (assuming a cut in interest rates). In an interview, the Central Bank’s president said he believes that, at some point, conditions could exist under which its market scenario projection could fall to the target, but that would depend on several factors, including progress in the fiscal consolidation process.

CMN establishes the 2018 inflation target at 4.5% and keeps the TJLP at 7.5%

The National Monetary Council (CMN) established the inflation target of 2018 at 4.5%, the same as of 2016 and 2017, and maintained the target interval at 1.5 p.p. (same of 2017). The CMN also maintained the Long-Term Interest Rate (TJLP), which is used as a base for most BNDES loans, at 7.5%.

The BRL appreciates and the central bank resumes intervention

The exchange rate appreciated 10.7% in June, moving to 3.21 reais per dollar. On June 30, the central bank announced an auction of reverse USD swaps for the first time this month.

Inflation once again shows sign of slowing

The June IPCA-15 rose 0.40%, below even the lowest market expectations.  Twelve-month inflation has now fallen to 8.98%, compared with 9.62% the previous month.  This surprise came after smaller increases in industrial and private sector service prices. This outcome reinforces the view that inflation increases in previous months were transitory.

The economy remains in recession and unemployment is rising…

The central bank’s monthly economic activity indicator (IBC-Br) remained practically stable in April, compared with the previous month, suggesting economic activity contracted in the second quarter. In May, 72.6 thousand formal jobs were lost (109,000, allowing for seasonal adjustment). The national unemployment rate rose to 11.2% in the quarter to May (10.8%, allowing for seasonal adjustment), the 18th consecutive increase.

... but confidence rebounded in June.

However, there are signs confidence is rekindling. The industrial confidence index (FGV) rose 5.3% in June. Although confidence remains low, this is the highest monthly increase in confidence since May 2009. Business confidence is likely to continue increasing as inventories shrink and demand stabilizes. The service and trade sector confidence indices also rose in June. Consumer confidence also improved significantly (5.0%), driven by the expectation component.

The fiscal deficit’s adverse trend continues

On a consolidated basis, the government recorded a primary deficit of BRL 18.1 billion in May, which was slightly worse than expected.  The surprise was due to worse results for states and municipalities. Over a 12-month basis, the primary deficit fell to 2.5% of GDP, and the nominal deficit remained at 10.1% of GDP.  Public debt rose from 67.6% to 68.6% of GDP.

Current account stays in positive territory in May

The May balance of payments showed a current account surplus of USD 1.2 billion, the second consecutive positive monthly result. This still represents a rolling 12-month deficit, albeit a shrinking one (falling to USD 29.5 billion, or 1.7% of GDP).  On the financing side, direct investment in Brazil has been resilient (USD 79.4 billion in 12 months), but portfolio flows, which are typically more volatile, retreated again. 

Despite international volatility, local assets gained value 

The outcome of the UK referendum caused volatility across international markets, and the long-term effects of the UK’s departure from the European Union are uncertain. However, in Brazil, domestic factors predominated and helped drive up asset prices. The BRL appreciated 10.7%, ending the month at BRL 3.21 per dollar. The Ibovespa gained 6.3% in BRL and 19.1% in USD, while country risk, measured by the five-year sovereign CDS, fell 46 bps and ended the month at 317 bps.

Upcoming events

Attention will now focus on how the government’s fiscal reform agenda advances through Congress, especially the proposed cap on spending growth. The impeachment process continues to move through the Senate, and a final vote is expected in August.


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