Bolsonaro Plan to Breach Spending Cap Costs Brazil in Bond Market

(Bloomberg) -- President Jair Bolsonaro’s efforts to bust through Brazil’s spending cap is already raising government borrowing costs and could result in as much as 74 billion reais ($13.3 billion) in extra payments on local bonds next year.

Higher baseline rates as the central bank jacks up the Selic in a bid to control inflation and increased risk premiums amid doubts about fiscal stability mean costs on existing debt could jump by 64 billion reais, according to projections by Adriana Dupita, an analyst for Bloomberg Economics who covers Brazil from Sao Paulo. New bonds issued to pay for extra outlays could add an additional 10 billion reais in debt expenses, she estimates.  

Congress is moving to approve changes in the spending cap the country has had since 2016 to make room for Bolsonaro’s new social program, which increases cash transfers to the poor. The plan, which comes before the broadly unpopular president seeks re-election next year, is worrying investors convinced the rule had helped keep spending at a sustainable level. The proposed change will raise interest rates on new debt by 0.9 percentage point in 2022 as investors demand a higher return for lending to the government, Dupita estimates. 

What Bloomberg Economics Says:

“A back-of-the-envelope estimate suggests the higher cost of new issuance represents around 10 billion reais per year. That’s not much -- but there’s more to consider. With nearly 35% of existing domestic bonds indexed to the Selic, each rate hike not only increases the cost of newly issued debt, it also raises the cost of a large share of outstanding debt. 

The 200-basis-point shift up in the Selic consensus following the proposed fiscal change could mean an additional 64 billion reais in interest payments on outstanding debt in 2022 alone. Though manageable, the additional burden represents another source of concern to an already worrisome fiscal outlook.”

-- Adriana Dupita, Brazil and Argentina economist. 

-- Click here for the full report.

Government officials have already seen an increase in the premium investors demand on Brazil’s bonds, with the average cost of securities issued in the past 12 months jumping 50 basis points, or half a percentage point, in September from the previous month. This was a direct result of investor’s worries around Brazil’s public finances, Public Debt Operations Coordinator Luis Felipe Vital told journalists in Brasilia last week.

The surge in interest rates can already be seen in Brazil’s fixed-rate bond market. Yields on government notes due in January 2024 jumped to 12.3% as of Friday from about 9.4% in early September. 

Latin America’s largest economy has been under investor scrutiny since the start of the pandemic as the government cranked up fiscal stimulus to support the economy. Last year the government’s primary spending reached a record 26.1% of gross domestic product. While that ratio was forecast to fall to 17.5% next year, busting through the fiscal limit could limit the decrease to 18.4%, according to the Economy Ministry.

Debt was already getting more expensive even without the new fiscal stimulus. Brazil’s central bank has been among the most aggressive in the world in seeking to damp down inflation, hiking rates by 5.25 percentage points since March to 7.75%. Rates are forecast to end the year at 9.25%.

Analysts at JPMorgan Chase & Co. see Brazil’s debt reaching 81.3% of GDP this year and 87.6% in 2022. Citigroup Inc. recently warned it could increase estimates for Brazil’s debtload should the new social program boost spending.

“The recent budgetary developments have significantly eroded the credibility and effectiveness of the main fiscal anchor, the constitutional spending ceiling,” Alberto Ramos, the chief Latin America economist at Goldman Sachs Group Inc., wrote in a note.

©2021 Bloomberg L.P.