Brazil Markets Halt Drop as Economy Chief Stays, Defends Aid
(Bloomberg) -- Brazilian markets rebounded from deep losses as Paulo Guedes vowed to stay on as economic chief and defended the government’s push to increase social aid to the poorest.
Speaking with Jair Bolsonaro at his side in Brasilia, Guedes defended a more flexible approach to spending, saying the country is not being fiscally irresponsible, but has to be sensible to social needs. He added that the president made “the right decision” in providing aid to truckers, who are struggling with high fuel prices, and said the government has suffered from “a lack of good will and tolerance.”
“I can’t be a 10 fiscally and zero socially,” Guedes said. “Brazil’s fiscal framework hasn’t changed. We’re just slowing the pace of the fiscal adjustment to accommodate social aid for a little longer.”
Markets pared back some of their losses, with stocks ending the day 1.3% lower and the currency climbing 0.2%. Both had sank earlier after key members of the economic team left in protest over plans to boost welfare spending that will break a key fiscal rule seen as essential to keeping investor confidence in the country. Stocks dropped as much as 4.5%, nearing a bear market.
The slump of the last few days -- the Ibovespa and the real still fare among the world’s worst performers this week, and stocks had the worst week since the early days of the pandemic -- is adding pressure on the central bank to raise rates more aggressively to tame inflation, with economists and traders now increasingly seeing a bigger hike than the 100 basis-points policy makers had pledged for next week.
“No one can really tell what’s ahead now. For markets, the move we’ve been seeing for the past few months continues -- stocks down, currency down, rates up,” said Mariam Dayoub, chief economist at Grimper Capital. “It’s just gotten worse now, and will only stop when we see something that puts a halt on this fiscal erosion.”
Tensions rose on Thursday after four members of the team that reports to Economy Minister Paulo Guedes stepped down: Treasury Secretary Jeferson Bittencourt, Special Treasury and Budget Secretary Bruno Funchal and two of their top assistants. All of them publicly cited personal reasons for leaving, but privately expressed deep concern over Bolsonaro’s fiscal largesse and Guedes’s unwillingness to push back anymore on those plans, according to people familiar with the matter who asked not to be identified.
“I did not quit, and the president never mentioned anything about that,” Guedes said at the press conference, putting an end to speculation he would also step down.
Esteves Colnago, who was already part of the economic team, will replace Funchal, Guedes said. He will pick Bittencourt’s replacement.
While many Brazilians have been hit hard financially by the pandemic and would clearly benefit from additional assistance, the spending plan risks backfiring by deepening a surge in inflation that would only weaken the country’s tepid economic recovery.
“The signals are terrible,” Gustavo Brotto, chief investment officer at Greenbay Investimentos, said of the additional spending. “They mean more inflation and less growth.”
Bolsonaro has been pushing the economic team and congress to find budget space to pay poor Brazilians 400 reais ($70.68) a month in the run-up to the 2022 election -- part of a new social program that’s unlikely to fit into the current spending cap rule. Investors accepted exceptions to the fiscal rule at the outset of the Covid-19 outbreak last year, but they’re growing increasingly wary of additional spending.
This highlights a harsh reality of the pandemic: While the world’s wealthy countries were able to dole out massive sums of cash to help their people and companies weather the economic crash, developing nations have found it much harder to implement such policies. Investors were only willing to lend these countries so much money last year, and now they are punishing some of them -- including Brazil, which sought to emulate the spending by developed nations last year -- as signs mount that inflation could spiral out of control. Consumer prices are climbing at an annual clip of 10% in Brazil, the fastest pace in more than five years.
Options traded at local exchange B3 now imply an 83% chance of an acceleration of the tightening cycle next week, up from about 40% on Thursday. Traders are moving bets toward 150 basis points, which would be the biggest rate hike in two decades, and also reviewing the level of Selic rate at the end of the cycle to as high as 11.5%. The bank already raised interest rates by more than 4 percentage points this year, to 6.25%.
Higher rates, a worse outlook for the economy and greater volatility stemming from the 2022 election race should challenge the outlook for Brazilian stocks over the next 12 months, according to Itau BBA strategists.
The resignations weren’t limited to the economic team. In the energy ministry, the secretary of oil and natural gas stepped down after Bolsonaro promised to make monthly payments to truck drivers in order to offset the impact of higher diesel prices.
Bolsonaro shrugged off the departures. As one person with knowledge of his thinking put it, the president would rather see those who don’t agree with his orders leaving government.
“There are secretaries who want to assert their will, so the economy minister made his decision,” Bolsonaro said later in a social media webcast. He had previously said Guedes would stay in government.
Brazil’s so-called spending cap rule has been in place since 2017, limiting the growth of public expenditures to the rate of the previous year’s inflation. It is seen by investors as a pillar of fiscal policy that’s needed to keep government finances from derailing. Congress approved exceptions to the rule in 2020 and 2021 because of the pandemic, causing the country’s fiscal deficit to reach nearly 14% of gross domestic product last year.
Most of that deficit was caused by a Covid aid program that paid monthly stipends to the poor. The gap tightened to 5.6% of GDP by August after the aid was extended with less generous terms this year.
BRAZIL REACT: Bolsonaro, Guedes Double Down on Populism
Bolsonaro’s proposed change to the fiscal rule, which was approved at a lower house committee late Thursday and should go to a full floor vote next week, is expected to allow the government to spend an additional 40 billion reais next year, according to people familiar with the matter.
The bill also creates a yearly limit for court-ordered payments, freeing up another 40 billion reais for spending and bringing the total extra budget room to about 80 billion reais.
Brazil’s spending cap is being breached “in the worst possible way,” said Gustavo Pessoa, a founding partner at hedge fund manager Legacy Capital. “The debt trajectory will hardly converge with the recession that Brazil should face in 2022,” Pessoa said in an interview.
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