Just four months into the new Fiscal Framework, the Federal Government has announced a loosening of the targets set last year - leading to a sharp devaluation of the Real. In this report we will analyze the main changes and their medium and long-term effects on the Brazilian economy and the Real.
Source: Bloomberg, Hedgepoint
The 2025 Budget Guidelines Bill (PLDO), recently presented to the National Congress, proposes achieving fiscal balance in public accounts for next year, while maintaining the same target set for this year. Initially, the projection for next year was a surplus of 0.5% of GDP, but now a zero deficit is being sought.
Thus, there is a possibility that the government will end next year with a deficit again, which could reach up to R$31 billion, considering the tolerance margin of 0.25% of GDP more or less according to the fiscal framework.
The government is still relying on a decision by the Federal Supreme Court (STF) which allows it to exclude the surplus from precatory payments from the calculation of the fiscal target until 2026. Otherwise, the deficit for 2025 would initially be R$29.1 billion (0.23% of GDP). The targets for 2026, 2027 and 2028 were also changed to 0.25%, 0.5% and 1% of GDP, respectively. Prior to the revision, the government aimed to achieve a surplus of 1% of GDP by 2026.
Since its approval last year, the market had already questioned the federal government's ability to achieve the fiscal surplus targets set out in the Fiscal Framework, and the changes made in the last week have shaken that confidence even more.
The framework was developed in an attempt to reconcile the containment of spending increases with the commitments made by Lula during the campaign, such as the policy of raising the minimum wage above inflation and the hiring of public workers. All of this was structured with primary result targets, i.e. pre-established deficit or surplus objectives.
According to statements made by Finance Minister Fernando Haddad, the set of rules was designed to be politically viable. In other words, it was created to deal with the pressure to increase spending and, in an ideal scenario, demonstrate a certain commitment to fiscal responsibility.
In addition to the mathematical discrepancy between the increase in spending established by campaign promises and the limit of spending growth to 2.5% per year, the government has also issued other indications that public finances could be overstretched:
1. The formulation of the budget law with underestimated expenses and overestimated revenue;
2. The limitation of budget cuts to R$23 billion, below what economists have calculated as necessary to guarantee a zero deficit by 2024 - around R$40 billion;
3. The provision that allowed the government to bring forward the expansion of this year's spending limit - a change in the framework itself - and which allows for extra spending of R$15.7 billion, in practice reversing the contingency. And now on the agenda is a possible readjustment for civil servants amid threats of strike action.
Although the market has never really "bought" the targets of the new Fiscal Framework, such a premature revision of the targets set out in it brings even more uncertainty regarding fiscal stability and the trajectory of Brazil's public debt. It is even clearer that the government will not make much effort to cut spending, and projects to increase revenue with a high political cost will likely be avoided.
As we have commented in previous reports, fiscal stability is essential for the Real to appreciate, so the current scenario should keep the currency under pressure in the short and medium term. Fiscal uncertainty could also bring inflationary pressure and raise Brazil's neutral interest rate (an interest rate that doesn't accelerate or decelerate inflation) - reducing Brazil's long-term growth potential.
In addition to domestic issues, the international environment is increasingly challenging for emerging currencies due to signs of higher interest rates for even longer in the US.
