The Brazilian Fiscal Crisis: The Lost Credibility

By Tatiana Acar

[7 min read]


Assessing how credibility affects both the economy and individuals in a tangible way is a complex issue in the economic debate. We can conceive the delicate concept of confidence through the image of a horse being trained to jump obstacles. In order to gain his trust, the athlete needs to show commitment and respect. With sufficient warning, the horse tends to follow his commands, and both will have a durable relationship. However, unexpectedly forcing it to jump will make the horse suspicious. If surprised, he can harm the athlete and destroy all the environment around him. Worse, once the trust is betrayed, it is hard to recover it. Brazil’s current crisis scenario could be linked to this metaphor since the fiscal misconduct seen in the last years has undermined the population’s confidence and generated great disarray among consumers, businesses, and investors. Output growth has fallen more than 7% in two years[1], causing unemployment more than doubling[2]. Recovering the lost development will consume a large part of Brazil’s next presidential term, which has been predicted by some analysts already[3]. But why has the country reached this stage? What is the relationship between credibility and the level of employment and income?

Credibility is built when people notice, over time, that the government has not only committed to the policy it communicated, but it has also managed to achieve its goals[4]. When a government spends continuously and increasingly, uncertainty about the country’s fiscal solvency tends to be higher. Thus, the effect of fiscal stimulus on the economy and individuals might become counterproductive by pushing up long-term interest rates, inflationary expectations and undermining longer-term growth prospects. This puts the government into a dangerous vicious circle, as the fall in the output causes a drop on tax revenues, further increasing the fiscal imbalance.

Coincidentally or not, in 2017, the drop in revenues in Brazil led to the fourth straight year of deficit, worsening the fiscal imbalance and the economic scenario. How has the confidence about the country’s fiscal health behaved in recent years? In the attempt to quantify this somewhat subjective concept, I built a fiscal credibility index, as seen below [1]. Its core meaning is intuitive – the more the market believes the government will make a fiscal effort to ensure debt sustainability in the future, the greater its credibility is. It ranges from zero, when there is no credibility, to one, when the fiscal credibility is at its maximum.

Fiscal Credibility Index [1] 


Source: Graph prepared by the authors.

Three different phases can be highlighted from the graph between 2003 and 2017. The first one, from 2004 to mid-2009, can be characterized by the building up of credibility. It started following the 2002 uncertainty crisis, when the potential election of the presidential candidate, Luíz Inácio Lula da Silva, was associated with a higher probability of default. With his victory in 2003, as opposed to what the markets expected, the appointment of an orthodox economic team provided a clear signal of continuity of the Inflation Target Regime[5], launched in 1999. The commitment shown towards the debt sustainability and a scenario of political and economic stability contributed to the return of confidence by financial markets, firms, and households. The second phase, between mid-2009 and 2012, was characterized by a temporary deterioration of the agents´ perception, as a reflection of the subprime crisis.

Still, what draws the most attention is the increasing depreciation of credibility from 2013 onwards. The economic model adopted by former president Dilma Roussef, known as the “New Economic Matrix”, changed the implicit target of the fiscal policy. The underlying goal was no longer to preserve public debt sustainability, but short-term economic growth with a strong focus on stimulating household consumption, subsidized credit, and indiscriminate increase in public spending. Consequently, the debt rose from 57% of GDP in early 2014 to 83% of GDP in December 2017[6].  Such change has not been dialogued with society, in the sense of a broad discussion about the sudden re-orientation of the economic policy and priorities, and the markets started to look at economic statistics with suspicion.

The pressure of this expansionist policy on prices led Dilma’s government to adopt palliative measures in order to curb inflation. Examples of these were the interventions on the energy sector by the unilateral reversal of the concession contracts of the generation/transmission energy companies, in order to impose lower tariffs, which temporarily kept prices from rising. However, this strategy was costly for the energy and oil companies (whose debt levels rose), for the government (which was forced to aid indebted companies) and the population (who pays much higher bills after controlled prices were lifted).[7]

Another expensive policy involved the offering of subsidized credit through BNDES to various companies, most of which were implicated in the Car Wash investigations. What was supposed to be a temporary and countercyclical action to increase productivity in the aftermath of the 2008 financial crisis, had become a permanent policy. With questionable efficacy in terms of increasing productivity, this policy had an estimated cost of R$500 billion (or US$ 150 billion) between 2009 and 2016[8].

Aside from other reasons, the lack of transparency of public accounts through “creative accounting”[9] greatly weakened the country’s fiscal credibility[10]. The smaller primary surpluses in each period led Dilma`s government to manipulate its budget and distort official statistics in order to stimulate better results. Even so, the government made use of reductions in the primary surplus target established for the year, through amendments in the budgetary law. In 2013, at the very end of the current fiscal year, the situation called for another government move, further reducing the fiscal target on December 18. These practices virtually erased all the benefits brought about by the primary surplus target system, designed to guide expectations and ensure more predictability to the economy[11]. It is worth mentioning that the main virtue of the fiscal target regime is to compel countries to have fiscal discipline by achieving surpluses. However, between 2015 and 2017, Dilma’s government shifted the fiscal target from surpluses to increasing deficits.

Lastly, and the most striking evidence of the decline of confidence in the Brazilian government, was the discovery of so called “fiscal pedalling”, in 2015. This consisted of delays in fund transfers from the treasury to public banks to finance social and welfare programs such as “Bolsa Família”, a conditional cash transfer system, summing R$ 72 billion (about US$ 20 billion) [12]. This practice was ruled a crime of fiscal responsibility, leading to Dilma’s impeachment and setting a cycle of political and fiscal crisis that persists to this day. The overall vulnerability of Brazil’s public accounts eventually resulted in the sovereign’s downgrade from investment grade to “junk rating”, which fueled uncertainty[13].

So far, the recovery of confidence and economic growth is not a clear government priority. Despite the approval of the spending cap by the Interim President Michel Temer, which limits public spending to inflation for the next 20 years[14], the step towards a sounder fiscal framework seems to have been set aside. With corruption charges against Temer – Brazil’s most unpopular leader ever[15]-, the lower house has blocked the trial from moving forward through concessions by the leader to pro-business lawmakers[16].  Moreover, with little support in Congress, and with the forthcoming of the presidential elections – which is filled by uncertainties about the possible candidates -, critical reforms such as the pension reform has not been the government’s main concern and therefore is far from being approved.

We have learned that the fiscal stimulus should be clear and credibly temporary, otherwise announced policies become discredited by people since continued public expenditure turns unsustainable and the government becomes unable to commit to the proposed policies. When governments spend considering only short-term benefits, they disregard the perverse long-term effects of doing so. The lack of confidence derived from inconsistent and non-transparent policies has the opposite effect to those sought by the Brazilian government, and its populist measures are unsustainable and bound to be reversed.

Now, instead of the promised economic prosperity, Brazil’s population is facing cuts in social benefits and in essential areas such as education, health, and safety. At least 15% of the 30 million people who emerged from poverty in the previous decade have fallen back down below the poverty line, reversing much of the temporary virtues of public spending[17]. Credibility requires time to be built, but it is lost quickly and with dangerous consequences to the most vulnerable population of our society and to future generations.



Tatiana Acar is a PhD candidate in economics at Fluminense Federal University (UFF), visiting scholar at the Institute of Latin American Studies (ILAS) at Columbia University and former professor of Public Finance at UFF.



[1] This indicator is under development for a doctoral thesis in the Graduate Program in Economics at UFF (Universidade Federal Fluminense), in Rio de Janeiro, Brazil, in partnership with my PhD advisor Gabriel Caldas Montes. Further details on its composition can be obtained contacting the author at:


[1] Data available at the BCB website (GDP at constant last year prices in R$ – Code: 1208):

[2] Data available at the BCB website (Unemployment rate – PNADC – Code: 24369) :


[4] Blinder, A, S. 2000.Central-Bank credibility: Why do we care? How do we build it?The American Economic Review, 90 (5), p.1421-1431


[6] (Gross general government debt (% GDP), code 4537)