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.

Continue reading “The Brazilian Fiscal Crisis: The Lost Credibility”

New Infographic Series on the Economic and Political Situation in Brazil

Brazil is in crisis. The economy shrank 0.2 percent in the first quarter, and the forecast is for negative growth of 1.2 percent this year. Unemployment rate reached 6.4 percent in April, its highest level in four years. There is also pessimism on consumer prices, raising the 2015 inflation forecast from 7.93 percent to 8.12 percent, above the central bank’s inflation target rate of 4.5 percent.

Politically, there is not much cause for optimism for Brazilian President Dilma Roussef, whose approval rating is at a record low 13 percent, according to an April 10 Datafolha poll. The government has lost influence over the legislative agenda and has been struggling to pass tax increases and cuts to social benefits meant to shore up fiscal accounts. Eduardo Cunha, speaker of Camara dos Deputados, Brazil’s lower house, is the man behind controversial actions that have threatened to derail the government coalition just months into Ms. Rousseff’s second term. Mr. Cunha is from the Brazilian Democratic Movement Party, supposedly the government’s most important ally; but he was elected speaker with the promise of independence from the Executive. Under his command, Camara dos Deputados has held 121 voting sessions in the first five months of 2015, a record number for the beginning of the legislative year since 1995.

This is not necessarily good news for the country. Today, Congress has more weight and more strength; it has also become more conservative and more self-centered. Two weeks ago, Mr. Cunha and his supporters pushed forward political reform measures after outmaneuvering other members of the house and disregarding three months worth of work from a congressional commission. Among the proposals approved in the first round were the private financing of political campaigns and the end of reelection in the Executive. The constitutional amendments still have to undergo a second round of voting in the lower house before moving on to the Senate for approval.

Starting this week, Brazil Talk will closely follow the economic and political situation in Brazil with a series of infographics that will inform our readers about the struggle for power in Brasilia as the government attempts to recover the economy. The first infographic – Austerity Ahead – explains the fiscal measures sponsored by finance minister Joaquim Levy to hold on to Brazil’s investment-grade credit rating and hit a primary surplus target of 1.2% of GDP by the end of this year. Mr. Levy has also slashed almost 70 billion reais from planned discretionary spending for 2015 and urged lawmakers to back tax increases. But Congress approved softer versions of the austerity bills, upsetting Mr. Levy’s efforts to increase government revenue.

Austerity Ahead