Worsening primary deficit, President Lula’s vetoes on the fiscal framework, and uncertainty about commitment to fiscal targets cast a shadow on business sentiment
Eduardo Cotrim — Foto: Luciana Whitaker/Valor
Uncertainties surrounding next year’s budget and presidential vetoes on portions of the fiscal framework law have exacerbated market participants’ discomfort regarding the country’s fiscal health, leading to a trend of risk premium incorporation in domestic assets during Thursday’s session. Additionally, the stock market was affected by the federal government’s proposal to eliminate the interest on net equity (JCP), impacting companies utilizing this mechanism.
At the end of the day, the foreign exchange rate advanced by 1.67%, trading at R$4.95 to the dollar, while Brazil’s benchmark stock index Ibovespa saw a decline of 1.53%, closing at 115,742 points. In the interest rate market, the DI contract rate for January 2027 surged from 10.215% to 10.38%, and the rate for January 2029 climbed from 10.69% to 10.84%.
Starting from Wednesday afternoon, market players began factoring in more risk premiums for local assets as the perception of deteriorating fiscal conditions in the country grew. This movement, triggered by the release of the central government’s primary result by the National Treasury, fueled long-term interest rates.
Analysts also point out that presidential vetoes on the fiscal framework law contributed to the discomfort. One of these vetoes overturned the prohibition on the Budgetary Guidelines Law predicting the exclusion of primary expenses from the fiscal and social security budget targets.
Eduardo Cotrim, manager at JGP, states that this decision was the main reason for the underperformance of domestic assets during Thursday’s session. “This veto weakened the framework and played a significant role in the poor exchange rate performance and the rise in the yield curve,” he noted, revealing that he currently holds no position in nominal or real interest rates.
Mr. Cotrim notes that, in recent days, the worsening perception of fiscal risk has regained focus due to speculation about abandoning the target of eliminating the primary deficit by 2024, along with worsening current fiscal results as revenue disappoints. “Revenue isn’t responding as the government anticipated. The recent asset deterioration is closely tied to this revenue disappointment,” he emphasized.
In Mr. Cotrim’s view, the market is assessing the credibility of delivering a zero primary deficit result by 2024 and the commitment to this target. He believes that Finance Minister Fernando Haddad “will need to be very determined for this to happen.” He went on to say: “Fiscal concerns are resurfacing as time passes and the more optimistic projections fail to materialize. Now, it remains to be seen whether the commitment to the primary result target will be upheld with feasible revenue estimates and all expenditure demands.”
According to Mizuho’s chief strategist for Latin America, Luciano Rostagno, the behavior of foreign investors towards Brazil might be shifting. He argues that long-term interest rates are rising more, and that’s precisely where foreign investors tend to allocate more.
“Foreign investors had been showing less concern and not paying as much attention to the fiscal details. The combination of a worse-than-expected primary result with [Minister of Planning and Budget, Simone] Tebet’s statement indicating that the government needs to raise an additional R$168 billion in revenue seems to bring a reality check to foreign investors, who are realizing the fiscal situation is worse,” said Mr. Rostagno.
Mauricio Valadares, chief investment officer at Nau Capital, believes that in recent days, market participants have shifted from focusing on the approval of the fiscal framework to worrying about the rule’s applicability and its ability to smooth the debt trajectory. “The market exaggerates movements. At the beginning of the year, it was pricing in a disaster. After the fiscal framework’s process, it might have leaned too much towards optimism,” he pointed out.
“I think it’s an adjustment, not necessarily a structural deterioration in investor sentiment towards the country. When outlining scenarios for interest rate cuts, we seem to have ample room to cut, and the stock market is usually a good performer. However, as we know that companies are under government scrutiny to increase revenue, we have less leeway than we could,” he said.
*Por Matheus Prado, Gabriel Roca, Victor Rezende — São Paulo
Source: Valor International