November saw an accelerated decline, with impacts visible in key indicators, currency shifts, and long-term interest rates, heightening economic concerns
12/10/2024
The government’s fiscal adjustment package and the proposed income tax exemption for individuals earning up to R$5,000 per month have worsened Brazil’s financial conditions, a composite measure of variables such as interest rates and exchange rates. This deterioration is expected to affect economic activity negatively. Economists consulted by Valor noted that the outlook for these conditions and their impact on the economy depends primarily on fiscal expectations for the federal government.
Financial condition indices aim to measure the effect of variables such as exchange rates, interest rates, and risk indicators on economic activity, often with a lag. Long-term interest rates, for instance, influence credit costs but can also serve as a forward-looking indicator of economic confidence, affecting investment decisions. Similarly, exchange rate fluctuations can impact corporate foreign debt, as seen with airline companies.
November, the month when the adjustment measures and tax exemptions were announced, saw a marked worsening in financial conditions. Compared to October, Brazil’s Ibovespa stock index fell by 3.11%, while the exchange rate per U.S. dollar rose 3.79%, surpassing R$6 for the first time. Last week, the FX rate increased again, this time by 1.18%, while the Ibovespa showed a slight rise of 0.22%.
According to the Brazilian Institute of Economics at Getulio Vargas Foundation (FGV Ibre), financial conditions have been in contractionary territory since April, driven by uncertainties about the sustainability of federal accounts. November saw a further deterioration, with the indicator dropping from 0.11 in March to -0.62 in early December. Values below zero indicate contractionary conditions.
“The pricing dynamics in Brazil are almost entirely dependent on fiscal policy, which has disappointed since the beginning of the year,” said Caio Dianin, a researcher in applied economics at FGV Ibre. The institute’s financial conditions index replicates a similar measure calculated by Brazil’s Central Bank.
“We cannot disregard the worsening external scenario, but it’s not the key driver,” Mr. Dianin added. FGV Ibre projects GDP growth of 2% for 2025, below the 3.1% annualized increase reported up to September by the IBGE, the national statistics agency.
The adjustment measures introduced in November are expected to reduce primary spending growth, excluding federal public debt expenses, by R$70 billion over the next two years. Among the proposals is a cap limiting the real increase in the minimum wage to 2.5% per year. The package has drawn criticism from fiscal experts and market participants, who argue that the measures do little to curb the pace of public debt expansion. The gross general government debt (DBGG), the key indicator of federal indebtedness, reached 78.6% of GDP in October, up roughly seven percentage points since December 2022, just before the current administration took office.
The proposed income tax exemption for individuals earning up to R$5,000 per month also faced criticism. Concerns included the lack of necessary fiscal compensation, the measure’s regressive impact favoring the middle class over poorer populations, and its potential to stimulate economic activity at a time when the economy is already operating beyond its potential. Both the fiscal package and tax changes require congressional approval.
According to MCM Consultores, after two years of expansionary conditions, financial conditions shifted to neutral in September this year and have since turned contractionary. Between July last year and November this year, the index fell from 1.2 to -0.3.
Fábio Ramos, an economist at UBS BB, said, “Without a doubt, financial conditions have worsened” since the announcement of the adjustment measures and the tax exemption. He added that they are likely to become “even more contractionary” in the future due to the Central Bank’s expected hike in the Selic policy rate. On Monday (9), the Central Bank’s Focus survey revealed that market projections for the overnight interest rate at the end of 2025 had risen to 13.5% per year from 12.63%. Currently, the Selic rate stands at 11.25% per year. Today, the Monetary Policy Committee (COPOM) begins its final meeting of the year.
With higher interest rate expectations, UBS BB officially projects GDP growth of 1.25% next year, potentially reaching 1.5%—still below 2024 levels.
At an event organized by XP Investimentos early last week, the Central Bank’s monetary policy director and incoming chair, Gabriel Galípolo, also highlighted the new financial conditions. Mr. Galípolo said that current levels of exchange rates, interest rates, and especially long-term rates are starting “to show some impact on financial conditions.” He said this is already sparking “some discussions about how [the shift] will affect investment and other decisions” in the economy.
Three weeks before the fiscal adjustment measures were unveiled, the COPOM noted in the minutes of its most recent meeting that “a reduction in expenditure growth, particularly in a more structural manner, could even boost economic growth in the medium term through its impact on financial conditions, risk premiums, and better resource allocation.”
- By Estevão Taiar – Brasília
- Source: Valor International
- https://valorinternational.globo.com/