José Roberto Mendonça de Barros says new administration must define a fiscal anchor and send tax reform to Congress

01/17/2023

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Jose Roberto Mendonça de Barros — Foto: Silvia Costanti/Valor

Economist José Roberto Mendonça de Barros says that the fiscal package announced by the economic team is “positive, welcome, and healthy.” But it represents the first step. It will be necessary to move forward in cutting expenses, and not only in increasing revenues. It is also necessary to present a rule that will serve as the country’s new fiscal anchor, and send the tax reform proposal to Congress.

“The ministers of Finance [Fernando Haddad] and Planning [Simone Tebet] have explicitly taken on the idea, which is very welcome, that they will try to keep the [primary] deficit between 0.5% and 1% of GDP,” said Mr. Mendonça de Barros, a partner at the MB Associados consultancy and former secretary of Economic Policy at the Ministry of Finance in the Cardoso administration. “If they hadn’t started with such a bold transition package, there wouldn’t see all this stress.”

He says, in an interview with Valor, that the Lula administration starts with a truly “cursed inheritance”: an inflation higher than 9% in the pocket of a large part of the population, well above the official index, of 5.8% for 2022. The full rate was lower due to tax cuts, which, however, do not benefit those who do not drive a car and pay the social tariff for electricity.

“This inheritance is complicated,” he said, and “increases the risk of difficulties between the Finance Ministry and the Central Bank.” According to him, it creates difficulties to take fiscal adjustment measures, such as the end of the tax relief on gasoline. On the other hand, it puts the Central Bank under pressure.

In his view, the Lula administration will face a very complicated economic scenario in the short term, with the deceleration of the world economy and a likely drop in commodity prices after March. But he sees opportunities thanks to two major trends. One is the relocation of factories from China to other parts of the world, a consequence of geopolitical tensions with the United States. The other is the decarbonization of the world economy.

“It won’t be easy,” he said. “If you start wanting to bring corpses from the industrial policy, like building refineries, naval program, chip factory, then I think it gets really complicated.”

Mr. Mendonça de Barros spoke to Valor twice, once before and once after the announcement of the government’s fiscal package. Read below the main excerpts from the interviews:

Valor: What is your view of the first days of the Lula administration?

Jose Roberto Mendonça de Barros: The Lula administration faces an enormous challenge, given the international economic situation and the inheritance received from the previous administration. I worked in the Fernando Henrique Cardoso administration, which left a blessed inheritance, which was unfairly called cursed. It was not. It was a blessed inheritance, also because of the civilized transition that was made. I believe that the government can see what a complicated inheritance is all about.

Valor: How do you see the international environment?

Mr. Mendonça de Barros: It is the most complicated scenario of the last decades. We have a strong deceleration of global growth. It is a rare combination of non-economic shocks with economic shocks, equally significant. Chronologically, it started with Covid, a huge supply shock at the height of globalization. It was inflationary pressure throughout the Western world, including Brazil, with an unprecedented fiscal and credit expansion. This response took place for understandable reasons, but in such a big way that it produced a demand shock. Then inflation came, which was an unavoidable consequence.

Valor: Will this still reverberate in 2023?

Mr. Mendonça de Barros: Yes, it will. Central banks were slow to respond. Brazil moved first, but after being a long time behind the curve. The U.S. central bank was a year behind the curve. Only now, in the last six or eight months, has the interest rate started to be high enough to knock down demand and bring inflation down. That’s not over. The discussion about the economic situation is about how far the Fed will go, whether it will raise rates by 25 basis points or 50 basis points at the February meeting. We, at MB Associations, think that it will go to 5% or 5.25% a year, at least. There is a long way to go.

Valor: In the past, the monetary tightening cycles had an impact on the exchange rates. What is going to be the channel that is going to hit us?

Mr. Mendonça de Barros: It was a different moment for us. It is always interesting to compare with Argentina. Ten years ago, we took a different path from Argentina because we had very large foreign exchange reserves. In Argentina, until today, the dollar is hand to mouth. When there is a shock abroad, inflation explodes. Here in Brazil, not anymore. The increase in commodity prices caught Brazil with a very positive capacity to increase exports. This was perceived in a very strong way last year, to the extent that the GDP was systematically higher than initially projected.

Valor: Will this trend continue in 2023?

Mr. Mendonça de Barros: Our scenario is that after March, the end of the Northern Hemisphere winter, commodity prices will fall. Demand is finally starting to fall worldwide, with the interest rate effect in the United States and Europe. China doesn’t have inflation as a problem, but it does have the Covid disaster. It has global GDP projections of less than 3%, which is very low. Absorption is going to be lower, and commodity prices tend to fall. It will be from March onwards, first by [reduced] seasonal demand for oil, although the temperature is higher than usual. In the case of food, the balance between supply and demand depends on the Latin American harvest.

Valor: Why this dependence?

Mr. Mendonça de Barros: We have the second non-economic shock in 2022: the world experienced the hottest year in history. The heat was so great that there were harvest losses in the Northern Hemisphere. And in Ukraine, you have the war, which is the third non-economic shock. The crop was not bad, but it makes the stock at the turn of last year to this year relatively low. As far as planting in Brazil is concerned, there is not going to be a problem, because we planted for a record harvest. However, it is another year of La Niña, which provokes a rainy spring. It rains well in the North and Northeast regions, but there is a lack of rain in Rio Grande do Sul. In Argentina, the weather is a disaster, they have already lost a portion of their crop, especially wheat. Brazil’s harvest will be very good, but there may be a little bit of a shortfall, as happened last year. So, this year we will no longer have this great income boost. In the last two years, a lot of tax was collected because of more expensive commodities.

Valor: How do things evolve in the medium and long term?

Mr. Mendonça de Barros: There is a geopolitical dispute between China and the United States, with many consequences, and one is the use of trade policy as a weapon. I’m talking about chips and the prohibition of direct and indirect exports from U.S. companies. We have Covid in China, which is leading companies that do not depend on the Chinese market for so-called reshoring. Part of the production is going to South Asia, part to Mexico, part to Eastern Europe itself. We have to keep an eye on this, especially in the Brazilian industry. And the other thing is the energy transition that runs in parallel. Energy transition is going through a paradoxical moment. Europe and a good part of the countries in the world have gone backward in energy because they are using coal, they are using what they have at hand. But it’s making us even more certain that we have to move forward in the energy transition. This puts us in a good position if we know how to take advantage of it.

Valor: And what about Brazil’s domestic economy?

Mr. Mendonça de Barros: Activity is slowing down. In the last quarter of last year, activity will be much weaker than in previous quarters. 2022 GDP is going to grow by 3%. But if you look at this year, everyone is working with something between 0.5% and 1%. We have 0.8%. These sources of growth from the past are going to be weakened or have the opposite sign. Interest rates are very high, at 13.75% per year, and the injection of income from abroad is going to be lower. Demand is starting to fall, defaults are rising. The service sector, which was the driving force behind the activity, is starting to slide. We enter this year with the GDP slowing down, but with very worrying inflation.

Valor: Can inflation complicate the new administration?

Mr. Mendonça de Barros: This is a truly cursed inheritance. When you look at full inflation, it is 5.8% in 2022, but the average of the inflation cores is above 9%. There are two major price groups. You have those that received tax breaks. For those who didn’t get a tax incentive, the [price] increase is much higher. The real inflation, for those who don’t have a car and pay the social energy tariff, is 9%. That is also why poverty increases. This inheritance is complicated. The minister of finance wanted not to renew the fuel tax relief, and the political wing of the government wanted to renew it to avoid a price shock upon arrival. The tax waiver costs R$50 billion per year. The Ministry of Finance was correct when it advocated the end of waivers.

Valor: Would this technically correct solution be politically possible, with radical groups in the streets?

Mr. Mendonça de Barros: I admit that increasing the price of diesel from the outset would be complicated, but not gasoline. Tax relief for gasoline is a subsidy to the middle class, it harms ethanol, it is an anti-environment measure, and it accounts for a great part of the lost tax revenue. It is possible to understand what the demand is from a political standpoint, but it was a mistake. Two months from now, if the gasoline tax is changed, I don’t know whether they will face the same problem or not. Here, inflation complicates things. The worst thing about this inheritance, in inflation, is this asymmetry that was built in a totally artificial and populist way. This increases the risk of difficulties between the Finance Ministry and the Central Bank.

Valor: What do you think of the fiscal measures announced by the economic team?

Mr. Mendonça de Barros: The Transition PEC (proposal to amend the Constitution), which leads to a primary deficit of more than 2% of GDP and strong growth in the debt-to-GDP ratio, would be destabilizing. The ministers of Finance and Planning have explicitly taken up the idea, which is very welcome, that they will try to keep the [primary] deficit between 0.5% and 1% of GDP. Why is this reasonable? All the analysts, since last year, already thought that a figure between R$80 billion and R$100 billion was reasonable. This was the waiver [to spend above the cap], which would mean something between 0.7% and 1% of GDP. If they hadn’t started with such a bold transition package, there wouldn’t see all this stress. But then, it is positive, welcome, healthy, but it is partial.

Valor: Why?

Mr. Mendonça de Barros: Because what we can put some security on are four items linked to tax collection. The first is PIS Pasep, which is legally authorized to be legitimately credited as government revenue. This means R$23 billion. And then, the expectation of the return of the gasoline tax, which is estimated at R$29 billion. This should already be there, but it was postponed, for political reasons. If it comes in March, better late than never. It is also money the proposal related to the Supreme Court’s decision that forbids the use of ICMS credits to purchase inputs. The estimate is R$30 billion. There is a revenue re-estimation in the budget, which everyone imagined could happen because inflation will be a little higher than initially thought. This comes to something close to R$20 billion, R$30 billion. Adding it all up, this part really brings in R$80 billion or R$90 billion in revenue. This is enough to bring the deficit down. It might be a little more than 1% of GDP, but it is already a good start.

Valor: What else remains to be done?

Mr. Mendonça de Barros: Three things are also explicit in the remarks of the ministers. First, a review of spending. We have a tradition of being a little suspicious of spending reviews because, in the past, many times promises were made and nothing happened. But now we believe that things can happen, like the revision of the Federal Unified Registration. There have been so many facilities in this recent period that there really is a way to have some expenditure. The second complementary point, and everybody knows that, is the new fiscal policy. We have to have a discussion by, say, April. We have to show what this fiscal rule is, that it is technically well organized and credible. The third point is tax reform, especially VAT [value-added tax]. This would mean a significant step in the right direction.

Valor: Minister Haddad said that his fiscal plan is a letter to the Central Bank. Has the tension between the Central Bank and the Finance Ministry started?

Mr. Mendonça de Barros: It is present. The two entities have the same objective, but they are going to have to develop a way of working in a complementary way. It is the first time that a newly elected government is installed with an independent Central Bank by law. Hence the image of the cards, on one side and on the other. I understand this as a learning process of coexistence, in a different institutional situation, with a complex inflation situation. That is why the markets understood the situation, nobody got nervous.

Valor: Would tax reform be a way to help rebalance the public accounts?

Mr. Mendonça de Barros: I think [it is important] not so much for the impact on short-term tax collection, but rather on the expectation and the medium-term message for attracting investments. This administration may have a combination of two very powerful things. One is the new stance towards the environment. If this is combined with a message of progress in tax reform, then we can say that we may have a significant increase in investments. But then we have to add something else that worries us, besides the fiscal part, due to past experience, which is the industrial policy. If at this moment, at the same time, we want to bring in the corpses of the industrial policy, like building refineries, naval programs, chip factories, then I think it gets really complicated. To review the sanitation framework, to review things that we have advanced.

Valor: In the first week, there was a lot of doubt about what the direction of the Lula administration was going to be, with conflicting remarks. Afterward, there was an attempt to unify the message. Will it be a government with a unified line?

Mr. Mendonça de Barros: There will be no unified message. The very assembly of the government team does not go in this direction. You have many people with different views. It will be even worse if the hegemonic tendency of the Workers’ Party manifests itself. There is an enormous opportunity. You see, the performance of the previous administration was so bad in health, education, environment, science and technology, and foreign relations, that this is an extraordinary opportunity. As a great financial market operator told me, the world is anxious to buy Brazil. They want to buy Brazil because the emerging world is all messed up. But, for God’s sake, you have to give them a reason to really buy.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/