Concerns about fiscal policy going against monetary policy, however, remain in place and cast doubt on Central Bank’s ability to tame inflation

09/21/2022

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Silvia Matos — Foto: Leo Pinheiro/Valor

Better-than-expected signs in July and August led to a significant revision of the economic projections by Fundação Getulio Vargas’s Brazilian Institute of Economics (FGV/Ibre). In the September edition of the Macro Bulletin, forecasts for activity in 2022 were revised upward, while inflation projections for this year and next were revised downward. Concerns about fiscal policy going against monetary policy, however, remain in place and cast doubt on the Central Bank’s ability to converge to the inflation target ahead.

The latest edition of the Macro bulletin points out that after the release of GDP data for the second quarter and the last two months, activity is still expected to slow down, but in a less intense way.

“In July, high-frequency indicators showed stability on the industry side, with positive momentum from services, and a drop in the retail sector. However, within the retail sector, the sale of fuels and lubricants stood out positively,” said economists Silvia Matos, Marina Garrido, and Mayara Santiago.

They point out that the services sector surprised to the upside, with a highlight for the transportation sector, which is today 20.2% above the pre-pandemic level. Based on high-frequency indicators for July, the manufacturing industry grew 0.4%, and remained flat in the year-over-year comparison. In the case of services, the expectation of growth of 5.5% year-over-year was overshadowed by the year-over-year increase of 6.3% and the monthly increase of 1.1%.

With the recent data and the perspective that services will continue to contribute positively to growth in the second half, FGV/Ibre now expects GDP growth of 0.4% in the third quarter, compared to the second quarter. The economists added that some measures passed by Congress are likely to drive growth in the third quarter. As a result, they revised the projection for GDP growth in 2022 to 2.5% from 1.7%.

Besides GDP projection, FGV revised upwards the 2022 forecasts for household consumption (to 3.5% from 2.4%), investment (to -0.4% from -3.5%), industry (to 1.7% from 0.5%), and transformation industry (to 0.2% from -1.3%). The numbers for electricity and others were also revised upwards (to 7.9% from 4.5%), as were construction (to 6.1% from 4.9%), and services (to 3.3% from 2.6%).

Forecasts for government consumption, exports and imports, agriculture, and extractive industry were revised downwards. So was the forecast for the GDP in 2023, now expected to contract 0.4%, compared with 0.3% before. This is explained by the delayed effects of the monetary policy, plus the need for less public spending and the decline in household consumption next year.

Silvia Matos, coordinator of the Macro Bulletin, points out that, besides the surprise in the transportation sector, which has been growing for 10 months, public services, energy, and agricultural production are expected to perform well this quarter.

“We foresee good growth in agriculture, which in the same quarter last year fell 9% because of the drought,” she said. “Public services should have a more relevant contribution in the quarter and may grow 2%. It would be a later normalization of this sector, which has a relevant impact on the GDP. Besides this, although energy has contracted, we are talking about a year-over-year variation of 10% after the thermal plants were turned on last year.”

The economist also argued that services provided to households, which did not grow that much in July, are 5.7% below the pre-pandemic level, which indicates some room for growth this quarter.

FGV/Ibre also revised its projections for inflation this year and next. In August, it expected inflation of 6.5% for 2022 and 5.1% for 2023. Now it expects 5.6% for this year and 4.7% for 2023. In the latest Focus, Central Bank’s survey with analysts, from Monday, the market’s outlook for inflation fell again, but is still less optimistic than that of the FGV/Ibre – it went to 6% from 6.4% in 2022 and to 5% from 5.1% in 2023.

In the bulletin’s inflation section, André Braz said that, whether due to the ICMS reduction or the risk of global recession, the prices of energy and important raw materials should remain lower for the next few months.

“And, in the same way energy products contributed to a broad-based inflation, their current behavior tends to contribute to price stability. Since energy and fuel are important costs for industrial activity and services, their current trajectory tends to reduce the need for transfers along the production chains,” Mr. Braz argued.

However, Ibre/FGV warned that the battle against inflation is not yet won and that a new cycle of monetary tightening could still be necessary.

Ms. Matos and Armando Castelar Pinheiro said that the scenario is of deceleration throughout this semester and next year in Brazil and in the rest of the world. Here, they said, the picture is more concerning because the fiscal policy has been very expansionary, which would be unsustainable from the standpoint of public debt and the fight against inflation.

They cited recent analysis from associate researcher Samuel Pessôa, published in FGV/Ibre’s blog, in which he argued that without fiscal adjustment it will be very difficult to get close to the inflation target.

Brazil’s president in the next four years, to be elected next month, will look at 2023 and see an economy at full employment with inflation well above the target. “The political cycle will speak louder in terms of spending,” Mr. Pessôa said. “We will have fiscal contraction in 2023. Otherwise, it will be very difficult for the Central Bank to deliver inflation on target in 2024.”

In this sense, Ms. Matos argues that if fiscal policy does not do its part, we may have higher interest rates or even more inflation. In her view, there is a “conflict” with tight monetary policy on one side and fiscal policy with continuous expansion of spending.

As for monetary policy, Ibre/FGV warned about a potential new cycle of interest rate hikes by the Central Bank, mainly because of the possibility of approval of a temporary suspension of fiscal rules to enable public spending that was not included in the federal budget for 2023.

“Depending on the fiscal policy choices next year, there is a risk that [this] will not help the Central Bank,” Ms. Matos said. “If expectations for 2023 and 2024 start to deteriorate, the Central Bank will have to raise interest rates more. And it will only lower interest rates if there is a clearer scenario from the fiscal policy standpoint. We depend on interest rates abroad and fiscal policy here. These two components are key to see how much real interest rates we are going to have.”

*By Marsílea Gombata — São Paulo

Source: Valor International

https://valorinternational.globo.com/