Economists say positive impact is temporary and that inflation will follow

*Alex Ribeiro — São Paulo

06/09/2022

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Affonso Celso Pastore — Foto: Leo Pinheiro/Valor

The government’s measures to reduce fuel prices may lower inflation and stimulate the economy in the short term, during the election period, but they will lose a good part of these gains next year, making the scenario of the new presidential term more challenging.

“The best definition for this set of measures is fiscal populism,” said former Central Bank President Affonso Celso Pastore. “First, it brings down inflation in the election year, with the goal of boosting the approval rating of the president. It transfers inflation to next year since the measures cannot be extended if they have a minimum of responsibility. This is not economic policy. There are no economic or social objectives.”

The time-honored definition among economists for populism is precisely policies that bring gains in the short term, helping the approval ratings of the rulers, but that does not prove sustainable in the medium and long term.

Financial market economists are calculating the effect that the package of measures may have. Considering that the measures achieve all the goals expected by the government, inflation this year could be about 3 percentage points lower than forecast, according to calculations by Itaú Unibanco, which is in line with the estimates of other lenders.

The problem is that at least part of the measures is temporary. The Bolsonaro administration announced its intention to reimburse the states that cut the sales tax ICMS on diesel and cooking gas to 0% from 17%. It also intends to reduce to zero the federal tax rate by the end of the year.

This measure, according to Itaú, would have a downward impact of about 0.9 percentage points on inflation in 2022. But, as they are only valid for this year, they would also cause a 0.9 percentage point increase in inflation in 2023, which today is the main target of monetary policy.

Considering both effects, inflation this year would fall to 6% from around 9% estimated by the market, easing the pressure over President Bolsonaro during the election campaign. However, inflation could rise to 5.4% next year from 4.39% forecast by the market. Thus, it will be moving away from the inflation target of 3.25%.

A former head of the Central Bank, who asked not to be named, says that the inflationary impact in 2023 and beyond could be even more severe. States and municipalities are giving up non-permanent revenue gains and would have to replenish revenues with tax increases once the boom in commodity prices has passed.

The increased fiscal risk caused by the measure could also cloud the inflationary scenario, said Solange Srour, the chief economist at Credit Suisse. “The fiscal risk is increasing and creates a new problem for the new administration, whoever the president will be,” she said.

According to her, the states’ tax cuts, based on a revenue gain that does not tend to be permanent, could weaken their fiscal situation further down the road. “When states are in difficulties, the federal government is always called upon to bail them out.”

Short-term measures, on the other hand, give only short-term relief on some prices, but in essence do not change the dynamics of inflation. “The Central Bank should not feel more comfortable to end the cycle of interest rate hikes,” she said.

Itaú estimates that the entire tax reduction package would have a fiscal impact of 1.7% of the GDP, also considering the bill that limits the ICMS tax rate on electricity, telecommunications and fuels to 17%.

From the point of view of economic activity, the package would have an initial stimulus impact. Tax cuts expand the population’s disposable income and tend to make room for more spending in household budgets.

But, in a further moment, the economy will tend to feel the impacts of the worsening in financial conditions. As a result, the prospects for GDP expansion in 2022 may improve in relation to the 1.2% forecast by the market in Focus, the Central Bank’s weekly survey with economists. But for next year, it may fall below the estimate of 0.76%.

For now, Ms. Srour said, the market’s reaction has been relatively moderate, in interest rates, exchange rates and stock markets. But there may be an intensification of risks as the proposal of constitutional amendment (PEC) is discussed in Congress and it becomes clearer that the first year of the next federal and state governments will be more difficult.

“In the debates about the PEC, the pressure to offer a larger and longer compensation to the states, besides other demands, may increase,” she said.

Igor Barenboim, partner and director at Reach Capital, has a different view. For him, one cannot rule out the possibility of the measures having a more lasting positive effect. “It can be good for inflation, it can be good for economic activity,” he said.

He argues that Brazil is being impacted by a commodity price shock, with both positive and negative unfolding. On the negative side is inflation, particularly severe in fuel prices. But there is also a positive impact on the economy that favors tax collection.

For Mr. Berenboim, it is acceptable that political forces use some of those gains to mitigate the negative impacts of the shock. Another economist with a large bank says that even with the program launched by the government, the primary result will be much better than expected.

A few months ago, this economist’s estimate was for a primary deficit of R$100 billion. With the surprise in the tax collection and the auction of power utility Eletrobras, the outlook has changed to a positive result of R$80 billion. The new expenditure with the fuel package may lead to balance or a primary deficit, but not as high as previously predicted.

Mr. Barenboim says that the impacts of an eventual worsening of fiscal risks on inflation and activity are not guaranteed. At this first moment, the markets’ reaction was moderate, and the real economy would have already readjusted prices considering a weakened real.

Source: Valor International

https://valorinternational.globo.com/