The Finance Minister should declare that accounting tricks will no longer be used to meet the fiscal target.
There are many challenges facing the new Finance Minister. On the external front—which, in Brazil, has historically been associated with crises—, the country, on the contrary, is nowadays witnessing excessive capital inflows. The capital which is flooding into Brazil is helping to appreciate the real, causing problems for exporters of manufactured goods and sectors that compete with imports. In order to mitigate the problem, the current minister has resorted to capital controls, in the shape of the IOF (Tax on Financial Operations), which try to make non-resident financial investments in Brazil less profitable.
The more intensive use of capital controls designed to depreciate the real exchange rate is fraught with serious problems. In order to achieve high domestic rates, it will be essential to tap foreign savings, that is, the very same foreign investments that capital controls try to inhibit. In order to overcome this inconsistency, capital controls try to separate the wheat from the chaff, taxing only those investments that are deemed to be speculative. However, capital is fungible and foreign investments always find ways of circumventing restrictions, especially if tax rates are high and controls are kept in place for a long time. Moreover, there is always the risk of being overzealous and frightening off not only “speculative capital”, but also the capital that is indispensable for productive investment.
If the wave of plentiful and cheap international liquidity persists for a long time, capital controls will not be able to prevent the real’s appreciation. Other measures that change the economy’s fundamentals will be necessary. An especially efficient measure would be to alter fiscal policy. As nearly all public expenditures are directed towards non-tradable goods, a fiscal adjustment would, by itself, depreciate the real exchange rate, which is the relation between the prices of tradable and non-tradable goods. In Brazil, however, the effect of a fiscal adjustment on the real exchange rate would be even greater, as it would permit the Central Bank (CB) to lower the Selic rate (the Central Bank’s short-term interest rate), thus reducing capital inflows.
It is fiscal policy that represents the biggest challenge for the new minister. Under the pretext of implementing an anti-cyclical policy to combat the international crisis, the current minister presided over an enormous increase in permanent fiscal expenditures, most of which were not associated with investments. This increase in spending may, indeed, have helped combat recessionary effects during the worst moments of the crisis, but today they constitute one of the main obstacles to economic growth.
Even as regards to combating the crisis, one should remember that several countries only resorted to fiscal policy when monetary policy’s effectiveness had been exhausted. In Brazil, on the other hand, the CB could only reduce the Selic rate to a level of 8.75%, because lower rates would have jeopardized the control of inflation. That is, even to combat the crisis, a more effective policy mix would have involved a greater reduction of interest rates by the CB and a smaller increase in public expenditures, especially recurrent ones.
But it is now, when the crisis has already passed and the economy is growing at a fast pace, that the worst consequences of this expansionary fiscal policy are finally appearing. In order to keep inflation under control, the CB has to maintain the Selic rate at very high levels, which hampers investment and growth and, as we have seen, also appreciates the real exchange rate.
However, the worst part of the inheritance that the new minister will receive from the current one lies in the discredited fiscal accounts. Accounting tricks have constantly been introduced into public accounting in order to meet the primary surplus target. The culminating point in this process, which is destroying our public accounting framework, was the Petrobras capitalization in which an issuance of gross debt was transformed into an improvement in the primary surplus.
The accounting alchemy was basically the following. The net debt is calculated for the non-financial public sector plus the CB and does not include the BNDES. The Treasury lent more than R$30 billion to the BNDES. Thus, the Treasury’s loan to the BNDES became a public sector asset. In other words, the Treasury’s loan did not affect net debt, because a liability (the public debt issued to finance the loan) and an asset (the loan) were created simultaneously. The BNDES then bought shares issued by Petrobras, and the latter, with the funds received from the BNDES, paid for part of the pre-salt barrels of oil that the government had sold to it. So the money, in fact, came out of the Treasury’s “left pocket”, passed through the BNDES and Petrobras, and returned to the Treasury’s “right pocket”. This “trip” generated a fictitious primary surplus of 1% of GDP, which corresponds to almost a third of the entire primary surplus estimated for 2010. It is clear that these kinds of measures do not contribute to enhancing the credibility of our public accounts. Today, the concepts of net debt and primary surplus which took years to achieve a high level of credibility, have been discredited. Not only have private banks begun to calculate alternative series for the debt and primary surplus, but the CB itself has warned that it will not take fictitious fiscal revenues into account in the models it uses to determine the Selic rate.
The new minister has been making very auspicious declarations regarding the future course of fiscal policy, signaling a break in relation to the extremely expansionist trajectory that was being followed until quite recently by the current minister. Naturally, it remains to be seen whether actions will follow words. However there is a declaration which, by itself, would constitute a great contribution: accounting tricks will no longer be used to produce illusory fiscal results. Let’s hope the new minister is committed to restoring the credibility of public accounts and reverses his predecessor’s misguided fiscal policy. We wish him every success in this difficult undertaking.
Note: The week before this article was written, it was announced that Guido Mantega would stay on as Finance Minister in Dilma Rouseff’s administration.