Brazil’s Gross Debt and the Fiscal Stance

The accounting tricks and the exaggerated expansion of government-owned banks have turned the gross debt into an indispensable indicator of fiscal stance.

Recently, two international rating agencies, Moody’s and S&P, have signaled that their evaluation of the Brazilian economy has worsened. One of its main reasons is the public indebtedness’ evolution. There are two main measures of the public debt: the gross and the net. Roughly speaking, the net debt is the gross debt minus a few financial assets, as the international reserves and loans given by the Brazilian Treasury.

For years, many analysts have called attention to the fact that the net debt was losing credibility as an indicator of fiscal solvency in Brazil. Much discredit has been brought to the primary balance and to the net debt statistics by the accounting tricks that the Brazilian government has repeatedly resorted to in order to increase the primary surplus and by the massive loans given by the Brazilian Treasury to government-owned banks. Not surprisingly, Moody’s and S&P base their negative reports on the gross debt to infer Brazil’s government solvency. According to the BCB’s measure,[1] gross debt has reached 59.1% of GDP in August, above the average of similar risk economies – 45%, as indicated by Moody’s. According to IMF’s measure, Brazil government’s gross debt is higher, 64.2% of GDP, below only three other emerging countries: Egypt (85.2%), Jordan (83.8%) and Hungary (79.9%) (Valor Econômico, 10/07/2013, editorial). The Treasury’s loans to government-owned banks, which are subtracted from the gross debt to compute the net debt, amount already to 9.5 percentage points of GDP.

The gross debt is a well-known solvency indicator of the government accounts. As such, it shows that Brazil has not performed well among its peers. Moreover, today, in Brazil, the gross debt has gained a new function: it also signals the government’s fiscal stance. Normally, the fiscal statistics (primary and nominal deficits) would be enough to infer if the fiscal policy is expansionary, contractionary or neutral. In other words, the fiscal deficits measures would suffice to show if the fiscal policy (combination of public expenditures and taxation) is helping the BCB to reduce the interest rate without putting the inflation target at risk, or, if, on the contrary, it is forcing the CB to raise the interest rate in order to keep inflation under control.

Recently, BCB has again changed its speech concerning fiscal stance, which, in the recent past, it used to classify as expansionary. According to BCB, as long as primary surpluses stay close to the recent values, “… conditions are created for the public sector balance-sheet to move into the neutrality zone in the time horizon relevant to monetary policy.” (Inflation Report, September 2013, pg. 68, my translation). Notice that the IR was published before the disclosure of August’s very bad fiscal results.

The BCB’s argument supposes that the recent figures for the primary surplus (1.9% of GDP until last July) are enough for hitting the inflation target with an interest rate near the neutral rate. There are many problems with this argument.

First, one concern is the already mentioned accounting tricks, which hinder the comparability of official statistics. Many analysts reconstruct the primary surplus figures, in an attempt to mitigate the effect of these tricks. Some government authorities even declared that these practices would no longer be used, although the people responsible for them have not been replaced. Moreover, judging by the recent measure to change, retroactively, the indexing factor of states and municipalities’ debt renegotiation, they keep actively creating ways of squandering the harshly achieved fiscal adjustment that was a sine qua non condition for the end of the Brazilian hyperinflation.

Another obstacle is that, even without accounting tricks, the fiscal stance today is largely determined by the funds provided by the Treasury to the government-owned banks. When those banks expand their loans with Treasury’s funds, there is an expansionary effect on aggregate demand. Such expansionary effect cannot be captured by the public net debt statistic, because the net debt does not change when the Treasury extends a loan financed by the issuance of public bonds. Nor does it show up in the fiscal deficit statistics, because the loans do not affect the deficit immediately. Hence, the importance of monitoring gross debt’s evolution as an additional indicator of the fiscal stance. Nevertheless, BCB has largely been ignoring this crucial aspect on its analyses.

In any case, it is hard to justify BCB’s new assessment of the fiscal stance. After all, the proof of the pudding is in the tasting. The tasting shows the BCB raising interest rate with inflation dangerously close to the band ceiling (6.5%). Hopefully, the BCB’s speech change does not reflect limits on its autonomy in making use of monetary policy. Less than twelve months away from elections, this could be disastrous.

[1] For an explanation of the BCB and IMF diferente gross debt measures, see my previous blog, Brazil: The Need For Fiscal Transparency, on August 12, 2013.