The first half of the year is ending with current inflation and expectations still unanchored, negligible monetary easing, interest payments owed by the government exceeding 8% of all the wealth produced by the country, and no prospect of a change in the scenario for the next presidential term – regardless of who is chosen in October as the "tenant" of the Palácio do Planalto (Presidential Palace).
The slowdown in the IPCA-15 in June, from 0.62% in May to 0.41%, did not halt the indicator's 12-month climb (4.8% compared to 4.64%), nor did it alleviate concerns about fiscal policy – the "Achilles' heel" of the Brazilian economy.
This represents a point of high vulnerability if the next government – meaning the Finance Ministry and the Central Bank – does not face the challenge of harmonizing fiscal and monetary policy beyond mere rhetoric. With fiscal expansion straining monetary restraint, the suffocation imposed on the productive sector by exorbitant interest rates will persist.
Three months before the election, amid financial scandals, little or nothing is known about the economic proposals of the main presidential candidates: Luiz Inácio Lula da Silva, seeking re-election, and Flávio Bolsonaro.
Without a rotation in leadership thanks to its constitutional autonomy, but still seeking financial autonomy, the Central Bank holds the reins, but anticipates turbulence that could interfere with its policy – both domestic and global, such as that resulting from the supply shock caused by the war in the Middle East and El Niño.
The minutes of the Copom meeting acknowledged the upward trajectory of inflation. The Central Bank chose not to raise interest rates. On the contrary, it cut them and indicated a pursuit of the 3% target in the longer term, without generating greater volatility in the economy. The market didn't understand.
In its Monetary Policy Report, released on Thursday, June 25th, the Central Bank showed with data that inflation will be converging to 3% in 2028. And it denied extending the timeframe for reaching the target. In short: it's uncertain whether the Selic rate will fall in August because cutting interest rates will require political maneuvering in addition to sound fundamentals.
This year, the Selic rate fell from 15% to 14.25%. And that's it. The real interest rate is hovering around 10%. This is a telling result regarding the challenge facing the next government: lowering the interest payments on the public debt, which exceeds R$ 1 trillion in 12 months.
On Tuesday, June 30th, the Central Bank will publish the balance of public accounts for May. It is an illusion to expect a change in financial expenditure. For this reason, the expectation prevails that the future "economic team" will commit to fiscal adjustment or be forced to do so.
"Transition" in Itaú's economy
"To achieve this, Brazil will need to break its long-standing pattern of seeking balance predominantly through increased revenue collection, without robustly addressing the structural dynamics of spending – a model that perpetuates an environment of high real interest rates and low economic growth."
This warning, while current and relevant, was issued in January by Itaú's Economic Research department under the leadership of Mário Mesquita , former Director of Economic Policy at the Central Bank. After a decade at Itaú, he will leave his post on Wednesday, July 1st. He will be succeeded by Diogo Guillen, also a former Director of Economic Policy at the Central Bank.
Recognized for his technical rigor, Mesquita, who will continue to represent Itaú's macroeconomic functions, endorsed the detailed report on fiscal proposals for 2027 signed by experts Pedro Schneider and Thales Guimarães.
In the document, they estimate that, if current rules are maintained without any course correction, the fiscal adjustment needed to stabilize public debt, at around 4 percentage points of GDP, will be increasing and of even more significant magnitudes.
"An effective adjustment will require a credible strategy and profound reforms to the budget and fiscal rules," point out the economists, who believe there are alternative fiscal adjustment strategies, starting with the pace of implementation.
Accelerated fiscal adjustments, they explain, tend to generate more immediate gains in credibility and a reduction in the risk premium, while gradual processes tend to lose momentum over time. Adjustments focused on reducing expenses are more effective in addressing imbalances, as well as being less recessionary than those based on increased revenue, a point that is particularly relevant in a context of high interest rates, such as in Brazil.
Schneider and Guimarães believe that simple, predictable, and mandatory spending rules are superior to primary result or debt rules, since they seek to directly control the source of the imbalance. Thus, the format of an effective adjustment plan would involve measures with a significant short-term impact and a greater focus on containing expenses.
Alongside these measures, a spending rule linked to the debt trajectory, which would at least temporarily lead to a return to a regime of zero real spending growth, could help increase the likelihood of a successful fiscal adjustment, argue the pair of economists.
They acknowledge that the set of measures needed in an adjustment "include notoriously difficult issues," such as the relationship between spending and the minimum wage and constitutional floors, reforms to social security and social assistance, subsidy cuts, and a review of tax benefits, aiming for an improvement in the primary result of 6.8 percentage points of GDP by 2036 compared to the scenario without reforms, with about 70% of that coming from controlling expenses.
Schneider and Guimarães calculate that implementing these measures could generate a primary surplus of around 1.3% of GDP as early as 2028 and up to 3.7% of GDP in 2036, in addition to bringing public debt to levels below current levels, creating a basis for sustainable economic growth with reduced real interest rates.
