Fiscal crisis in Brazil: a microwave-pizza approach

Inflation gives no sign of relief and fiscal figures are getting worse. As recession deepens, Brazil is still looking for the bottom of the crisis. Português

João Ricardo Mendes Gonçalves Costa Filho
7 March 2016

worker stands in a partially completed construction project in the Vidigal 'favela', or community, on March 3, 2016 in Rio de Janeiro, Brazil. Mario Tama/Getty Images. All rights reserved.

The Brazilian recession is deepening and we are still looking for the bottom (and hoping that we are not going to find a “hatch” when we hit there). Inflation gives no sign of relief and fiscal figures are getting worse. This is not the first time I address this issue (see here), nevertheless I think we should tackle it from a different perspective: the “microwave-pizza impact” on Brazilian near future. Spoiler alert: it is not a good thing.

The current fiscal dynamics

Brazil “took off” in a famous The Economist cover, but its propulsion was supported by the recovery from the 2008 financial crisis that masked the real supply-side constraints we have managed to avoid throughout the past fifty years. It is difficult for a company in Brazil to survive due to the heavy tax burden. As a citizen, the level of our tax load is outrageous, especially given the far-from-satisfactory public services. Add a poor infrastructure, protectionism, insistent demand-expansionary policies such as tax cuts (yes, we still pay a lot of taxes even though there have been some tax cuts) and credit increases via public banks and we get toady’s situation: macroeconomic disorder and microeconomic hurdles.

When the macroeconomics is wrong, the impact of good microeconomic policies hardly appear. How can we feel productivity gains if everybody has been diminishing production?

Amid a recession we could consider fiscal expansion. But the traditionally Keynesian receipt faces a problem: there is no room for expansion. We are already spending more than we should. Government spending rises even though revenues may not follow them. (The reason is addressed here). But, doesn’t the European experience call for avoiding away austerity right now, since “the boom, not the slump, is the right time for austerity” (John Maynard Keynes 1937 Collected Writings)?  

First, the Brazilian currency area has fulfilled the requirements while the European hasn’t (see here), hence the situation is different across the Atlantic. Second, the political economy of our deficits reveals that whenever the situation is good we do not tackle our structural problems. Third, money – and perhaps patience – is vanishing. Graph 1 presents Central Government Revenues and Expenditures (without adjusting for inflation). Expenditure has grown steadily while revenues have been surprising negatively for more than a year.

Graph 1 – Central Government Result: Revenues and Expenditures

Graph 1.jpg

Source: Data from Brazilian Central Bank; author’s elaboration

Primary surpluses become deficits and we had to choose whether to print money, raise debt or taxes (since spending cuts are out of question, unfortunately). In some sense, we have being doing all of them.

Inflation has been stubbornly above Central Bank’s target. It should have being around 4,5% (calendar-year), but in the last twelve months it has achieved 10,71%. For a country that experienced hyperinflation in the past, two-digit figures are a major concern. And given the lack of expectations anchoring and inertia, the recession alone will not be able to bring it down to the target.  

Among the main reasons inflation is high there are the relative price adjustments: administered (government determined) prices versus “free” (market determined) prices and the exchange rate. Climate issues have also contributed. Moreover, we were operating in a high level before these shocks hit the economy. If we had managed to maintain services prices around 4,5%, for instance, even after all those realignments, we would not have hit the two-digit level. Hence the expectations lack of anchoring.

Graph 2 – Twelve-month accumulated consumer inflation

Graph 2.jpg

Source: Data from Brazilian Central Bank; author’s elaboration

Besides the rising inflation, low primary surpluses and the new primary deficits accelerated public indebtedness. As a percentage of GDP, gross debt hit 67,03% in the first month of 2016, from 58,12% one year before.

Graph 3 – Gross Public Debt (%GDP)

Graph 3.jpg

Source: Data from Brazilian Central Bank; author’s elaboration

Neither the “picture” of 2015 nor the “movie” of how we got there is encouraging.

What about the (near) future?

The prognostic of Brazilian fiscal figures may depend on how much families will substitute market production for household production. That means, for instance, instead of restaurant dinners and retail shops, families may decide to eat at home, postpone or cut other purchases and/or do it by themselves. The trade-off is that on one hand, there is no outlay when you are doing by yourself (you do not pay a wage or a markup for yourself). On the other, you are giving up other things such as leisure to do the task (what economists call opportunity cost).  

During recessions, there is a growing demand for goods that help you produce at home, relative to those acquired in the market. The last graph presents the performance of supermarket sales and food-related services. I have deseasonalized volume sales for both, calculated the three-month moving averages and then calculated the growth relative to the same month in the previous year.

Graph 4 – Supermarket and Food-related Services

Graph 4.jpg

Source: Data from IBGE; author’s elaboration

It is easy to see that the deceleration is higher in retail “food-services” (our proxy for market-produced products). Of course one should expect that both would decrease. But this means that we are changing restaurant dinners for microwave pizzas. The problem is that this natural change will increase our fiscal problems further.

The Luka Barbosa’s thesis (advised by Gino Olivares from Insper) showed that aggregate tax revenues respond to retail sales, employment and real wage more than to the GDP performance. Retail sales were the last to feel the impact of the recession, meaning that there is more room to fall. Furthermore, the labor market adjustment is not complete and more deterioration is expected. Both “feed” each other and contribute for lower public revenues, while spending rises since we cannot manage a fiscal consolidation due the political gridlock that has been established since the first month of the President’s new mandate.

Microwave pizza may taste good, but certainly not as good at as restaurant pizza. This is also true for public finance and the Brazilian fiscal crisis.

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