IMF Recommends Brazil Keep Rates High, Post Budget Surplus

  • Brazil should post primary budget surpluses of 3.5% of GDP
  • Monetary policy should be tight until inflation outlook falls

The International Monetary Fund made tough policy recommendations for Brazil on Thursday, suggesting that monetary policy remain tight until inflation expectations more clearly approach the official target, and that the government start aiming for strong primary budget surpluses.

Brazil’s current monetary policy settings are “broadly appropriate given inflation expectations,” the fund said at the conclusion of its so-called Article IV mission. The multinational lender said the government should front-load its fiscal consolidation, and suggested a “possible objective” of reaching a primary budget surplus of 3.5 percent of gross domestic product over the coming half-decade.

The IMF’s prescription for monetary policy to remain tight runs counter to market bets that the central bank will lower the key Selic rate in October for the first time in four years. Inflation expectations for 2017 remain more than half a percentage point above the 4.5 percent target, according to a weekly central bank poll.

Critical Juncture

Latin America’s largest economy is mired in a two-year recession, with the highest borrowing costs in a decade weighing on activity. At the same time, Finance Minister Henrique Meirelles is seeking to pass through Congress legislation that would cap spending to ensure Brazil’s long-term fiscal stability. His plan still allows the government to post budget deficits before interest payments through 2018.

With only that spending cap, Brazil would take several years to stabilize its debt, according to the IMF. The country hasn’t recorded a surplus as high as recommended by the fund since 2005, and its last surplus was in 2013. The government forecasts deficits of 2.7 percent, 2 percent and 1 percent from 2016 to 2018, respectively. In 2019, it would be zero, according a presentation of next year’s budget made by the Finance Ministry in July.

The Finance Ministry knows that the spending cap bill isn’t enough and is only the start of a structural fiscal adjustment that includes social security reform and reduction of other obligatory expenses, its press office said by telephone. It said the IMF’s report was in line with what the government is proposing, and that the Finance Ministry will not discuss the numbers of future primary budget targets.

The central domestic risk in Brazil is that the government fails to deliver on its fiscal consolidation, as it attempts to shepherd reforms through Congress with a tight schedule, according to the IMF’s report.

“If key reforms are watered down or get stalled in Congress, the boost to confidence will be short lived, and the recession may continue, putting further stress on income and balance sheets throughout the economy,” the report said. The Finance Ministry is optimistic its spending cap proposal will be approved, with very low risk it is watered down, according to its press office.

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