Spend Less Lula For The Sake Of Brazil

Editor's Note: Lula in Brazil, has decided to cut public spending by more than U.S. $ 11,000 million. The United States Congress did not approve a tax, and Lula, appealing to fiscal sanity, decided to spend less. Is this good or bad? I can send your comments to: paola@moneyweekes.com

Spend Less Lula of Brazil for Good

Buenos Aires, Argentina

April 9, 2008

Who knew at the beginning of his term! Who would have imagined Luiz Inacio Lula da Silva to decide a cut in public spending to maintain fiscal accounts in order? ... Perhaps the Brazilians would have to be thankful for this decision, some will think ... Why is that Brazilians should welcome the decision to take Lula to reduce fiscal expenditures in U.S. $ 11,411 million?

No doubt that a beneficiary, directly or indirectly, public spending must like this kind of decision. I imagine the construction companies participating in tenders for public works ... do not think they are very happy ... of course not. Is that the Lula government should solve the problem that arose from the non-approval by Congress on the extent of transaction tax, which the government took away income from $ 23,000 million.

Beyond the discontent that many Brazilians may have about this decision, the fact is that I understand it is a good measure .... Why I think is a good decision? ... Let's see:

First is a clear sign of the continuity of economic policy line that is carrying on the government of Lula. It shows that markets beyond the circumstances, there is a concrete commitment to maintaining fiscal discipline. In many instances the countries of the region have enjoyed budget surpluses but, at the slightest variation in the economic climate, it vanished off the poor decision to hold governments (and care), and it was demonstrated that the discipline tax was not one of the objectives of these governments, but circumstantial situations one who knows what (product of privatization? do extraordinary recoveries revenue?, etc, etc).

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Another effect that may occur marginally, but not the main objective of this measure is an attenuation of inflationary pressures by reducing domestic demand. This resulted from lower spending even more relevant when one considers that activity indicators are showing strength in domestic demand, which can put pressure on prices and force the Central Bank of Brazil to determine a rate hike benchmark interest Selic, currently stands at 11.25%.

Inflationary pressures in Brazil, like what is happening in other Latin American countries are latent and are driving the market mood to the point that last week, economists raised their forecasts for the benchmark Selic rate to 12 , 5% by the end of the year (from 12% previously projected), while also boosted estimates for the HICP inflation rate to 4.5% (from 4.47%).

And when inflation threatens to subside, immediately accused the real impact as the market anticipates a possible increase in rates. That's exactly what happened when he met the change in market expectations which provides a greater increase in the Selic rate at the end of the year. The dollar again break the floor of R $ 1.70 in recent days.

Given this situation and perhaps as a way to test it on the belief that monetary policy has been carried out since the Central Bank of Brazil, at the annual meeting of IDB asked its president, Henrique Meirelles on possibility of the Brazilian monetary authority chooses to set specific levels on the exchange rate. Meirelles, unhesitatingly and emphatically called this alternative as "incompatible? with efforts to preserve the inflation rate under control. As the president of the Central Bank of Brazil: "Countries that have tried to engage in non-explicit goals (in the exchange rate) have also had serious problems with inflation?.

Not bad that Meirelles think so, but perhaps should have his words carefully because among the audience were officials from Latin American countries that intervene the foreign exchange market to maintain stability implicitly determining exchange rate ... I imagine that after their statements were be given any apology.

The truth of this is that so far this year, the real has accumulated a nominal appreciation against the dollar of 4.5% (and 20.4% since early 2007) and is more likely that Brazil will register this year its first current account deficit, after five consecutive years of surpluses. In the meantime, producers can only expect measures to alleviate the negative effects of real appreciation on competitiveness but rarely see a direct action of economic policy on the exchange rate (maybe yes, some slight intervention in the market currencies).

I have not much doubt that Brazil is determined to implement long-term sound policies but must pay any costs in the short. Surely the time will give the reason for this wise decision.

We will meet again tomorrow,

Horacio Pozzo