Difficulties in pushing reforms, political tensions – including fluctuations in the relationship between President Jair Bolsonaro and the Federal Supreme Court (STF) – and great uncertainty over government accounts. Political turmoil and fears of “budgetary populism” in the wake of the 2022 elections are polluting the economic environment, even with expectations for gross domestic product (GDP) growth close to 5% in 2021, the highest in 11 years.

The complex political scenario, with just over a year left before the elections, makes it difficult to achieve a more consistent exchange rate depreciation, which would be a natural consequence of high commodity prices and good export performance, and to fight inflation.

Economics Minister Paulo Gedes himself acknowledged the problem. “This dollar should have been falling, but the political noise is preventing it from falling,” he said on Tuesday (14).

Another consequence of volatility is that the stock market is not growing as much as it could, even after the companies performed well in the second quarter.

On September 8, the day after Bolsonaro criticized STF again, B3 closed the day with a 3.75% fall, the worst in six months. At the time, the dollar hit its biggest daily high in just over 14 months – rising 2.84% at the close.

Subsequently, these movements were canceled, especially after the president issued a statement to the nation stating that he never intended to attack any of the powers. However, given the history of the relationship between Bolsonaro and STF, the market remains in the shadows, suspicious of what may happen from now on.

XP Investimentos analysts note that divisions between the executive, judicial and legislative branches of government make it difficult to resolve economic issues such as the complexity of judicial decisions and the promotion of reforms and privatization in Congress, and exacerbate the already high fiscal risk. This affects future interest rates and fixed income premiums.

Paulo Gama, an XP political analyst, notes that, despite a placating note released by Planalto last week, “the story gives us hope that this characteristic of confrontation and the resulting instability will continue.”

According to Gama, a continuous rise is not expected, but rather there will be ups and downs, moments of greater or lesser tension. “This movement is intensifying with the 2022 electoral period approaching,” he says.

“Attention will also be focused on the development of the political scenario, in particular on the voting in the National Congress, such as the discussion of the budget for 2022, concerning preliminary expenditures,” said the chief economist of Fibra Bank, Cristiano. Oliveira.

The combination of risks makes the scenarios worse

The combination of risks has boosted forecasts for exchange rate, inflation and base interest rate. And reduced the estimates for GDP.

Five weeks ago, the financial market forecast 5.3% economic growth this year, according to the central bank’s median forecasts in a Focus report. Now the latest bulletin points to a rise of 5.04%. For 2022, the average forecast dropped from 2.05% to 1.72%. This index may fall further, judging by the wave of revisions caused by the stagnation of the economy in the second quarter.

This deterioration in sentiment in Brazil comes at a time when the international market is showing signs of recovery. While global markets are recovering, as in the case of the US, the Brazilian stock market has fallen by about 3% since the beginning of the year, even under a favorable microeconomic scenario for companies. Brazil’s country risk, as measured by 5-year CDSs, increased 25% over the same period, according to Investing.com.

Political risk and the prospect of tough elections in 2022, in addition to fiscal risk, are prompting exporters to keep some of their dollars outside Brazil – more than $ 40 billion is held abroad, according to data from the Central Bank and Foreign Trade. Secretariat (Secex). As a result, the supply of dollars in the Brazilian market does not increase as much as it could, preventing a sharper fall in prices.

And even positive news coming from the fiscal side, such as lower-than-expected primary deficits and higher tax collection rates since the turn of the century, are not stimulating the economy.

“Positive annual results may ultimately represent more risk than relief in the face of the current difficult financial situation, if viewed as a ‘fiscal bonus’ for an election year,” said Caio Megale, chief economist at XP Investimentos.

Elections tend to put more pressure on government accounts

And it is in the pre-election scenario that discussions about government accounts become more active, says analyst Davy Lelis of Valor Investimentos. “That’s when governments are more likely to take more populist measures.”

One example is the issuance of court orders. The government has an amount of R $ 89 billion to be paid next year, but is seeking to pay part of that amount in installments. He has already sent a proposal to Congress to amend the Constitution (PEC) and in parallel is participating in similar negotiations with the participation of the Federal Accounts Chamber (TCU) and the National Council of Justice (CNJ).

These negotiations lost momentum following Bolsonaro’s September 7 statements, but Minister Paulo Gedes is still demanding assistance. “How do I react? Help, Minister [Luiz] Fux [presidente do STF]; help, president [Rodrigo] Pacheco [do Senado]… How can I fulfill our commitment, the increase in the Bolsa Família, which everyone knows is necessary? “, – said Guedes on Wednesday (15).

The purpose of the installment plan is to make room for other costs, such as the expansion of Auxílio Brasil, the successor to Bolsa Família, without breaking the cost ceiling.

This measure does not enjoy a good reputation in the financial market. “This represents a Union default and gives a negative view of the financial market,” says Kamila Abdelmalak, chief economist at Veedha Investimentos.

According to Etore Sánchez, chief economist at Ativa Investimentos, the installment plan is changing the dynamics of government debt, as the budget reserve will not be retained to pay off future obligations. “So the trajectory of gross government debt, which was no longer very healthy, is picking up steam, especially for future generations.”

Anti-inflation pollution

The ramifications of this financial uncertainty could hinder the fight against inflation. “The longer it lasts, the lower the chances of inflation getting closer to the target next year, as the worsening economic situation intensifies, even before a determination is made to maintain or change the tax regime,” economists at Bradesco say.

One of the factors affecting prices in Brazil is the exchange rate. According to the median forecasts of financial institutions compiled in the latest Focus report, the central bank should end the year at 5.20 reais, up from 5.10 reais five weeks ago.

The midpoint of market expectations for inflation – in both 2021 and 2022 – is also rising. The IPCA is projected to rise in 23 weeks this year to reach 8%. The following year, the median was 4.03%, after an eight-week high.

As a result, expectations for the benchmark interest rate (Selic), the instrument used by BC to contain inflation, are also increasing. The median forecasts indicate Selic will be at 8% at the end of this year, up from 7.25% five weeks ago. By the end of 2022, the average estimate also rose from 7.25% to 8% in the same five weeks.

According to Bradesco, coordination between fiscal and monetary policy will be the most powerful tool to prevent contraction of economic activity in the leading economic discussions in 2022 and risks of fiscal dominance (when fiscal risk becomes dominant in economic policy), which will certainly add additional factors. list of uncertainties for the year.

The alternative is to clean up the house.

Davi Lelis from Valor Investimentos notes that the main thing for the government right now is to clean up the house in order to provide more predictability for consumers and companies; ensure that inflation does not explode and illuminate the political landscape. “It’s very important to invest in bringing the three powers closer and have a solid articulation in Congress,” he says.

However, Sept. 7 showed that the judiciary and the executive are far from agreeing, and the cancellation of all Senate work this week, determined by House President Rodrigo Pacheco (DEM-MG), shows that the climate with a part of Congress is also not the best. Earlier this month, the same Senate overturned an interim measure by a large margin that created three employment programs of interest to the government.

Kamila from Veedha Investimentos notes that the market believes that the political scenario is bad and hinders the progress of reforms. “They are needed to reduce the ratio between public debt and GDP, which, according to the Central Bank, is currently 83.8%.” Another need, she said, is for the government to signal that it will meet its obligations regarding fiscal responsibility and spending ceilings.