Brazil meets target that does not stabilize debt, says Srour

The relationship between fiscal policy and long interest rates occupies the center of the Brazilian macroeconomic debate.

In an analysis based on a recent study by UBS Wealth Management, Solange Srour assesses that Brazil faces a significant structural challenge: the current primary surplus targets are insufficient to stabilize public debt given the current level of real interest rates.

Two components of long interest rates
The CNN Money columnist explains that the long interest rate can be decomposed into two elements: the expectation of monetary policy over time and the risk premium.

In the case of the United States, the recent increase in long rates does not reflect a loss of confidence in North American fiscal policy, but rather a repricing of monetary policy and the perception that neutral interest rates should be higher in the future, including due to technological changes and the demand for capital generated by artificial intelligence.

In Brazil, the scenario is different. According to Srour, the increase in long rates observed since the end of 2024 is directly associated with a loss of credibility in fiscal policy.

"This increase in the long interest rate that has occurred since the end of 2024 has to do with a loss of credibility in fiscal policy," he stated. She highlights that initiatives adopted during that period deteriorated the prospects for debt stability.

Fiscal shock, not small adjustments
The analyst argues that positive fiscal shocks, such as the spending cap and the Social Security reform, were able to reduce the risk premium by up to almost 200 points.

Based on this, she argues that only a change of regime - and not small adjustments - would be capable of reducing Brazilian real interest rates from the current level of around 7.5% per year to close to 5.5%.

Among the necessary reforms, Srour cites administrative pensions, the de-indexation of the minimum wage and, possibly, the de-indexation of the areas of health and education in relation to tax collection.

To stabilize the debt in relation to GDP (Gross Domestic Product), Srour estimates that a fiscal adjustment of around 3.5% to 4% of GDP would be necessary.

"We have very unambitious primary surplus targets, which do not stabilize the debt", he stated.

She highlights that optimistic projections that point to debt stabilization assume a potential GDP of 3% to 3.5% and real interest rates of 4% to 4.5% - conditions that do not correspond to the current reality, with real interest rates at 7.5%.

Risk of postponing the adjustment
Srour warns that postponing the fiscal adjustment will make the problem even more serious in the future. In a scenario of structurally higher global interest rates, the opportunity cost for investors increases, and the requirement for a primary surplus to stabilize debt tends to grow.

"Brazil's fiscal foundation is out of adjustment and the real interest rate here will not fall with small adjustments, because this has historically never happened", he concluded.

The analyst also rules out the hypothesis of artificially reducing the Selic as a solution to alleviate the cost of debt. According to her, a forced fall in the base rate would lead investors to migrate to longer-term bonds, which offer higher remuneration, putting even more pressure on the risk premium.

See the 5 signs that Brazil's public accounts are at risk

The texts generated by artificial intelligence on CNN Brasil are made based on video cuts from the newspapers in its programming. All information is investigated and checked by journalists. The final text is also reviewed by the CNN journalism team. Click here to find out more.

Source: CNN