Despite all the pomp and circumstance surrounding the unveiling of Brazil’s “growth acceleration plan” earlier this year, many investors have shrugged off president Luiz Inacio Lula da Silva’s latest attempt to “unleash” the economy. There were no fireworks when, after repeated delays, the so-called PAC plan – designed to ramp up annual GDP growth to 5% by next year – was finally announced on January 22; even the local stock exchange index remained alarmingly flat upon its launch, following a long period of exuberant gains. When some state governors said they were not impressed, finance minister Guido Mantega argued that they had either not read or not understood the PAC.
He has since embarked on a crusade at home and abroad to spread the gospel truth about the plan. Nevertheless, few people outside government circles (or outside the sectors that will directly benefit from public investment) would now bet on 5% growth, due to the high tax burden (nearly 40% of GDP) and the planned increase in public spending. Growth engine? “The programme is part of our development agenda,” said Mantega. “It’s a complement to the economic and social policy that has been implemented by the Lula government,” he told Congress last month, as he explained the general philosophy behind the government plan. “There is an economic theory that assumes that the state must be as small as possible. Our government considers it is important that there is a certain level of public spending on investment in some areas, as this may be an engine for growth.” Replying to left-wing critics, he said: “We are not implementing an orthodox policy. We are lowering the primary budget surplus and implementing social programmes that were not done before.”
The PAC is Lula’s primary thrust for economic growth following a disappointing performance during his first term. Most macroeconomic indicators have improved (from inflation to trade balance). Brazil’s financial position has become increasingly robust thanks to a favourable external scenario, but economic activity has remained sluggish: Brazil’s GDP growth is one of the weakest in Latin America, and it has remained well below the performance achieved by other emerging market countries. Now, armed with a new mandate and with a stronger majority in Congress, Lula has pledged to deliver the goods. The plan is intended to address several bottlenecks that hamper economic activity, such as investment in transport infrastructure and energy. Substantial funds will finance social needs in housing and water sanitation.
Most of the funds are expected to come from the government and state-owned companies, and public investment is expected to increase by 1% of GDP, according to Mantega. In the words of Dilma Rousseff, the civil chief of staff who has emerged as an influential government manager, the PAC amounts to “a straight shot of public money in the veins”. Meanwhile, the programme also includes tax breaks to boost the civil construction and capital goods sectors, as well as computer manufacturers. Fiscal incentives are due to amount to 6.6 billion reais (around $3.1 billion) this year and 11.8 billion reais (around $5.6 billion) next year; some of the measures were announced before the plan was unveiled. The PAC reflects a preference within the Brazilian government towards state-led development.
This is in line with the traditional political orientation of Lula’s workers’ party (PT), which is supported by several local economists. Joao Sicsu, from the federal university of Rio de Janeiro (UFRJ), argues that the increase in public investment will lead to a GDP growth of 4.5% and an investment rate of 22% of GDP in 2007. The government is aiming to reach an investment rate of 25% of GDP by 2010. Private joke in public Policy changes have gradually been implemented by Guido Mantega, who succeeded Antonio Palocci last year. Mantega has also appointed more interventionist secretaries at the finance ministry and frequently clashed with the central bank’s cautious monetary policy. As he presented the PAC, he ironically pressed the bank’s president to cut the benchmark Selic interest rates. “You see, Meirelles”, he said as he commented on market projections, “people do expect a decline in interest rates.”
The provocation caused some unease, but was later dismissed as a joke. Nevertheless, Mantega believes that cuts in the Selic rate and a more robust economic growth will allow him to reduce the debt servicing ratios from 5.6% of GDP this year to 3.9% of GDP at the end of Lula’s mandate in 2010. Mantega also says it is now more important to focus on the reduction of the nominal budget deficit than on the primary budget surplus, which excludes interest rate payments. Primary budget targets were introduced almost 10 years ago by the IMF to ensure that Brazil would be able to service its debt and avoid a moratorium.
The new government programme includes an official target of 4.25% of GDP for the primary budget surplus, but it will be able to use a rebate of 0.5% of GDP for a so-called priority investment programme in infrastructure (PPI). In practice, the primary budget surplus may eventually amount to 3.75% of GDP. Nevertheless, Mantega maintains that the nominal budget deficit may be almost zeroed by 2010 [see table]. One of the most severe analyses of the government plan came from Alexandre Schwartsman, who was until recently a central bank director. Now chief economist for Latin America at ABN Amro, he dismissed the plan as “much ado about (almost) nothing”. “There is nothing in the PAC that deals effectively with public spending. The fiscal dynamics is the main obstacle to the success of the programme,” he added. “The programme does not address the reasons for the current weakness of the investment rate.
It says that the public sector invests very little, but it fails to ask why. The reason lies in the fiscal situation of the country. Current government spending increased from 22% of GDP to 33% of GDP within 15 years, and the tax burden also increased, which are two destructive forces weighing on private investment ... The mere notion of putting public investment at the core of the PAC is in itself debatable.” Meanwhile, the former central bank director still backs Meirelles’ controversial policy. “Monetary policy does not jeopardize the plan. Real interest rates have fallen by 5.5 percentage points since October, and will continue to fall to around 7.5% by the end of the year. These are still high by international standards, but they are the lowest in recent history in Brazil. The PAC carries a great fiscal impulse. If you press down the accelerator with one foot, you will have an increase in demand, and you may have to lift the other foot a little,” Schwartsman concluded.
On the other hand, Walter Molano, head of research at BCP Securities and one of the few PAC enthusiasts among financial analysts, believes in a growth spurt. “The shift in external conditions is forcing the credit rating agencies to soften their positions on Brazil, paving the way for an eventual upgrade to investment grade,” he noted recently.