MNI INTERVIEW: Iran War Fuels Brazilian Fiscal Risks

So far Brazilian government measures to contain fuel prices amid the war in Iran are set to have a neutral fiscal impact, but additional measures are likely and could add to inflation expectations and increase fiscal risks, former Treasury Secretary Jeferson Bittencourt told MNI.

"The first set of measures, with an estimated cost of BRL30 billion, was offset by an export tax on crude oil and diesel. From a strictly fiscal standpoint, this initial tranche of measures has a neutral impact,” said Bittencourt, now head of macroeconomics at ASA Financial Institution.

"If the government continues trying to mitigate these effects, which may persist for an extended period, there may be a temptation to declare a state of emergency or to resort to extraordinary credits exempt from the primary balance target, as was done in other cases.”

While the government reduced federal PIS/Cofins taxes and provided consumer subsidies calculated to take BRL0.32 off the price of a liter of diesel, pump prices went up regardless and truck drivers have still threatened to strike, Bittencourt noted.

"The federal government has signaled that its package of measures is not yet finalized,” he said.

The government has indicated that it could use a BRL7 billion windfall from an upward revision of its budgetary assumption for the price of Brent crude to USD73 from USD66 to compensate state governments for revenue losses from a temporary exemption from their value-added ICMS taxes on diesel imports for two months. However, Bittencourt noted that while tax exemptions will have a predictable cost, oil market fluctuations could erode the government’s gains from higher prices.

"Upward revisions to gross general government debt are expected, which could exceed 83% of GDP by the end of 2026, marking an increase of nearly 12 percentage points of GDP over the past four years," he said.

HIGHER RATES AMID WAR

The fiscal cost of attempting to contain the effects of the war is also likely to add to inflation expectations, meaning that Brazil faces higher interest rates than projected at the start of the year, as well as slightly lower GDP growth, Bittencourt said. 

The easing cycle undertaken by the Central Bank of Brazil’s Copom monetary policy committee could now be shorter or more gradual, with a growing consensus that the terminal rate is likely to be closer to 13% than the 12% previously expected, he said.

"In this context, the Copom delivered a 25-basis-point cut at its last meeting, whereas the vast majority of the market had expected 50bp before the war, alongside a steepening of the entire yield curve,” Bittencourt said. (See MNI BCB WATCH: Easing Pace Unclear Due To Iran, More Cuts Seen)