But still… there is a lot to be done.

In spite of everyone’s criticisms to the current monetary policy, there are good news in the coordination of economic policies under the government of Dilma Rousseff. Differently from before, this government has been recognizing that a tighter fiscal policy could help the Central Bank (CB) to implement a laxer monetary policy. On the other hand, the CB has been conditioning new SELIC cuts to the achievement of fiscal targets.
Policy makers are now understanding the need to implement a tighter fiscal policy in exchange for a lower SELIC rate, but in practice there are serious challenges to adopt a more restrictive fiscal policy in 2012. The most evident one is the minimum wage adjustment of 14% to be enacted at the beginning of the next year. As social security payments are linked to the minimum wage, this will increase the social security deficit to 1.2% of GDP from 1.0% in 2011, not to mention the impact on the wage bill. Another barrier for implementing a better fiscal result is political: this year’s expenditures cuts generated some problems within the governmental base and in Congress and repeating the medicine next year could prove to be too bitter. In addition to these factors, public revenues could drop as share of GDP (from 23.8% this year to 23.6% in 2012) as the economy slowdown in 2012. Finally, the need to make investments in preparation for the 2014’s World Cup and 2016’s Olympics should reduce the room for expenditure cuts. All in all, expect to see the primary surplus to reach 2.7% of GDP and, therefore, to fall short of the 3.1% target.

On the negative side the country still misses a better coordination between monetary and credit markets. Public credit continues fueling the dynamism of credit markets, which restricts the space for implementing a laxer monetary policy. In line with this view, the Central Bank suggested recently in one of its communiqués the introduction of measures to moderate the concession of subsidized credit (a clear reference to credit supplied by the BNDES, the development public bank).

In contrast with other sectors, credit markets have barely moderated. The credit stock is growing around 20%y/y since the middle of 2010, and will surpass the CB’s 17%y/y forecast for overall expansion this year. In September, public credit grew 21.2%y/y, with no sign of moderation (21.4% y/y in Q1 2011). Also in September, private credit expanded 18.4%y/y, down from 19.9%y/y in the first quarter of the year (see chart below).

In spite of its resilience, one should expect to see credit markets to follow the overall tone of the economy and to ease. If that proves not to be the case, then the CB will have less space for implementing a laxer monetary policy, and the risks of overheating will increase.

In this context, and with additional reductions in the SELIC, expect to see more “macro-prudential” measures to keep credit markets under control.

Sources: Brazil Central Bank, Bloomberg, BBVA Research

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