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ByAntonio Carlos Lemgruber

Although inflation and “monetary correction” have practically disappeared in Brazil since 1995, the country continues to use a strange concept to measure the behavior of fiscal policy: the “primary surplus”. This is the difference between government revenues and government expenses without including one major expense: nominal interest payments.

As far as we know, Brazil is the only country that emphasizes this “primary surplus”, as opposed to the more normal concept of government deficit in nominal terms, including all revenues and expenses.

The problem is that the so-called primary surplus hides more important numbers than it reveals. Unless the public deficit is greater than government interest payments, this strange “primary” concept will always indicate a surplus. Or the other way around: with lowering nominal interest rates, the primary surplus will increase even if all other government expenses are growing faster than government revenues.

There is no technical reason to separate interest payments as a different type of government expense, in contrast to personnel expenses or capital expenditures. By the same token, all revenues must be considered.

What is happening in 2010 in Brazil is that both government revenues and current government expenditures are growing much faster than GDP, while public investments are being restricted and nominal interest payments are becoming less important in the government budget.

In other words, for a given level of “primary surplus”, the government deficit is in fact increasing dramatically. Worse, the growth of the deficit is being accompanied by a huge growth of the size of government revenues and expenditures.

Fiscal policy is becoming a mess: a growing public deficit, a growing tax burden and a low level of public investments.

The right thing to do would be to diminish the public deficit, with more investments and less taxes. Is that possible? Yes. The country just needs to stop spending frantically with personnel expenditures and other current expenditures.

As a by-product, of course, interest rates would fall even more and, consequently, the public deficit could be further reduced.

Analysts talk a lot about a virtuous macroeconomic triple policy approach in Brazil – inflation targeting, flexible exchange rates and primary surpluses. Wrong. What we have is a vicious cycle of populism, with overvalued exchange rates and – as a matter of fact – public deficits. At the end of the day, inflation is a fiscal phenomenon.  

Unfortunately, the efforts of the last 15 years in Brazil, as far as the control of inflation is concerned, might disappear very quickly in the next few years. Just like they did last century in the fifties, and later in the seventies, after two growth periods when many economists were talking about “Brazilian economic miracles” (1952-1957 and particularly 1967-1973).

Again, some analysts are calling the period from 2003 to 2010 as a new Brazilian economic miracle. We have doubts, however, just like in the late fifties/early sixties and in the mid-seventies/early eighties, about the sustainability of this new golden period of low inflation and high economic growth.

The fiscal policy of 2010 may ruin the existing virtuous cycle. Brazil should abandon as soon as possible this emphasis on primary government surpluses. It is meaningless.