Brazil Pledges $30 Billion Spending Cut to Ease Rate Increases

Brazil’s government pledged yesterday to slash 50 billion reais ($30 billion) from this year’s spending plans in a bid to ease pressure on the central bank to raise interest rates.

The yield on the interest rate futures contract maturing January 2013, the most traded in Sao Paulo, is heading for its biggest weekly drop in almost four months as traders trim bets that inflation, now at a 26-month high, may surge.

“At the margin, it leaves breathing room for the central bank,” Siobhan Morden, head of Latin America strategy at RBS Securities Inc, said yesterday. While the move was “a lost opportunity for a shock of confidence” because the announced amount was in line with market expectations, “there is some relief they plan to deliver” on the cuts, Morden said.

Policy makers, after raising the benchmark rate to 11.25 percent from 10.75 percent last month, said they were counting this year on a wider budget surplus before interest payment to rein in consumer prices. The budget cut announced yesterday, which still needs to be detailed, will remove all stimuli implemented in 2009 and 2010 to spur the economy during the global financial crisis, Brazil Finance Minister Mantega told reporters in Brasilia.

Yields on interest rate futures contracts due January 2013 remained unchanged at 12.68 percent yesterday. The yield plunged 23 basis points, or 0.23 percentage points, in the two previous days as traders anticipated the budget cut.

‘Have to Wait’

Yields may rebound today as investors wait for details on how the government plans to deliver the promised budget cut, Marcelo Salomon, chief economist for Brazil at Barclays Plc. In New York, said in phone interview.

“There was already the expectation that this would be the size of the cut, but what we lack is how it will be achieved,” said Alexandre Santanna, an economist at Rio de Janeiro-based BNY Mellon Arx, which manages 12 billion reais. “It’s a good level, but with the fiscal policies of the former government and not knowing where the cuts will come from, we have to wait.”

Social programs and infrastructure investments will be maintained, while government hiring will be frozen, funding to the state development bank reduced and all ministries forced to trim spending, Mantega said.

Brazil missed its fiscal targets last year as Lula kept in place tax cuts enacted after Lehman Brothers Holding Inc.’s bankruptcy in September 2008 and boosted spending in the run up to Rousseff’s election.

Deterioration

Rousseff has promised to curb spending that increased faster than economic growth under her predecessor Luiz Inacio Lula da Silva.

In a speech opening Congress Feb. 2, the president told lawmakers she is committed to “maintaining a macro-economic policy compatible with fiscal balance, a firm control of inflation and rigorous use of public money.”

Brazil’s budget deficit before interest payments, the so- called primary surplus, ended 2010 at 2.8 percent of gross domestic product, short of the government’s 3.1 percent target.

The International Monetary Fund, in a report last month, said Brazil saw a “particularly pronounced” deterioration in its public finances and is expected to miss its 2011 surplus target by a “wide margin.”

The central bank, in the minutes to their Jan. 18-19 meeting, said they are counting on a primary surplus equal to 3 percent of GDP this year to help slow inflation.

‘Shot in the Arm’

Mantega repeated today that the government would meet its primary target of 117.9 billion reais this year without relying on one-time revenue windfalls or accounting changes as it did in 2010.

The target is equal to 2.9 percent of nominal GDP, which he estimated would reach 4.1 trillion reais.

Finding ways to do more with less resources will be the government’s new “mantra,” Planning Minister Miriam Belchior told reporters. To rein in spending the government will ban the purchase or rental of new properties and also prohibit the buying of new cars, she said.

Mantega said the budget cuts will deliver an immediate “shot in the arm” of the economy that should allow the central bank to reduce interest rates at an “opportune” moment. The cuts won’t harm the economy, which will grow 5 percent this year, he said

Traders are wagering policy makers will increase the benchmark rate to 11.75 percent from 11.25 percent next month as they seeks to rein in inflation running at a two-year high.

Inflation quickened to 26-month high of 5.99 percent in January as record low unemployment and credit growth fueled the fastest economic expansion in more than two decades.

The central bank forecasts Latin America’s biggest economy grew 7.3 percent in 2010.

Balancing Act

Interest rate futures show central bank President Alexandre Tombini may lift the Selic rate to 13 percent by year end, according to Bloomberg estimates.

Morgan Stanley, in a Feb. 7 report, said Brazil has “limited maneuvering room” to cut its budget without overhauling the country’s pension system and reducing 553 billion reais in non-discretionary earmarks that make up nearly three-quarters of this year’s 773 billion reias budget.

A spending cut equal to 1 percent of GDP would slow inflation by 0.32 percentage points, according to the median estimate in a central bank survey published Nov. 8.

As part of the government’s austerity drive, Rousseff has refused to budge on the government’s proposal to lift the minimum wage 6.8 percent this year to 545 reais. Unions, who saw wages rise 62 percent in real terms under Lula, are pushing for a boost to at least 580 reais.

Inflation will remain “around” the 4.5 percent target in the next two years if policy makers increase the benchmark interest rate 150 basis points to 12.25 percent in 2011 and the real remains stable, Carlos Hamilton, central bank director for economic policy, said Dec. 22.