Raising Brazil's spending cap expected to prolong high interest rates

The Brazilian senate’s constitution and justice committee  approved a constitutional amendment to increase the government’s spending cap by 145bn reais (US$27.6bn) for both next year and 2024, which is likely to force the central bank to keep its base rate high for longer, threatening progress of projects in various sectors.

"Interest rates are currently high and have been for a long period of time, making it prohibitive for companies, mainly small firms, to be able to finance new and even some existing projects," Miguel Nery, director of mineral exploration and mining association ABPM, told BNamericas.

Nery said the scenario makes it difficult for small mining companies to move forward with early-stage projects as they face more risks and depend on funding from investors.

The constitutional amendment, which still needs final approval from the senate and from the lower house, which is expected in the coming days, is aimed at maintaining social programs to help low income families, such as Bolsa Família, during the first two years of the administration of president-elect Luiz Inácio Lula da Silva.

Originally, Lula’s transition team requested authorization for extra spending of 175bn reais a year above spending cap rules for his four-year term. But analysts warn that even the lower amount will tend to make it more difficult to combat inflation.

"In our assessment, the new constitutional amendment not only validates a large fiscal expansion in 2023 but also takes place without offsetting revenue or expenditure adjustments, without a commitment to pursue fiscal structural reforms to address known fiscal fragilities, and without a proposal for a medium-term fiscal anchor to replace the now much higher spending ceiling," Goldman Sachs economists wrote in a research report.

"Furthermore, a looser fiscal stance against a backdrop of a tightening labor market undermines the effectiveness of monetary policy and the central bank quest to lower inflation and re-anchor inflation expectations." 

Later on Wednesday, the central bank was expected to announce its latest Selic base rate decision, with most analysts predicting it will stay high for a more prolonged period.

Currently, the rate is at 13.75%, up from 2% at the start of 2021, as inflation remains above the central bank target.

Growth is forecast to slow next year, mainly because of the lagged effects of the increase in interest rates on the real economy.

Lula takes office January 1.