Brazil's government on Thursday took a significant step by detailing spending cuts aimed at achieving substantial savings over the next two years. These measures are part of an effort to bolster the new fiscal framework, but they have not calmed the concerns of investors, who remain anxious and have roiled financial markets.
Investor Reactions and Market Impact
The announcement of increased tax exemptions surprised investors and raised concerns about the government's reliance on overly optimistic fiscal projections. As a result, the Brazilian real reached its weakest closing level ever at 5.99 per dollar. Interest rate futures rose further, and the Bovespa stock index fell by approximately 2%. Barclays (LON:BARC) pointed out that the highly anticipated measures to curb expenditures were overshadowed by income tax reform plans aimed at easing the burden on the middle class. This, in turn, limited the credibility of the measures and led to calls for a firmer response from the central bank.Uncertainty over the fiscal outlook had already prompted the central bank to call for structural measures to control spending. In November, the central bank accelerated its tightening pace with a 50-basis-point hike, bringing interest rates to 11.25%. JP Morgan now expects the central bank to hike rates by 100 basis points in the next meeting and views the government's fiscal estimates as overly optimistic.Finance Minister's Response
Finance Minister Fernando Haddad sought to calm the market following a meltdown on Wednesday caused by the announcement of a proposal to increase the income tax exemption threshold for those earning up to 5,000 reais per month from 2,824 reais. After weeks of delays, markets had expected the package to focus solely on spending cuts, in line with previous statements by Haddad. These statements had suggested that the government would wait until next year to propose changes in tax exemptions to fulfill a campaign promise by President Luiz Inacio Lula da Silva.On Thursday, Haddad told a press conference that the broader income exemptions would have a 35-billion-reais fiscal impact, which would be fully neutralized by compensatory measures. These measures will take effect only in 2026 after Congressional approval.Compensation Measures
The government stated that approximately half of the compensation would come from setting a higher effective tax rate for the wealthiest. The proposal would increase the effective income tax rate for those earning more than 600,000 reais per year. For individuals earning over 1 million reais annually, the rate would reach 10%. Currently, the effective tax rate for the top 1% of earners is 4.2%, and for the top 0.01%, it is 1.75%.To cover the remaining fiscal hit, the government would end the income tax exemption for retirees with severe illnesses or those who suffered accidents and earn above 20,000 reais per month, among other measures. Media reports of a coming increase in the income tax exemption had already dampened market sentiment even before the official announcement.Haddad emphasized that the US dollar has been strengthening globally, and that inflation in Brazil is expected to end the year within or very close to the official target range of 1.5% to 4.5%. He stated, "The market needs to reevaluate what the government is doing. They have been incorrect in terms of growth and deficit projections. Our work is not complete. I do not believe in quick fixes. I am satisfied with this year's results." ($1 = 5.9377 reais)READ MORE