Lula is right, and the Central Bank is the cause of the fiscal imbalance.

Eleven out of ten economists directly or indirectly linked to the financial market attribute the high level of the Selic interest rate observed in Brazil to the fiscal imbalance of the central government (federal government + Central Bank). According to their reasoning, since the government spends more than it collects, it needs to borrow a lot of money from the market, increasing the demand for credit and, given the low savings rate in Brazil, producing a high interest rate. The solution is to reduce the primary spending of the general government, cutting unnecessary and/or inefficient expenses (which ones?), in order to reduce the interest rate. In this way, the Brazilian fiscal imbalance would originate from the excess of primary spending of the general government, which is why the spending cap should be maintained by force by the economic team of the new Lula government.

At the inauguration of the new president of BNDES, Aloisio Mercadante, President Lula once again spoke out against the Central Bank's Monetary Policy Committee's decision to maintain the Selic rate at 13,75% per annum. With accumulated inflation over 12 months of 5,79%, the real interest rate (ex-post) is 7,52% per annum, the highest in the world. President Lula stated today that "There is no explanation for the interest rate at 13,5% [13,75%). We have been fighting for the interest rate in Brazil for years."

There is no effect without a cause. Of course, there is an explanation for the high level of interest rates in Brazil, but that explanation is not fiscal imbalance. On the contrary, The fiscal imbalance is a result of the interest rate policy adopted by the Central Bank of Brazil in recent years..

Let's look at the numbers. Figure 1 below shows the 12-month cumulative evolution of the central government's primary result and the nominal interest that the central government pays on its debt stock. Note that until March 2020 (the month in which the first social distancing measures were adopted in Brazil), the central government incurred a primary deficit of around 1,5% of GDP and paid nominal interest slightly above 4% of GDP. With the primary spending undertaken to address the economic, social, and health consequences of the Covid-19 pandemic, the public sector's primary deficit increased to almost 10% of GDP in December 2020, but the payment of nominal interest fell to 3,5% of GDP that month, continuing its downward trajectory until June 2021 when it reached 2,93% of GDP. Please note, dear readers, that a spectacular increase in the central government's primary spending (as a percentage of GDP) was achieved with a reduction in the nominal interest payments made by the central government, that is, an OPPOSITE result to that expected based on the economic theory used by financial market analysts. What is the reason for this? Very simple: the interest rate is not the price of "loanable funds" but the price of money, which is set by the Central Bank at the Copom meetings. As the Central Bank reduced the interest rate to 2% per annum throughout 2022, the cost of carrying the public debt (strongly tied to the Selic rate due to Treasury Financial Bills and repurchase agreements) decreased by almost 25% between March 2020 and June 2021.

In March 2021, the Central Bank of Brazil began a cycle of interest rate hikes that brought the Selic rate to 13,75% per annum at the end of 2022. This increase in the Selic rate caused nominal interest rates to rise from 2,93% of GDP in June 2021 to 5,12% of GDP in December 2022, exceeding the level observed in the period prior to the pandemic. During the same period, the primary result of the general government went from a deficit of 4,61% of GDP to a surplus of 0,56% of GDP. In other words, an improvement in the primary result of 5,17% of GDP was followed by an increase in nominal interest expenses of 2,19% of GDP. A significant portion (42%) of the improvement in the primary result was dissipated in increased expenses related to public debt interest.

Figure 2 below shows the percentage of the general government's nominal result (without currency devaluation) that can be attributed to expenditure on public debt interest payments.

The reader can verify that interest expenses accounted for approximately 80% of the general government's nominal deficit (without currency devaluation) until the beginning of the COVID-19 pandemic. This percentage fell to just over 20% by December 2020 due to the increase in the primary deficit and the reduction in interest expenses. From March 2021 onwards, the percentage increased again, exceeding 100% at the beginning of 2022. In December of last year, expenses for interest payments accounted for 112% of the general government's nominal deficit.

These figures leave no room for interpretation other than that the fiscal imbalance in Brazil is of a financial nature. In this context, reducing primary spending is not only cruel from a social point of view, but also stupid from an economic point of view. Rebalancing public accounts in Brazil requires solving the problem of the "missing expenditure" in the public debate in Brazil, that is, the excessive spending on interest payments on the public debt. Its solution lies in monetary reform in Brazil and in the institutional framework of the inflation targeting regime, in order to allow for a stable and reasonable inflation rate (something like 4% per annum) to be achieved with a structurally lower interest rate.