Walter Molano | Budget season
Budget season is upon us, as governments around the world establish their parameters for next year’s fiscal policy.
While budget season is important in any year, this time it will provide important insights into the assumptions governments are using following the devastating impact of the COVID-19 pandemic.
Mexico is a good place to start. In contrast to many governments, which are throwing fiscal discipline out the window, the administration of Andres Manuel Lopez Obrador has decided to implement an austerity budget for 2021. Their aim is to eliminate the primary budget deficit in order to reduce the stock of sovereign debt.
Mexico’s debt-to-GDP ratio is estimated at 54.7 per cent this year, but the government intends to reduce it to 53.7 per cent of GDP by the end of next year. Of course, the administration is using several optimistic assumptions to get there.
To begin with, it is assuming a GDP growth rate of 4.6 per cent in 2021, which is much higher than the 3 per cent consensus forecast. It is also using an average annual oil price of US$42.10, which is on the high side of market expectations. Last of all, it is assuming an average daily oil production rate of 1.847 million barrels per day, which is also on the high side of expectations.
Nevertheless, the government’s attempt to rein in the fiscal deficit will be welcomed by the rating agencies, which have had Mexico in their cross hairs for some time. It is also helping to explain the continued strength of the currency.
The Mexican government seems to be bucking the global trend towards more fiscal largesse.
Brazil is another country following the Mexican trend, by showing a remarkable level of fiscal restraint. The administration of Jair Bolsonaro submitted its proposed budget at the end of August, using a GDP growth rate assumption of 3.2 per cent for 2021. This was actually a little lower than the consensus forecast of 3.5 per cent.
One of the constraints to the government’s budgetary planning is the fiscal responsibility rule, which limits the shortfall. This forced the government to scrap a new social programme called Renda Brasil, which was supposed to replace former President Luiz Inacio Lula da Silva’s very popular Bolsa Familia programme.
New government assistance programmes significantly boosted President Bolsonaro’s popularity during the pandemic, and it was why he wanted to promote Renda Brasil. Local economists argued that the circumstances of the COVID-19 pandemic justify a breach of the fiscal rules.
However, the spending cap is constitutionally mandated and Finance Minister Paulo Guedes is refusing to violate the rule. This has created a bit of tension within the government. Nevertheless, the tough fiscal position could be one of the reasons why the Brazilian currency has finally found a floor and is starting to recover.
No restraint from Argentina
Argentina is another country in the midst of its budgetary preparations for 2021. Unfortunately, unlike Mexico and Brazil which are showing restraint, the left-of-centre Fernandez administration is pulling out the spending stops. No longer constrained by its need to service its debt, it is shooting for a primary fiscal deficit of 4.5 per cent of GDP.
Fortunately, it will monetise the shortfall without creating additional inflationary pressures. This is the reason why the government is expecting the inflation rate to fall to 29 per cent, which is significantly less than the 46.5 per cent market consensus. The government is also wishing for a GDP growth rate of 5.5 per cent in 2021, well above the market consensus of 4.5 per cent growth. It hopes to do this by increasing public-sector spending, directing funds into many of the infrastructure programmes that were started during the previous administration.
It’s hard to see how this populist administration will attract much investment from the private sector. One of the many populist measures the government is considering is a solidarity tax, which will be a one-time levy on the richest individuals in the country.
Not surprisingly, many of these households are picking up and moving to Uruguay, marking another exodus of the country’s physical and human capital.
Another interesting country that is working on next year’s budget is Ukraine. The government is expecting a GDP growth rate of 4.6 per cent, which means that there will probably be a significant payment of the GDP warrants in 2022. This is probably the reason the government has been buying back its GDP warrants in the secondary market.
As it stands now, the fiscal deficit will be 6 per cent of GDP in 2021, and it is forcing the government to consider higher taxes on a range of consumer products — which would only serve to cool the economy.
The various budgetary exercises across the emerging markets underscore the assumptions governments are using for next year.
It is clear that most are expecting a solid bounce from the pandemic, which means that they are assuming some sort of vaccine or mitigation of the spread. This could provide a ray of hope for investors.
Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.