Rising dollar and rising future interest rates; How the market reacted to the announcement of government spending cuts

Market anxiety was high for the release of the spending cuts package, as was the market’s reaction to the news. The first effect, which came even before the official numbers, was the spike in the dollar, which on Wednesday (27) reached the highest level in history: R$5.91. The stock market also fell significantly on the same day. But it didn’t stop there.

The market reacted disproportionately, assesses André Galhardo, chief economist at São Paulo Economic Analysis. In the expert’s opinion, the problem lies in the joint announcement with the Income Tax exemption for those earning up to R$5,000. “In the interpretation of the financial market, the joint disclosure with the so-called ‘income reform’, a Lula campaign promise, was inappropriate.”

“On the one hand, the government announces measures that support compliance with the fiscal framework in the long term, but jointly announces a measure that aims to have greater tax expenditure. “The problem lies precisely in announcing savings on one side and spending on the other,” says Galhardo.

Immediate impact on the dollar, high inflation

This Thursday morning (28) the dollar broke the R$6 barrier and spent the day hovering around that value. For the economist, “unless there is unexpected news, it is unlikely that the American currency will devalue in relation to the real in the coming days, and then we have an inflationary problem — which we were already facing in the last quarter — and which could be worsened by this extra exchange rate devaluation.”

The disproportionate reaction of the market — which expected even more significant cuts — is reflected in the future interest rate. An increase in the Selic rate at the next Copom meetings had already been predicted and expected, but this joint announcement of the IR exemption should result in an even greater increase in the interest rate at the next meeting, scheduled for December.

And André Galhardo warns of an impact that could affect the economy as a whole.

“On the one hand, you exempt families that earn up to R$5,000 from income tax, but on the other hand, the exchange rate devaluation process itself, resulting from this announcement, ends up bringing more inflation. So, you save on taxes, but end up spending more on products in general.”

Main points of the package

Among the highlights: a ceiling for the adjustment of the minimum wage and the medium-term reduction of the salary bonus. The richest also contribute to the package, as among Haddad’s proposals is the end of exceptions that help to circumvent rules to break the ceiling in public service and, also, a reform of military pensions.

A ceiling will also be established to curb the growth of parliamentary amendments, as well as the imposition of limits on the release of tax benefits. A fine-tooth comb on benefits such as BPC and Bolsa Família are also among the measures that need to go through Congress to take effect.