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Are there reasons to doubt fiscal sustainability in Brazil?



Are there reasons to doubt fiscal sustainability in Brazil? - BIS Papers No 20, part 5, October 2003 84 BIS Papers No 20 Are there reasons to doubt fiscal sustainability in Brazil? Ilan Goldfajn1 1. Introduction In principle, a simple calculation should provide the answer to the question posed in the title. The current primary surplus of 4.25% of GDP would be more than 1 percentage point higher than the surplus required to stabilise the debt/GDP ratio, assuming a modest 3.5% GDP growth rate and a real interest rate as high as 9%.2 Projecting these numbers over the next decade leads to a steeply declining debt/GDP ratio over the years (Graph 1).3 Graph 1 However, this simple calculation seems to be insufficient to persuade the sceptics. There is a considerable degree of subjectivity when assessing fiscal sustainability in a real economy. One can always choose sufficiently adverse paths for the relevant variables in the future - GDP growth, real interest rates and real exchange rates - that may lead to different assessments. Debt sustainability exercises should focus on medium- and long-run scenarios, but it is not uncommon to see biased assessments resulting from assumptions that are largely influenced by transitory adverse market swings. In general, neutral assessments are more common in tranquil times. It is important to discuss fiscal sustainability based on the probability of certain assumptions being borne out. What would be the probability of observing further real exchange rate depreciation in Brazil over the next five to 10 years? What would be the chances that equilibrium real interest rates remain as high as the current ones? Both questions are relevant given the sensitivity of the Brazilian public debt to these variables. This note argues that both probabilities are small when a five- to 10-year time 1 The author thanks Armínio Fraga for suggesting the topic of this note and for va

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