🐉 Dragon unslain

Happy Friday! Today, the latest inflation numbers. The Supreme Court’s decision on how state-controlled companies must be run. And a split-baby solution for payroll tax exemptions. 

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Higher drug prices push inflation up

Brazil’s April inflation rate came in at 0.38 percent, slightly above median market expectations of 0.35 percent. In the last 12 months, consumer prices have risen by 3.69 percent. The cost of healthcare products rose by 1.16 percent in April, the biggest jump among all categories. 

• According to André Almeida, a coordinator at the Brazilian Institute of Geography and Statistics, “the numbers reflect a 4.5 percent drug price increase authorized by regulators.”

 Why it matters. While headline inflation remains on a downward trend, analysts worry about food and transportation prices, which continue to be the key inflation drivers in Brazil.

Expectations. Markets are growing pessimistic about how prices are behaving in Brazil. While forecasts for this year remain within the government’s target band (from 1.5 to 4.5 percent), expectations for 2025 are for higher consumer prices. That should refrain the Central Bank from making deep cuts to Brazil’s benchmark interest rate, which currently stands at 10.5 percent.

Jitters. As we mentioned in yesterday’s issue, analysts are starting to factor in the impacts of the Rio Grande do Sul floods on Brazilian overall inflation. The damages to food stocks are not yet fully assessed, which could make Brazilians’ grocery shopping more expensive (Brazil’s southernmost state produces 70 percent of the rice consumed in Brazil). Damages to infrastructure are set to increase transportation costs.

• Meanwhile, investment firms have begun lowering their GDP expectations by up to 0.3 points. XP Asset has slashed its 2024 growth projection from 2.4 to 2.1 percent, but Fernando Genta, its chief economist, says the impact could be greater.

• Besides higher inflation, the tragedy is set to reduce the purchasing power of millions of Brazilians, and family consumption is the country’s main GDP driver.

Wait and see. If the Rio Grande do Sul catastrophe stops getting worse, the impacts of the tragedy may only become truly visible next month.

Supreme Court keeps governance bar

An 8-3 Supreme Court majority upheld provisions of 2016 legislation on the governance of Brazilian state-controlled companies. The rules in question create barriers for the nomination of politicians to executive positions, such as demanding long quarantines from public office and party leadership before they can be allowed to take board seats. 

Context. A left-wing party in the Luiz Inácio Lula da Silva coalition had questioned the constitutionality of these provisions. Last year, retired Supreme Court Justice Ricardo Lewandowski (now justice minister) had suspended these provisions until the court’s full bench reached a decision.

• Private investors saw these rules as a shield against conflicts of interest and the use of state-owned companies as political bargaining chips. But Mr. Lewandowski ruled that the barriers were excessively restrictive and harmful to political freedoms enshrined in the Constitution.

Yes, but … While upholding the governance standards, the court voted to make an exception and preserve nominations made by the Luiz Inácio Lula da Silva administration that did not meet the 2016 criteria. 

• One such case is Alozio Mercadante, who presided over a foundation maintained by the Workers’ Party and would not be able to be the chair of the National Development Bank (BNDES), or Petrobras chief executive Jean Paul Prates, a former senator.

 Why it matters. Brazil’s main state-controlled companies have, without exception, posted profits without interruption in recent years, according to government data. For investors, that is a direct reflection of the governance standards set by the 2016 law.

• Justice André Mendonça, who voted with the majority, highlighted that the biggest state-controlled companies saw their net profits plummet by 24 percent in 2023 — coincidentally or not, the period during which the guardrails against political appointments had been lifted.

Keep in mind. During the past decade, the massive and controversial Operation Car Wash revealed that several of these political appointees to state-controlled companies used their offices to embezzle public money. A recent World Bank report stated that corruption schemes “were intrinsically intertwined in the structure of political parties” since the democratic transition of the mid-1980s.

• Operation Car Wash’s investigators, however, disregarded due process in many cases — and politicians have bent over backwards to disregard the operation’s findings, as well.

Changes? The House in 2022 passed legislation to lower the governance bar for state-controlled firms, but the bill has stalled in the Senate. 

• Meanwhile, under Workers’ Party leadership, Petrobras tried to change its statute to make it easier for the government to make purely political nominations to its board — but an ensuing investor selloff forced the company to back down.

Payroll tax exemptions to be gradually lifted 

Finance Minister Fernando Haddad and Senate President Rodrigo Pacheco on Thursday announced an agreement to end the dispute between the government and Congress around payroll tax exemptions granted to 17 economic sectors. The benefit will be ended by 2028, by reintroducing the tax in 5 percent increments each year, until reaching the standard 20 percent rate.

Context.  In 2011, during the Dilma Rousseff administration, the government allowed 56 sectors to pay payroll taxes of only 1 to 4.5 percent of their gross revenues, instead of the standard rate of 20 percent of all salaries paid in a month. The Michel Temer administration narrowed it down to 17 sectors from 2019 onwards.

• These tax breaks were supposed to benefit the sectors that create the most jobs in Brazil. However, a study by the Institute of Applied Economic Research (Ipea) found that these sectors do not employ the most people, and many of them have reduced formal employment since 2011.

• The benefit was set to expire at the end of 2023, but lawmakers extended it until 2027. In November, President Luiz Inácio Lula da Silva vetoed the extension outright to raise revenue, but Congress overrode his veto. 

• Lula then issued a provisional decree partially limiting the impact of the tax break. The Senate watered that decree down and went ahead with granting exemptions to small municipalities. Then, the government took the matter to the Supreme Court.

• Mr. Haddad is still to discuss solutions for small municipalities in a meeting with mayors on Monday.

 Why it matters. According to the finance minister, the payroll tax exemptions will create a budgetary hole of “about BRL 22 billion” (USD 4.28 billion) this year alone.

Now what? The government will have to present a compensatory measure to cover the total exemption this year and partial exemption in future years. Mr. Haddad, however, did not want to speculate on how his office would pull it off.

• Brazil’s fiscal responsibility laws forbid the creation of tax benefits without an accompanying measure to compensate for lost revenue. It was the lack of such compensation that led the government to litigate.

Quick catch-up

Independent oil producers, the so-called “junior oils,” accounted for 50.4 percent of Brazil’s onshore oil production in 2023. It was the first time that junior oils beat Petrobras, the massive state-controlled oil company.

Rio Grande do Sul residents receive no respite as forecasts suggest the state should experience more storms and cold temperatures — and floods could get worse. The number of people removed from their homes is close to 330,000.

Experts warn that once river levels go back to normal in Rio Grande do Sul, Brazil’s southernmost state could face a health crisis linked to bacterial diseases transmitted by water or by the consumption of contaminated water and foodstuffs.

The sale of tickets for a Bruno Mars concert in Rio has been suspended. City officials did not authorize the event, scheduled for October 5, the eve of municipal elections. The city could not simultaneously guarantee the safety of the concert and the election.

The Superior Electoral Court set trial dates for Senator Sergio Moro, accused of disrespecting campaign financing rules in 2022. The court will decide whether to impeach him on May 16 and 21.

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