Since his arrival in office on January 2015, Finance Minister Joaquim Levy has spearheaded a series of austerity measures to prevent an investment rating downgrade on the Brazil’s sovereign debt. This comes at a time when Brazil’s annualized inflation rate is expected to reach its highest level in twelve years.

During her first four-year term, Dilma Rousseff’s government sought to control rising inflation by suppressing energy and fuel costs for consumers while municipal and state governments refused to raise prices. Shift to January 2015 and Brazil’s inflation rate rose to 7.1 percent due to an average 8.5% increase in food, electricity and public transport prices in the country. Further increases are expected, given the normalization of administered tariffs, tax increases to buttress the budget and the phasing out of several tax breaks and benefits. The only option for Mr. Levy will be to make the politically unpopular decision to let prices adjust upwards.

Why is the Government Hiking Interest Rates?

A widening account deficit of $10.3 billion recorded in December 2014, alongside the aforementioned level of inflation, has forced the BCB to row against the current tide of monetary easing enjoyed around the world. The BCB have raised interest rates by 50 basis points to 12.25 percent in January, and is expected to further monetary tightening throughout 2015. Leaving the door open for more rate hikes in an effort to soothe high inflation has been viewed positively by the market and will strengthen investor confidence in the short term.

The Immediate Impact of Brazil’s New Austerity Measures

Joaquim Levy has recently announced a series of austerity measures, including a cap on government spending and tax increases for businesses, aimed at shoring up Brazil’s wavering finances.

Levy’s New Austerity Measures:

• Limiting federal spending to $26.3 billion between January 2015 and April 2015, compared with $29.2 billion in the previous year.
• Raising tax on fuel, imports, credit and cosmetics to increase revenue by more than $6.9 billion.
• Reducing pension and unemployment benefits in 2015 by an estimated $6.2 billion per year.
• Reducing payroll tax breaks that were granted in 2011 to boost employment in industrial sectors hit hardest by the financial crisis. This will save the government $1.9 billion this year and $4.6 billion in 2016.

The announcement of these measures come days after Moody’s downgraded the debt of state-owned Petrobras to junk status, and is widely regarded as the first steps in saving Brazil’s own investment-grade rating on its sovereign debt.

At the end of February 2015, the Brazilian government announced a higher-than-expected primary surplus for January at $7.5 billion, or 0.61% of GDP. This surplus should be considered a positive step forward for the new Finance Minister, who will continue to spearhead the the country’s austerity efforts.

Still under the 1.2% target set for 2015, more of these measures should be expected throughout the rest of the year.

*($1 = 2.89 reais)