Lara Resende's proposal to cut Selic to 7.5% divides economists and worries the market

Economist André Lara Resende's proposal to reduce the Selic rate to 7.5% following an announced decision by the Central Bank opened an intense debate in the financial market. According to the channel Investidor Sardinha, which gathered the opinion of nine economists, the government does not intend to implement the idea: the Minister of Economy, according to the presenter, said that the government does not look at the issue in that way.

Lara Resende is one of the creators of the Real Plan, was director of the Central Bank in 1985 and 1986 and presided over the BNDES in 1998, during the FHC government. For the presenter, this explains why the proposal is taken seriously, even by those who disagree with it. He recalls that the economist declares himself liberal and that, in an interview with Exame in 2018, he said he would privatize all state-owned companies.

In the article published on Substack, Lara Resende proposes taking the Selic rate, currently at 13.75%, to 7.5% in 12 months. The two percentage points above 5.5% would be removed later. He also suggests a national fiscal and monetary council, which would define fiscal and interest targets for four to five years, with a Selic rate between 3% and 5.5%. According to the presenter, the economist himself admitted that the 7.5% number was a guess, with no account behind it, and that his role is to think, not apply.

The diagnosis: interest that consumes the budget

The starting point is the cost of debt. According to the numbers mentioned in the video, the country spends R$1.4 trillion per year on interest on gross debt, equivalent to 10.5% of GDP, and gross debt reaches 82.5% of GDP. The 2025 primary deficit, at 0.4% of GDP, would be one of the smallest in the world. According to Lara Resende, it is the burden of interest that takes the nominal deficit to more than 10% of GDP. He argues that the debt grows 12.7% per year due to interest, while nominal GDP grows 7%.

The economist also states that interest payments transfer to people who live on income from public bonds around eight times what the government spends on Bolsa Família. He differentiates the rentier from the investor and says he is part of the first group. According to the presenter, Lara Resende does not defend the deficit: she claims that the government spends poorly and criticizes populist spending and parliamentary amendments.

Criticism: fiscal risk, dollar and history

According to the presenter, the majority of economists interviewed consider the diagnosis to be correct, but the medicine to be wrong. The main argument is that interest is a consequence of fiscal risk, and that cutting it without reducing risk would be price fixing. In this reading, the measure could lead to so-called fiscal dominance, with the Central Bank pressured to finance the Treasury. There would also be a risk of weakening the autonomy of the Central Bank.

The video lists the effects expected by these economists: a rise in the dollar, an outflow of foreign capital, an increase in the cost of fuel, wheat and electronics, and the return of inflation in a few months. Critics also cite that the US$350 billion in reserves would not buy credibility, as a relevant part is not liquid. According to the presenter, 10% of the domestic debt is in the hands of foreigners and half of the federal debt (49.3%) is made up of LFT, linked to the Selic.

Critics turn to examples. In 2012, Selic fell to 7.25%, inflation reached 10.67% in 2015, GDP fell by almost 7% in two years and interest rates returned to 14.25%. In Turkey, the interest rate cut was followed by inflation of 85.5% in October 2022. In Argentina, inflation was 211% in 2023. According to the presenter, the difference with Japan, with high debt and low inflation, is that the Asian country has gigantic domestic savings and debt almost entirely in Japanese hands.

What does this mean for the investor

The presenter maintains that Lara Resende does not defend the Modern Monetary Theory (MMT), although she approached it in a 2020 book. The article, according to him, does not mention the acronym and is based on the fiscal theory of the price level, by John Cochrane, from Stanford. For the channel, savers would be the most harmed by a forced cut: 36 million CPFs are registered with the Treasury and 50% of public debt is in pension and welfare funds.

As a more gradual alternative, economists interviewed by the channel suggest expanding the inflation target, which would give the autonomous Central Bank room to reduce interest rates with less noise. In the presenter's assessment, the biggest problem with the proposal is the signal it sends to the market, which could take resources out of the country and put pressure on the dollar. He also notes that the stock market has registered a significant drop since Lula's election and that the market is scared.

Automatically translated from Portuguese.