Reuters/Brasilia

Worried about a rapid deterioration of Brazil’s finances, many investors are calling on President Dilma Rousseff to make sharp budget cuts.

But their warnings are falling on deaf ears, at least for now.

Government officials say Rousseff has no plans to substantially change her fiscal policy despite recent market jitters that have driven the country’s currency lower and kept forecasts for future inflation uncomfortably high.

Even some of Rousseff’s own political allies have sounded the alarm after a slowdown in tax intake stemming from tax breaks and steep increases in expenditures led to the country’s worst performance on its main budget deficit target in nearly five years in September.

Many investors are worried the deteriorating finances could lead credit ratings agencies to downgrade Brazil, which could in turn scare off investors, jeopardise the country’s fragile recovery and prolong an era of mediocre economic growth.

Fears of a downgrade helped sink the real to its weakest in two months and sharply raised the yield of interest rate futures.

The real has weakened more than 7% since October 31.

Some government officials acknowledge mistakes have been made in fiscal policy, such as using accounting gimmicks to meet their main target last year.

However, they say the market is over reacting.

“I think market players are exaggerating,” said a government official, who declined to be named. “There is concern inside the government, but we believe the fiscal print this year will be enough to keep the debt dynamics stable and avert a credit downgrade.”

Another official said the government will not push for legislation that caps its debt intake, current spending or drop the primary surplus as its main fiscal target.

After pointing to rising price pressures due to a pick up in public spending, the central bank now says the fiscal balance may turn neutral in the future, or less inflationary.

The change in stance shocked many investors who doubt the pace of spending will slow any time soon.

Finance Minister Guido Mantega defends Brazil’s fiscal record as “one of the best in the world in the last 15 years.” The latest fiscal results were “the worst in a period of transition to a better situation,” Mantega said in an interview with the daily O Globo published on Sunday.

There are two reasons why Rousseff is sticking to her guns. It would be political suicide to make budget cuts that shed thousands of jobs with less than a year before presidential elections in which Rousseff is widely expected to run.

A wave of massive protests to demand better public transportation and other services in June also raised pressure for more spending. And secondly; it is hard to cut the budget without reducing public investment in Brazil.

By law about 90% of the budget is earmarked to specific expenditures like pension and public salaries, leaving the remainder effectively in control of the government.

Despite those limitations, the conflicting views are another sign of a persistent and growing schism between Rousseff’s government and markets.

Some analysts say that disconnect has worsened Brazil’s recent slowdown after a decade of red-hot economic growth that made it a Wall Street darling.

“The government itself created a lot of confusion by not establishing clear fiscal goals,” said Mansueto Almeida, a researcher with IPEA, a government economic think tank.

“The government needs to improve its communication with markets. We still see a lot of contradictory messages.”

Local media have also bombarded Rousseff for what they say is an attempt to water down the tough fiscal rules that helped Brazil achieve an investment grade credit rating.

“At this point, one wonders what is the reason for so much juggling, since nobody believes the federal government’s commitment to control expenditures,” Folha de Sao Paulo, one of Brazil’s leading newspapers, said in an editorial yesterday.

Privately, officials admit it will be nearly impossible to achieve this year’s fiscal goal. However, they believe that a rollback in some tax cuts and other stimulus, a stronger economic recovery and fewer capital transfers to state banks will improve the government’s accounts in coming months.