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ECONOMICS: LATIN AMERICA PERSPECTIVES
SEP 0918 2015
BRAZIL: A NEW (UPHILL) FISCAL BATTLE
+ Fernando J. Losada, Senior Economist—Latin America Research.
S&P's decision to downgrade Brazil to junk status this month
prompted the government to announce a more ambitious fiscal plan.
But politicians' reaction to the proposal was lukewarm at best,
suggesting the government may not be able to put it fully into action.
After the Downgrade, a Swift Reaction
Shortly after S&P became the first of the
big three ratings agencies to cut Brazil's
sovereign credit rating to junk status, the
government ditched an earlier budget
proposal and recommitted itself to fiscal
discipline. President Dilma Rousseff rallied
around her finance minister, Joaquim Levy,
and announced a primary surplus target of
0.7% of gross domestic product (GDP) for
fiscal year 2016.
It was the government's recent decision to
backpedal on its fiscal promises by
reducing its primary surplus targets and
increasing its expected primary fiscal
deficit that cost Brazil its investment-grade
rating. As S&P correctly pointed out, the
backpedaling would have caused Brazil's
debt ratios to deteriorate sharply over the
next couple of years.
What's more, there appeared to be a lack
of widespread support for fiscal discipline
as a way to address the country's econom-
ic malaise. As a result, the S&P kept the
rating on negative outlook, suggesting that
the rating agency's next move is more
likely to be another downgrade rather than
a move back into investment-grade
territory.
To forestall this, the government has called
for a combination of revenue increases and
spending cuts worth some BRL60 billion
(US$16 billion). The cornerstone of the
revenue increases is the reenactment of a
financial transactions tax, known as the
CPMF, which is expected to generate more
than 93% of the projected BRL34 billion
incremental revenue. The idea is to
maintain the CPMF at a rate of at least
0.2% during the remainder of Rousseff's
term.
The government also proposed increases
in capital gains taxes and reductions in
export subsidies. The main items included
in the BRL 26 billion worth of proposed
spending cuts include a delay in civil
servant salary increases until July 2016,
and reductions of housing subsidies, an
infrastructure investment program and
healthcare outlays (Display 1, next page).
The Devil's in the (Political) Details
In principle, the announcement is good
news because it suggests Rousseff hasn't
given up on the notion of fiscal reform. It
also implies that Levy still exerts some
influence when it comes to economic
policy. We think this recommitment to
fiscal discipline could persuade other
ratings agencies to delay any downgrades
of their own. Moody's, which still considers
Brazil investment grade, welcomed the
news.
However, we think there's a substantial risk
that the government will find itself unable
to implement the plan in full. The initial
reaction from legislators was barely
lukewarm. Eduardo Cunha, the chairman of
the lower house, said he wouldn't support
the CPMF, though he did vow not to block
the initiative in Congress. But he added
that he thought Congressional approval
this year "is close to impossible"
Meanwhile, local media reported that
business leaders don't support the tax
plan, especially given Brazil's worsening
recession, and would prefer to see more
aggressive spending cuts. It's unclear
whether the federal government's offer to
share the revenues from the CPMF with
state governments will be enough in the
current anti-tax environment.
Even some lawmakers from the ruling
Workers Party oppose the plan, according
to local newspapers, especially the
proposal to freeze public workers' salaries.
The more leftist wing of the Workers Party
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EFTA00607213
has called for special taxes on the banking
sector and the wealthy. Even former
President Luiz Inacio Lula da Silva has
reportedly suggested relaxing the fiscal
stance and lowering interest rates to boost
growth. Organized civil servant unions have
warned that they could go on strike.
Congress, Bribery Probe Still Problems
At this point, it looks as though Congress
will water down the plan. That will make it
difficult for the government to deliver on
its fiscal promises in 2016. If Congress
strikes the CPMF down, the government
may have to rely on nonlegislated taxes
such as a special contribution on gasoline
consumption, known as the CIDE tax. This
would result in less than half of the
revenues that would have been generated
by the CPMF. It would also push prices
higher, thus compromising Brazil's
anti-inflation strategy.
To be fair, the fiscal plan is mostly a
patchwork rather than a comprehensive
strategy to deal with structural fiscal
difficulties, including spending rigidity and
wage indexation rules. This most likely
reflects the Rousseff administration's lack
of political capital, which makes it hard to
get Congress to sign off on deep reforms.
If Congress changes the plan significantly
or if the president lacks the ability to push
it through Congress at all, Levy may resign.
That could lead to asset price volatility and
provide extra incentive for the political
opposition to push impeachment proceed-
ings against Rousseff.
And let's not forget that the ongoing
corruption investigation, which makes the
political climate even more volatile, also
Display 1
The New Fiscal Plan
Impact of Main Projected Fiscal Adjustment Measures (SRL Billion)
Spending Reductions
Delay in Public Wage Increases
Reduction in Housing Subsidy
Reduction in Healthcare Outlays
Reduction in Infrastructure Investment
Government Employment Freeze
Reduction in Agricultural Subsidies
Other
Revenue Increases
Financial Transactions Tax
Increase in Tax on Capital Gains
Reduction in Export Subsidies
Reduction in Subsidies on Interest Income
Other
Minus Lower Projected Revenue From Existing Taxes
7.0
4.8
3.8
3.8
1.5
1.1
4.2
Total
26.2
Total
32.0
1.8
2.0
1.1
2.8
5.5
34.2
Total Projected Fiscal Adjustment
60.4
Through September le. 2015
Source: Local Newspapers and AB
makes it harder for the government to
garner support for its fiscal plans. This
week, the federal prosecutor's office
formally accused 15 political figures,
including former President Lula's chief of
staff, of bribery. The probe has also
extended to involve several high-profile
international banks that Brazilian prosecu-
tors say may have been involved in a
pay-to-play scheme aimed at securing
access to official contracts.
Against this backdrop, we think the risk of
more ratings downgrades is high.
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