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Brazilian Congress unlikely to support austerity measures to narrow unsustainable fiscal deficit, as electoral campaigning takes priority

30 Oct 17

Brazil's primary fiscal deficit has been growing rapidly since 2014, with the shortfall in 2018 expected to be larger than last year.



IHS Markit perspective

Outlook and implications

  • Most of President Michel Temer's efforts have been channelled into defeating corruption charges and securing political survival, in effect paralysing policymaking.
  • Economic measures needed to tackle the deficit such as pension reform, the raise of some taxes and freezing in civil servants pay are being strongly resisted by members of Congress.
  • With the general election already in the horizon, the political appetite for unpopular measures has been reduced drastically; this, and the weakening of the president regarding Congress, makes highly unlikely the approval of any important austerity measures next year.

Risks

Government instability; Policy direction

Sectors or assets

All

Brazil's President Michel Temer (L) and Lower House President Rodrigo Maia attend the inauguration ceremony of the Radiosurgery Centre at the Paulo Niemeyer Brain Institute on 15 September 2017 in Rio de Janeiro, Brazil.

Mario Tama/Getty Images

On 25 October, President Michel Temer announced that Sáo Paulo's Congonhas Airport would not be included in the list of airports to be privatised in 2018; the Congonhas concession was expected to net revenue worth USD1.6 billion. These concessions have been pencilled in as part of the extra revenue required to prevent missing the primary fiscal target for next year, which has been set at about USD50 billion, or about 2.5% of GDP, far higher than the USD40-billion target for 2017; until 2013, Brazil recorded a primary fiscal surplus that averaged 2–3% of GDP. This means that the government will need to find additional source of revenue to stay within the targets next year.

The decision not to offer Congonhas to private operators was taken after deputies from the Republican Party, part of the government coalition, threatened to withdraw their support for Temer during the critical vote held on 25 October in which the Lower House rejected corruption charges against the president. Temer eventually survived the vote, but – as illustrated by the Congonhas case – to the price of having to make concessions to major allies, in effect derailing fiscal deficit targets.

Following the vote, Temer and particularly his finance minister Henrique Meirelles indicated that the government will now move to secure the approval of the pension reform; pension payments take about 35% of Brazil's government spending and are now close to unsustainable levels. However, there are growing indications that they would seriously struggle to secure the approval in Congress of such unpopular measure. This is being further compounded by the fall out between Temer and the speaker of the Lower House Rodrigo Maia. The support of the latter was instrumental in passing important congressional bills over the last 12 months such as the cap on public expenditure for next 20 years (approved in December 2016) and the labour reform (July 2017). Maia has publicly expressed his displeasure with Temer's party, the Brazilian Democratic Movement Party (Partido do Movimento Democrático Brasileiro: PMDB), and the president himself for allegedly trying to undermine the Democrats (Democratas: DEM), Maia's party.

On 10 October, Maia delivered a hard-hitting speech, complaining that the government was trying to bulldozer legislation through the House without consulting him. Maia threatened not to vote any further Executive Orders (Medidas Provisórias: MPs) tabled by the government – an important tool to speed up votes in the House, as they take precedence over all other pieces of legislation. Indeed, Temer has been using MPs whenever possible as a expedite way to implement economic reforms.

Congress' reluctance to approve further public expenditure cuts or raise taxes forced the government to increase its fiscal deficit targets in August to about USD50 billion for 2018. On these bases, deficit levels are likely to remain very large up until at least 2020, posing concerns for business confidence and government's credibility, particularly because of its implications for Brazil's public debt burden, which has been growing very rapidly.

Ambitious, tight fiscal agenda

The meeting of fiscal targets requires a set of measures, which must be voted by Congress; these include:

A pension reform (still to reach the Congress floor) with indications that most Congress deputies have little appetite for it – particularly in the run-up to the October elections.

On the tax revenue side, the government estimates that it will collect about USD2 billion via a levy on investment funds; USD600 million should accrue from an increase in social security contributions from civil servants salaries from 11% to 14%. A one-year freeze in salary increases of public servants is expected to net another USD1.6 billion

Regarding corporate taxes, the approval of Refis, a new programme that allow companies in tax arrears to renegotiate their debts, is also part of the congressional agenda. Similarly, the government is pushing Congress for the approval of an MP that creates leniency deals for banks to be negotiated with the Central Bank of Brazil; the latter would also bring additional revenue. The government is also proposing another MP increasing the aliquots of federal social security taxes, PIS and Confins, to compensate for a Supreme Court's decision to exclude the state tax ICMS from the calculations of those two duties.

Congress is also being urged to approve a bill that abolishes some payroll tax exemptions granted to companies of some economic sectors during the government of former president Dilma Rousseff.

Additionally, the government still needs to send to Congress a proper proposal for the Federal Budget 2018 as the original project has to be modified to include the new fiscal deficit target.

Outlook and implications

Most of the measures being proposed by the government are extremely unpopular therefore Congress is reluctant to back them. Two factors are contributing to slow down dramatically the pace of reform. First, signs of sustainable economic recovery are resulting in complacency, with many congressional deputies arguing that since the economy is rebounding austerity is no longer needed. IHS Markit has revised GDP numbers for Brazil up to 0.9% in 2017 and 2.20% in 2018. Interest rates are declining rapidly – from 14% early last year to 7.5% currently – while unemployment dropped from 13.7% in January to 12.6% in August.

Second, is the growing clout of Congress regarding a weakened president who no longer has the ability to set the legislative agenda. Temer seems to have secured survival, but with all efforts channelled to that end, reforms were delayed, resulting in the agenda losing momentum. The window of opportunity to approve any new reforms will also be shortened by the recess of Congress, starting on 22 December. This suggests that it is extremely unlikely that the Congress will vote any important austerity measures next year. From January onwards, deputies and senators will already have only one thing in their minds: do everything they can to be re-elected in October 2018. Indicators to watch are whether further setbacks in Congress make the meeting of fiscal targets unfeasible; conversely, whether recent indications of a pick-up in tax revenue prove sustainable.

 
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