Weekly Report - 06 April 2023 (WR-23-14)

BRAZIL: Haddad seeks fiscal deal

Brazil’s finance minister Fernando Haddad is looking for money. On 3 April he said he would be targeting increased taxation of international e-commerce companies and online gambling, as well as closing loopholes in the treatment of corporate fiscal credits. Above and beyond these practical measures Haddad faces a much bigger political and economic challenge: getting his new fiscal framework approved in congress, making it work in practice, and ensuring it boosts economic growth, an objective which could ultimately be critical for the success or failure of Luiz Inácio Lula da Silva’s third presidency.

According to Haddad, the government needs to raise up to R$300bn (US$59bn) in additional revenues to underpin the new fiscal framework, and to avoid introducing new domestic taxes which he claims are off the agenda. The finance minister says his team has a long list of revenue-raising measures which will be introduced in a phased manner. The three at the top of the list are expected to contribute R$15bn (US$5bn). More are said to be in the pipeline. Haddad said the tax system is “completely disorganised” and suggested that reducing tax avoidance and evasion would go a long way to capture the necessary funds.

Behind the hunt for money lies the proposed change in the fiscal responsibility framework. Since 2017 successive governments have been subject to a constitutional spending cap which prevents any increase in real terms year-on-year expenditure.

The legislation, which effectively rules out countercyclical fiscal policies, has lost credibility. Successive governments on the left and the right have found ways to sidestep it and to seek spending “waivers” from congress. The lack of fiscal discipline has acted as a major disincentive for financial markets and foreign investors. The debt-to-GDP ratio, at over 70%, is considered unsustainable.

Haddad’s task has been to find a way to balance the need to control the fiscal deficit and the debt ratio – pleasing the business community – while at the same time encouraging the increased investment and pro-poor growth desired by his centre-left government. At the heart of the new proposal is a requirement that limits expenditure growth in any given year to 70% of the rise in revenues. The new approach also calls for a ‘floor’ level for annual public investment, which is set at R$70-R$75bn (US$13.8-US$14.8bn). 

According to the finance ministry’s calculations, under the new framework the primary budget deficit will be limited to 0.5% of GDP this year and will transition to a surplus of 0.25%-0.75% by 2025. On this projection the debt-to-GDP ratio, currently at 73%, will peak at 75.7% in 2024 and begin to fall thereafter to 75.0% in 2026.

Financial markets reacted favourably, albeit with a degree of caution. Share prices and the real currency had a modest rally. Roberto Campos Neto, the head of the autonomous central bank who is seen as an interest rate hawk, nevertheless welcomed what he called the “goodwill” from the finance ministry to tackle the debt burden. 

It remains to be seen whether the plan is enough to convince the central bank to reduce interest rates later this year. Katrina Butt, an economist at AllianceBernstein LP, welcomed the “orthodox” attempt to stabilise debt but said the plan was too dependent on high levels of economic growth. Mario Sergio Lima of Medley Global Advisors said the framework was “a step in the right direction” but “insufficient” because it relies too much on revenue generation which the government does not control. 

The main issue is political, however. The government lacks a majority in congress and will have to sell the fiscal framework bill to opposition parties which could demand a quid pro quo in return. While Haddad has criticised tax loopholes and incentives, special interests and congressional lobbies have long defended them.

Fiscal reform

Government congressional leaders suggest the fiscal reform can be voted as a supplementary bill, which requires a simple majority (257 out of 513 deputies in the lower chamber), but if treated as a constitutional amendment, the bar could end up higher, at three-fifths (308 votes). The Lula administration is suggesting that the framework could be approved and become law by the middle of this year, which might turn out to be over-optimistic.

Key adviser in talks with Putin

Celso Amorim, a former Brazilian foreign (2003-2010) and defence (2011-2014) minister and current foreign policy adviser to President Luiz Inácio Lula da Silva, met Russian president Vladimir Putin in Moscow on 30 March. Both men are said to have discussed Lula’s proposal to form an international contact group to promote peace talks in the Ukraine.

Amorim told CNN Brasil that it would be an exaggeration to say the doors to peace were open but that on the other hand they weren’t “totally closed”.  Saying that there were no “magic solutions”, Amorim added that eventually “a realisation will emerge that the cost of war, not just the political cost, but the human and economic cost, will be greater than the cost of the concessions needed for peace.”

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