Brazil & Southern Cone - November 2013 (ISSN 1741-4431)

On 4 November Brazil’s national treasury secretary Arno Augustin complained that fiscal policy was under “speculative attack” by the markets following the release of very weak September accounts.

Brazil’s primary budget deficit grew to R$9.0bn (US$4.15bn) in September, the highest for five years. The August primary deficit of R$432m (US$195m) was the first for the month in a decade. The primary deficit figure, which represents the public sector’s excess revenue over expenditures before debt payments, is a closely watched measure of the country’s ability to service debt. The deficit could further raise the prospects of a credit downgrade and has fuelled speculation that the central bank could raise interest rates above 10%. Indeed external bulls-turned-bears on Brazil, such as the likes of the UK’s Financial Times, are now openly speculating that Brazil will be the first of the Brics group of leading emerging economies (Brazil, Russia, India, China and South Africa) to lose its investment grade rating. In the region, Peru, along with Colombia the new investor darling, is now more strongly rated than Brazil (see sidebar).

Augustin’s complaint came on the heels of new warning from the International Monetary Fund (IMF), which in its latest Brazil country report, released on 23 October, noted that “excessive fine tuning of fiscal policy (including through public banks) has weakened the credibility of Brazil’s long-standing fiscal framework, while broader policy uncertainty has weighed on Investment”. The IMF also revised down its potential growth estimate for Brazil to 3.5% from 4.25% and warned that “a substantial scaling up of investment will be necessary to boost potential growth”.

That very same day, the federal chamber of deputies in Brasília voted 344-9 in favour of a draft bill that effectively will allow a renegotiation of state and municipal debts. The bill, expected also to get swift senate approval, will provide relief to states and municipalities struggling with high debt and give mayors and state governors more spending room ahead of the 2014 general election, which is set to be dominated by voter demands for improved public services. Opposition legislators immediately expressed concern that the bill would allow the government led by President Dilma Rousseff to favour states and municipalities administered by the ruling Partido dos Trabalhadores (PT) and its coalition allies – one of the strongest proponents of the bill was the PT mayor of São Paulo, Fernando Haddad (the São Paulo city government could shave some 44% or R$20bn [US$9.12bn] off its debt).

• States and municipalities get room for manoeuvre

The new legislation, agreed by the federal finance ministry on 8 October, changes the benchmark index used to calculate the interest that state and municipal authorities pay on their liabilities with the federal government, swapping the IGP-DI wholesale and consumer price index for the benchmark consumer price IPCA index. In effect, the interest charges on the debt, now linked to the IGP-DI index plus 6%-9% annually, instead would be linked to the IPCA index plus 4%, or the benchmark Selic interest rate, whichever is lower. The bill also would make this change retroactive to 1997.

According to the central bank, outstanding state and municipal debt as of 31 August 2013 stood at R$545bn (US$249bn). If this debt could be refinanced, it would alleviate debt-servicing costs for local governments. However, under the fiscal responsibility law of 2000 (Lei de Responsabilidade Fiscal [LRF]), states and municipalities are legally prohibited from selling debt. Dyogo Oliveira, the finance ministry's acting deputy executive secretary, asserted on 9 October that the latest change would unlikely have an impact on the federal government’s bottom line. “The fiscal situation of states and municipalities is rather tight and the solution that is being proposed is a matter of fiscal justice”, Oliveira stated.

According to the local business daily Valor, São Paulo’s city government could reduce its debt to some R$30bn (US$14bn) from around R$50bn (US$23bn) currently, giving the Haddad administration more room to finance some R$5.0bn in planned investment. End box

Although federal tax revenues remain on target (just about) and the finance ministry claims its balance sheet will be unaffected by the above proposed changes for states and municipalities, there is growing concern about the twists and turns of the Rousseff government’s fiscal policy.

On central bank data, Brazil’s net public sector debt, as defined by the local authorities, was R$1.57trn (US$0.72bn), or 33.8% of GDP, as of 31 August. The finance ministry expects total tax revenues of about R$1.trn in 2013; it reported an accumulated intake of R$806.4bn to September, basically static (0.9%) on the year-earlier period. In comparison to the central bank however, the IMF puts total non-financial sector public debt (on its broader definition) at 68.2% of GDP, one of the highest among emerging markets.

Finance Minister Guido Mantega downplayed the import of the latest fiscal figures, insisting that a lower primary surplus will still suffice to meet scheduled debt obligations in 2013. The official primary surplus target is 3.1% of GDP, but unofficially the ministry has been working towards a surplus target of about the same as last year’s 2.3% of GDP. Mantega was critical of the latest IMF assessment (prepared after meetings with the finance ministry back in June), saying that it was “incoherent”, “mistaken” and done by “technical staff” with no real understanding of the Fund’s position on the country. He sniffed that the Fund’s chief economist, Olivier Blanchard, was “was much more in tune with our…programs”.

Nonetheless, on 31 October Mantega said the government was examining spending cuts in order to meet the primary target. Noting that the proposed cuts may come from salary benefits, including things like unemployment cover, the minister said he was going to “talk to the unions to study the problem together”. Current expenditure (mainly salaries and other benefits) swallows up 80% of the federal budget. President Dilma Rousseff is aiming to boost capital investment in infrastructure, but with the purse strings increasingly tight, she is turning to the private sector for assistance. Private economists long have been calling for fiscal reform to tackle the country’s high labour costs and onerous tax burden, arguing that it would unleash faster private sector growth and reduce the need for sustained State intervention in the economy.

Mantega went on to announce a 20% cut in new loans by the national development bank (Bndes) to R$150bn (US$67bn) in 2014, from R$190bn this year. Bndes lending to states and municipalities will be frozen, while “we will reduce stimulus” to state banks, Mantega stated. *In the September 2013 edition of our sister publication, Latin American Economy & Business, we looked in some depth at the role of Bndes in the Brazilian economy.

Some private economists have called on Mantega to simply reduce the official surplus target from 3.1% (to something like 2.3%-2.4%; after all still a very decent result), rather than have it look like the finance ministry is trying to ‘fudge’ the figures. Critics say the ministry’s ‘creative accounting’ in order to meet, on paper at least, the full year target has eroded confidence in the government’s commitment to the primary surplus target, which along with inflation targeting and a free-floating exchange rate form the three pillars of Brazil’s macroeconomic policy.

Augustin forecast a strong fiscal surplus in the final three months of year (partly cushioned by a cash windfall from the latest Libra oil field auction) and insisted that the government could meet the 2.3% of GDP surplus target. The markets are sceptical – the primary surplus in the rolling 12 months to September was just 1.6% of GDP.

• Peru – stealing Brazil’s thunder

In late October Fitch raised Peru's long-term foreign issuer default ratings to BBB-plus from BBB, noting that the “pragmatic” government led by President Ollanta Humala was on track to record its third consecutive fiscal surplus (albeit a small 0.4% GDP) in 2013. Standard & Poor's raised its Peru rating to BBB-plus in August. Peru now ranks better than both Brazil and Mexico. Chile remains the best ranked sovereign in the region.

• No tax Christmas this year

The government also is withdrawing tax and other stimuli in an effort to recover its fiscal position – for instance a temporary reduction in the tax on industrial products (IPI) will come to an end on 31 December, including for the key auto sector, which makes up a fifth of the industrial base. There is concern that this will hinder the industrial sectors’ still very tentative recovery. Overall, industrial production is still volatile and failing to gain traction – it rose just 1.6% year-on-year in the nine months to September.