Brazil & Southern Cone - June 2015 (ISSN 1741-4431)

When Finance Minister Levy stayed away from a press conference to announce BRL69.9bn (US$22.1bn) worth of government spending on Friday 22 May there were ripples of concern running throughout Brazilian and international financial markets. According to press reports Levy, who was said to be seeking deeper cuts of BRL80bn, had stayed away to signal his disagreement. Planning Minister Nelson Barbosa made the announcement on his own. This led to rumours of a split within the government and the possible resignation of the finance minister, regarded by financial markets and the business community as a key figure in the attempt to get Brazil back on track. Levy denied these rumours. “I didn’t think of quitting at all”, he said.

Levy nonetheless told reporters, “There are people who think everything is solved. It isn’t. We still have work to do”. In other comments, he acknowledged that the federal government has an ongoing problem of “systematically insufficient revenues”. But Levy stresses that it is not just a question of raising taxes; Brazil needs deeper structural reforms. Speaking to businessmen in Rio, Levy sought to reassure them that he was looking beyond austerity and working on pro-growth measures, including an agricultural stimulus plan and a package of measures to promote infrastructure investment. According to Juan Jensen, of the consultancy Tendências, “Levy first acted as a fireman to put out the fiscal fire. Although the job is not done on the fiscal side, he is signalling that there are other things he can do to get the economy going”.

Getting the federal congress to approve adequate spending reductions is a complex and on-going battle. In late May, Levy got approval for a new set of measures. They included regulation MP665, limiting access to unemployment benefits (increasing the prior qualifying period in employment from 6 to 12 months); and MP664, restricting access to otherwise generous sickness and pension benefits. But some of these gains were offset by a congressional decision to change the way pension payments are calculated, which ultimately will increase costs. It is difficult to calculate the full impact of these measures. One assessment by economists at Itaú Unibanco is that they will save BRL2bn this year, but could add expenditure equivalent to 0.5% of GDP by 2040. Levy also faces a major longstanding structural problem, in that the vast majority of public spending in Brazil is ring-fenced by constitutional mandates. In 2014, for example, only 6% of total budget spending was discretionary.

So far, Levy has no data to show that things are getting better. The overall fiscal deficit (which includes debt interest payments) rose to an unsustainably high 7.8% of GDP in the 12 months to March 2015 (compared to 6.2% last year and to 2.2% in 2010). Levy is aiming for a primary fiscal surplus equivalent to 1.2% of GDP this year, after a 0.63% deficit in 2014. He also intends to boost the primary balance to 2% of GDP in 2016. On current trends, many economists believe this won’t be achieved. A recent research note by Capital Economics suggested that part of the current deficit reflects the government’s expensive and ineffective foreign currency (FX) swaps programme, which is now being wound down. Putting this to one side, the primary balance has deteriorated this year because of a worsening local and regional government budget performance, and a deteriorating balance in the INSS social security fund. Capital Economics forecasts that the best that Levy can hope for to deliver is a primary surplus of 0.2% of GDP this year, rising to 1% in 2016.

According to Brazil’s national statistics institute (IBGE), first quarter GDP fell by 1.6% year-on-year (and 0.2% quarter on quarter). The unemployment rate rose to 6.4% in April, up from 6.2% in March. Inflation, pushed up by a depreciating Real, has risen to 8.2%; almost double the central bank (BCB)’s target of 4.5%. Economists believe the inflation rate has peaked and will now trend down, but are expecting the BCB to have to tighten interest rates again in June, following a 50bps hike in the benchmark Selic rate to 13.25% in early May. In other words, all the data in Brazil is currently pointing towards continuing stagflation.

• ‘On a recent visit to London, Levy’s message to investors was that “Brazil is going through a period of economic adjustment. Our priority has been to ensure the sustainability of public finances as the basis for a new growth cycle. We expect the current slowdown of our economy to be temporary”.’