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

Speaking at a recent seminar hosted by the influential Federation of Industries of São Paulo  (Fiesp), the secretary general of the Organisation of Economic Co-operation and Development, Angel Gurría, urged the Brazilian government led by President Dilma Rousseff to continue apace with the current fiscal adjustment, warning that because of the country’s structurally high interest rates, its debt burden was becoming onerous, at 9% of GDP already.

Gurría, addressing the seminar entitled ‘A positive agenda for Brazil’, said that progress towards fiscal adjustment also was fundamental for investor confidence in Brazil, which would be key to restoring economic growth. Gurría made the point that in the absence of fiscal surpluses, the Brazilian government is obliged to emit debt at rates that are among the highest in the world. In Mexico, for example, interest rates are at 2.7% currently; in Brazil the benchmark Selic rate is at 14.25%. This circle – whereby the economy is stagnant and the government is forced to rely on expensive debt – “is very dangerous”, Gurría stressed, as it raises overall country risk. He recommended that the government make very clear its commitment to fiscal reform, to a process that would allow for the gradual stabilisation of public finances and debt. That would generate market confidence and allow for a gradual reduction in both interest rates and risk premiums.

“Brazil is at a decisive moment”, he continued, with in play the social gains made over the past decade (when 25m people exited poverty and incomes of the poorest 10% rose three times faster than those of the wealthiest 10%).

Turning to his audience, Gurría argued that it was incumbent upon the local private sector to support the federal government’s fiscal adjustment efforts. The Fiesp and other private sector associations have long been critical of the ruling Partido dos Trabalhadores (PT) and are especially harsh on the Rousseff government. “In the same way that Brazil is a key partner of the OECD, it is essential for the private sector to be a partner of the federal government”, he stressed, making the point that while overall productivity in Brazil grew by about 12% in the past decade, “the industrial sector declined”.

While the Fiesp would argue that this is the fault of PT government policies, Gurría hinted at Brazilian manufacturing’s traditional inward-looking and somewhat isolationist attitude. Even today, Brazilian exports, for example, make up no more than 12% of GDP. He lamented Brazil’s isolation from global production chains. “At the moment, among the 40 countries whose economies are monitored by the OECD, Brazil is the least integrated in global value chains. This shows that the country could be failing to win in external trade”, he said.

As with many countries, he continued, Brazil is still facing the challenge of how to stimulate investment, and with public finances under pressure, the private sector has to assume the lead role. Gurría also stressed, however, that the Brazilian government needs to facilitate those investments by simplifying bureaucracy, improving legal security and improving the country’s infrastructure.

Deficit target adjusted again

In an announcement that surprised few, on 27 October the Rousseff government  revised down its primary fiscal target - the budget balance before interest payments. The government now expects a primary fiscal deficit of 0.85% of GDP, or R$51bn (US$13.3bn), in 2015. Most analysts suggest that this may be optimistic, as it relies on at least R$11bn in revenue from the sale of concessions for 29 hydroelectric power stations in an auction due on 25 November. Given the many legal obstacles faced by companies currently operating hydroelectric plants in Brazil, particularly in the Amazon, this may be ambitious.

On 23 October, the federal tax agency announced that tax revenues were R$95bn (US$24m) in September, down 4.1% year-on-year over September 2014. In the first nine months in 2015, tax collection was R$901bn, down -3.7% on the first nine months of 2014 and the lowest result since 2010. The deficit could also grow if the government decides to pay debt it owes to state-controlled lenders before the end of the year.

In her blog for O Globo, the respected economics commentator, Miriam Leitão, argued that the current deficit was the result of the government’s long-term failure to withdraw the stimulus measures put in place during the financial crisis of 2008. While acknowledging that these measures were necessary at the time, Leitão said that they should have been reversed in 2010, at the start of Rousseff’s first term. Instead, the Rousseff government continued to spend, and continued to select certain industries to subsidise, most notably Brazil’s automobile industry.

The increase in the minimum wage, which is linked to pension payments, has also led to a significant increase in government expenditure. The central bank has come in for strong criticism from noted economists for its failure over the years to draw attention to the rising levels of state spending. The government’s attempts to correct its course are now attracting flak from both Right and Left in the federal congress, with the political crisis in Brasília only deepening the gloom around Brazil’s economic prospects.

Fitch downgrade – priced in

The international ratings agency Fitch downgraded Brazil’s sovereign credit rating from BBB to BBB- with a negative outlook on 15 October, one notch above junk. With the decision already priced in, the stock market and the Real barely registered the change. Standard & Poor’s (S&P) has already stripped Brazil of its hard-earned investment grade; if either Moody’s or Fitch follow suit, the country faces a severe risk of capital flight as many international funds will be under a legal obligation to ditch Brazilian investments. In early October, Moody’s indicated that it did not plan an imminent downgrade of Brazil. But the government is worried by the fact that all of Brazil’s economic indicators are at the same level of other countries rated as junk by Moody’s.

In the note accompanying the decision, Fitch cited Brazil’s rising levels of public debt, increased challenges to fiscal consolidation and the impact of the recession on government finances. The negative outlook “reflects Fitch’s view that economic and fiscal underperformance is likely to persist while political uncertainty could continue weighing on broader confidence, delay a turnaround in investment and growth and increase risks for the medium-term fiscal consolidation needed for debt stabilisation”.

The day after the Fitch decision, S&P published a report stating that Brazil has more companies at risk of a credit downgrade than any other emerging market. Of the 134 potential downgrades for emerging market firms, 28 are Brazilian.