Brazil's Lost Fiscal Decade Is Time Bomb for Next President

(Bloomberg) -- Between rising homicide rates and near-record unemployment, Brazil’s next president will face a myriad of daunting tasks. Yet the one challenge that will most shape the country’s future is whether it can put its public accounts in order.

Policy makers got a fresh reminder last week of how dire the country’s budget situation is when the central government posted its biggest deficit on record for the month of March, excluding interest payments. Brazil’s entire public sector, including state-controlled companies, states and municipalities, recorded a primary deficit of 25.1 billion reais in the same month, the central bank reported on Monday.

Latin America’s largest economy hasn’t posted a primary surplus -- which excludes the cost of servicing its debt -- since 2013 and won’t do so until 2022 or 2023 at the earliest, according to the latest finance ministry estimates. And that’s in a best-case scenario, with a future administration tackling Brazil’s ballooning social security obligations.

"The next government won’t have time to think. It will have to act," Raul Velloso, an economic consultant and specialist in public finances, said in an interview. "The fiscal situation got so bad because of the amount of obligatory spending, and measures to curb this are needed urgently."

Despite some initial successes, President Michel Temer has seen his pledge to fix the public accounts steadily undermined by a hemorrhaging of support in Congress as corruption accusations mount and elections approach. In addition to weak revenues, one of the biggest problems is that the government has virtually no room to maneuver. Ninety percent of government spending is written into law, meaning the government can only alter 10 percent of spending.

After loose spending and weak growth made Brazil lose its investment-grade status under former President Dilma Rousseff, Temer made some progress with the approval of a bill freezing public expenditures in inflation-adjusted terms. Government coffers were boosted by revenue from power plant auctions and discretionary spending cuts. Policy makers were praised for their transparency even when announcing massive budget shortfalls, such as the 159 billion reais primary deficit target for 2018.

Optimism faded this year after Congress shelved plans to vote on a measure that would curtail fast-rising pension outlays. Now, the effectiveness of the very spending cap is at risk and Brazil could even infringe on a fiscal law known as the "golden rule," according to a member of the economic team who requested anonymity. The golden rule stipulates that the government can only borrow to invest, not finance current expenses.

"This government did all that it could, and even more than we thought it would do," former Treasury Secretary and current chief economist for Banco Safra, Carlos Kawall, said in an interview. "Brazil has to implement the pension reform, or all efforts will be lost."

Brazil’s finance ministry didn’t respond to requests to comment for this story.

Slow progress on Brazil’s fiscal consolidation and rising debt levels leave the economy vulnerable to adverse domestic and external shocks, Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc., wrote in an e-mail on Monday. Already this year, Brazil’s sovereign credit rating has been cut further into junk by Fitch and S&P Global Ratings, and Velloso warned that investor scrutiny is on the rise.

"Financial markets are on edge now more than ever," he said.

©2018 Bloomberg L.P.

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