Why the Future of Brazil’s Economy Rides on Pensions

(Bloomberg) -- Latin America’s largest economy, Brazil, is at a crossroads. Fixing its public finances could open the door to a virtuous cycle of expansion; failing that, it risks slipping deeper into junk-level credit ratings and sub-par growth. The only way out is to overhaul a costly pension system, economists agree. President Jair Bolsonaro’s economic team led by Economy Minister Paulo Guedes revealed a proposal on Feb. 14 that hopes to satisfy investor demands for belt-tightening while still winning approval in the country’s fractious Congress.

1. Why is pension reform so important?

Brazil’s pension expenditures are already high compared to other countries, and a rapidly aging population makes the current system a ticking time bomb. Brazil spends the equivalent of 13 percent of gross domestic product on social security, well above the average of 8 percent for G-20 nations, according to a government report published in December. The pension fund for private sector workers is expected to run a deficit of 218 billion reais ($57.6 billion) this year up from 195.2 billion reais in 2018, while the fund for public servants will also be in the red. At present, Brazil’s economically active population pays for retirees’ pensions. The number of citizens over the age of 65 will jump to 25.5 percent of the population in 2060 from just 9.5 percent now, according to the national statistics agency.

Why the Future of Brazil’s Economy Rides on Pensions

2. What can be done?

Mustering lawmaker support for pension reform failed as recently as 2017 under former President Michel Temer. While Bolsonaro’s administration is still finalizing details of the proposal it will send to Congress, several key points are clear: His government wants to establish minimum retirement ages for men and women, and implement individual savings accounts for workers who enter the labor market, so that future generations will be responsible for saving for their own pensions. The goal of those and any other steps is to generate roughly one trillion reais in savings over 10 to 15 years. Questions that remain unanswered include whether or not retirement ages for men and women will be equal and how that will apply to the military.

3. Does this stand a chance of being approved?

The pension reform will be sent to Congress on Feb. 20 as a constitutional amendment rather than a normal bill, meaning that it will be subject to a lengthy approval process and heightened scrutiny from lawmakers. The measure will first have to be backed by two lower house commissions before heading to the floor, where it will have to win support of 308 of 513 deputies in two separate votes. At that point, the reform will reach the Senate, where it will need to be approved by a commission and then by 49 of 81 senators in two separate votes. If the Bolsonaro administration is successful in building a coalition in Congress, lower house approval could come as soon as June, with the Senate following suit by August. That’s no easy task, given that Brazil has over two dozen political parties. The government might have to make concessions that would weaken the reform’s fiscal impact.

Why the Future of Brazil’s Economy Rides on Pensions

4. What are investors hoping to see in the reform?

Investors reacted positively when the outline of the proposal was made public. It included the introduction of a minimum retirement age -- 65 years for men and 62 years for women and a transition period of 12 years. For investors, the closer the projected savings are to 1 trillion reais, the better; anything below 500 billion reais would be seen as a disappointment. A final focal point is the timeline for approval. While seen as highly unlikely, passage in the first half of the year would elate investors. A more realistic scenario is approval in the third quarter.

5. What happens if it isn’t approved?

Failure to change the pension system would most likely prompt a massive selloff. Analysts would lower their forecasts on local assets ranging from the stock market to the currency. Ratings agencies could downgrade Brazil’s sovereign debt rating further into junk, thus raising the government’s borrowing costs as pensions swallow up an ever-increasing percentage of the budget. The central bank would likely be forced to raise the benchmark interest rate to fend off inflationary pressures from a weaker real and help prevent sharper declines in investor confidence. Put together, those factors would hamstring Brazil’s already slow recovery in investments and economic growth.

The Reference Shelf

  • A Brazil Treasury report on government spending in recent years and international comparisons.
  • A QuickTake on the highs and lows of Brazil’s economy.
  • A Bloomberg profile of economy "super minister" Paulo Guedes.
  • A Bloomberg story on Bolsonaro’s prospects in Congress.

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