Exactly two weeks after conceding [6] that a primary surplus was no longer in the cards after budget data in July came in meaningfully worse than expected, Brazil is scrambling to restore some semblance of confidence in the government’s ability to close a yawning budget gap by implementing austerity even as political turmoil has made embattled FinMin Joaquim Levy’s life a living hell of late.
On the heels of a painful S&P downgrade [7], Brazil now says it plans to enact some BRL26 billion in primary spending cuts for the 2016 budget on the way to achieving in a primary surplus that amounts to 0.7% of GDP.
In other words, a complete 180 from what the government said prior to the downgrade.
Needless to say, reconciling tax increases and budget cuts with the party mandate won’t be easy. “Budget cuts and tax increases discussed by govt in response to Brazil’s credit rating downgrade don’t agree with central tenets of Workers’ Party,” Bloomberg notes, citing an unnamed party official.
Particularly divisive will be the CPMF revival which isn’t likely to be approved. Here’s Bloomberg with a bit more [8] on the announcement:
Finance Minister Joaquim Levy proposed a new round of spending cuts and tax increases that are designed to close the budget gap and protect Brazil from further credit downgrades.
The government will reduce 26 billion reais ($6.8 billion) in expenditures from next year’s budget in large part by capping salaries of civil servants and suspending exams for new entrants, Levy said Monday. Brazil also plans to raise 28 billion reais in revenue by boosting taxes, including a levy on financial transactions.
“We know this effort to cut spending will only take us so far, so as would happen in any country in the world in a moment of reduced economic activity and tax income, you have to seek out other resources,” Levy told reporters. “We’re trying to find that balance.”
Obviously, the market will cast a wary eye towards the effort even as one assumes Brazil is to be applauded for trying, especially given the hugely contentious political environment and the threat of further social upheaval.
And here's Goldman with the full breakdown:
The authorities announced today a number of spending cuts and expenditure saving measures (worth an estimated R$26.0bn) and tax increases and a reduction of a number of tax breaks/benefits (estimated to yield approximately R$45.8bn). The key objective is to improve the federal government fiscal balance from the -R$30.5bn (-0.5% of GDP) deficit announced on August 29, to a +R$34.4bn (+0.55% GDP) surplus.
Most of the proposed adjustment will come from higher taxes; particularly from the reinstatement of the controversial Financial Transactions Tax at a rate of 0.2% which is expected to yield a substantial R$32bn.
Minister Levy stated that the tax should “not last more than 4 years.” Furthermore, approximately R$10bn will come from the reduction in projected outlays with civil servants which is likely to elicit strong rejection by the main public sector unions.
Many of the measures require Congressional approval of several pieces of legislation which, in our assessment, adds significant implementation risk. Given the administration record low level of popularity and its weak and increasingly fragmented support base in Congress we expect some of these measures to face significant resistance (to be either rejected or watered down during the legislative debate), particularly the approval of the widely rejected CPMF tax.
In all, we expect the 2016 budget discussion to be a drawn-out, jumpy and noisy process with a significant risk that only a subset of the proposed measures will clear Congress and with fiscal yields below the government proposal. Furthermore, we could not fail to notice that in today’s announcement there were no medium- and long-term fiscal measures to arrest the projected upward drift in mandatory spending (e.g., social security reform).
Overall, we remain of the view that a deep, permanent, structural fiscal adjustment remains front-and-center on the policy agenda to restore both domestic and external balance. In our assessment, at the end of the fiscal consolidation process Brazil needs to end up with a primary surplus of 3.0% to 3.5% of GDP (which is still quite distant from today’s fiscal reality). This would be the level of primary surplus that would put gross public debt on a clear declining trajectory; something that is required for Brazil to rebuild fiscal buffers and regain policy room to use fiscal counter-cyclically, whenever needed and appropriate.
Given the very slow pace of fiscal consolidation, and its poor quality geared towards tax hikes and investment cuts), the burden of current account adjustment will likely continue to fall disproportionately on monetary policy and the BRL.
The question now, is whether this was a good move.
That is, is it better to simply stick with the projection of a primary deficit and let the market be pleasantly surprised if things miraculously turn a corner, or is it better to try and head off further pressure on the country's credit rating by rolling out a largely non-credible plan to plug the budget gap and risk surprising on the down side?
We'll see, but at least in the short term, Goldman is probably correct to assume that in the absence of a stable political situation, the BRL will remain in focus and if FX pass-through picks up and the Fed hikes, we may need to see a Selic hike.
For an indication of how things are going, simply watch the data points on this chart:
