Brazil 'downgrades' its fiscal target
- The Brazilian government has revised its primary surplus target for 2015 down by roughly 1%-point to 0.15% of GDP and now aims to achieve a 1%+ primary balance only in 2017
- The revision makes the target more credible, but given the need to stabilize debt the magnitude of the revision leaves practically no room for fiscal slippage
- An increasingly difficult economic and political environment complicates the situation
The adjustment of the fiscal adjustment
On 22 July 2015 the Brazilian government adjusted the fiscal target for 2015 to USD 2.6bn or 0.15% of GDP, from 1.2% of GDP previously. Moreover, the government indicated a further downward revision is possible, as USD 7.8bn (0.45% of GDP) in revenue is contingent on congressional approval and the realization of income from planned infrastructure concessions. Thus, the primary balance could run into a deficit this year. To reinforce its commitment to fiscal consolidation, the government announced another USD 2.6bn in discretionary spending cuts. The targets for the coming two years were also revised from a yearly primary surplus of 2% of GDP to 0.7% of GDP in 2016 and 1.3% of GDP in 2017 (figure 1). Consequently, public debt will increase in the coming two years and only stabilize in 2018. Disappointing public revenues on the back of a disappointing economic growth were the main reason for the downward revision.
The adjustment is not a surprise, as it was generally expected that the government would miss the 1.2% of GDP primary surplus target. Thus, it bodes well for credibility that the government has decided to draw a realistic budget. However, the magnitude of the adjustment was surprising and highlights the rigidity of Brazil’s pubic expenses and the implementation risks the fiscal adjustment faces moving forward. A large share of current expenditure is constitutionally mandated, and the high degree of fragmentation of the Brazilian congress and ongoing political tensions make the necessary congress approval for reining in such spending very difficult. The significant fiscal target revision has also evaporated Brazil’s room for fiscal slippage. That is reinforced by the fact that on 28 July S&P, whose rating of Brazil is just above junk, revised its outlook on the sovereign rating from stable to negative, as they estimate the chances of fiscal slippage are high on the back of weaker economic growth prospects and increasing political uncertainty.
The adjustment levy on the economy
A deteriorating economic situation does not make things easier. The economy was already in the doldrums in 2014, but the frontloaded adjustment of macroeconomic imbalances is hurting economic output (figure 2). A corruption scandal of historic proportions is also weighing down on sentiment and activity. In 15Q1, GDP contracted by 1.6% yoy as private consumption, previously a growth driver, turned negative (-0.9% yoy) on the back of a marked deterioration of the labour market (figure 3), high inflation (8.9% in June 2015) and tighter credit conditions. Also considering ongoing austerity measures, monetary tightening and problems in the construction and energy sector as a result of the ‘Car Wash’, we expect the economy to contract by at least 1.5% in 2015. Better economic policies should support a mild recovery of 0% - 0.5% in 2016. But risks are tilted to the downside, on the back of increasing political uncertainty.
Brace for impact?
Fallout from the ‘Car Wash’ corruption scandal in recent months has made the Brazilian political landscape increasingly challenging. Against a backdrop of historically low presidential approval rates, the chances of a political perfect storm threatening political stability are uncomfortably high, though that is still not our main scenario. ‘Car Wash’ is a corruption scandal involving state owned oil company Petrobras and, so far, high ranking politicians and business men. The recent arrest of the executive of construction conglomerate Odebrecht brings the investigations very close to former president Lula, who is officially being investigated for having abused his influence to the advantage of the company. Rumours that the president of the Lower and Upper House will soon be charged for corruption in the ‘Car Wash’ triggered the former to step out of the coalition. These events increase political tensions and increase the chances of political instability flaring up in the near term, which could ultimately include a presidential impeachment. And that is set to derail the correction course on macroeconomic policy, threaten Brazil’s investment grade sovereign rating and derail its economic recovery in 2016.