Brazil: Economy Downgrade Points to Need for Fiscal Reform – March 2014
Published 16 April 2014
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On 24 March, Standard & Poor’s reduced Brazil’s credit rating from BBB (outlook negative) to BBB- (outlook stable). They cite Brazil’s lower than expected growth at 2% over the coming two years, well below potential, and the government’s inability to adjust the fiscal position before the October election. The decision surprised, but Brazilian government bonds still retain investment grade, and S&P underlined they were comfortable in maintaining this rating. Investment grade is critical to Brazil’s drive to attract foreign capital investment and make up for low domestic savings.
S&P note that the Federal Government has weakened its fiscal commitment. In 2013, the Federal Government stopped making up for shortfalls in the States’ contributions to the overall primary surplus (surplus before interest payments on debt) target of 3.1% of GDP.
- Tax breaks for industry to boost growth are being counted by the Government as “revenue” when calculating the primary surplus. This is an unconventional approach: normally it is investment that is not counted in primary spending because it boosts growth and therefore tax revenues. Industry grew by only 1.3% in 2013.
- The fiscal target was met in 2013 because of revenues from the sale of the Libra oil field and, in 2012, by creative accounting, swapping bonds and shares for cash with the State-owned banks.
- The federal budget deficit (including interest payments) in Brazil was 3.2% in 2013. S&P predict it will rise to 3.9% in 2014.
Despite the negative fiscal outlook, the downgrade was unexpected. Recent economic news has been better. The economy grew 0.7% in Q4 2013, when many commentators had predicted shrinkage. Industry recovered in January gaining much ground lost in December. And a strong appetite for the high interest rates on Brazilian bonds has helped the Real start 2014 strongly.
The Finance Ministry reacted strongly. The downgrade was “inconsistent with the conditions of the economy” and “contradictory with the strength and fundamentals of Brazil.” The Government points to near full employment and 2.3% growth in 2013, one of the highest amongst G20 countries. Medium term it hopes programmes to increase tertiary education and launch major transport infrastructure projects will contribute to higher growth.
S&P has fired a warning shot about the consequences of delaying reforms, whoever wins the election. Key reforms, already raised in Government circles, are cutting abuse in unemployment assistance claims and changing the way the minimum wage is indexed which is pushing up linked social security payments and wages generally. Both reforms will encounter trade union resistance. S&P does not expect radical reforms after the election but is expecting progress.
Brazil must strengthen its investment grade status to attract the continued investment inflows on which it depends to boost growth. Lowering Brazil risk, increasing growth, and moderating wage inflation, will help British business both to increase exports and achieve better returns on investment.
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