Barbosa’s mission impossible
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Emerging Markets

Barbosa’s mission impossible

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Brazil’s new finance minister tells Emerging Markets that his country cannot stand idle in the face of political turmoil. But that may well be wishful thinking

In early March, Nelson Barbosa unveiled changes to improve infrastructure financing rules during a meeting with the Brazilian capital market association in Brasilia. But few paid attention. The Brazilian capital had just been engulfed by another bout of political fever. Lula, the former president and icon of the Latin American left wing movements, had been taken into custody to answer questions relating to the Petrobras corruption scandal.

Pro- and anti-Lula supporters took to the streets, often confronting each other. The political crisis has reached a climax as Congress launched an impeachment process against Rousseff, and the centrist PMDB party decided to leave the ruling coalition.

Meanwhile the new finance minister, who succeeded Joaquim Levy late last year, has been left with a recession on his hands, a steep fall in tax collection, a widening fiscal deficit, successive downgrades by credit rating agencies that left Brazil two notches below investment grade, and double-digit inflation. Welcome to the new Brazil!

The political noise over the corruption investigation involving Lula and the possible impeachment of Rousseff have made the task of fixing the largest Latin American economy even more difficult.

“We cannot stand idle in the face of the current political turmoil,” says Nelson Barbosa in an interview with Emerging Markets. “The ongoing political talk cannot delay or prevent the country from going forward.”

FISCAL PLEDGE

Barbosa, a previous budget and planning minister, has often been regarded as someone who was undermining the efforts of his predecessor, Joaquim Levy, to achieve greater fiscal discipline. Now, in line with Rousseff’s directives, he has been promoting a new balance. “Our great challenge is to seek a new internal rebalancing, the stabilisation of the economy, including inflation control and fiscal restructuring, and above all, measures that promote the resumption of economic growth, income and employment,” he says.

“We need to move from a fiscal adjustment process to an agenda of fiscal reform. We need long term reforms than can set the lasting foundations for a new macro-economic balance in our country,” he says.

While investors point to Brazil’s fiscal deficit as a great source of weakness, the new finance minister, an academic from the Getulio Vargas Foundation who is close to Rousseff’s Workers’ Party (PT), has repeatedly been in favour of greater fiscal flexibility.

His predecessor Levy had argued in favour of a primary budget surplus that would help stabilise the debt-to-GDP ratio but Barbosa has supported a review of these targets. As a result, the planned primary budget surpluses have become deficits.

Brazil was due to register a surplus of 1.55% of GDP this year but Barbosa used his influence to change the target to 0.5% of GDP deficit. “We have had periods of strong volatility regarding government revenues, whether from companies or from households,” he says, “so it is necessary to have a margin to absorb those fluctuations. We have to combine stricter spending limits with some flexibility to make up for short term up and downs that we have seen in Brazil in recent years.”

However, many investors see this as an attempt to shift the goalposts. Last year, Brazil registered a 1.9% primary fiscal deficit and its nominal budget deficit increased to 10.3% of GDP. “The political situation continues to be very uncertain,” says Ramon Aracena, chief Latin America economist at the Institute of International Finance (IIF), “mainly because corruption investigations continue to have implications on some politicians. It is not clear what is going to happen with the government yet. As a result, it has created some sort of economic paralysis. The government has not been able to push the fiscal adjustment.”

He adds that the fiscal situation is one of Brazil’s biggest problems. “It is a structural issue that is going to need some kind of constitutional amendment in order to fix it once and for all, but this is not going to happen. You have 90% of the federal budget revenues that are earmarked; what the government can adjust is very little.”

Aracena has forecast that the gross debt to GDP ratio will increase to 75% of GDP in 2016 and to 85% of GDP in 2017 (from 66.2% at the end of last year).

Still, Barbosa is adamant. “We have a short term, a medium term and a long term fiscal agenda so that we can be sure of the sound character of the fiscal policy and of the stability of the public debt in the medium term,” he says.

Barbosa has promised to implement spending caps and to push for a controversial but much needed pension reform. “We need to reform the social welfare system. We need to reform what is not essential to be able to preserve what is essential,” he says. “The pension bill will be sent to Congress [this month] in April. This is an issue that no one can escape in Brazil or elsewhere in the world. We are already late and we need to face this issue.”

Barbosa has argued that social security benefits and pensions amount to 44% of overall primary spending. “Combined spending increased from 6% in 2002 to 8.7% of GDP in 2016 — an increase of nearly three percentage points.”

The social security deficit amounted to Br85.3bn last year, up 51.3% over the previous year, an unsustainable trend.

The pension reform is unpopular among the Workers’ Party and left wing activists, who have rallied around Rousseff in an attempt to prevent Congress voting for her impeachment. The political fever has become so high in Brasilia that Congress may be in no mood to pass pension reforms or even the unpopular financial transaction tax, known as CPMF, any time soon. Barbosa defends the CPMF as a “temporary tool to sail through the current period of instability and economic volatility”. But corruption and politics will again dominate the agenda and jeopardise Barbosa’s plans.

THE ROAD TO NOWHERE

“His policies are going in the right direction from the technical level in terms of spending and pension reform,” Aracena tells Emerging Markets. “They are also going to try a fiscal reform. The problem is that you need political support. You need a strong coalition and you do not have this here. Regardless of what people at the technical level want to do, if you do not have the political back-up, it is not going to go anywhere. And that is my expectation: they are not going to go anywhere.

“You have a crisis of confidence... One of the most important things in this business, like in any business, is confidence. If you have it, everything is much easier to do. If you lose it, everything becomes much more difficult. Indeed, the credibility has deteriorated sharply.”

Moreover, the road to restore confidence is a rocky one, as Luciano Coutinho, the president of Brazil’s National Development Bank (BNDES), admits. “Such efforts demand persistence, coherence over time. You cannot recover it at once but you may do so thanks to a patient and persistent effort to set up an investment-friendly environment.”

In early March, the finance ministry and the BNDES unveiled new rules to boost investment in infrastructure through debentures. Financing costs may be cut from 1.3 percentage points to two percentage points for those strategic investments. But similar moves have been announced in the past and they may not resolve the confidence crisis.

In spite of the large powers of the finance minister, the outcome of the current crisis seems far beyond Barbosa’s reach. Business has been suffering as a result of the last recession (GDP contracted by 3.8% last year and may shrink by some 4% this year, according to several economists).

Bankruptcies and unemployment are on the rise as well as non-performing loans. Some public banks may need to be re-capitalised, the IIF says.

Consumer confidence is falling according to a recent survey from The Boston Consulting Group. Fifty-one percent of respondents say they now feel some “anxiety about the future”. Only 30% said so in 2012. Sales of some durable consumer goods have been falling sharply for the past two years and other retail sales have recently suffered a decline too.

On the positive side, Brazil’s position on the external front has improved, mainly due to the depreciation of its currency. The current account deficit is expected to fall “close to zero” at the end of the year, according to Octavio Barros, Bradesco’s chief economist, and FDI remains strong.

Meanwhile, Barbosa remains optimistic that a hard landing in China will be avoided. “The slowdown of the Chinese economy should not be a concern to Brazilians,” he says. “We are ready to deal with this sort of volatility. Our actions are focused on the control of inflation and the capacity of the government to achieve a higher [fiscal] primary surplus on a recurrent basis. Brazil has a high level of international reserves, which gives us the means to deal with exchange rate variations without creating financial problems.”

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