Itaú BBA - Spending cap is approved and Social Security reform advances in Congress

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Spending cap is approved and Social Security reform advances in Congress

January 2, 2017

The next step in the fiscal reform agenda, the Social Security reform, is successfully advancing in the Lower House.

The Brazilian economy in December 2016

The legislative agenda continues to advance. The spending cap bill has been approved by Congress, the Social Security reform has been accepted by the Lower House Constitutional Committee, and the voting on the state debt renegotiation bill has been concluded (although partially vetoed by President Temer). The government has also announced a series of measures related to credit and to the reduction of red tape. The Central Bank signaled a faster pace of interest rate cuts ahead, while the economic weakness persists and inflation continues to decline. The current account deficit remained flat, but the fiscal deficit is rising. 

Spending cap is approved by the Senate and the Social Security reform advances in the Lower House 

The constitutional amendment establishing a cap on public spending was approved by the Senate in a second-round vote of 53 to 16 (a three-fifths majority or 49 votes were needed). The next step in the fiscal reform agenda, the Social Security reform, successfully advanced in the Lower House Constitutional Committee. In February 2017, after the parliamentary recess and the subsequent election for senate and lower house leaders, Congress will continue to analyze the bill; a special committee will be established for this purpose. In general terms, the reform seeks to unify and streamline the rules for access to social security benefits in order to ensure the system’s equilibrium and sustainability. Among the proposed changes are the introduction of requirements for retirement that include a minimum age of 65 and a minimum contribution period of 25 years, with transitional rules for men over 50 and women over 45.

President Temer partially vetoes the state debt renegotiation approved by Congress

President Michel Temer sanctioned, with vetoes, the states debt deal with the federal government. The proposal that had been approved by the Lower House maintained benefits to the states that adhered to the Fiscal Recovery Regime, but exempted them of several requirements made by the Senate. Therefore, the state debt renegotiation program that will be in place is the same one that had been approved by the Lower House in August, which extended debt payments for 20 years, and required states to limit their spending growth, for a period of 2 years, to inflation of the previous year.

Government announces credit measures and the curbing of red tape

The Central Bank announced a new plan to address structural issues in the financial system. The proposed actions include the simplification of the rules for reserve requirements; the improvement of the consumer credit bureau (“cadastro positivo”), which will contribute to lower default rates; the fostering of mortgage lending through regulation of real estate credit instruments; measures to streamline the use of credit cards; reassessing the impact of earmarked credit; and encouraging a structural agenda aimed at reducing bank spreads. The government is also working on measures to increase the efficiency and productivity of the economy as a whole, reducing the red tape and streamlining its labor and fiscal obligations.

Central Bank signals faster pace of rate cuts ahead and CMN maintains TJLP at 7.5%

Of the four scenarios provided in the Copom’s 4Q16 Inflation Report, the inflation forecasts for 2017 are slightly below the target in those that assume a stable Selic base rate, and above the target in those that assume a lower Selic rate. We note, however, that inflation forecasts for 2018, which will gain relevance in the upcoming Copom discussions, are at or below the target in all four scenarios, even those that assume lower interest rates. This means that a long easing cycle is not inconsistent with achieving the inflation target. We expect the Copom to accelerate the pace of rate cuts from 25 bps to 50 bps in January, bringing the Selic rate to 13.25%. The National Monetary Council (CMN) maintained the long-term interest rate (TJLP) at 7.5%, in line with expectations; the decision will become effective in the first quarter of 2017.

Weak economic activity persists...

According to the October figures, economic activity continues to deteriorate. Industrial production fell by 1.1% MoM/sa, retail sales dropped 0.8% and real-service sector volumes contracted by 2.4%. However, the indicators for November – such as vehicle production, import volume and highway vehicle traffic – rose, signaling an increase in industrial production in the month (data to be released on January 5). As to the labor market, no signs of improvement: in November, there was a net loss of 127 thousand jobs and the unemployment rate rose to 12.3% (both after seasonal adjustment). We expect marginal stability in 4Q16 GDP after seven consecutive declines.

…while inflation continues to decline

Inflation as measured by the IPCA-15 stood at 0.19% in December, once again below market expectations. The widespread decline in service- and industrial-related prices had a significant impact on the month’s results. Inflation has dropped to 6.6% in the last 12 months, and we expect the full-year IPCA to reach 6.3%, which is significantly below the 10.7% reported in 2015.

The current account deficit remains stable...

The current account deficit totaled USD 878 million in November (above market expectations), but has declined in the last 12 months, to USD 20.3 billion (1.1% of GDP), while direct investments in the country offered another upside surprise, rising to USD 79 billion over the last 12 months.

... but the fiscal deficit has increased

The consolidated public sector posted a primary deficit of BRL 39.1 billion in November, bringing the primary deficit for the last 12 months to BRL 156.8 billion (2.5% of GDP, from 2.2% previously) and the nominal deficit to BRL 581 billion (9.3% of GDP). Regional governments registered a primary surplus of BRL 0.4 billion in November, while the gross public debt rose to 70.5% of GDP (from 69.5% previously).

Financial assets appreciated in November

The Ibovespa Index was up 1.4% in USD terms (although declining 2.7% in local currency), the country risk as measured by the 5-year CDS fell by 16 pp to end the month at 281 bps, and the BRL appreciated 4.1%, to 3.26 per USD.

Upcoming Events

The Central Bank will set the Selic interest rate on January 11. The industrial production figure for November will be disclosed on January 5; we forecast an expansion. Congress will be in recess throughout the month of January, resuming activities on February 2, when the new lower house and senate leaders will be elected. The evolution of states' public accounts will be a key issue given that the state debt renegotiation bill approved by Congress does not provide a final solution.



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