Itaú BBA - Primary deficit of 2.5% of GDP in 2016

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Primary deficit of 2.5% of GDP in 2016

January 31, 2017

Result was slightly better than the target of -2.6% of GDP

The consolidated public sector posted a primary budgetdeficit of 156 billion reais (-2.5% of GDP) in 2016, slightly better than the fiscal target of 164 billion reais (-2.6% of GDP). The central government had a deficit of 160 billion reais (-2.6% of GDP), regional governments had a surplus of 5 billion reais (0.1% of GDP) and state-owned enterprises had a deficit of 1 billion (0.0% of GDP). Gross debt expanded to69.5% from 65.5% in 2015, while net debt widened to 45.9% of GDP from 35.6%. In our view, the approval and implementation of the spending cap and pension reform are pivotal to reverse the upward trend in public debt in a consistent way. In December, the primary deficit of 60.1 billion reais was narrower than expected (our and market’s forecast were at 68 billion reais), and the biggest surprise involved smaller payments of net budget leftovers (so-called “restos a pagar”) than the government had indicated.

In December, the central government posted a deficit of 60.1 billion reais, which was better than our estimate and the market’s (both at -68 billion). The number was -64.2 billion reais under the Central Bank’s methodology. Revenues were 2 billion reais above our forecast, while expenses were 6 billion reais below our estimate. The surprise involving expenses reflected mostly smaller payments of budget leftovers (so-called “restos a pagar”) in the discretionary spending line. In 2016 as a whole, the central government had a deficit of 154 billion reais (-2.5% of GDP; -160 billion reais or -2.6% of under the Central Bank’s methodology), slightly better than its target of 170 billion reais (-2.7% of GDP).

Regional governments posted adeficit of 6 billion reais in December (our estimate: 4 billion). In 2016, their balance was 0.1% of GDP (see chart). In 2017, their primary result should be near zero, as the rebound in economic growth will be offset by payments of budget leftovers “restos a pagar”.

The primary result continued on a deteriorating trend in 2016. Rising expenses and shrinking tax revenues pushed the primary balance to the worst level in the historical series (see chart). The -2.5% of GDP deficit (-156 billion reais) was slightly better than the annual target of -2.6% of GDP (-164 billion reais) and was impacted by 1.1% of GDP (64 billion reais) in extraordinary revenues produced by the repatriation of funds held overseas and auctions of licenses for hydropower plants. In 2017, recurring tax revenues will recover very gradually, as the economic indicators that drive tax revenues (retail sales and the wage bill) will expand more slowly than GDP. Hence, achieving the annual target (deficit of 2.2% of GDP or -143 billion reais) will again depend a lot on extraordinary revenues (we estimate around 60 billion reais or 0.9% of GDP).

Public debt also remained on an unfavorable trend (see first chart). The general government’s gross debt expanded to 69.5% of GDP from 65.5% in 2015 and 56.3% in 2014. In December, development bank BNDES returned 100 billion reais (1.6% of GDP) to the National Treasury, cushioning the increase in gross debt for the year. Net debt widened to 45.9% of GDP from 35.6% in 2015 and 32.4% in 2014. In addition to the primary deficit and sharp contraction in GDP, the upward trend in debt levels was driven by large interest expenses (see second chart), which continued to advance (to 7.7% of GDP in 2016 from 6.9% in 2015) — if the calculation excludes FX swap transactions that resulted in a loss of 1.5% of GDP in 2015 and a gain of 1.2% of GDP in 2016.

In order to reverse this deteriorating trend, approval and implementation of structural reforms are pivotal. The public spending cap, approved in late 2016, and the pension reform that Congress will debate in the coming months will be vital to gradually reverse the fiscal unbalance when economic growth resumes. With reforms, the upward trend in primary expenses — in place for at least the last 20 years — will be halted, producing positive implications of faster economic growth and lower interest rates, which will help to stabilize public debt in the medium term.


Pedro Schneider


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