Itaú BBA - Fiscal Adjustment: How Much More to Go?

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Fiscal Adjustment: How Much More to Go?

June 29, 2015

The fiscal adjustment already implemented is slightly less than half the adjustment required to stabilize the public debt.

The fiscal adjustment is not expected to end this year. But how much more is there to go? To answer this question, we first need to determine the fiscal adjustment’s necessary size. Afterwards, we will verify how much of the adjustment has already been implemented.

The size of the adjustment is defined by the primary surplus required to stabilize the public debt dynamics. The calculation of how much has already been implemented is done by adding the fiscal impact of the measures already announced.

We determine as necessary a multi-year fiscal adjustment that increases the primary surplus to 2.5% of GDP (level that stabilizes the public debt in the long term, according to our calculations) until 2018.

Our view is that the necessary fiscal adjustment is 5.0 percentage points of GDP, and less than half of it has already been implemented.


The decline of the primary surplus in recent years has created the need for a fiscal adjustment in order to regain public debt sustainability. The need for adjustment was underscored in 2014, characterized by a sharper decline in the primary surplus and a rising public debt-to-GDP ratio.

The adjustment started this year, with a series of tax hikes and spending cuts. But how much of the necessary adjustment has already been implemented and how much more is there to go? To answer this question, we first need to determine the fiscal adjustment’s necessary size. Afterwards, we will verify how much of the adjustment has already been implemented, with the measures already taken and their impact on the primary surplus. That is the goal of this report.

The Necessary Fiscal Adjustment: 5.0% of GDP

We estimate that the primary surplus required to stabilize the public debt-to-GDP in the long term is about 2.5% of GDP. To reach it, we should take into account the starting point (primary result right before the adjustment started), and adjust it by: i) the non-recurrent revenues that compose it (which will not be repeated going forward); ii) the growing trend of certain mandatory expenditures, especially in social security, which point to a declining primary surplus trend if all else remains constant; and iii) the expectation for future tax revenues that depend on the economic cycle. Let’s see the numbers:

1. The primary result finished 2014 at -0.6% of GDP, 3.1% of GDP below what is required to stabilize the public debt (2.5%).

2. The non-recurrent revenues for 2014 (stemming from the REFIS program, extraordinary dividends and the telecom auction 4G), amounted to 0.6% of GDP.

3. We estimate that the increase in social security expenditures – due to the aging of the population and the minimum wage rule that indexes part of these expenditures – will be of 1.2% of GDP from 2015 to 2018 (see appendix).

4. As for future mandatory expenditures, we must also consider the interest-equalization disbursements from the Treasury to BNDES due to the development bank’s investment program (PSI, in Portuguese). The payment of these expenditures was delayed in previous years and has already started to be recognized in April 2015. We assume that these payments will occur gradually, adding 0.2% of GDP per year until 2018. Therefore, the final impact on the annual primary surplus will be 0.2% of GDP.

5. Economic cycle: From 2015 to 2018, we calculate that the cycle effect will be positive, at 0.2% of GDP, given that we project a decline in economic activity this year, but growth in 2016, 2017 and 2018. We estimate that this year’s economic activity decline will reduce the primary surplus by 0.5% of GDP, but the recovery in subsequent years (still moderate in 2016) will add 0.1% to the primary surplus in 2016, 0.3% in 2017 and 0.3% in 2018 (see appendix).

Adding all the factors above, we arrive at the scope of the fiscal adjustment that must be made: of 5.0% of GDP (the economic cycle effect is positive, so it has a negative value in the sum of the necessary adjustment).

How much of the adjustment has already been implemented?

According to our calculations, already-implemented fiscal measures add up to 1.9% of GDP: 38% of the necessary adjustment.

Of the adjustment already done, spending cuts represent 1.0% of GDP (we include here the cut in discretionary spending – investment and administrative costs – approved in the budget-freeze decree of 2015). Another 0.8% of GDP are tax hikes. Finally, regional governments contribute 0.1% of GDP to the adjustment, calculated with the regional primary surplus year to date against the same period last year (see final table of the appendix).

So although the adjustment already implemented – of almost 2.0 pp of GDP – is historically significant, it represents slightly less than half the adjustment needed to increase the primary surplus to levels more consistent with public-debt stabilization.

This exercise also highlights the importance of structural reforms aiming to reduce the growing trend of federal spending as a percentage of GDP, especially the expenditures on social security benefits.



The growing trend of social security expenditures

The growing trend of expenditures on social security and lifetime monthly income as a percentage of GDP stems from two factors: the growing number of beneficiaries depending on these programs above real GDP (volume effect) and the readjustments indexed to the minimum wage above the GDP deflator (price effect).

The minimum wage rule is well known (inflation of the previous year + real GDP growth of two years before) and indexes around two-thirds of social security payments and all of the lifetime monthly income benefits. Assuming that the current rule will be maintained, the minimum wage will continue to pressure expenditures. Regarding the future number of beneficiaries, we forecast its trend taking into account IBGE (official statistics unit) estimates of the population older than 55 years, which indicate sustained growth in the number of elderly people above real GDP.

Therefore, our forecasts point to an expansion in social security expenditures, regardless of the end of the fator previdenciário (an index that reduces social security payments for those who retire too early) for the 85-95 age bracket (sum of years of age and years of work for women and men, respectively), rising to 90-100 by 2022.


Cycle Effect

The table below shows our estimates for the growth in cyclical tax collection (those that are correlated to economic activity) in real terms. The estimates are based on our forecasts for GDP growth: -1.7% in 2015, +0.3% in 2016, 1.8% in 2017 and 1.9% in 2018.

Measures Already Implemented


Luka Barbosa


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