Itaú BBA - New administration proposes fiscal reforms

Brazil Review

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New administration proposes fiscal reforms

junio 1, 2016

Michel Temer’s interim administration has been sworn in and is proposing fiscal reforms to rein in public spending.

The Brazilian economy in May 2016

Michel Temer’s interim administration has been sworn in and is proposing fiscal reforms to rein in public spending. The measures involve changes to the Constitution, which require Congressional approval. In the meantime, the primary deficit remains high, and the annual deficit target has been raised. Two new ministers have stepped down after certain audio files related to the Operation Carwash investigations were released. The government has also started efforts to stimulate infrastructure investments. The economy remains in recession, with GDP falling further over the first quarter and unemployment climbing higher. Partial inflation figures for March came in above expectations, but the trend is still downwards. External accounts continued to adjust, with a reduction in the current account deficit. Markets fell in May. The main issues now on the horizon are the fiscal reform agenda, the impeachment process in the Senate and the next Copom meeting, scheduled for June 8.

The new administration takes over...

Vice-president Michel Temer took office on an interim basis on May 13, after the Senate allowed the impeachment process to proceed by 55 votes to 22. The president’s definitive removal from office would only occur after a final Senate vote in favor of impeachment, which requires a two-thirds majority, i.e. approval from 54 senators. No date has been set for the final vote, but it must take place within 180 days of the president’s suspension. Temer has completely reshuffled his cabinet. The biggest changes in the economic area are: Henrique Meirelles (Minister of the Treasury), the Central Bank (Ilan Goldfajn – awaiting Senate approval), BNDES (Maria Silvia Bastos Marques) and Petrobras (Pedro Parente).

... submits reform proposals...

Minister Henrique Meirelles submitted two important measures: the first setting a ceiling for public expenditure, linking any spending increase to inflation. This will allow public spending as a percentage of GDP to fall over the next years, reversing the upward trajectory from the past decade. However, this requires a constitutional amendment and support from three-fifths of Congress, as well as other changes to minimum wage and social security rules to ensure spending limits are adhered to. The constitutional amendment bill has yet to be sent to Congress. The second measure involves the BNDES bringing forward the payment of a BRL 100 billion debt with the National Treasury (1.6% of GDP), which does not depend on Congress. 

... and changes the fiscal target.

The government increased this year’s primary deficit target from BRL 96 billion to BRL 170 billion, or 2.5% of GDP.  The administration obtained a major victory when the new target was approved by Congress. In April, the consolidated public sector recorded a cumulative, 12-month primary deficit of BRL 139 billion (2.3% of GDP), with a nominal deficit of BRL 603 billion (10.1% of GDP).  Public debt stands at 67.5% of GDP, up 0.3 pp on the preceding month. 

Two ministers stood down                                                

Romero Jucá, Planning Minister, and Fabiano Silveira, Transparency, Enforcement and Control Minister, resigned when recordings of conversations related to the Operation Carwash investigations were published. 

Infrastructure investment stimulus plans

Another government initiative aims to boost infrastructure investments. The new federal secretary responsible for this area, Moreira Franco, announced the government will stop regulating the rate of return on infrastructure projects and promised to redefine the legal and regulatory frameworks in order to make investments more attractive.  

The economy is still in recession...

First-quarter GDP declined again, its fifth consecutive slip. The drop was less intense than expected, of
-0.3%, while consensus was for a 0.8% decrease. The positive surprise came from investments, which fell 2.7% (they were expected to fall 6.1%), and the service sector, which grew 0.1% (expected decline of 1.1%), while consumption was worse than expected (-1.7%, vs an expectation of -1.0%). The year-on-year decline of GDP was 5.4%. 

... and the job market continues to deteriorate

The Continuous PNAD measure of national unemployment rose to 11.2% in the quarter to April, a 3.2 pp year-on-year increase. According to the Ministry of Employment, April saw a net loss of 62 thousand formal jobs (170 thousand with seasonal adjustments), affecting various sectors of the economy.

May’s inflation above expectations, but the trend is still downward

The IPCA-15 rose 0.86% in May, coming out above market expectations. This means the 12-month rate rose to 9.62%, after hitting 9.34% the previous month. The main culprits for this month’s increase were the health care and personal care, food and beverages and housing groups, with the biggest individual impacts coming from medications and water and sewage rates. These pressures drove regulated prices up 1.45%. On the other hand, the transport group posted a negative rate as fuel and airline ticket prices fell. We believe May’s increase in inflation is an outlier and the downward trend in inflation is unlikely to change. 

External accounts continue to improve

April saw a current account surplus of BRL 412 million, which was above expectations and above the April average in previous years. The accumulated 12-month current account deficit retreated again (to USD 34.1 billion, or 2.0% of GDP, compared with USD 41.4 billion, or 2.4% o GDP in March). The biggest surprise came in the income account, with a significant drop in the profits and dividend deficit. As far as current account financing is concerned, direct investment in Brazil has been resilient, but portfolio flows continue to retreat. The data confirm the ongoing current account adjustment, which began last year with the exchange rate depreciation and the slowdown in economic activity.

Markets fall

After rising in April, Brazilian asset prices fell in May, partly influenced by signals from the Fed. The exchange rate depreciated 4.2%, ending the month at BRL 3.60 per dollar. The Ibovespa declined 10.1% in BRL and 13.7% in USD, and country risk, measured by the 5-year sovereign CDS, rose 6.8%, closing the month at 363 bps.

Upcoming events

Attention will now focus on how the government’s fiscal reform agenda progresses through Congress, particularly the proposal to create a ceiling for spending growth. The impeachment process continues in the Senate. The next Monetary Policy Committee (Copom) meeting will be on June 8. 



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