Itaú BBA - Spending Cap advances in the Senate

Brazil Review

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Spending Cap advances in the Senate

diciembre 1, 2016

In a first round of voting, the Senate approved the Constitutional Amendment Bill that sets a cap on public spending growth.

The Brazilian economy in November 2016

In a first round of voting, the Senate approved the Constitutional Amendment Bill that sets a cap on public spending growth. The Central Bank Monetary Policy Committee (Copom) cut interest rates by 25 basis points (bps), reducing the Selic to 13.75%. Federal government and governors seek an agreement in an attempt to resolve state funding crisis. The economy continues to shrink: GDP fell again in the third quarter, and unemployment continues to rise. Inflation continued to show signs of slowing. External accounts were stable, and asset repatriation contributed positively to public accounts in October. Uncertainty over future U.S. policies generated volatility in international markets. Possible conflicts between the Judiciary and Congress may hinder the development of fiscal reforms.

Senate approves spending cap in first round of voting

In a first round of voting, the Senate approved Constitutional Amendment Bill 55 (PEC 55), which sets a cap on public spending growth. Sixty-one senators voted in favor (49, or three-fifths of 81 senators, were needed to approve it), and 14 senators voted against. The bill now moves on to a second round of voting, which is likely to take place on December 13, based on the Senate’s timetable. The government’s second major fiscal reform plan, targeting Social Security, could be submitted to Congress in December.

Central Bank continues cycle of interest rate cuts

The Copom delivered its second rate cut, another 25bp move, taking the Selic to 13.75%, in a unanimous vote. The accompanying statement leaves the door open for an acceleration to 50bps, although it does not commit the Copom to deliver it. We reckon disappointment with economic activity will feed into the inflation outlook, and, provided the external environment does not become more unsettled, this will likely make the committee more comfortable about accelerating the pace of monetary easing.

Federal government and governors seek agreement in an attempt to resolve state funding crisis…

The federal and state governments announced their intent to reach an agreement to balance public accounts. The government would agree to transfer BRL 5 billion to the states, originating from a share of the revenues collected from fines in the asset repatriation program. In return, state governors would commit to a structural adjustment in their spending. The main proposals include a spending cap for each state, similar to the federal spending cap, and joint efforts to implement state and federal Social Security reforms, to be sent to Congress.

... but states in more critical situations, like Rio de Janeiro, require a deeper adjustment

Rio de Janeiro State Governor Luiz Fernando Pezão has presented a package of fiscal measures as the state’s financial crisis reaches new depths. The state is expected to end 2016 with an estimated primary deficit of BRL 17 billion, or 2.4% of GDP. Government employees of various stripes in Rio de Janeiro protested against the measures, which led the State government to recoil from the approval of said measures. A joint plan of action with the federal government may be presented in the next weeks.

Two ministers stepped down

The former Culture Minister, Marcelo Calero, and the Government Secretary, Minister Geddel Vieira Lima, stepped down amid a scandal involving a building in the city of Salvador. The National Institute of Artistic and Historical Heritage, a department run by the Ministry of Culture, had refused the building’s construction permit. As Government Secretary, Geddel Vieira Lima helped the president coordinate social and political efforts, particularly relationships with Congress, and liaised with the States.

The economy continues to contract

Gross Domestic Product (GDP) fell again in the third quarter, down 0.8%, although this was a smaller drop than expected.On the supply side, services were down for the seventh consecutive month (-0.6%), and agriculture shrank 1.4%.The industrial sector also retreated, down 1.3%, after growing in 2Q16.On the demand side, family consumption fell for the seventh time (-0.6%).Investments shrank 3.1% after rising in the previous quarter.Compared with the same quarter last year, GDP was down 2.9%.

The labor market and consumption remain weak

In October, there was a net loss of 75,000 formal jobs, or 79,000 if we strip out seasonal effects.The seasonally-adjusted rate of unemployment rose to 12.1% during the quarter ending in October.In recent months, the trend for contraction in real wages has weakened.Retail sales remain weak and fell further in September (-1.0% vs. the previous month and -5.5% year over year).

Inflation continues to show signs of slowing

The IPCA-15 rose 0.26% in November, which was less than the market expected (0.28%). This means the 12-month rate slowed from 8.3% to 7.6% in November. The month’s result is explained by a widespread decline in industrial products and a reversal in the recent food price shock.Inflation in less volatile groups, such as services, has also retreated, reflecting weaker economic activity.

Stable external accounts…

October’s current account deficit was USD 3.3 billion, slightly ahead of market expectations. The cumulative twelve-month deficit fell again, to USD 22.3 billion, or 1.3% of GDP, while direct investment in Brazil beat expectations, totaling USD 8.4 billion in October, or USD 75 billion over the past 12 months.

... and asset repatriation continued to bolster public accounts in October

In October, the consolidated public sector registered a surplus of BRL 39.6 billion, with support from tax revenues generated by the asset repatriation program. However, the month’s surplus will not change the unfavorable trend for fiscal results. The cumulative, twelve-month primary deficit was BRL 137.2 billion (2.2% of GDP, lower than the 3.1% of GDP registered in September), and the nominal deficit was BRL 544 billion (8.8% of GDP). Regional governments continue to show better results than expected. Public debt fell back from 70.7% of GDP to 70.3%.

Uncertainties linked with the U.S. generated market volatility

Uncertainty over future U.S. policies led to volatility in global markets. The Ibovespa fell 4.6% in BRL and 10.7% in USD while country risk, measured by the 5-year sovereign CDS, rose 23 bps and ended the month at 297 bps. The BRL depreciated 6.8%, ending the month at BRL 3.40 per dollar. Brazil’s central bank responded to this turn of events by intervening in the currency market using FX swaps.

Upcoming events

All eyes remain on the government’s fiscal reform agenda. According to the Congressional timetable, the Senate’s second vote on the spending cap is scheduled for December 13. The government may submit its Social Security reforms to Congress before the end of the year. Possible conflicts between the Judiciary and Congress may hinder the development of reforms. In the monetary policy area, the central bank releases its fourth-quarter Inflation Report (IR) on December 20.



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