EcoPerspectives// 2nd quarter 2018  
Kicking the can down the road(map to fiscal consolidation)  
Despite the current economic recovery and a persistently favourable international environment, it is still premature to hope for  
sustainable fiscal consolidation. The errors of fiscal policy in past years have left their mark in the form of deteriorated public  
finances. The new administration that will take power in January 2019 will face the formidable task of meeting high social  
expectations while laying down fiscal targets that reassure investors. Structural reforms will have to be reintroduced, such as the  
pension reform that was swept under the carpet by the Termer administration. Without structural reforms, Brazil’s public finance  
trajectory could become unsustainable in the medium to long term.  
Real GDP growth averaged 1% in 2017, in line with expectations.  
Activity stalled in Q4 2017, with annualised growth of only 0.2% q/q,  
seasonally adjusted (saar), limiting the carry-over effect to only  
- Growth and inflation  
GDP Growth (%)  
 Inflation (%)  
.4% in 2018. With the exception of retail sales, economic indicators  
were rather disappointing in the first two months of the year  
industrial production, services, job market and bank lending).  
Our forecast calls for GDP growth of 3% in 2018. Mild inflation,  
historically low key rates and a rebound in formal employment  
should bolster household purchasing power and consumption,  
which has been the main growth engine so far. Exports should  
benefit from buoyant world demand and improvements in the terms  
of trade. Prospects are relatively favourable in most business  
sectors, which should trigger an upturn in investment. Even so,  
there are still strong fiscal headwinds.  
3.4 3.3  
-3.5 -3.5  
Sources : National accounts, BNP Paribas  
This scenario is subject to political risks with the approach of  
October’s elections. Former president Lula, who was leading in the  
polls, is no longer in the running after the Supreme Court’s 4 April  
ruling. Fortunately, Brazil has a solid external position (FDI and  
foreign exchange reserves) that should enable it to absorb not only  
a domestic shock but also an external trade and/or financial shock.  
- Economic recovery to be confirmed  
Real GDP, y/y % change  Real GDP, q/q % change (sa)  
Reforms as hard as pulling teeth  
At the dawn of a crucial election year, the indefinite postponement  
of pension reform has led the three main rating agencies to  
downgrade Brazil’s foreign currency denominated long-term  
sovereign debt rating. Primary public spending has risen three times  
faster than GDP over the past decade. After adopting a reform in  
late 2016 that froze current spending in real terms, pension reform  
was supposed to be the other commitment that would restore the  
credibility of fiscal policy in the medium to long term.  
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018  
Source : IBGE  
It is now up to the next administration to push through this  
unpopular reform, and in general, to overhaul the country’s social  
policies, which are a corner stone of more inclusive economic  
growth. Social spending by the federal government accounts for  
more than 40% of primary spending, or 8.5% of GDP (vs 6.6%  
between 2010 and 2014). For the consolidated public sector, the  
figure is even 15% of GDP. In the February 2018 Economic Survey  
of the OECD, potential savings from a comprehensive reform of  
social policies are estimated at 2.7% of GDP from a 10-year horizon.  
Other measures to streamline spending could generate additional  
savings of about 5% of GDP.  
In 2017, the federal public accounts (i.e. the central government,  
central bank and social security administration) managed to improve  
despite another swelling of the social accounts deficit (to 2.8% of  
GDP). The federal government’s primary deficit (excluding interest  
charges on the debt) was reduced to 1.9% of GDP from 2.6% in  
2016. Fiscal revenues increased by 5.2% in real terms in 2017,  
bolstered by the recovery in economic growth (which lifted fiscal  
revenues by 1.2%) and exceptional revenues (notably due to  
concessions and licenses). At the same time, spending increased  
by only 2.4% in real terms thanks to new cutbacks in discretionary  
spending. Appropriations to the Growth Acceleration Programme  
PAC)  a programme initiated by President Lula in 2007 to fund  
EcoPerspectives// 2nd quarter 2018  
public investment, especially for infrastructure  have been slashed  
in half since 2014 to 0.5% of GDP. Meanwhile, federal social  
welfare benefits accelerated again, by nearly 10% in real terms last  
- Unsustainable debt dynamics cannot be ruled out  
Gross federal government debt (% of GDP)  
Best-case scenario (reforms, increase in potential GDP, primary surplus)  
Worst-case scenario  
Spending on pensions accounts for 11.6% of GDP, compared to an  
OECD average of 8.1%, even though the population is still relatively  
young (7.8% in the over-65 age group, compared to an OECD  
average of 16.2%). Brazil has the lowest average age of retirement  
leave (55, compared to an OECD average of 64), and one of the  
highest replacement rates (98% of wages, vs an OECD average of  
Social programmes need to better target their beneficiaries. The  
emblematic family allowance (Bolsa Familia, 0.5% of GDP) is  
geared towards to poorest fringes of the population and is an  
undisputed success in fighting poverty and unequal access to  
education and health care. Yet major savings could be generated  
from certain social benefits provided to the middle classes. The  
minimum wage, which serves as the threshold for social welfare  
allocations, has increased 80% in real terms over the past 15 years,  
compared to per capita GDP growth of only 23%. It is now seven  
times higher than the poverty line, and even higher than the median  
income. Consequently, it is recommended that social benefits,  
including pensions, be indexed to inflation rather than to the  
minimum wage. The merging of the two unemployment benefit  
systems (Seguro Desemprego and FGTS) would also generate  
synergies, and the savings could be used to finance extended  
coverage (currently a maximum of five months).  
2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025  
Source : BNP Paribas  
small. All else equal, a 100 basis point increase in US key rates and  
a 20% depreciation of the USDBRL exchange rate would increase  
Brazil’s public debt ratio by only 10bp and 60bp, respectively. The  
average maturity of the debt is rather long (4 years for domestic  
debt and 8 years for external debt), the average life to maturity is  
nearly 6 years, and the amortisation profile is relatively smooth (15-  
8% maturing within the next 12 months).  
The 2018 target of a primary deficit of BRL 159 bn (about 2.2% of  
GDP) seems to be achievable. Total government financing needs  
for the current year are substantial, estimated at BRL 637 bn, or  
more than 9% of GDP. Moreover, they are expected to swell in the  
years ahead, accentuating fears that Brazil will not be able to  
respect the “golden fiscal rule”, which says that debt issues should  
not be used to finance current spending excluding investment.  
Whether the government will successfully reduce the primary deficit  
to 0.8% of GDP by 2020 will depend on the nature of future fiscal  
policies and the adoption of reforms. But there is also the risk of a  
downturn in the global economy.  
Avoiding a risk of snow(ball effect on debt) in Brasilia  
In three years, federal debt outstanding has increased by 56% and  
the gross debt ratio by nearly 20 points of GDP, to 74% at year-end  
017, which is high according to emerging country standards.  
Brazils interest charge on debt is unusually heavy at 6.1% of GDP  
in 2017, compared to about 4% for Italy and 1.5% for Japan, two  
countries whose public debt load is much higher than for Brazil. This  
is the corollary of structurally high domestic rates. They reflect the  
hysteresis effect derived from past macroeconomic instability, and  
more recently (2014-2016) from budget overruns, the depreciation  
of Brazilian real (BRL) and high inflation. As a result, the apparent  
interest rate on the federal debt (interest charge as a share of debt)  
was 8.2% in 2017.  
Even if structural reforms were to lift the potential growth rate from  
2.3% to 3.5%-4%, a primary surplus of about 1% of GDP would still  
be necessary to stabilise the public debt ratio. Under a best-case  
scenario, public debt would peak at about 84% of GDP in 2022  
before falling back gradually. Inversely, in the absence of any major  
new reforms, a snowball effect could make the public debt  
unsustainable, and it could hit 110% of GDP by 2025.  
The disinflation process and the relative stability of BRL since early  
2016 have helped ease monetary policy (the Selic declined 750  
basis points to 6.5%), which seems to be winding down. This in turn  
helped ease domestic financing conditions (the average debt  
refinancing rate in BRL declined from 16.3% in early 2016 to 9.9%  
in February 2018, only a third of which is in fixed rate instruments).  
Nearly 97% of federal debt is denominated in BRL (including 0.3%  
in international bonds) and handled in a deep and liquid local bond  
market. Non-resident holdings of Treasury notes have been reduced  
by 14% in two years to BRL 428 bn in February 2018 (roughly  
USD 128 bn), or 12.4% of local bonds outstanding. Gross external  
debt amounted to USD 37 bn. The “direct” currency and interest rate  
risks associated with the US Fed’s monetary policy are relatively  
Amortisation of the debt + interest + share of primary deficit in compliance with  
the golden rule + guaranties as part of state government bailout plans  BNDES  
state development bank’s payments to the Treasury.  
QUI SOMMES-NOUS ? Trois équipes d'économistes (économies OCDE, économies émergentes et risque pays, économie bancaire) forment la Direction des Etudes Economiques de BNP Paribas.
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