President Luiz Inácio Lula da Silva wants to ease constraints on government spending in Brazil, expanding the state’s role in Latin America’s largest economy despite investor concerns.
Brasilia is set for a Congressional vote in the coming weeks on the bill that will ensure real spending increases every year. If approved, the changes would allow the veteran leftist to allocate extra funds for infrastructure and social benefits, key planks of the president’s pledge to end hunger in the nation of 208 million.
However, it would also mean breaking with a ceiling that limits budget increases to the inflation rate. Introduced in 2017, the spending cap has become a pillar of the state’s fiscal credibility and helped stabilize the South American nation’s debt level.
Ministers say Lula will find a balance between delivering on election promises and managing public finances responsibly, committing to a balanced budget in 2024.
They also point to the president’s record during his first two terms in office between 2003 and 2010, when he rode a global commodity boom to lift tens of millions out of poverty through welfare programs while largely abiding by economic orthodoxy.
But that hasn’t prevented the market from worrying about a possible shift to the left towards less business-friendly policies. Concerns were compounded by the president’s frequent attacks on the country’s independent central bank, accusing it of dent growth by keeping its benchmark lending rate at 13.75%.
Of particular concern is the impact of the extra spending on public loans, which is relatively high for a developing country economy to 73 percent of gross domestic product.
“The new framework is undoubtedly worse than the previous one when it comes to debt sustainability,” wrote Marcos Casarin, chief economist for Latin America at Oxford Economics.
The market reaction to the new tax regime has so far been mixed. The goal of eliminating a budget deficit next year has provided some reassurance to some fund managers.
Jared Lou, portfolio manager at William Blair, said: “We don’t like the idea of a spending cap being traded for a spending cap, but we applaud the government’s intention to run a primary surplus over the next few years.”
While the new rules stipulate that spending must grow by a minimum of 0.6 percent annually above inflation — even when revenue collection declines — there is a ceiling of 2.5 percent.
Under the proposals, annual spending can increase up to 70 percent of the previous year’s increase in state revenues. This drops to 50% if budget targets are not met.
To even the score, Finance Minister Fernando Haddad plans to raise R$150 billion ($30 billion) by cracking down on tax evasion, closing loopholes and imposing tariffs on online gambling. Officials expect total government revenues of R$2.37 trillion this year.
However, investment bank BNP Paribas said Haddad’s goal of eliminating the budget deficit – regardless of debt interest payments – next year and generating a surplus by 2025 is “only achievable with tax increases and very optimistic assumptions”.
“When we play with the numbers we don’t get a primary surplus in two years, or stabilized debt in three,” said his Latin America research chief, Gustavo Arruda. “The government is assuming much stronger growth than we believe Brazil’s potential is.”
Alberto Ramos, head of Goldman Sachs’ Latin American economic research team, said the new fiscal framework lacks effectiveness.
“There is no trigger mechanism that automatically imposes some kind of adjustment if goals are not met. No fines or administrative penalties.”
Instead, the president should write to Congress explaining why goals were missed and outlining corrective measures.
Exempting some sectors from the rules, such as spending on federal universities and environmental projects, together with the creation of a minimum threshold for public investment and the promise of higher minimum and public sector wages, would make it difficult to keep spending within the range allowed, Ramos added.
Another concern is that Lula could face political pressure from more radical elements of his base not to limit public spending.
Designed to restore Brazil’s battered public finances after the economically disastrous presidency of Dilma Rousseff, Lula’s handpicked successor, the 2017 cap has long come under criticism from the left for squeezing funds for essential public services and infrastructure .
However, the cap was legally bypassed to allow for Covid-19 relief measures and again last year by Lula’s predecessor Jair Bolsonaro to raise handouts ahead of his failed re-election bid. Lula also won a congressional waiver before taking office to further increase payments.
But a deeper problem is Brazil’s chronic misallocation of state resources, experts say, along with its complex tax system.
More than 90 percent of the country’s budget is mandated spending, mostly on public sector pensions and salaries, which can only be changed with Congressional approval.
Lula’s job now is to steer the bill through a fickle and fragmented Congress, where his Workers’ Party lacks a majority.
Rodrigo Pacheco, president of the Senate, told a conference in London last month that he expected the tax framework to be approved, albeit with some changes he declined to specify.
Lucas de Aragão, a partner at political consultancy Arko Advice, said the conservative-leaning Congress was unlikely to want big increases in spending.
“Congress is more conservative and right-wing [than the president]. He has become more fiscally responsible. . . This reduces the space for adventurous spending.
Additional reports by Carolina Ingizza and Michael Stott
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