Publish in Perspectives - Wednesday, March 7, 2018
S&P and Fitch downgraded Brazil's rating after the country's national assembly (photo) failed to approve the government's reform of the pension system. (Photo: Mario Roberto Duran Ortiz)
The delay in pension reform presents another challenge in Brazil.
BY LATIN AMERICA ADVISOR
Brazil on Feb. 16 effectively shelved its controversial pension reform when President Michel Temer ordered the country’s military to take charge of security in Rio de Janeiro, blocking any constitutional reforms while a federal intervention is underway. Political Affairs Minister Carlos Marun acknowledged that the government didn’t have enough votes in Congress to push through the pension reform. How important is the pension reform to Brazil’s long-term fiscal health, and what does Temer’s “Plan B” for the economy involve? What will be the fallout now that the pension reform it has been shelved? Will the reform, which international investors and ratings agencies have generally favored, fare any better under Brazil’s next president?
Lisa M. Schineller, managing director of S&P Global Ratings: S&P Global Ratings downgraded Brazil’s sovereign credit ratings to ‘BB-’ in January due to slower-than-expected progress in passing structural fiscal legislation to correct the country’s large fiscal imbalances. The downgrade also incorporates our view that resistance within the public sector will likely limit the pace, breadth and depth of timely reform under the next administration as well, coupled with uncertain policy prospects and difficulties in managing coalition dynamics after the election. The challenges in advancing pension reform is one example of this dynamic. All of this is in the context of the fact that fiscal weakness is a prominent sovereign credit rating weakness. General government deficits that have averaged 9 percent of GDP between 2015 and 2017; net general government debt reached 57 percent of GDP in 2017, up from 40 percent in 2010. Also, the social security deficit (for private and federal workers) rose to 4.1 percent of GDP last year—more than half the overall deficit, and more than double the primary (noninterest) general government deficit of 1.8 percent of GDP. While the Temer administration has held the line on discretionary spending, its ability to do so has become increasingly more challenging. Nondiscretionary spending accounts for about 85 percent of total central government spending, with social security-related spending alone about a third of the total. Given the ongoing worsening of Brazil’s aging profile, age-related expenditure will put incrementally higher pressure on the budget—and absent changes make it very difficult to comply with the constitutional cap on spending passed in 2016. However, so will payroll-related spending. The next administration will face a complex fiscal scenario upon assuming office. Tackling these fiscal challenges will require broad-based support across party lines and branches of government to pass controversial constitutional amendments following this October’s elections.
Thomas Rideg, president of M-Brain Americas Inc.: This reform is indeed important to Brazil’s long-term fiscal health as the Brazilian public pension system is the nation’s largest primary expense, representing about 13 percent of GDP. This figure is comparable to nations with average populations that are much older than that of Brazil, meaning that as Brazil’s population gets older, the public pension burden will increase to unsustainable levels if no reforms take place. Shelving the reform now to pick it up in a few months will not have such a material impact in the short term other than a slight potential decrease in investor confidence. The most unfortunate impact of the shelving of this reform is that it adds one more big item to the busy agenda of Brazil’s new government in 2019. All in all, investors have increasing confidence in Brazil, with a more positive than negative presidential election outlook for October, meaning that many of the needed reforms will likely be carried out. It would be easier on the new government if this reform were already handled.
It is important that focus of the reform be done is such a way so as not to punish the Brazilian workers contributing to the INSS, who at the age of their retirement will receive a percentage of their salaries as pensions based on the average of their salary history. The reform must protect these contributors’ return on investment and instead focus more severe measures on where the pension system is hurting the country the most, which is on the extravagant rewards of public service employees that receive early retirement benefits at the same levels of their career salaries, often extending to spouses and former spouses.
Monica de Bolle, senior fellow at the Peterson Institute for International Economics: The pension reform was a crucial pillar of Temer’s ‘Bridge to the Future,’ the document prepared in 2015 laying out the PMDB’s vision for fixing Brazil’s longstanding structural problems. It has been widely recognized that the spending cap approved in December 2016 would only be viable with the enactment of a broad reform to the country’s pension and social security system. Spending on pension and other social security benefits are projected to rise from about 8 percent of GDP to well over 10 percent in the next three years. As a result, these expenditures are likely to consume much of the budget without significant reform, while adding to Brazil’s worrisome deficit and debt trajectories. The decision to abort the reform given its unpopularity and lack of congressional support is a blow to the country’s medium-term fiscal sustainability, and one of the main reasons for the recent credit downgrades by both S&P and Fitch. After the general elections in October, the new administration will need to urgently find a way to place pension reform at the top of its priorities. Temer’s ‘Plan B’ is basically a list of pieces of legislation and other initiatives that are either already being considered by Congress or have been widely discussed in the past. Although some of the measures contained therein are positive, they do not address Brazil’s grave fiscal challenges, nor do they serve as ‘substitutes’ for pension reform. Whether the next administration will have any success where the Temer government has failed will depend on a host of factors, including the willingness to take up an unpopular reform in a context of heated political tensions, as well as on the ability of the new executive branch to sway what is likely to be a highly fragmented Congress in 2019.
Milko Matijascic, researcher at the Institute of Applied Economic Research (IPEA) in Brasília: Postponing the pension reform was inevitable, since it is unpopular and general elections will take place in October. To compensate, the federal government intends to reinforce its support for a set of 15 projects, which are already being discussed in Congress and involve issues such as the autonomy of the central bank, reinforcement of regulatory agencies, state recovery and privatization of Eletrobras, as well as several important microeconomic reforms. All of these measures can have a positive impact on investors’ expectations. Nevertheless, even the ruling party representatives in the legislature are skeptical about achieving these reforms, given that the electoral campaigns will begin in April. Social security reform represents a challenge because markets are demanding a reduction in high levels of public spending in order to reduce the public deficit and free up more resources for public investment, which is essential for resuming economic growth.
The argument makes sense, even considering that long-term projections give rise to much controversy and are subject to large statistical margins of error. In the short term, it seems that the markets have absorbed the new scenario well. However, social security will be a top priority for the next president’s agenda, since without it the ratings agencies will maintain Brazil’s negative assessment, making it very difficult to get resources from foreign institutional investors and improve the investment climate in Brazil.