Brazil Survey What will be the impact of the pension reform? Pension reform was approved last October, and includes measur...

Brazil Survey

Brazil Survey
What will be the impact of the pension reform?

Pension reform was approved last October, and includes measures such as raising the retirement age and increased workers’ pension contributions in a bid to save close to USD 200 billion over the next decade. The reform has undoubtedly provided a short-term boost to confidence, and raised expectations for progress on other reform fronts going forward. Moreover, the measures are an important step towards strengthening the public finances. However, the majority of panelists polled by FocusEconomics believe that the pension reform alone would not be enough to stabilize the public debt-to-GDP ratio—which, at close to 80%, is extremely high by emerging-market standards. The LatinFocus Consensus Forecast sees the public debt-toGDP ratio peaking in 2021 and declining marginally thereafter, suggesting panelists see further measures going forward to improve the fiscal outlook. “The approval of pension reform was essential to avoid the unsustainable rising trend of public debt. However, it is not enough to stabilize the public debt in the medium to long-run.” Mauricio Nakahodo, economist at Banco MUFG Brasil S.A. “Other measures are necessary to reduce the ratio.” Fernando Honorato Barbosa, chief economist at Banco Bradesco “[…] interest rate cuts were decisive to significantly improve the outlook for the public debt-to-GDP ratio as much as recent [political] developments were.” José Francisco Lima Gonçalves, chief economist at Banco Fator “The spending cap and the pension reform were the most important reforms [to reduce the debt burden]. The others are auxiliary, but not as fundamental as those were.” Sergio Vale, chief economist at MB Associados

Which further steps would reduce public debt?
Panelists frequently mentioned that fiscal and administrative reforms—particularly to address high mandatory expenditure— were key in order to complement the pension reform and put the public debt-to-GDP ratio on a firm downward path. In this regard, the fate of a package of measures presented to Congress in November—which includes the creation of a fiscal council, a fiscal emergency amendment enabling austerity measures, and changes to public-sector pay and conditions—will be important to watch. Most panelists do not see the package being implemented in full, however. “Brazil has roughly 90% of mandatory expenses in its annual budget, so the spending cap has been a burden on discretionary expenditure since 2017, especially public investment. To reduce the public debt/gdp more reforms targetting mandatory expenditure are required, such as: administrative reform and the fiscal emergency reform. The latter also include several measures to states and municipalities, that are also in fiscal difficulties.” Fernando Honorato Barbosa, chief economist at Banco Bradesco “Undoubtedly, administrative reform, which aims to reduce and control mandatory spending, is the biggest challenge and has the greatest weight on public accounts. In addition, tax reform would be of paramount importance to simplify the revenue side and improve the business environment.” Tarciso Gouveia, head of macroeconomic research at Petros.

What is the outlook for the reform agenda?
Panelists unanimously agreed that there will be some further progress on the government’s reform agenda, with tax reform the area mentioned most often by panelists. However, panelists were also clear that there were unlikely to be sweeping changes to the tax system, but rather more moderate tweaks, such as unifying federal taxes. Administrative reform to reduce the public wage burden was also mentioned frequently. However, this could be politically contentious, as demonstrated by the government’s decision to delay such a reform late last year for fear of public unrest. “A modest tax reform that focuses on simplification of some revenue streams appears possible, given strong support from Congressional leaders.” Jeffrey Lamoureux, head of country risk for the Americas at Fitch Solutions “The agenda is very complicated, but at least the value added tax should be somehow created.” José Francisco Lima Gonçalves, chief economist at Banco Fator.

“Both administrative and the fiscal emergency reforms have a significant approval probability, with some adjustments to the content – but should still have a positive effect on spending reduction over the next 10 years. We think a deep tax reform is unlikely, but the unification of federal taxes has significant probability of approval. Central Bank autonomy has a high probability of approval this year, as well as some privatizations.” Fernando Honorato Barbosa, chief economist at Banco Bradesco “In the case of administrative reform, it is more likely to be approved some reform focused on new public servants. And we expect a minor version of tax reform concentrated on the unification of a few federal taxes and some harmonization on the rates, and some changes to income tax.” Mauricio Nakahodo, economist at Banco MUFG Brasil S.A.

How will the 2020 budget impact the economy?

In December, Congress approved the 2020 budget. The government assumes GDP growth of 2.3% and inflation of 3.5%—both figures which are slightly above our panelists’ forecasts—and sets a primary deficit target of 1.6%. The panel had mixed views on the economic impact of the budget, ranging from contractionary to broadly neutral. “The 2020 budget is less restrictive than the previous years. The expenses are still restricted by the spending cap, but the restriction is smaller in the margin.” Fernando Honorato Barbosa, chief economist at Banco Bradesco “2020 will be another year of budget constraint due to the need for fiscal adjustment. This is a year of local elections and we might see some higher expenditures during the first half, but as compared to past election years, the situation is also tough at regional level meaning moderate expenditures.” Mauricio Nakahodo, economist at Banco MUFG Brasil S.A. “As we have been seeing lately, it will be a drag for economic growth”. Flávio Serrano, chief economist at Haitong “The public budget, while conservative, should make room for investment resources as fiscal dynamics improve, particularly with regard to the primary surplus that is expected to be much better in 2020.” Tarciso Gouveia, head of macroeconomic research at Petros “Moderate fiscal consolidation will be somewhat of a drag on aggregate demand. On the other hand, fiscal consolidation can be a positive driver for private confidence and, thus, investments. All in all, the effect should be roughly neutral.” Luis Suzigan, senior economist at LCA Consultores.

Will Brazil receive a rating upgrade this year?
Virtually all panelists expect Brazil to receive a credit rating upgrade this year in response to the improved fiscal and growth outlook. While some panelists see positive economic repercussions from an upgrade, others see no significant change, and some pointed out that the credit rating will remain below investment grade—an important threshold for decisively boosting capital inflows. “We should witness portfolio capital flows and a strengthening of the real (R$) in the short term.” Tarciso Gouveia, head of macroeconomic research at Petros “We think the BRL would strengthen against the USD [in the case of a rating upgrade], helping maintain the inflation rate at a low level, even under a solid rebound of economic activity.” Helcio Takeda, head of research at Pezco Economics “Very little [impact] – already priced into bond markets.” William Jackson, chief emerging markets economist at Capital Economics “Somewhat limited [impact], there’s a lot of uncertainty in the political and economic areas.” César Carrasquero, executive director of treasury & finance at Banesco “It will be positive, but not as positive as gaining back the investment grade, which we consider may happen only after 2022.” Sergio Vale, chief economist at MB Associados.

How will the stock market evolve in 2020?
In 2019, the Brazilian stock market reached an all-time high on investor optimism over economic reforms and lower interest rates. For 2020 panelists are broadly optimistic on the outlook for Brazilian stocks, with most seeing further price gains. “According to our scenario, we expect at least 16% [gains]. Alongside our macroeconomic scenario, there is still plenty of room for advancing multiples of companies. In addition, we should watch a new round of IPOs throughout 2020.” Tarciso Gouveia, head of macroeconomic research at Petros “[Stock prices should rise] linked to our expectation of more solid GDP growth this and next year.” Mauricio Nakahodo, economist at Banco MUFG Brasil S.A. “Most fundamental drivers of stock prices are already counted in. The low interest rates, less weak economic activity. Further relevant gains depend on inflows of capital. I don’t expect too much of this.” José Francisco Lima Gonçalves, chief economist at Banco Fator.

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