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Macro Vision
Friday, November 14, 2014
The Feasible Fiscal Adjustment
The Brazilian economy needs macroeconomic adjustments to regain sustainable growth. One of the
main adjustments is fiscal, through an increase in the primary surplus. But what’s the feasible fiscal
adjustment under the current conditions?
On the one hand, the fiscal adjustment is essential to rebuilding confidence in the economy. On the
other hand, the implementation of this adjustment is challenging in the short term.
In general terms, we believe in a macro scenario of minimal adjustments: sufficient to avoid economic
deterioration, but not deep enough to generate a vigorous growth recovery. Our expectations for fiscal
adjustment are in line with this scenario. We believe that the government will adjust the public account
by up to 1.0% of GDP, reaching a primary surplus of 1.2% of GDP in 2015.
The primary surplus needed to stabilize the debt-to-GDP ratio is higher than the forecast for next year –
we estimate a necessary primary surplus between 2.0% and 2.5% of GDP. Evidently, the fiscal
adjustment will have to be multiannual, extending beyond next year. A successful start in 2015 may
generate the confidence needed to maintain the adjustment in the following years.
The magnitude of next year’s adjustment is comparable to that of 2003 and 2011. The impact of the
adjustment is already considered in our economic activity and inflation estimates for 2015.
But there are clear implementation risks, given the difficulty of the adjustment, particularly in a scenario
of modest growth and high inflation.
The incentive to adjust is clear. In addition to avoiding a deterioration in risk perception, the fiscal
consolidation trend over the next years is likely to have a positive impact on confidence and growth.
Fiscal Dynamics in Recent Years
5%
4%
Over the past three years, the primary surplus in
the public sector fell from 3.1% of GDP in 2011
to 2.4% in 2012, 1.9% in 2013 and 0.6% in the
12 months ending in September 2014. Our
estimate for recurring primary surplus, which
excludes non-recurring revenue and expenses,
dropped from 2.7% of GDP in 2011 to -0.5% in
September 2014 (see chart).
Primary surplus reaches minimal
levels
Official
Recurring (excludes atypical revenues and
expenses)
3%
2%
The decline in primary surplus stems from the
impact of the economic slowdown on tax
0%
collection as well as a more expansionary fiscal
% GDP 12M
stance on both revenue (tax cuts) and
-0.5%
-1%
expenditure. Tax collection growth has been
Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14
relatively stable in real terms in 2014, while
Source: Central Bank, Itaú
expenditures have grown 5.3% – significantly
surpassing potential economic-growth estimates. The central government's recurring revenue to
GDP has declined moderately since mid-2012, after rising steadily from 2000 to 2007, while its
total expenditure to GDP remains on an uptrend (see chart).
1%
0.6%
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Macro Vision – Friday, November 14, 2014
Spending Grows Faster than
Revenues
23%
22%
% GDP
21%
20%
19%
18%
17%
16%
15%
14%
Central Government Total Expenses
Central Government Total Recurring Revenues
13%
Dec-00
Sep-03
Jun-06
Mar-09
Dec-11
Sep-14
Source: National Treasury, Itaú
Public Debt on the Rise
64%
50%
% GDP
48%
62%
46%
60%
44%
42%
58%
40%
56%
38%
36%
54%
34%
52%
Public Sector Net Debt (rhs)
General Government Gross Debt
50%
Jan-07
Dec-08
Nov-10
Oct-12
32%
30%
Sep-14
The reduction in primary surplus, combined
with the recent increase in the government’s
debt financing costs, has been putting
additional pressure on public debt. The public
sector’s net debt as percentage of GDP has
risen 2.4 pp this year, to 35.9%. General
government gross debt has grown 5.0 pp, to
61.7% of GDP. The divergence in the increase
between the two is partly explained by the
exchange-rate depreciation (which mitigates
the rise in net debt) and Treasury loans to
BNDES (which only affect gross debt).
Given that interest expenses are likely to
remain high going forward, the maintenance of
the primary surplus at current levels is likely to
consolidate the uptrend in public debt. Our
debt-dynamics simulations show that, if the
primary surplus remains stable at 0.0% of GDP
from 2015 onwards (level still higher than the
recurring primary surplus estimated for 2014),
net debt will increase by more than 10 pp of
GDP over the next four years (assuming a
stable exchange rate). According to our
calculations, the primary surplus required to
stabilize public debt in the long run is between
2.0% and 2.5% of GDP (this estimate assumes
potential GDP growth of 2.5% and real interest
rate of 4.0% in the long term).
Source: Central Bank
The debate on fiscal adjustment, which rebalances public accounts and ensures the sustainability
of public debt, therefore seems relevant at the moment.
Is It Possible to Adjust?
We believe that a change in fiscal policy that raises the consolidated primary surplus to 1.2% of
GDP in 2015 and 1.8% of GDP in 2016 is feasible. This adjustment would signal the government’s
intention to maintain the equilibrium of public accounts. The adjustment would require efforts on
both the expenditure and revenue sides, as well as contribution from both central and regional
governments.
A significant adjustment of central government expenditures is difficult to implement. The first
challenge is that, if we only take into account the minimum wage increase next year (close to 9.0%
in nominal terms, according to the rule that still applies to 2015) and the expected increase in
social security beneficiaries, social security, LOAS and RMV costs will increase by around 0.2 pp
of GDP in 2015 by our estimates. To compensate, the government could: i) maintain the
administrative expenditures ("outras despesas de custeio", comprising mainly the expenditures
through the ministries: Defense, Social Development, Education, Science & Technology, etc.)
stable as a proportion of GDP, which would be a significant change from previous years when
expenses in this line grew by 0.2 pp of GDP per year; ii) implement a cut of 0.3 pp of GDP on
investment (other capital expenditures); additionally, the government can iii) implement the
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Macro Vision – Friday, November 14, 2014
already-signaled changes in the rules of survivor pensions and unemployment insurance. We
believe that these rule changes would save around 0.2% of GDP. In the end, the central
government’s total expenditure would decrease about 0.3 pp of GDP next year (from 19.6% to
19.3% of GDP).
On the revenue side, the fiscal adjustment will require an increase in the tax burden, which could
happen via tax-cut reversals and the creation / re-formation of new taxes:
Cide: Our scenario includes revenue of BRL 5.0 billion (0.1% of GDP) in 2015, through the
reconstitution of the Cide fuel tax. We assume an increase in Cide to BRL 0.07/liter for both
gasoline and diesel, to be announced by year-end 2014 or early 2015, and take effect in April
2015 (due to the 90-day grace period for increases in the contribution rate). Changes in Cide are
carried out via decree, without the need for Congressional approval, provided that it does not
exceed the upper limits set forth by law (BRL 0.86/liter for gasoline and BRL 0.39/liter for diesel).
IPI: We assume a 3% to 5% increase in the IPI (tax on manufactured items) for automobiles and a
partial reconstitution of the IPI tax rates on certain appliances, furniture and construction materials
by the end of 2014. Together, the new rates would generate an increase in revenue from 2014 to
2015 of approximately BRL 4.0 billion (0.1% of GDP). The IPI exemptions currently in force are
expected to expire at the end of 2014.
Revenue via increases in gasoline and diesel prices: In addition to the increases in Cide, our
scenario also assumes additional increases in gasoline and diesel prices in order to reduce the
gap between prices observed in Brazil and abroad. This, in our view, generates an increase in
revenue (primarily through dividends and income tax from the oil and gas industry) of around 0.1%
of GDP for 2015.
Others: The adjustment would require the creation or reformation of new taxes or contributions,
generating revenue of around 0.3% of GDP in 2015. This hypothesis involves higher
implementation risks because it would require congressional approval.
Non-recurring revenue: As observed in recent years, tax authorities are likely to once again rely on
non-recurring revenue from concessions, extraordinary dividends and Refis. Because the annual
volumes of these revenues have been gradually declining (which is intuitive in the case of
concessions and Refis), we estimate that non-recurring revenue will decrease about 0.1% of GDP
in 2015, compared with the volume expected for 2014.
For regional governments, we believe that an increase in primary surplus, to 0.3% of GDP from
0.1%, is possible. This is a feasible and relatively common adjustment for the first year in office –
in the case of state governments.
Therefore, adding (1) the drop in central government spending, of 0.34% of GDP; (2) the revenue
increase of 0.52% of GDP generated by tax increases (we estimate that unchanged tax revenue
will grow at the same rate as GDP); (3) a decrease of 0.1% of GDP in non-recurring revenue; and
(4) an increase of 0.2% of GDP in the primary surplus of regional governments, the consolidated
public sector would reach a primary surplus of 1.2% of GDP in 2015. (Table 1)
In 2016, we believe that the persistence of a tighter fiscal stance will help raise the primary surplus
to 1.8% of GDP. Part of the increase in the primary surplus would arise from the maintenance of
the tax increases implemented in 2015. Our scenario also includes an additional increase of BRL
0.07/liter in Cide on gasoline (to BRL 0.14/liter) and a full reconstitution of the IPI tax on vehicles
(to 7%), certain appliances, furniture and construction materials. Furthermore, we assume an
additional cut of 0.2 pp of GDP in investment, administrative expenses ("outras de custeio") stable
as percentage of GDP and an increase of 0.1 pp in the primary surplus of regional governments.
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Macro Vision – Friday, November 14, 2014
Table 1: Fiscal Adjustment Scenario: Primary Surplus 2015/2016 (%GDP)
2010
2011
2012
2013
2014
2015
2016
23.2%
23.8%
24.2%
24.2%
23.9%
24.2%
24.6%
1.1. Tax Revenue C.G.
20.1%
21.4%
21.7%
21.3%
21.2%
21.7%
22.1%
1.2. Non-tax revenue C.G.
3.5%
2.8%
2.9%
3.4%
3.1%
2.9%
2.8%
1.3. Restitutions and tax incentives
-0.4%
-0.4%
-0.4%
-0.5%
-0.4%
-0.4%
-0.4%
1. Total Revenue - Central Government (C.G.)
17.4%
17.5%
18.3%
18.7%
19.6%
19.3%
19.2%
2.1. Payroll
4.4%
4.3%
4.2%
4.2%
4.3%
4.3%
4.3%
2.2 Social Security Benefits
6.8%
6.8%
7.2%
7.4%
7.6%
7.7%
7.8%
2.3. LOAS, RMV
0.6%
0.6%
0.7%
0.7%
0.7%
0.8%
0.8%
2.4. Unemployment Insurance
0.8%
0.8%
0.9%
0.9%
1.0%
0.9%
0.9%
2.5. Other Administrative Costs
3.4%
3.3%
3.5%
3.7%
4.0%
4.0%
4.0%
2.6. Investment
1.2%
1.3%
1.4%
1.3%
1.5%
1.2%
1.0%
-
-
-
0.2%
0.2%
0.1%
0.1%
3. Transfers to Regional Governments
3.7%
4.2%
4.1%
3.9%
4.1%
4.1%
4.1%
4. Central Government Primary Surplus (1-2-3)
2.1%
2.3%
2.0%
1.6%
0.1%
0.9%
1.4%
5. Regional Governments Primary Surplus
0.6%
0.9%
0.4%
0.3%
0.1%
0.3%
0.4%
6. Consolidated Primary Surplus (4+5)
2.7%
3.1%
2.4%
1.9%
0.2%
1.2%
1.8%
7. Recurring Primary Surplus (Itaú)
1.2%
2.7%
1.8%
0.9%
-0.4%
0.8%
1.5%
2. Total Expenditure C.G.
2.7. Transfers to CDE
Source: National Treasury, Central Bank, Itaú
Table 2: How to adjust?
Changes in taxes/rules (impact on the primary surplus)
2015
Increase in Cide (fuel tax)
Revenues from oil/gas sector
Increase of IPI (tax on manufactured items)
Others
TOTAL REVENUES
Survivor Pensions
Unemployment insurance
TOTAL EXPENSES
TOTAL
2016
Dif. 2016-2015
R$ bln
5.0
5.0
4.0
15.0
29.0
5.0
%GDP
0.1%
0.1%
0.1%
0.3%
0.5%
0.1%
R$ bln
9.6
10.0
10.0
25.0
55.0
5.0
%GDP
0.2%
0.2%
0.2%
0.4%
0.9%
0.1%
R$ bln
4.6
5.0
6.0
10.0
26.0
0.0
%GDP
0.1%
0.1%
0.1%
0.2%
0.4%
0.0%
5.0
10.0
39.0
0.1%
0.2%
0.7%
5.0
10.0
65.0
0.1%
0.2%
1.1%
0.0
0.0
26.0
0.0%
0.0%
0.4%
* Source: Federal Revenue Service, Finance Ministry, Itaú
Conclusion
Considering the need for fiscal adjustment, but also the challenges in implementing it, we project a
fiscal adjustment of 1% of GDP next year, taking the primary fiscal surplus to 1.2% of GDP. For
2016, we forecast an ongoing adjustment, taking the primary surplus to 1.8% of GDP.
This scenario involves a fiscal drag (determined by the variation of the structural primary surplus)
of about 0.9% of GDP per year in 2015 and 2016 – a similar adjustment to the one carried out in
2002 and 2003, and already incorporated in our economic activity forecasts for the coming years.
There are clear implementation risks due to the difficulty of the adjustment, particularly in a
scenario of modest growth and high inflation. But the incentive to adjust is also clear. In addition to
avoiding the deterioration in risk perception, the fiscal consolidation trend over the next years is
likely to have a positive effect on confidence and growth.
Luka Barbosa
Economist
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Macro Vision – Friday, November 14, 2014
Macro Research – Itaú
Ilan Goldfajn – Chief Economist
Tel: +5511 3708-2696 – E-mail: [email protected]
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