Former central bank governor Fraga says spending measures could worsen precarious fiscal situation
by: Joe Leahy in São Paulo/FT
Brazil’s new government urgently needs to defuse fiscal “time bombs” that are set to blow up the country’s already strained budget, according to Arminio Fraga, the former central bank governor and founding partner of Gávea Investimentos, one of the country’s biggest hedge funds.
The administration of interim president Michel Temer would have to reverse a planned increase in spending on education as well as growth in the pension system that together are set to add up to 12 percentage points of gross domestic product to the budget in the next decade.
“If you do the arithmetic, it’s explosive,” said Mr Fraga at a conference in New York.
The Temer government is trying to refloat Brazil’s sinking economy after taking over from President Dilma Rousseff following her suspension in an impeachment process this month.
Among the priorities is resolving a budgetary mess created during Ms Rousseff’s five years in power. The president is being impeached for manipulating the public accounts to disguise the deteriorating state of public finances.
The interim government has announced a new target for the 2016 central government primary budget deficit — the balance before interest rate payments — that was worse than economists had expected at R$170bn, or about 2.7 per cent of gross domestic product. The new target was 74 per cent above Ms Rousseff`s earlier highest estimate.
“This is a target that we judge to be very realistic,” said Henrique Meirelles, the new finance minister.
Mr Fraga, a former hedge fund manager with global financier George Soros, worked with the opposition during the election campaign against Ms Rousseff in 2014.
He said the challenge facing the interim Temer government on the budget was already extremely difficult even before accounting for the so-called time bombs of education and pensions.
Ms Rousseff was running a 2 per cent primary fiscal deficit. This meant the government was effectively borrowing money from the markets to meet its interest payments.
Together with interest payments, which in Brazil are among the highest in the world with the benchmark rate at 14.25 per cent, the total budget deficit was about 10 per cent.
This was fuelling an increase in Brazil’s gross public debt from 51.7 per cent of GDP in 2013 to 66.5 per cent of GDP last year.
Mr Fraga said that if other liabilities were included, such as the need for loans to help state governments struggling with the recession and the likely need to recapitalise Petrobras, the state-owned oil company, public debt would rise to 75-80 per cent of GDP.
“With 6 per cent real rates and a primary deficit, that [gross debt] grows very fast so from there to 90 per cent is just a couple of stops on the debt subway,” Mr Fraga said.
To stabilise the debt, the Temer government would need to begin posting a primary fiscal surplus of 3-4 percentage points of GDP, which meant it would have to find a total of 5-6 percentage points of GDP in cuts to public expenses or new tax revenues.
However, Brazil has also created a new law that envisages doubling spending on education from 5 per cent to 10 per cent of GDP over 10 years. The pension system is also expected to grow in cost by 7 per cent of GDP over the next decade.
If you do the arithmetic, it’s explosive
Arminio Fraga, former central bank governor
Both of these together would add a further new burden of up to 12 percentage points of GDP to the budget at a time when the government is struggling to come up with savings of 5-6 percentage points.
Brazil’s pension system is generous, allowing for early retirement, indexing pensions to the minimum wage and even permitting some inheritance of pensions.
“It just doesn’t add up,” Mr Fraga said of the education bill and the pension system.
Mr Fraga said the impeachment of Ms Rousseff, under whose rule Brazil’s economy contracted 4 per cent last year, had been done in accordance with the constitution. The functioning of Brazil’s institutions, in which the police and prosecutors exposed government corruption while the supreme court ensured the impeachment was conducted according to the rules, “bodes very well for our future”.
“I do think once this goes through we are likely to have a different Brazil,” he said.
Mr Fraga said interim president Temer had published a policy document for solving the crisis, “A Bridge to the Future”, which laid out market-friendly ideas.
“He has support and he got there through legitimate means and as a Brazilian I can only hope that he can go to work and get some of this done,” Mr Fraga said.
Copyright The Financial Times Limited 2016.