Brazil is losing its fiscal policy compass

Fiscal Policy
Public policy
Macroeconomics - Economic growth - Monetary Policy
Fiscal Policy - Public and Welfare Economics

The last few years have seen an unfortunate deterioration of the credibility and quality of fiscal policy in Brazil, as the government has increasingly resorted to creative accounting practices in an attempt to mask a largely current expenditures-driven deterioration in the fiscal performance.

Following a long history during the 1970s, 80s and early 90s of fiscal policies characterized by booms and busts, unpredictability and lack of transparency, a “change of regime”, culminating in the adoption of the 2000 Fiscal Responsibility Law, took place in the late 1990s. This included a strong effort to improve budget management, and transparency of the fiscal accounts; a restructuring of sub-national debts, combined with the adoption of a framework to enforce a sustained improvement in the state and municipal finances; and firm adherence to preannounced primary surplus targets for the consolidated public sector, averaging 3.4 % of GDP over 1999-2008.

These policies facilitated significant declines in the gross and net public debt, and in sovereign debt spreads, as well as Brazil’s achievement of investment grade. More importantly, the prudent overall fiscal stance, contributed -- along with inflation targeting, a flexible exchange rate policy, and a favorable international environment-- to sustained growth (averaging 4% in 2002-08), low unemployment and inflation, current account surpluses and a net external creditor position.

To be sure, the quality of fiscal adjustment fell short of what would have been desirable in a number of respects. As current public expenditures continued their relentless rise relative to GDP - reflecting in particular a failure to carry out needed reforms in the pension system and the public administration - the primary surpluses were achieved through a substantial increase in the tax burden, to a level significantly higher than in most comparable economies, and including the adoption or increases in especially distortive taxes (on turnover, on key production inputs, or on financial transactions). At the same time, public investment largely stagnated over 1998-2009, aggravating already substantial infrastructure gaps. These developments contributed to a deterioration of competitiveness, especially in manufacturing industries, and sowed seeds for a sub-par economic performance in the more recent years (characterized by weak growth, rising inflationary expectations, and an increasing current account deficit despite high commodity prices).

Moreover, since 2009 it has become increasingly difficult to gauge the true stance of fiscal policy, as - faced with a deceleration of revenues and continuing strong spending pressures- the government has resorted to a growing number of atypical operations and accounting stratagems to create an appearance of complying with the announced primary surplus targets.

The (non-exhaustive) list of such “creative accounting” practices includes:

  • A progressive reduction of the coverage of the public sector.

This began with the exclusion in 2009 of the national petroleum company (Petrobras), and in 2010 the national electricity company (Eletrobras), from the definition of the public sector. The stated purpose of such exclusions was to avoid unduly constraining the scope for needed investments by such companies. Initially, since these enterprises were financially strong, their exclusion reduced the primary surplus of the redefined public sector, and increased its net debt. In more recent years, however, their deteriorating financial performance (reflected in the case of Petrobras in a sharp decline of its market value) probably implies that the primary surplus is being increased (and the net debt reduced) by the exclusion of the two enterprises. This is, however, difficult to quantify, since the Central Bank has discontinued the publication of the primary surplus and debt series including the enterprises. Moreover, since the late 2000s the government has been excluding from the primary surplus target a growing number of transactions, including priority public investments and lately a range of tax concessions enacted to stimulate the economy. These latter exclusions amounted to over ½ % of GDP in 2009 and 2010, and to nearly 1% of GDP in 2012. They are projected to rise further, to around 1.3% of GDP in 2013 and 2014.

  • Anticipation of revenues and postponement of cash payments.

The authorities have repeatedly resorted to the anticipation of dividends from federal enterprises and banks in recent years. Such advance payments amounted to over ½ of GDP in 2012. In 2010 the government also included among primary revenues a part (equivalent to almost 0.9 % of GDP) of proceeds of advance sales of oil exploration rights to Petrobras. Moreover, recent years have witnessed a sharp rise in the floating debt, which is not reflected in the primary balance and the public debt figures. Unpaid recognized spending obligations by the federal government (restos a pagar processados) have nearly quadrupled since 2008, and currently amount to more than ½ % of GDP. Committed, but as yet unrecognized and unpaid, spending obligations (restos a pagar não processados) have also risen sharply and stand at around 3.5% of GDP.

  • Extensive resort to quasi-fiscal operations through public banks.

Brazil’s main countercyclical fiscal response to the 2008-09 global financial crisis took the form of a massive increase in directed lending by the National Development Bank (BNDES), supported by loans from the national Treasury. The use of the federal banks (especially BNDES and Caixa Economica Federal) as tools for fiscal stimulus continued, however, during the subsequent cyclical recovery. The stock of Treasury loans to these institutions --which do not affect either the primary balance (being treated below-the-line) or the net public debt (since they are considered as an acquisition by the government of financial assets)-- jumped from under 1% of GDP in mid-2008 to over 9% of GDP at the end of 2012. The accumulation of such credits entails (difficult to quantify) future fiscal risks for the government, in addition to implying a sizable budgetary subsidy (since they carry a rate below the cost of government debt).

A proposal by the federal government in the Budget Framework Law for 2014 to no longer have to compensate shortfalls from the primary surplus targets by states and municipalities. This is tantamount to a further narrowing of the coverage of the primary surplus target, and will significantly weaken the incentive for the Treasury to exercise the control powers over subnational indebtedness granted to it by the debt restructuring agreements of the late 1990s and by the Fiscal Responsibility Law.

The upshot of the above-mentioned changes is a major loss of value of the recorded primary balance as a signal of the fiscal policy stance, and of the net public debt as an indicator of fiscal sustainability in Brazil. The loss of a reliable “fiscal compass” undermines the ability of the government, as well as of economic agents, to gauge the cyclical appropriateness of the fiscal stance. In the current circumstances, the recent and further projected declines in the primary surplus significantly underestimate the degree of fiscal stimulus to domestic demand. The fact that such stimulus has had little apparent effect in the last couple of years in lifting the growth rate suggests that the growth performance in Brazil is now constrained by competitiveness and supply factors, rather than by lack of demand.

Furthermore, the proliferation of creative accounting and quasi-fiscal operations risks undermining the hard-gained credibility of fiscal policies and institutions with both the domestic public and the international markets. It would be important for the government to restore such credibility in the near future, by refraining from such operations and moving forward in the adoption of best international accounting standards. Consideration should also be given to defining the limit on the federal government debt called for by the Fiscal Responsibility Law, but as yet not legislated.

If this is done, it may also be desirable for Brazil to begin utilizing cyclically adjusted fiscal indicators to inform the choice of its budgetary and debt targets. To promote market confidence in, and socio-political acceptability of, cyclically adjusted indicators, and more generally to strengthen its fiscal policy credibility, the government should consider the early creation of an independent fiscal watchdog (modeled for example on the US Congressional Budget Office, or the UK’s Fiscal Responsibility Office, or other independent fiscal councils).



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