Brazil’s large deficit and high public debt burden underscore its continuing fiscal challenges notwithstanding last year’s somewhat better-than-expected performance, Fitch Ratings says. With general elections due in October 2022, this year is a key year to revitalize the government’s fiscal reform agenda for boosting budgetary flexibility and maintaining the credibility of the spending cap.
Data on Friday showed Brazil’s general government deficit more than doubled to 14% of GDP from about 6% in 2019. This was better than our forecast of 16.4% primarily due to under-execution of budgeted spending, which improved the central government outturn, and higher regional government surpluses. Central government revenue contracted by a nominal 10.2%, while primary spending grew 35% as Brazil implemented one of Latin America’s biggest Covid-19 support packages.
Economic contraction which we estimate at over 4% and the wider deficit pushed general government debt to 89.3% of GDP from 74.3% in 2019, well above the 60% ‘BB’ category median. We anticipate smaller increases in 2021-2022 on the back of primary deficit reduction and GDP growth. The 2021 primary deficit should narrow to about 3.1% of GDP as revenue rebounds and emergency stimulus measures are withdrawn. The possibility that the pandemic limits economic activity and stimulus extends further into 2021 is a significant risk to our fiscal forecasts.
Fitch assumes the government will adhere to the spending cap this year. The cap has become an important fiscal policy anchor but was effectively suspended last year via a ‘public calamity’ law to facilitate the pandemic response. The mismatch between the Extended National Consumer Price Index (IPCA) and the National Consumer Price Index (INPC) could put pressure on the spending cap in 2021, as the cap is tied to the lower IPCA while some spending adjustments use the higher INPC.
Any political pressure to increase permanent social transfers or pandemic-related spending could also make compliance challenging. However, in a scenario of extended pandemic spending, it is unclear if the government would introduce a provisional measure for authorization from Congress to issue “extraordinary credits” that would be exempt from the cap or try to renew the public calamity law, freeing it from having to meet the cap or the primary deficit target.
Low interest rates and deep domestic capital markets underpin debt affordability and financing flexibility, and one-off measures could temporarily improve the public debt trajectory. However, interest rates are expected to increase this year in response to recent inflationary pressures. Moreover, permanently stabilizing and reducing debt/GDP would require faster primary deficit reduction and spending cap compliance, and this would require restarting reforms.
President Bolsonaro’s administration has submitted bills intended to simplify the tax system, contain public payroll costs and arrest the growth of mandatory spending to increase budgetary flexibility.
However, the political backdrop makes it unclear if and when these measures will pass through the legislature. The pandemic, municipal elections last November and elections of leaders of the Lower House and Senate on 1 February have stalled the reforms. Bolsonaro’s government has made efforts to build a Congressional alliance to enact them, but its ability to do so could be tested by resistance from vested interests, fluid political dynamics in Congress and the recent decline in the president’s approval ratings.
The Negative Outlook on Brazil’s ‘BB-‘ rating reflects the pandemic’s impact on Brazil’s fiscal deficit and public debt burden, as well as persistent uncertainty regarding consolidation prospects given spending pressures and the unclear fiscal reform outlook.
External imbalances remain in check, supporting the rating. The current account deficit narrowed to 0.9% of GDP from 2.7% in 2019 on significant import compression and reductions in outbound travel and profit remittances. Inward FDI fell by about half to USD34.1 billion but fully covered the current account deficit. Fitch expects mild deterioration in 2021 given the projected growth rebound.
