Brazil faces fiscal challenges despite strong 2021 outturns
Brazil’s latest fiscal data confirm our view that 2021 would be a year of rapid consolidation in the immediate aftermath of the Covid-19 pandemic, Fitch Ratings says. However, this will not be repeated in 2022 due to weaker growth, an expected deterioration in the primary balance and higher interest costs.
Our forecasts in December anticipated a significant fiscal improvement in 2021, and central bank data released on Monday show that by some metrics this was greater than we expected. The general government deficit narrowed sharply to 4.2% of estimated GDP in 2021 (compared to our December forecast of 5.1%) from around 14% in 2020, while general government debt dropped to 80.3% of GDP (compared to our forecast of 80.9%) from 88.6%.
The withdrawal of Covid-19 support, revenue outperformance (driven by high nominal GDP growth, strong commodity prices, and a shift to consumption of higher-taxed goods over services), and a primary surplus at the regional government level meant the public sector posted its first overall primary surplus (0.75% of GDP) since 2013.
Revenue outturns may have benefited from some structural changes driven by the pandemic, including greater formalization, digitalization, and other business reorganizations. One-off factors, such as the significant prepayments by development bank BNDES of its Treasury loans, helped reduce the debt ratio.
We think deficit and debt reduction will be temporary in the face of tightening financing conditions and higher spending made possible by changes to the calculation of the spending ceiling, Brazil’s main fiscal anchor. These are reflected in the Negative Outlook on Brazil’s ‘BB-’ rating, which we maintained in December.
We forecast the general government balance to widen to nearly 8% of GDP this year, but 2021’s outperformance could lead to some downward adjustment. The primary balance will deteriorate as higher spending weakens subnational finances. Meanwhile the central government will use extra spending (worth about 1.1% of GDP) possible under the adjusted spending ceiling calculation, and through capping judicial claims it must pay (precatorios), to facilitate an expanded social transfer program (Auxilio Brasil).
Fitch expects a sharp deceleration in Brazil’s GDP growth in 2022 to 0.5% amid above-target inflation, with IPCA-15 reaching 10.2% in January. The slowdown reflects tightening financing conditions, as fiscal uncertainty resulting from last year’s spending ceiling changes has prompted Banco Central do Brasil (BCB) to tighten monetary policy more aggressively. BCB increased the benchmark rate to 9.25% in December from a low of 2% at the start of 2021, and we expect further rises in early 2022.
Rate hikes will weigh on growth while pushing up sovereign borrowing costs. The general government interest-to-GDP ratio rose to 4.9% last year from 4.4% in 2020 and will rise more sharply in 2022 given higher interest rates on new borrowing and the presence of floating-rate debt.
These factors mean the debt burden will climb in 2022, to around 83% of GDP. Risks to our 2022 fiscal projections include weaker-than-forecast growth, higher-than-expected borrowing costs and an unanticipated increase in spending if the pandemic worsens. Higher-than-expected precatorios payments in 2022 and larger-than-anticipated public-sector wage increases could also hurt fiscal performance, as could measures under consideration that may reduce fuel taxes. The approach of October’s elections compounds policy uncertainty and risks to growth from any resulting deterioration in investor sentiment. Their outcome will influence medium-term fiscal consolidation prospects.
Material policy shifts that worsen the outlook for public finances and fiscal credibility, or a severe deterioration of domestic and/or external market borrowing conditions, could lead to a negative sovereign rating action. Easing of fiscal risks and financing conditions or greater confidence in a fiscal consolidation path that contains the medium-term pace of the increase in public debt can stabilize the ratings.
