LatinFinance - September/October 2015 - 72

Lost battle?
Planning and budget minister Nelson Barbosa has said Levy's fiscal adjustment was one
of the main casualties to what he repeatedly
calls "the tax revenue frustration".
Pointedly, it was Barbosa, rather than
Levy, who announced new fiscal surplus
targets on July 22: a meager 0.15% of GDP
this year instead of 1.2% originally planned,
0.7% and 1.3% in 2016 and 2017, respectively, rather than 2% for both years; and 2%
in 2018. An 8.6 billion reais budget cut was
unveiled, which followed a 69.9 billion reais
budget cut announced in March.
If the government's receipt of other
revenues is again delayed due to setbacks in
concessions, for example, or in repatriation
of legal funds held by Brazilians abroad,
an additional 26.4 billion reais could be
deducted from the fiscal target, Barbosa
said. Those shortfalls could effectively lead
to a primary fiscal deficit of 0.3% of GDP,
according to economists. "The reintroduction of exceptions to the budgetary calculation flies in the face of [Levy's] crusade for
greater fiscal transparency. This would
appear to be a battle that Mr. Levy has lost,"
says Marcelo Carvalho, chief economist for
Latin America at BNP Paribas.
Brazil's troubles are getting more serious,
according to former central bank director
Luis Eduardo Assis. "Levy is the right man at
the wrong place at the wrong time," he says.
"What is at stake is the survival of the government. The talk about [Rousseff's] impeachment is going to come back with a vengeance
and the recession will not help at all."
Despite the formidable obstacles, Levy
continues to persevere. "We have not given
up on the fiscal target," Levy said during the
July fiscal policy review announcement. "We
are perfectly aware of the magnitude of the
change," he added. Levy referred to the fall in
revenue as a "temporary phenomenon".
The markets did not buy Levy's view,
however. The real fell to its lowest level in
12 years against the dollar and interest rates
shot up. The fiscal effort is insufficient, according to Itaú Unibanco. Brazil would need
a steady fiscal primary surplus of at least
2.5% in order to stabilize the long-term debt
dynamics, says Luka Barbosa, economist at
Itaú Unibanco.
"In our long-term scenario, the real interest rate falls to 4% and the potential growth
is around 2%. We should only get there in
2018. But in the short term, as GDP has been
contracting and interest rates are above the
equilibrium level, the fiscal primary surplus
would have to be much higher," Barbosa says.

72 L ATINFINA NCE.COM - September/October 2015

MANSUETO ALMEIDA
BRAZILIAN INSTITUTE OF APPLIED ECONOMIC RESEARCH

"BRAZIL IS GOING TO
HAVE THE HIGHEST
INTEREST RATE BURDEN AND THE HIGHEST
DEBT-TO-GDP AMONG
EMERGING MARKET
COUNTRIES"
Moody's is the latest to act on concerns
over Brazil's debt load, following Austin Ratings, a local ratings agency, which stripped
Brazil of its investment grade (to BB+ from
BBB) following the steep revision of the fiscal targets in July. In August, Moody's downgraded Brazil to Baa3, from Baa2, citing
fiscal concerns and poor economic growth
prospects that will affect tax collection and
ultimately increase the debt burden.
Brazil now needs to send strong signals
to prevent the main US credit rating agencies stripping its investment grade rating.
"There is still some work to be done. The
fiscal slippage was a very large one, and
we cannot take this lightly. We have to take
the issue of debt under consideration. If
we fail, the costs will be very high, as far
as companies and the society as a whole
are concerned," said Levy at the American
Chamber of Commerce in São Paulo in
mid-August.
Mansueto Almeida, a senior researcher
at the Brazilian Institute of Applied Economic Research, says the debt-to-GDP ratio
may reach 72% by 2018. "Brazil has not
been able to promote a fiscal effort yet, neither in the short term nor in the long term.
Some measures that have been approved in
congress have increased public spending.
And there are actually prospects for rising
public expenditures for the next 15 years...
It is quite worrying," he says. This would
include an increase in Brazil's education
budget from 6.5% of GDP to 10% by 2022,
according to recent legislation; and allocations of an extra 1% of GDP to health spending and 1.5% to pensions.
Levy is well aware of the structural imbalance between the increase in compulsory
spending and the level of tax collection,
Almeida says. "Very strong political support is needed to adjust. Is the government

really able to sort itself out and pass some
structural reforms? This is the big issue
- and I would rather think not," says Almeida, who advised the opposition candidate
Aécio Neves during the last presidential
campaign. "We are running the risk of losing Brazil's investment grade and of losing
Joaquim Levy."
But Fernando Honorato Barbosa, chief
economist at Levy's former employer,
Bradesco Asset Management (BRAM), says
a loss of investment grade is unlikely within
the next 12 months. If and when it comes,
Brazil's credit default swaps may range
between 320 and 400 basis points, with
an equilibrium at 330-340 basis points, he
says. The Moody's downgrade had already
pushed those spreads to 330 basis points in
August.
Any international comparison would be
far from flattering. "Brazil is going to have
the highest interest rate burden and the
highest debt-to-GDP among emerging market countries," says Almeida. India has traditionally been the most indebted emerging
market country, but its debt load has been
falling amid strong economic growth.
Moreover, immediate external conditions, with a stock market crash in China
and a looming US interest rate hike will
not make things any easier for emerging
markets and Brazil. "It will be the first time
that the US will hike rates in 10 years. So you
can expect some volatility on market rates,"
says BNP Paribas' Carvalho.
"Very often, the market thinks it is prepared, but I do not know if it actually is. A
large number of traders have not seen the
[US Federal Reserve] hiking rates in their
professional life. It's like your first kid."
Carvalho says. "You have nine months to
get ready, but when it does happen, everything changes. It is a bit like this regarding
the Fed. Everybody knows it is going to
happen, but when it actually happens there
is going to be some stress," he says.
Even so, some of Levy's former BRAM
staffers expect the finance minister to
remain for the long haul. "My impression
is that he will persist. He is not going to
give up so easily," says former colleague
Barbosa. "His objective is to implement a
few fiscal reforms such as the interstate tax,
whose rate currently varies from one state
to another. This could be his legacy."
"Obviously if the whole adjustment effort
is thrown upside down, it is possible that
neither he nor Rousseff would like him to
stay," says Barbosa. "But I do not think Levy
is on his way out." LF

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