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Brazil: Temer’s Legacy is The Next President’s Inheritance

Economist Zeina Latif warns of the risks of sweeping Brazil’s current problems under the carpet and leaving them for the next administration to deal with.

The interim government in Brazil has greatly facilitated the life of the next president. The country was moving toward a scenario of uncontrolled inflation and recession without end in sight. While Brazil in the past was seen as a country where it was expensive and complicated to do business, it also came to be considered a risky country with high levels of unpredictability. Low return and high risk is a combination that discouraged investments in the productive sector.

The reorientation of economic policy has been fostering a more stable and predictable economic environment. Advances have been achieved on various fronts: in the management of macroeconomic policy; the running of government-controlled companies and banks; measures to reduce the risk of future fiscal backsliding, principally by the state governments; structural reforms to balance the public accounts over the long run; the so-called microeconomic reforms (such as labor law reform); the agenda for concession contracts; and removal of distortions created in recent years (tax breaks and rules on exploitation of the subsalt hydrocarbon reservoirs).

This will allow the economy to gain traction in the coming quarters, depending on the time needed for the interest rate cuts by the Central Bank to benefit aggregate demand. Better economic policy management, inflation anchored around the target, recovering economy and approval of tough reforms together leave a tremendous legacy for the next president. But the game is not yet won.

The challenge facing the country is huge. The question of fiscal solvency will continue to contaminate the economic climate for some time to come, because the public debt as a percentage of GDP will continue climbing in the coming years. While it’s true that the “spending cap rule” reduces the fiscal risk, it does not guarantee control of expenditures. And even though the proposed social security reform contains advances, its contribution to fiscal equilibrium in the next few years will be limited.

The next president will not benefit greatly from the social security reform. A period of rapid growth of expenses is still on the horizon, as an inevitable byproduct of the demographic transition.

The reform won’t be enough to stabilize social security spending in relation to GDP in the next 10 to 15 years, according to the government and specialists such as Paulo Tafner, meaning an additional effort will be needed to contain spending, with a possible sacrifice of other public policies.

The fiscal effort will go beyond the social security reform. The primary deficit (excluding interest payments) now stands at 2% of GDP, while in order to stabilize the public debt (as a % of GDP), a primary surplus of 2.5% would be required. This demands an effort equivalent to 4.5% of GDP.

Legacy is Crucial

The legacy of the current government can be an important element in the elections in 2018. The stronger the legacy, the less concerned economic agents will be about who the next president will be, e.g., whether or not he/she will be committed to structural reforms and fiscal discipline. The burden passed on to the next president is massive: namely the challenge of needing to improve the economic and social indicators.

The current government will do a big favor to the next by not sugarcoating the pill. It needs to clearly reveal the cost of concessions made in the social security reform proposal. How much will it cost, for example, to continue allowing teachers and police to retire earlier, or of setting different retirement ages for men and women?

Besides this, it needs to highlight the fiscal risks, including possible future expenses, such as the cost of default of FIES [student loans], the hole in the balance sheet of Caixa Econômica Federal and shortfall of pension funds of government-controlled companies.

It is important for the government to be more transparent. This can force an honest economic debate in the coming election campaign, helping to prevent a repeat of Dilma’s 2014 strategy hiding head in the sand and then failing to obtain approval of reforms to resolve the pile of problems.

Good politicians do not deny problems; they find ways to overcome them. The legacy of the current government must not drive the next president to political escapism.

Brazil Macro Policy & Government

Zeina Latif is chief economist at XP Investments. She holds master and doctorate degrees in Economics at University of Sao Paulo (USP).

Previously she worked at Royal Bank of Scotland as senior economist for Latin America, and ING, ABN Amro and HSBC Asset as chief economist for Brazil.

She is columnist at the newspaper Estado de São Paulo and she is counselor at the Social and Economic Development Council of the Republic Presidency.

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