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Test of Maturity

We’ve had other fiscal crises in the past. But those were other times, marked either by negligence regarding fiscal discipline or imbalances and skeletons inherited from the past. The government needed to call on the IMF on some occasions in the 1980s and 90s, and even at the start of this century, because the fiscal crisis implied inability to honor foreign debt.

The IMF wound up playing an important role, that of an external element that “forced” government officials to conduct contractionary policies, despite the weakness of the economy. This was an element that required government action, and increased its bargaining power with Congress.

The country has held no debt with the Fund since 2006. Coincidence or not, that year also marked the start of retrogression in the management of fiscal policy, reflecting the change in the finance minister. Nevertheless, the favorable external situation and the end of the ties imposed by the Fund contributed to fiscal laxity. During the bonanza years, we forgot values like fiscal discipline; lessons supposedly learned proved to have been chimeras. We repeated errors of the past and saw rapid deterioration of the public accounts.

It is not correct to blame the entire budget imbalance on recent governments, because structural factors have had an important role in this erosion of the public accounts, like growing social security expenditures in a country with an aging population. But the errors in management, with exaggerated expansion of spending and increased tax breaks, have aggravated the picture.

The fiscal scenario today is the most serious in recent memory, primarily due to the sheer numbers. The primary results (excluding interest payments) are at levels unseen since the consolidation of the public accounts in the 1980s, when the monetary budget (which included an important part of fiscal policy) was eliminated. The primary result at the end of 2015 was a deficit of 1.88% of GDP, and now stands at 2.3%, while the only other deficit years since 1985 were in 1987, 1989 and 1997, in all cases with deficits of around 1% of GDP.

The picture is starker due to the absence of easy solutions. There is no more room for the so-called “control at the teller’s counter,” which is when the government suppresses the release of appropriations, with a particular impact on public investments, the category that has the most flexibility for cutbacks. Nor is there room to increase the tax burden as in the past. Additionally, today there is greater budgetary rigidity. Hence, reforms are needed.

Reform could net tremendous benefits. The recessive cost of the fiscal adjustment in the short term tends to be smaller in comparison with a traditional fiscal adjustment through cutbacks in public investments and tax increases. And more importantly, there’s the benefit over the longer term of sustained equilibrium in the public accounts and better economic growth.

While structural reforms that attack distortions and mistakes in allocating public resources imply going against the immediate interests of portions of the population that benefit from the current rules, this is outweighed by the greater benefit to society as a whole. There is a cost for some (in truth many, given the huge presence of the government in the economy), but the bonus is for all.

A balanced and carefully formulated structural adjustment will help avoid greater sacrifices. This is an important distinction. It is not possible to combine in the same package elements of the traditional adjustment, involving cuts in investments and tax hikes, and the adjustment via reforms.

The government needs to choose the battlefields. It will have to select priorities and be resolute in designing effective public policies and reforms, eliminating or reformulating policies that are not meeting their objectives or that generate distortions in the economy and distribution of income. It is important to distinguish between legitimate vested rights and benefits to special interest groups.

Pragmatism will be necessary, balancing good technical aspects and political viability. A possible reform of the social security system with a transition regime that operates slowly, altering the rules only for new workers, might be easier to push through Congress, but it will demand other measures to contain the increase of expenses by the system.

In the absence of the IMF, the grave economic crisis will be the springboard propelling the reforms. This will be a major test of the country’s maturity: the ability to understand the unprecedented situation faced by the country and to recognize that adjustments are necessary. It will be an important test for democratic institutions. The policy shifts cannot be hostages to the veto power of interest groups and rent seekers.

This is not an agenda for just a single government. It will be an agenda of the country for many years. But the transition government will have to get the ball rolling. 

Americas 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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