Brazil’s fiscal framework buys time, but hard choices loom

That means a brand‑new fiscal rule will no longer be essential in the next administration, whoever wins this year’s presidential election, to keep the basic functioning of the federal government, something that had seemed unavoidable just a few months ago.

However, the expected debate over a credible and firm fiscal adjustment, based on slowing the pace of spending growth, remains unavoidable. Projections for the primary balance are still weak and the already high public‑debt trajectory continues to rise. Without an adjustment, interest rates will not fall structurally, making sustained higher growth difficult.

The agenda includes measures to curb the growth of mandatory spending and further pension changes. It also involves politically difficult initiatives considered important to address fiscal imbalances, such as reducing the volume of congressional earmarks and cutting tax subsidies and incentives.

Economists say the key question is whether the adjustment—likely postponed until 2027, after this year’s elections—will be carried out “willingly” or “under pressure.”

Economists still expect some primary surplus, but only toward the end of the decade. In the Central Bank’s Focus survey, the median forecast for the primary balance moves from a deficit of 0.5% of GDP in 2026 to a surplus of 0.3% in 2031, reaching around 0.8% in 2034 and 2035.

Debt dynamics

Even so, economists estimate Brazil needs surpluses above 2% of GDP to stabilize its debt‑to‑GDP ratio, or at least 1.5% if financial conditions improve, such as a lower long‑term real interest rate, which itself reflects the fiscal outlook.

As a result, even in the Focus survey, the general government’s gross debt ratio keeps rising, with median projections increasing from 83.8% of GDP in 2026 to 101.2% in 2035.

Constitutional Amendment 136, which changed accounting rules for precatórios payments, avoided what analysts describe as “hitting the wall,” since without it the room for discretionary spending would have fallen to nearly zero starting in 2027.

“It would have been R$50bn to R$60bn more in precatórios suddenly entering the spending rule and the primary target, which would have caused paralysis from 2027 by squeezing discretionary expenditures. That will no longer happen automatically. Even with the exclusion, money doesn’t grow on trees, debt will keep rising without offsetting measures,” said Roberto Secemski, Barclays’ chief Brazil economist.

If Amendment 136 eased the immediate problem, economists say it also reduced the sense of urgency for Brazil’s fiscal adjustment, which may now proceed more slowly.

International evidence, however, suggests faster adjustments tend to work better, Itaú Unibanco argues. “The quicker and more focused on spending control it is, the more successful it tends to be, and it causes less contraction in activity than very slow adjustments centered on raising revenue,” said the bank’s economist, Pedro Schneider.

Reform debate

Discussing a completely new fiscal rule from 2027 would be a “total waste of time,” said Marcos Mendes, an associate researcher at Insper. “Brazil has already shown it lacks the capacity, maturity and political cohesion to respect a fiscal rule.”

In his view, a “serious government” taking office in 2027 and committed to fiscal adjustment will pledge results stronger than those required by the current rule. “There’s no time to lose. The legislative agenda is very ugly and we must go straight to the reforms that matter,” he said.

Those reforms, he said, begin with establishing a consistent rule for adjusting social security and welfare benefits, either by changing the minimum‑wage formula or decoupling benefits from the wage floor.

Secemski and Bráulio Borges, director at LCA Consultores and an associate researcher at the Brazilian Institute of Economics at Getulio Vargas Foundation (FGV Ibre), also point to revising the minimum‑wage rule. Since 2023, it has been adjusted by inflation plus GDP growth from two years earlier. At the end of 2024, the government capped the real increase at 2.5%, matching the spending cap under the fiscal framework, but economists say more changes are needed.

“It wouldn’t necessarily be zero growth, because politically that’s difficult. But it could rise by half of GDP growth, or by per‑capita GDP,” Borges suggested.

A second key measure is decoupling expenditures from revenues, particularly in health and education, Mendes said.

“There was an attempt to ease the constraints created by mandatory floors by counting existing expenses toward them, whether education funding through Fundeb or congressional earmarks in health, but it remains unclear whether there will be structural change,” Secemski said.

With current rules, if the government increases revenue, nearly half fails to improve the primary balance because those expenditures automatically rise as well, Borges noted.

“We don’t need an ultra‑orthodox scenario of freezing spending, but instead of linking it to revenue, we could tie it to something else, like population,” he said. Changes in the minimum wage and spending indexation could generate relatively quick gains.

Third, Mendes said Brazil must defuse certain “fiscal time bombs” in the pension system, such as the individual micro‑entrepreneur (MEI) regime, and complement the 2019 pension reform with changes to rural retirement, military pensions and gender differences.

“The deficit in urban pensions is stable, but the rural deficit grows sharply. It wouldn’t even require a major reform, simply implementing registration to curb fraud,” Borges said, referring to the registry of special rural insured workers in the National Register of Social Information (CNIS).

Social programs and tax breaks

The fourth key reform front is improving the targeting of social programs. Economists acknowledge that the current government has made progress with Bolsa Família, but not with the Continuous Cash Benefit (BPC), a welfare benefit for the elderly and people with disabilities.

“Bolsa Família rules had been severely weakened. The BPC is growing excessively due to lawsuits. And there’s the longstanding debate around programs that no longer make sense, like the salary bonus,” Mendes said.

On the BPC, Secemski noted that the government attempted to curb court-ordered benefit expansions, but Congress blocked the move. “Fundeb [the basic education fund] should stabilize from 2027, but it has tripled in real terms since the start of the decade. All of these are clearly unsustainable trajectories,” he said.

Even in the case of precatórios—whose immediate issue was resolved by Constitutional Amendment 136—Secemski said it remains unclear whether their growth will slow and how the government intends to manage them going forward. “Simply removing them from the fiscal target ‘fixes’ the framework’s problem, but not the impact of rising indebtedness.”

Tax expenditures

Other critical points on the reform list include reducing congressional earmarks and reviewing tax expenditures. Both are politically thorny.

“We have a more powerful Congress, but also one with many individual incentives, fragmented resource allocation, and a Balkanized budget. We would need a government with a clearly defined policy that would, on day one, introduce a broad adjustment package, with measures amounting to 4% to 5% of GDP, that imposes itself as the agenda, rather than being led by Congress’s agenda, which is more earmarks, more tax breaks, more protections. Changing that is not simple,” Mendes said.

Specifically on tax expenditures, Mendes said incentives must be created to encourage public support for reducing them. “You won’t rally society to eliminate privileges just to boost government revenue. The only way I see is to tie any reduction in tax expenditures to cuts in tax rates: for every 1 percentage point of GDP in reduced tax breaks, lower some tax rate. It’s a bit like the initiative to ask for receipts with individual taxpayer IDs,” he said.

Election timing and market reaction

Economists generally do not expect fiscal reform to be part of the election-year debate, but 2027, the first year of the next administration, is widely seen as the “ideal time” to launch such a process. “The presidential election will be behind us and it will be the farthest point from the next one,” Borges said.

New administrations also typically find it easier to push through difficult measures early in their terms. “These are unpopular adjustments that, if not done at the start, when political capital is at its peak, become increasingly unlikely later on,” said Secemski.

The risk, he added, is that Brazil could return to the uncertainty seen in late 2024 and early 2025, when financial markets were anxious over fiscal policy. When the measures introduced failed to meet expectations, “the market spun out,” he said, pointing to the sharp depreciation of the real against the dollar.

“Market players understood that if it didn’t happen then, it wouldn’t happen until the next term. If we reach the end of 2026 or early 2027 with a renewed sense that fiscal adjustment won’t come, or will be too mild or delayed, the market could react again. Not because debt/GDP will explode in 2027, but because the rising path would be priced in immediately,” Secemski said. “Markets won’t sit idle in the face of a debt trajectory they see as unsustainable.”

If nothing is done, Warren Rena estimates that gross public debt could rise from 84.8% of GDP in 2026 to 114.5% by 2035. A partial and gradual adjustment—such as replacing the current minimum-wage rule with inflation-only indexing and freezing federal employee salaries from 2027 to 2030—would not stop the upward trend, but it would result in smaller annual increases. In this base-case scenario, debt would reach 102% of GDP in 2035.

A more ambitious package—eliminating the salary bonus, changing health and education spending rules, halving congressional earmarks, and cutting the federal share of Fundeb funding from 23% to 19%—could limit debt growth to a peak of 93.4% in 2030 and a decline to 87.7% by 2035, Warren estimates.

Some progress, but long road ahead

Despite criticisms, Borges sees some fiscal consolidation already taking place. He expects the government to deliver a structural primary balance—excluding temporary revenues and economic-cycle effects—close to zero by the end of 2026, improving from around -0.5% of GDP in 2025 and -1% in 2024. Back in 2014, during the Dilma Rousseff administration’s recession, the structural primary balance was around -2.5% of GDP.

“There is consolidation underway, using multiple strategies: initially it was all spending cuts, now it’s more revenue increases. But the point is we need to reach a 1.5% of GDP surplus. We still have a long way to go, and we can’t take another ten years to get there, because international conditions have changed,” Borges said.

Compared to the past, global interest rates are now higher and are likely to stay that way.

“In 2021, the international environment contributed almost nothing to our long-term rates. Today, that contribution is nearly two percentage points. We’re not going back to the ultra-low global rates we saw in 2009, 2010, or again in 2021 and 2022. That means we no longer have the space we once had for a slow, gradual fiscal adjustment,” Borges said.

In a statement, the Finance Ministry said the average primary result of President Lula’s third term will be significantly better than those of previous administrations, such as Michel Temer’s and Jair Bolsonaro’s. “Compared to the Bolsonaro administration, in particular, the cumulative primary deficit under Lula’s third term will be 70% lower,” the statement said.

The ministry added that the fiscal framework targets continue to be met, and projections for the coming years remain consistent with those limits, “which makes the term ‘fiscal crisis’ misleading.”

“In 2024 and 2025, the primary target was met, with results closer to the center of the target band than to the lower limit,” the ministry added.

It also said that expenses linked to “reversing the precatórios default under the Bolsonaro government” and to climate disaster relief for Rio Grande do Sul account for 75% of the deductions from the fiscal target. “It’s important to note that the deducted amounts are still counted in fiscal statistics,” the note said.

*By Anaïs Fernandes — São Paulo

Source: Valor International

https://valorinternational.globo.com/