On February 4th, in a message to the newly installed Congress, the president, Jair Bolsonaro, added some granularity around his government’s economic policy agenda. Further details have emerged from recent public statements by Paulo Guedes, the economy minister. A proposal for social security reform is likely to be presented to Congress by end‑February for debate, but it will take time before it goes to a final vote, probably in June or July. Other ambitious elements of the economic reform agenda—tax reform and privatisation—are likely to be pushed to late 2019 or early 2020. In the meantime, as the government is likely to prioritise pension reform, it will also pursue political “wins” with more modest measures to improve the business environment.
Following the establishment of an enlarged Ministry of Economy (that subsumes the ministries of finance, planning, and trade and industry) in an attempt to ensure harmonisation of economic policy, Mr Guedes has appointed six special secretaries, all of whom are seen as liberal and advocates of free markets. This has reinforced the expectations of a shift towards greater economic liberalisation and fiscal responsibility. Indeed, Mr Guedes’ ideas are fairly radical for Brazil—and are likely to face obstruction in a fragmented Congress.
Social security reform
With respect to the most important economic policy item—social security reform—the government is unlikely to use the bill put forward by the previous Michel Temer administration (2016‑18) and which made some advances through various congressional commissions in 2017. Although the government’s proposal is expected to be presented to Congress by the end of February, the vote on the bill will not be held for some time, as it will be vetted by various committees in both the Chamber of Deputies (the lower house) and the Senate (the upper house). The final vote on the bill in the Senate will probably be held in June or July. As it will require a constitutional reform, a three‑fifths majority will be needed. This is always a challenge in Brazil, particularly for a politically sensitive reform such as to the pension system.
The proposal that will be presented to Congress is likely to include an increase in the minimum retirement age and the minimum number of years of contribution required to be eligible for a full pension. A leaked draft of the bill indicated that the economic team wanted to set a minimum retirement age of 65 for both men and women, but this is likely to be altered before being presented to Congress, with different (and lower) retirement ages for both women and men. The draft bill also proposes a shorter transition period for the increase in the retirement age than suggested by the previous administration, in order to guarantee immediate fiscal savings. The legislation is likely to propose a gradual implementation of a capitalisation regime, whereby individual accounts of mandatory contributions are retrievable upon retirement, as opposed to the current system in which pensions are funded by a common pool of contributions by current workers. This would probably only apply to new entrants into the labour market, however. Unification of civil servants and private workers is also likely but military pensions will probably be dealt with in a separate bill.
Although, given the urgency, social security reform will be the most closely watched indicator of the government’s ability to get Congress to approve its reform agenda, other structural reforms will be needed to unlock Brazil’s growth potential. Simplifying the country’s highly complex tax system (including federal, state and local taxes) and implementing a common value‑added tax (VAT) across the country, as envisaged by Mr Guedes, will face strong opposition from state governments and regional alliances in Congress, because it means that states will lose the ability to adjust taxes for attracting businesses or balancing their accounts. Mr Guedes may use a reduction in corporate tax rates (from 35% currently to 20%) to leverage support in Congress, but the introduction of taxes on profits and dividends to counterbalance the revenue loss is likely to meet its own opposition.
Mr Bolsonaro has indicated that he would not be willing to fully privatise strategic state‑owned or ‑controlled enterprises including Petrobras (the biggest oil, gas and energy company), Banco do Brasil (the largest retail bank in Brazil) and Caixa (the fourth‑largest retail bank). Nonetheless, we expect some progress on privatisation in the medium to long term, but with a focus on divestment of non‑core businesses, such as insurance, credit cards and lottery for the state‑owned banks, and distribution for Petrobras. The government may use capital markets in this process to reduce its shareholding position through initial public offerings. Accelerating the bidding for infrastructure concessions such as airports and roads is also likely to be quickly achievable and will face little opposition.
On the trade liberalisation front, the government may well undertake a number of measures to boost productivity that would not require congressional approval. These include unilaterally reducing trade tariffs (without breaching rules set by Mercosul, the Southern Cone customs union) and reducing Mercosul’s external tariffs to the global average. Turning Mercosul into a free‑trade area rather than an (imperfect) customs union is also on Mr Guedes’s radar, but we do not expect any significant progress on this goal in the short term. In terms of improving the business environment, the government is likely to focus on measures such as improvement of the portal for digital trade, reduction of processes for opening/closing a business and modernisation of existing microcredit programmes (for supporting small to medium‑sized enterprises).
A first political win
The recent election of Bolsonaro’s allies from the Democratas (DEM) party as leaders of both the Chamber of Deputies (Rodrigo Maia) and the Senate (David Alcolumbre) represented a key victory for the government. Mr Maia and Mr Alcolumbre have the keys to set the legislative agenda in Congress, in addition to deciding on significant processes such as parliamentary inquiries (CPIs) that could easily weaken the executive. The composition of parliamentary blocs (formed to act through special committees responsible for overseeing legislative debates on specific issues) will also assist the administration, as it will be able to choose key appointments to oversee many of these commissions.
Although this does not imply that the parliamentary blocs will support every bill proposed by the government, especially as still‑powerful centrist parties are likely to negotiate their support on a case‑by‑case basis, it reflects a fairly strong government position in Congress at the outset at least. Nonetheless, coalition building will be key to securing the support of 308 deputies in the lower house required for approving constitutional amendments (such as social security and tax reform); the government only has the support of an estimated 300 at present. In addition, the government may need the support of other parties to neutralise the threat of opposition from Renan Calheiros, a legislator who withdrew his candidacy from the vote for the Senate presidency at the last minute and who could become a rallying point for the opposition.
Finally, the sequencing of reforms will also be crucial. A victory in social security reform will buy the government time and support, paving the way for later battles such as tax reform and more controversial privatisations, such as the Petrobras distribution business— which are unlikely to be presented to Congress until end‑2019 or early 2020. In the meantime, the government will try to take small steps on the business environment and trade liberalisation fronts, and prioritise infrastructure concessions to boost revenues in the short term. Investors will monitor the progress of pension reform during the months of debate in Congress. There are downside risks for Brazil’s fiscal and economic outlook should there be disappointments in our and the markets’ baseline assumption of sufficient progress in bolstering the public finances.