Scenario forces government to review revenue and spending, posing risk of shutdown

06/17/2024

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Manoel Pires — Foto: Wenderson Araujo/Valor

The change in the federal government’s primary result target for 2025 slowed the fiscal adjustment process and compromised the debt trajectory. The increase in mandatory expenses and the decreasing room for discretionary expenses, which fell by 0.5 percentage points of GDP from 2011 to the 12 months up to April, have delivered a warning. The government must not only increase revenues to meet the target but also make the framework viable within spending and avoid the risk of a shutdown of the public sector in the coming years due to insufficient spending to sustain its operation. The scenario requires a change in the fiscal strategy, even though the government faces downturns with successive defeats in Congress, and it is hard to change expenses regarded as priorities for the Lula administration.

According to Manoel Pires, a researcher at Fundação Getulio Vargas’s Brazilian Institute of Economics (Ibre-FGV), one of the most delicate points of the debate is the increase in mandatory expenses in relation to total spending. That reduced the room for discretionary expenses. He says that in 2011 total spending was equivalent to 16.8% of GDP, while mandatory expenses were equivalent to 14.6% of GDP. The difference, of 2.2 percentage points, was related to discretionary expenses. Now the difference is 1.7 pp in the 12 months up to April. Total spending is 20.1% of GDP and mandatory expenses are 18.4%.

Based on data and analysis carried out by Mr. Pires, the topic is addressed by Ibre-FGV director Luiz Guilherme Schymura in the “Carta do Ibre” report released this month.

Mr. Pires points out that, as the federal government changed the 2025 primary result target, the improvement planned in the coming years became more gradual than initially expected, with an increase of 0.25 p.p. per year instead of 0.5 p.p. until 2027. The targets are now zero primary results in 2025 and a surplus of 0.25% of GDP in 2026, the last year of President Lula’s current office. The surplus of 1% of GDP would only be achieved in 2028 after a positive primary result of 0.5% of GDP in 2027. The flexibility range of 0.25 p.p. up or down has been maintained.

The change in the target, he says, was due to factors including the impact of municipal elections on the Parliament’s agenda in the second half of the year and the worsening in the government’s relationship with the Congress. Increased non-recurring revenue is expected to favor the fiscal result in 2024. The difference, plus the additional adjustment to the previous target, according to Mr. Pires, would require an effort involving over R$100 billion.

In this context, the government’s decision to change the fiscal target is natural, but there are impacts, the economist says. “The fiscal framework will pose a different challenge to the government, changing its deficit reduction strategy. The government will also have to discuss spending, which somehow is already happening.”

One of the negative impacts of changing the fiscal target is that the idea of an incremental improvement each year has been undermined, Mr. Pires points out. The zero target for 2025 remained the same as that for 2024. When the change was announced—before the Rio Grande do Sul disaster—it indicated that the primary result in 2025 could be worse than that of 2024. Excluding the effect of the floods, Mr. Pires estimates that the 2024 deficit could reach 0.57% of GDP (R$65.7 billion). For him, under the current conditions, it will be “very difficult” to achieve the target. Considering the flexibility range, the deficit in 2024 could reach 0.25% of GDP. He points out that by failing to meet the target in 2024 the government could create triggers for 2025, which could lead to freezing spending or reviewing the target for this year.

Mr. Pires points out that, under the 2025 Budgetary Guidelines Bill (PLDO), next year’s fiscal result could reach R$75 billion, including registered warrant payments (IOUs issued by the judiciary branch). The PLDO provides for a primary deficit of R$29.1 billion, plus IOUs amounting to R$39.9 billion. With recent news suggesting that IOUs may exceed expectations, the deficit could get close to R$75 billion in 2025, the economist explains.

Under the PLDO, primary spending in 2025 would total 18.96% of GDP, slightly above the 18.93% of GDP in 2024, in the reading carried out in the first two months. It gets worse, Mr. Pires notes. Mandatory expenses increase to 17.24% of GDP in 2025, from 16.87% this year. Discretionary expenses grow from 2.06% to 1.72% of GDP, of which 0.32 p.p. refers to mandatory amendments. “Actual discretionary expenses are equivalent to 1.4% of GDP. Then, a problem arises. In binary thinking, it is hard to tell what the minimum discretionary expenses would be to avoid a shutdown. Historically, the lowest level was 1.5% of GDP, during the pandemic, when many public agencies were closed due to the lockdowns, which resulted in lower discretionary expenses.”

The PLDO projection is not as accurate as that of the annual budget bill (PLOA), Mr. Pires says. “However, it delivers a warning about the framework’s ability to make the budget viable. Therefore, the government started addressing spending. Besides making the target viable by increasing revenue, it now has to create the conditions for the viability of the [fiscal] framework within the budget.”

Regardless of the level that would lead to a shutdown of the public sector, the economist says it is easy to see that the minimum spending possible in a Workers’ Party administration, with more public policies, is different from the Bolsonaro administration. He points out that the PLDO projection for 2026—when discretionary expenses, discounting mandatory amendments, should be at 1.27% of GDP—is very bad and unlikely to happen in an election year. “That brings the debate forward in an attempt to make the framework viable in 2025.”

The problem, according to him, is that the budget is becoming increasingly rigid. He says there was an increase in mandatory expenses with the permanent policy of increasing the minimum wage—with impacts on spending on Social Security, unemployment insurance, and salary allowance, among others—, an increase in the amount of social security benefits, expansion of the Bolsa Família cash-transfer and increased spending linked to revenue, such as congressional earmarks and constitutional minimum healthcare spending. Minimum spending on education was also reestablished, although it has no practical effect on increasing expenses. Furthermore, the new framework provides for an investment floor, the economist points out.

“There is individual merit in all items but the whole does not fit within a fiscal rule. Total spending is 20.1% of GDP, considering the 12 months up to April, including IOUs. When the framework was created, the government’s argument was to maintain spending levels considering 19% of GDP. The data is influenced by the temporary effect of early court-ordered payments. However, it seems politically difficult for the government to maintain spending at 19% of GDP. There is always a reason for early spending and bringing it a little above the framework,” Mr. Pires points out.

To analyze spending structurally, Mr. Pires compares spending in the first four months of 2024 with the same period of 2023, excluding IOUs, and with inflation-adjusted numbers. Total spending increased by 7.6%, equivalent to three times the spending growth rate allowed by the fiscal framework, of 2.5%, inflation-adjusted. Personnel expenses increased by 3.1%, social security expenses, by 7.9%, and discretionary expenses, by 21.2%. “The government has a huge spending pressure to manage.”

Mr. Pires draws attention to the 4.1% increase in the amount of social security and accident benefits issued in March compared to the same month in 2023. He points out that this trend has been in place since the middle of the second half of 2023.

According to the economist, the current situation shows that the fiscal structure requires slow adjustment in Brazil. “We have a high tax burden considering the country’s development level,” he said. The Organization for Economic Cooperation and Development’s average tax burden increased from 31.5%, in 2010, to 34% of GDP, in 2022, a 2.5 percentage points growth, Mr. Pires notes. “Many of the OECD countries, especially in Europe, made adjustments with increased tax burden in the 2010s.” In Brazil, he compares, tax burden increased from 32.2% to 33.1% in the same period, or 0.8 p.p. [Finance Minister Fernando] Haddad’s [defending] the adjustment by revenue makes sense. However, it’s not possible to focus it all on the revenue side.” On the other hand, he says, spending in Brazil is very rigid, as it involves many constitutional matters, making changes difficult. Also, there are acquired rights.

“The whole leads to ambiguity, which we are currently experiencing,” Mr. Pires says. In periods of low growth, even if the current situation is better than before the pandemic, the policy is confusing. There are signs to control debt, while there is excessive concern about the cyclical impact of such control, he explains. “It is necessary to improve fiscal results but also to increase public spending to stimulate the economy.” He points out that IOUs are becoming an instrument of countercyclical fiscal policy.

“That is very weird. It is where the government found a relief valve to create a narrative to increase spending to stimulate the economy.” Traditionally, he says, this is done via investment or with tax relief for low-income households. Struggling to adjust revenue and expenses leads to a gradual fiscal improvement that is subject to reverse. Whenever the timing is too long, the adjustment is subject to shocks, as happened in the pandemic and now with the disaster in Rio Grande do Sul.

“The adjustment can’t be too fast that it is impossible nor too slow that no one believes it,” Mr. Pires claims. While it requires credibility, the adjustment program needs to have a balance of revenues and expenses, to preserve public investments, the economist points out. Furthermore, it is necessary to “sell the future with an agenda of structuring reforms,” in which economic growth expectations could alleviate the burden on public accounts, as happened in the past with the pension reform and is being aimed with tax reform, in the long-term.

Mr. Schymura, from Ibre/FGV, points out that the current political moment is an additional challenge, as the government is experiencing many defeats in Congress. He points out that the Lula administration was already the target of criticism for only reestablishing old programs and now news says it needs to make adjustments on the spending side. “What could be offered in exchange for decoupling the minimum wage from Social Security? It requires positive, unexpected news. I see a difficulty in putting together a narrative to package such a fiscal adjustment.”

Mr. Pires says the idea that nothing seems possible to be discussed in terms of reducing spending is worrying. For him, although the spending review plan is important, betting on it as a sufficient solution for the fiscal framework was a “strategic mistake.”

In the short term, according to Mr. Pires, administrative measures need to be taken and spending can be contained again. “The minimum wage brings a lot of pressure but it is difficult to reverse. From a strategic point of view, the government could choose an item to seek victory on the spending side.” The minimum healthcare spending, if there is room for that, could be an example. “If they manage to do that, the scenario for 2025 could improve and it would be possible to make 2026 viable.”

Healthcare spending, according to Mr. Pires, could be aligned with the framework’s spending rule. “Another interesting discussion is changing the concept of net current revenue to which healthcare spending is linked.” This revenue is currently subject to many variations, such as the recent commodity shock.

Among possible short-term measures, Bráulio Borges, consultant at LCA Consultores and researcher at Ibre, cites the mechanism known as DRU, which allows flexible use of part of revenues by the federal government, that was extended until the end of 2024. “There is an opportunity to approve a new proposal to amend the Constitution later this year, possibly expanding its scope and increasing its percentage. An extended and boosted DRU could create flexibility in the short term, to mitigate the problem of these ties, such as healthcare, and improve budgetary rigidity.” He also mentions the salary allowance, which represents 0.2% of GDP per year, a program that could be improved by adjusting its focus, with no need to be eliminated, he argues.

*Por Marta Watanabe — São Paulo

Source: Valor International

https://valorinternational.globo.com/