EFTA00607213.pdf

SEP 0918 2015 I: ECONOMICS: LATIN AMERICA PERSPECTIVES BRAZIL: A NEW (UPHILL) FISCAL BATTLE + Fernando J. Losada, Senior Economist—Latin America Research. S&P's decision to downgrade Brazil to junk status this month prompted the government to announce a more ambitious fiscal plan. But politicians' reaction to the proposal was lukewarm at best, suggesting the government may not be able to put it fully into action. After the Downgrade, a Swift Reaction To forestall this, the government has called ratings agencies to delay any downgrades Shortly after S&P became the first of the for a combination of revenue increases and of their own. Moody's, which still considers big three ratings agencies to cut Brazil's spending cuts worth some BRL60 billion Brazil investment grade, welcomed the sovereign credit rating to junk status, the (US$16 billion). The cornerstone of the news. government ditched an earlier budget revenue increases is the reenactment of a However, we think there's a substantial risk proposal and recommitted itself to fiscal financial transactions tax, known as the that the government will find itself unable discipline. President Dilma Rousseff rallied CPMF, which is expected to generate more to implement the plan in full. The initial around her finance minister, Joaquim Levy, than 93% of the projected BRL34 billion reaction from legislators was barely and announced a primary surplus target of incremental revenue. The idea is to lukewarm. Eduardo Cunha, the chairman of 0.7% of gross domestic product (GDP) for maintain the CPMF at a rate of at least the lower house, said he wouldn't support fiscal year 2016. 0.2% during the remainder of Rousseff's the CPMF, though he did vow not to block term. It was the government's recent decision to the initiative in Congress. But he added backpedal on its fiscal promises by The government also proposed increases that he thought Congressional approval reducing its primary surplus targets and in capital gains taxes and reductions in this year "is close to impossible" increasing its expected primary fiscal export subsidies. The main items included Meanwhile, local media reported that deficit that cost Brazil its investment-grade in the BRL 26 billion worth of proposed business leaders don't support the tax rating. As S&P correctly pointed out, the spending cuts include a delay in civil plan, especially given Brazil's worsening backpedaling would have caused Brazil's servant salary increases until July 2016, recession, and would prefer to see more debt ratios to deteriorate sharply over the and reductions of housing subsidies, an aggressive spending cuts. It's unclear next couple of years. infrastructure investment program and whether the federal government's offer to healthcare outlays (Display 1, next page). What's more, there appeared to be a lack share the revenues from the CPMF with of widespread support for fiscal discipline The Devil's in the (Political) Details state governments will be enough in the as a way to address the country's econom- In principle, the announcement is good current anti-tax environment. ic malaise. As a result, the S&P kept the news because it suggests Rousseff hasn't Even some lawmakers from the ruling rating on negative outlook, suggesting that given up on the notion of fiscal reform. It Workers Party oppose the plan, according the rating agency's next move is more also implies that Levy still exerts some to local newspapers, especially the likely to be another downgrade rather than influence when it comes to economic proposal to freeze public workers' salaries. a move back into investment-grade policy. We think this recommitment to The more leftist wing of the Workers Party territory. fiscal discipline could persuade other 1 EFTA00607213 has called for special taxes on the banking sector and the wealthy. Even former Display 1 President Luiz Inacio Lula da Silva has The New Fiscal Plan reportedly suggested relaxing the fiscal Impact of Main Projected Fiscal Adjustment Measures (SRL Billion) stance and lowering interest rates to boost growth. Organized civil servant unions have Spending Reductions warned that they could go on strike. Delay in Public Wage Increases 7.0 Congress, Bribery Probe Still Problems Reduction in Housing Subsidy 4.8 At this point, it looks as though Congress will water down the plan. That will make it Reduction in Healthcare Outlays 3.8 difficult for the government to deliver on Reduction in Infrastructure Investment 3.8 its fiscal promises in 2016. If Congress Government Employment Freeze 1.5 strikes the CPMF down, the government may have to rely on nonlegislated taxes Reduction in Agricultural Subsidies 1.1 such as a special contribution on gasoline Other 4.2 consumption, known as the CIDE tax. This Total 26.2 would result in less than half of the revenues that would have been generated Revenue Increases by the CPMF. It would also push prices Financial Transactions Tax 32.0 higher, thus compromising Brazil's anti-inflation strategy. Increase in Tax on Capital Gains 1.8 Reduction in Export Subsidies 2.0 To be fair, the fiscal plan is mostly a patchwork rather than a comprehensive Reduction in Subsidies on Interest Income 1.1 strategy to deal with structural fiscal Other 2.8 difficulties, including spending rigidity and wage indexation rules. This most likely Minus Lower Projected Revenue From Existing Taxes 5.5 reflects the Rousseff administration's lack Total 34.2 of political capital, which makes it hard to Total Projected Fiscal Adjustment 60.4 get Congress to sign off on deep reforms. Through September le. 2015 If Congress changes the plan significantly Source: Local Newspapers and AB or if the president lacks the ability to push it through Congress at all, Levy may resign. That could lead to asset price volatility and makes it harder for the government to international banks that Brazilian prosecu- provide extra incentive for the political garner support for its fiscal plans. This tors say may have been involved in a opposition to push impeachment proceed- week, the federal prosecutor's office pay-to-play scheme aimed at securing ings against Rousseff. formally accused 15 political figures, access to official contracts. And let's not forget that the ongoing including former President Lula's chief of Against this backdrop, we think the risk of corruption investigation, which makes the staff, of bribery. The probe has also more ratings downgrades is high. political climate even more volatile, also extended to involve several high-profile 2 EFTA00607214 The information contained herein reflects the views of AllianceBernstein LP. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein LP. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any proiection, forecast or opinion in this material will be realized. Past performance does not guarantee future rests The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AlianceBernstein LP. does not provide tax, legal or accounting advice. 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