Brazilian government's decision to increase primary fiscal deficit targets likely to undermine policy credibility

Brazilian Finance Minister Henrique Meirelles (L) and Minister of Planning, Budget, and Management Dyogo Oliveira announce the new fiscal target during a press conference at the Ministry of Finance in Brasilía, on 15 August 2017.

SERGIO LIMA/AFP/Getty Images

On 15 August 2017, President Michel Temer's government announced a marked revision to Brazil's primary fiscal deficit targets for 2017 and 2018. The revised deficit for this year will increase to USD50 billion from USD43 billion previously; for 2018 the deficit will be USD50 billion versus the USD40 billion previously estimated. Furthermore, the government is now projecting a primary surplus to be achieved only in 2021 rather than in 2020 as initially planned.

The revised targets, which will be sent to Congress for approval, constitute a significant setback for the economic team, led by Finance Minister Henrique Meirelles. Just a few weeks ago, Meirelles was insisting that it would not be necessary to revise the targets, but worse-than-expected tax revenues have forced him to change that view. The primary deficit registered in the 12 months to June came in USD57.25 billion, or about 2.8% of national GDP. In 2016, the total fiscal deficit, including interest payments, reached 8.93%.

The situation has been compounded by an uncooperative Congress, which appears unwilling to support austerity measures and tax hikes needed to improve the country's unsustainable fiscal position. The eroding of support is in large part explained by the corruption allegations directly affecting President Michel Temer, which prompted the Lower House to vote on whether to allow the Supreme Court to conduct a criminal trial against the president. The vote, held on 2 August, went in Temer's favour but at the price of weakening his support base.

To gather the votes he needed, Temer offered funding for several projects sponsored by loyal deputies in their own constituencies; such commitments cost the government USD1.3 billion in unbudgeted expenditure. Additionally, under pressure from the agribusiness lobby in Congress, Temer agreed to wave debts from rural producers in a measure worth USD3.2 billion. Both these moves have added to the fiscal shortfall.

The president's weakness has given Congress the advantage in dealings with the government. Accordingly, a good number of deputies and senators are now demanding cabinet posts and money for their provinces in exchange for supporting the government. Prosecutor General Rodrigo Janot is expected to present new corruption charges against Temer later this month and therefore the Lower House would be asked to vote again on the matter. This will increase the pressure on the government to take short-term measures to gain enough support to preserve Temer's position. Many members of Congress have complained heavily about Meirelles and the economic team, and already have managed to block several revenue-enhancement measures. The diluted REFIS programme is a case in point; REFIS is a scheme that grants a degree of discount to companies with tax arrears if they agree to pay the initial tax owed in instalments. The government initially forecast that the incentive would generate revenue worth USD4 billion; however, a bill tabled in the Lower House modified the scheme to such an extent that ultimately it is projected merely to yield USD125 million. Meirelles is now trying to renegotiate the proposal but it is certain that Congress will not allow him to achieve the original fiscal yield target. A government proposal to remove payroll tax exemptions granted to hundreds of economic sectors also is facing obstruction in Congress.

Prior to adjusting the aggregate fiscal targets Temer hinted at the possibility of increasing the income tax rate. However, the suggestion was promptly rejected by both the speaker of the Lower House, Rodrigo Maia, and Paulo Skaf, the president of FIES, the powerful Federation of Industries of São Paulo. The government has now confirmed that tax increases are not part of the fiscal deficit reduction programme.

Outlook and implications

The softened targets reflect the difficulties that the government is facing in its efforts to contain the fiscal deficit. It is very unlikely that Congress will support tax increases or the necessary cuts in government costs in the run-up to the 2018 general election. The new fiscal target assumes a freeze in pay and pension contributions to public servants. However, this requires Congressional approval and it is far from clear whether this will be granted. As a result, even the new target could be missed if Congress refuses to co-operate. No deputy or senator seeking re-election next year will support unpopular economic measures proposed by an extremely unpopular government.

Further fiscal slippage would undermine Meirelles's credibility. He still enjoys the backing of the markets and is perceived as the guarantor of fiscal discipline. Indeed, he embodies the remaining credibility of the Temer government's economic policies. As such, the markets and the rating agencies may still give Meirelles some further benefit of the doubt. According to media reports, the upward revision in the fiscal target was not larger due to Meirelles having stood his ground against cabinet calls to increase the deficit to USD57 billion. It indicates that the finance minister still has a strong political voice and managed to convince the president that a larger deficit would damage the government's reputation and undermine market support. However, the revised targets are still a clear reversal for the government and Meirelles. The internal discussion between ministers serves to reinforce further the government's weakness in any negotiations with Congress. The main indicators of policy direction will be the vote in Congress on expenditure cuts as well as the fate of moves to sell infrastructure concessions, as the government struggles to obtain sufficient revenue to meet even the revised fiscal targets.