Monetary and financial issues

Economic Survey of Brazil 2009: Reaping the benefits of macroeconomic consolidation

 

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The following OECD assessment and recommendations summarise chapter 2 of the Economic Survey of Brazil published on 14 July 2009.

 

Contents

 

Fiscal management has so far been commendable, but long-standing fiscal challenges have yet to be fully addressed

Brazil’s fiscal track record, as gauged in terms of attainment of the primary budget surplus targets, is exemplary. This, together with prudence in public debt management, is delivering a gradual reduction in public indebtedness. In addition, the government now enjoys a net foreign asset position; as a result, unlike in previous episodes of financial duress, its debt dynamics are no longer affected adversely by a depreciation of the exchange rate. These are remarkable achievements, especially because public indebtedness has traditionally been the single most important source of macroeconomic vulnerability. The government has been able to sustain fiscal adjustment, despite the limited room for manoeuvre caused by a ratcheting-up of current spending over the years and strong downward rigidities in the budget, through revenue hikes. To illustrate, primary general government spending has risen by almost 7% of GDP since macroeconomic stabilisation in 1994 to nearly 32.5% of GDP in 2008. Measures will therefore need to be taken to stem further increases in expenditure in the future. To do so, a cap could be introduced on the expansion of outlays. Attempts to introduce such a ceiling have been made in the past, and draft legislation to that effect awaits Congressional approval. Policy action in this area is important to make room in the budget for rebalancing expenditure in favour of capital outlays, which would be consistent with the authorities’ efforts to develop infrastructure and to reallocate budgetary appropriations towards cost-effective programmes.


Additional reform to the pension system would be advisable

Much has been done over the years to put the pension system on a sounder financial footing. Parametric reforms included a comprehensive overhaul of pension entitlements for private-sector workers in 1998 to discourage early retirement and to encourage the creation of complementary retirement savings schemes. The separate social security regime for civil servants was reformed in 2003, although several provisions are yet to be legislated, including the creation of complementary pension funds for government employees. More recently, initiatives have been taken to improve compliance in the regime for private sector workers through better enforcement and administration, including the transfer of responsibility for collection of social security contributions from the Ministry of Social Security to the Federal Revenue Service. Backtracking on these policy efforts would be regrettable. Robust economic growth in the last few years, which has delivered rising incomes and plentiful job creation in the formal sector, has contributed to stabilising the deficit of the social security system. But its long-term financial sustainability could be bolstered through complementary measures. This is important, because pensions for private-sector workers account for about one-third of federal primary expenditure, and outlays on pensions for retired civil servants are placing an increasingly heavy financial burden on the states and municipalities. Consistent with previous OECD policy advice, minimum age provisions should be introduced in the private-sector regime for retirement on the basis of length of contribution; the link between pension benefits and the minimum wage should be severed, although the purchasing power of the minimum pension could be at least maintained, possibly through its indexation to a price index that best reflects the consumption basket of pensioners; and regulations should be issued allowing for the creation of complementary pension funds for civil servants, preferably of the defined-contribution type and in line with entitlements prevailing in the private sector.

 

A fiscal target will need to be set for the longer term

The public debt-to-GDP ratio is likely to remain at close to 40% of GDP in 2009-10 and then to fall gradually to close to 35% over the medium term. This achievement is commendable but does not obviate the need for continued prudence in financial management and unabated commitment to the consolidation of fiscal adjustment. This is because Brazil’s gross public debt remains high by comparison with its emerging-market peers, and a rapid fall in the net debt-to-GDP ratio late in 2008 was due predominantly to a pronounced exchange-rate depreciation, rather than to enhanced fiscal effort, given that the public sector is now a net foreign creditor. Future policy discussions should focus on setting the level of public indebtedness that the authorities consider appropriate for the longer term and the corresponding budget targets. The policy debate on this matter should be guided by the need to prepare for the emergence of future liabilities, including those associated with the pension system. To do so, Brazil already has the budgetary instruments required for longer-term planning and policy evaluation, such as the Budget Guidelines Law (LDO) and the multi-year budget plan (PPA). One important consideration is the use of budgetary savings associated with a likely fall in debt-service obligations over the coming years. A case can be made for using these savings to retire debt at a faster pace, to alleviate the tax burden while tackling the well known weaknesses of Brazil’s tax system (discussed below) and to reallocate at least part of the budgetary appropriations towards cost-effective programmes, which would be consistent with ongoing efforts to improve the efficiency of government operations.

 

Adoption of an overall budget balance target would be welcome

The authorities have expressed their intention to redefine the fiscal rule in terms of the overall (nominal) budget balance, rather than the primary budget surplus. This would be a positive development. It makes sense to focus on the primary budget surplus when debt maturities are short and the bulk of the traded public debt pays floating interest rates or is indexed to the exchange rate. In such an environment, interest payments are overly sensitive to short-term fluctuations in the exchange rate and to changes in the monetary stance. But this situation is now changing: sustained fiscal adjustment and prudent public debt management have raised the average duration of traded securities and reduced considerably the shares of floating-rate debt and of instruments indexed to the exchange rate or denominated in foreign currency in the stock of government financial liabilities. In this new policy environment, a focus on the overall budget balance, rather than on a fiscal aggregate that excludes interest payments, would be welcome, because the consolidated public sector’s overall budget balance has remained in deficit, despite earlier successive increases in the primary surplus target and continued adherence to the fiscal rule. If the fiscal rule is redefined, it would be advisable to draw increasing attention to trends in the overall budget balance in public communications in preparation for its future adoption as the fiscal target. This would ensure a smooth transition to the new, more appropriate fiscal rule and contribute to building confidence in the policy framework.

The composition of the public debt is improving
Consolidated public sector, in % of GDP, end-period debt stocks

Source: Federal Treasury.

 

The monetary policy regime is working well, but more can be done in support of further financial deepening

Brazil’s monetary policy framework changed radically ten years ago, when the real was allowed to float freely. The current regime, combining inflation targeting and a flexible exchange rate, is working well, as noted in previous Surveys. Monetary policy has been conducted in a forward-looking manner, and the central bank’s inflation fighting credentials have been strengthened over the years. The policy move in late 2008 to free up part of commercial banks’ required reserves held at the central bank was essential for shoring up credit as the global financial and economic crisis worsened. Nevertheless, there is still considerable scope for easing the remaining compulsory reserve requirements for a variety of bank deposits. Progress should be sought in this area, because it would reduce the implicit tax burden on financial income, which would lower intermediation costs. Most countries that have adopted inflation targeting as the framework for monetary policymaking have reduced or eliminated such requirements.

There is room to reduce compulsory reserve requirements

1. Includes the “additional requirements” on sight and time deposits, as well as savings accounts, that are remunerated at the SELIC rate.
2. Deflated by IPCA.
Source: Central Bank of Brazil.


Another consideration is the existing regulations on the allocation of credit to selected sectors, especially agriculture and housing, including through mandated saving arrangements. These requirements were introduced in the past, when financial markets were less developed, and market failures would have prevented sufficient credit from being extended to important sectors of economic activity. But maintenance of mandated credit provisions may well be impeding further financial deepening and resulting in resource misallocation. These restrictions should be gradually removed to improve the efficiency of the financial sector and to reward long term saving adequately. As in the case of compulsory bank reserves, these constraints on the allocation of credit amount to a tax on financial income, which affects the cost of intermediation. The payoff from reform in this area could therefore be considerable in terms of reducing the stubbornly high real rates of interest facing those without access to preferential credit terms, which weigh heavily on the economy’s growth potential.

 

How to obtain this publication

 

The complete edition of the Economic Survey of Brazil is available from:

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.

 

Additional information

For further information please contact the Brazil Desk at the OECD Economics Department at eco.survey@oecd.org

The OECD Secretariat's report was prepared by Luiz de Mello and Mauro Pisu under the supervision of Peter Jarrett. Research assistance was provided by Anne Legendre.

 

 

 

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