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Brazil Debt Suffering Social-Spend Promises With Election

As President Dilma Rousseff’s lead narrows in polls before October’s election, she and her top opponent are courting voters with spending promises that would undermine the fiscal discipline investors say is needed to restore confidence in the economy.

Rousseff boosted this month cash transfers to the poor, said in April she will increase income tax exemptions for 2015, and pledged to continue raising the minimum wage. Senator Aecio Neves, the runner-up in polls, last month distanced himself from earlier talk of unpopular austerity measures and urged Congress to extend minimum wage increases by at least the rate of inflation through 2019.

Analysts from credit rating firms to the World Bank agree Latin America’s largest economy needs to cut spending to help bring inflation under control, boost investments and thereby quicken growth. With a total tax burden already at 36 percent of gross domestic product, a widening budget deficit, and more than 80 percent of central government outlays earmarked by law, Brazil has little room for fiscal maneuvers, said Jankiel Santos, chief economist at Banco Espirito Santo de Investimento.

“They’re promising paradise, not blood, sweat and tears,” Santos said in a phone interview from Sao Paulo. “A budget tightening is inevitable, so these pledges may become a political liability.”

GDP growth in the first quarter slowed by half to 0.2 percent from the previous three months, as investments fell by the most in two years, the government said last week. Only Argentina and Venezuela will expand less than Brazil among major Latin American economies this year, according to the latest IMF forecast.

Lowest Point

Industrial confidence dropped in May to the lowest point since 2009, according to data published by the National Industry Confederation. Consumer confidence also has plunged as Brazilians see their purchasing power erode, falling last month to the weakest level in more than five years, according to a survey conducted by Getulio Vargas Foundation, an education and research institution based in Rio de Janeiro.

Falling revenue from slower growth and tax breaks to help fuel demand have widened the budget deficit to 3.1 percent of GDP in the 12 months through April from 2.4 percent two years earlier. Brazil is forecast this year to have the largest budget deficit after Venezuela among eight Latin American economies in a Bloomberg survey of economists.

Credit Downgrade

Standard & Poor’s in March lowered its Brazil credit rating to BBB-, the lowest investment grade, flagging slow economic growth and expansionary fiscal policies. The move was partially anticipated by investors and left yields little changed.

Nearly four years of above-target inflation and the slowest economic growth during any presidency since Fernando Collor, who stepped down in 1992 amid a corruption scandal, have taken their toll on Rousseff’s electoral prospects.

Rousseff’s lead over Neves fell to 17 percentage points in a May 7-8 Datafolha from 28 points in February. She was supported by 37 percent in the May poll, which had a two percentage-point margin of error. That wouldn’t be enough for her to win in the Oct. 5 first round, where a candidate must have more votes than all others combined.

Neves said in a TV interview yesterday that it would be possible to reach the center of the inflation target, currently at 4.5 percent, within 18 to 24 months of taking office.

Eduardo Giannetti, an economic adviser to presidential candidate Eduardo Campos, said Brazil needs to rein in spending and increase interest rates at the outset of the next government to help ease inflationary pressure. Campos, former governor of Pernambuco state, has pledged to reduce the number of government ministries. He trails in third place with 11 percent in the latest Datafolha poll.

‘Credibility Shock’

“With a credibility shock, with confidence restored, the Brazilian economy has already shown and will show again that it quickly returns to the right path,” Giannetti said in a May 30 interview in Bloomberg’s Rio de Janeiro office.

Press officers for President Rousseff and Senator Neves did not respond to e-mails requesting comment on the financial impact of their proposals.

Among voters who earn as much as 1,448 reais ($636) per month, the lowest income bracket in Datafolha’s survey, Rousseff’s support is 47 percent, compared with 17 percent for Neves and 13 percent for Campos.

“This is the toughest campaign since 1989,” said Carlos Manhanelli, a Sao Paulo-based electoral marketing consultant. “Everything the candidates are saying is to benefit the middle and lower middle class, where most of the votes are,” he said in a phone interview.

Stock Market

Since Rousseff took office on Jan. 1, 2011, the Sao Paulo Stock Exchange index has fallen 26 percent, while average yields on Brazilian dollar bonds increased to 2.13 percentage points over U.S. Treasuries from 1.89 percent, according to JPMorgan.

When her popularity started falling in late March, equity markets rallied on hopes that opposition candidates will intervene less in the economy, increase corporate profit margins, particularly for state-run companies, and adopt a more disciplined fiscal policy.

Rousseff’s 4.5 percent increase in income tax exemptions next year and a 10 percent increase in Bolsa Familia cash transfers starting this month will cost the government 9 billion reais. That puts at risk meeting the target of 1.9 percent of GDP for the primary budget surplus, which excludes interest payments, according to Felipe Salto, an economist at Sao Paulo-based consulting firm Tendencias Consultoria Integral. Last week she extended a $9.7 billion payroll tax cut.

Financial Crisis

Rousseff said that her government shielded Brazil from the 2008 financial crisis while reducing inequality and maintaining labor benefits. “We won’t let this country return to the traditional policies of squeezing wages,” she said at an event in Bahia on April 30.

A deteriorating budget scenario and generous campaign promises increase the chance Moody’s Investors Service Inc. will follow Standard & Poor’s and either reduce Brazil’s rating or change its credit outlook to negative, Salto said.

Spending on Bolsa Familia, which benefits approximately a quarter of Brazil’s population of 200 million, increased by 64 percent in inflation-adjusted terms since Rousseff took office on Jan. 1, 2011, government data show.

An automatic minimum wage increase as proposed by Neves is particularly worrisome because it drives up labor costs at a time that Brazil’s industry is losing international competitiveness and boosts pension payments and other benefits, said Christopher Garman, director for emerging markets at Eurasia Group.

Minimum Wage

Neves also presented an amendment to Congress that would automatically increase the amount of tax exempt income by the rate of inflation over the next five years.

While Rousseff made general promises to keep raising the minimum wage, Neves went further, proposing a renewal until 2019 of the current formula based on inflation and economic growth. That proposal contradicts one of his advisers, former Central bank governor Arminio Fraga. In April Fraga told Estado de Sao Paulo newspaper that salary increases exceeded productivity gains and risked choking the labor market.

The minimum wage has increased 90.5 percent since 2007, compared with inflation of 48.2 percent over the same period.

“My takeaway is that we’re probably going to get higher taxes next year,” Garman said by phone from Washington. “It’ll be difficult to roll back these fixed expenditure items, with the minimum wage being the No. 1.”

World Bank chief economist Augusto de la Torre said Apr. 9 that Brazil needed to tighten its fiscal policy more to allow for more lax monetary policy. The central bank has increased its benchmark interest rate by 375 basis points since April 2013, the longest tightening cycle in the world.

Bad first quarter economic growth data last week reinforce that Brazil must curb its expansionary fiscal policy to escape slow growth and fast inflation, Tendencias’ Salto said.

“Promises that things will continue as rosy as they were are illusionary,” Salto said.

To contact the reporter on this story: Raymond Colitt in Brasilia Newsroom at rcolitt@bloomberg.net

To contact the editors responsible for this story: Andre Soliani at asoliani@bloomberg.net Harry Maurer

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