Brazil's Loss Is Levy's Gain as Cut to Junk Favors Austerity

  • S&P downgrade may force policy makers to act faster on budget
  • Rousseff will have to pay political price of spending cuts

Brazil’s return to junk may be exactly what Finance Minister Joaquim Levy needed.

Standard and Poor’s dressing down of Latin America’s largest economy on Wednesday could finally convince lethargic policy makers to revive the economy and close the biggest budget deficit in at least two decades.

"The downgrade creates a more favorable environment for approving measures because leaders realize when something needs to be done," said Congressman Ricardo Barros, sponsor of the 2016 budget bill in the lower house. 

The bad news for the government is that President Dilma Rousseff probably will pay the bulk of the political price for the belt tightening. The president will have to confront lawmakers who are reluctant to back tax hikes and would rather she cut spending and dismantle welfare programs that have been a hallmark of her party’s 12 years in power.

"Tax increases are extremely difficult in Congress," said Mauricio Quintella, head of the allied Party of the Republic in the lower house. "There’s always somewhere to cut."

Stands Stronger

Minister Levy, who last week had to deny speculation he would step down, at least temporarily stands stronger following the rate reduction, said John Welch, a strategist at Canadian Imperial Bank of Commerce.

Levy warned in recent months that Congress’s reluctance to cut spending increased the risk of a downgrade. He fought against members of the administration who eventually convinced Rousseff to propose a 2016 budget that forecasts a deficit before interest payments, which contributed to S&P’s decision. His push to cut more government fat has become unavoidable despite Rousseff’s reluctance, said Welch, who has followed Brazil for more than four decades.

"This strengthens Levy’s hand and puts enormous pressure on Dilma," he said. "If she doesn’t adopt deep, structural spending cuts, she won’t survive the rest of her mandate."

Levy told reporters Thursday the government this month would present a plan to shore up fiscal accounts, adding that Brazilians may have to pay higher taxes to fix the economy. He said the Rousseff administration would try to beat its own forecast and post a budget surplus next year.

The government in recent weeks has floated several proposals including higher levies on income, inheritance and automotive fuel. Budget Minister Nelson Barbosa on Wednesday said the government is studying ways to reduce pension payouts and Levy told TV Globo hours after the downgrade that Brazil needs to increase the retirement age.

Welfare Cuts

In her Independence Day speech on Monday, Rousseff signaled for the first time she may have to cap or reduce social welfare spending and investments.

"If she has to ask society, companies, families to make an additional effort to help Brazil get where it needs to go -- to be seen throughout the world as a strong country -- I’m certain President Dilma Rousseff will make that proposal," Levy said Thursday.

With their eyes set on on mid-term elections next year and the 2018 presidential vote, many legislators want Rousseff to pay the political price for the crisis by cutting social welfare programs, including pension benefits and her flagship low-cost housing program, said Gabriel Petrus, a political analyst at business consulting firm Barral M Jorge.

"It’ll kill the legacy of her party’s social welfare programs by showing they weren’t sustainable," Petrus said. "The trade-off is Dilma stays in power, but it kills any chances for her party’s re-election."

While Levy has gained visible support from Rousseff, his situation remains precarious, Eurasia Group said in a report Thursday. His differences could resurface with Barbosa, who favors more moderate spending cuts. Congress is unlikely to show much support for unpopular measures such as trimming health-care benefits, the political consulting firm said.

Economic Stimulus

In fact many members of the Brazilian Democratic Movement Party, Rousseff’s biggest ally in Congress, for months have called on the president to shift her focus from austerity to stimulating the economy. They say a recovery would boost tax revenue without exposing Brazilians to further tax increases and benefit reductions.

“Only a return to growth with will Brazil out of this situation,” said Senate president and party member Renan Calheiros.

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