Brazil: Constitutional amendment on public spending to reduce sovereign risks at federal level

November 2016

Article source: PRIME

RISK TREND (2 yrs)

Sovereign risk arrow1 ; Tax risk arrow2

The Chamber of Deputies (lower house) on 25 October approved a second-round vote (by 359 votes to 116) of a constitutional amendment proposal, known as PEC 241, establishing stronger limits for federal public spending. The bill was sponsored by the government of President Michel Temer as part of its broader austerity plan, and was initially approved by the lower house in a first round of voting on 10 October. The proposal will now pass to the Senate (upper house) where it also needs to pass through two rounds of voting. If approved, the bill will affect all three branches of the federal government (executive, legislative and judiciary) and determines that percentage increases in federal spending from one year to the next cannot exceed the accumulated inflation of the past 12 months. The limit will remain in place for 20 years, though the bill allows changes to this limit after ten years.

Constitutional amendment on public spending to reduce sovereign risks at federal level

  • The amendment will restrain public spending, reducing fiscal imbalances and decreasing non-payment and default risks in the long term. While negotiations may result in adjustments to the proposal, it will likely be approved within the next few months. Its implementation will help curb the expanding primary deficit and public debt – respectively at around -2.8% and 70.1% of GDP – while creating sanctions to discourage non-compliance. The bill is also part of broader austerity efforts that include (and rely upon) approving a pension reform – the social security system has also registered a growing deficit and represents more than 40% of the government’s primary expenses. The likely approval of both proposals will therefore increase the federal government’s financial health over the next two years.
  • The approval of austerity reforms will make major tax hikes unlikely in the near future. Although the government’s dire fiscal situation means that slight tariff adjustments remain possible, its focus on limiting expenditure and reforming social security signals that Temer will prioritise cutting expenses rather than boosting revenue. That will likely remain the case as the government attempts to regain the market’s trust, attract private investment and foster economic activity. The proposal to raise taxes would also be opposed by senior allies in the ruling coalition, notably the Brazilian Social Democratic Party (PSDB) and the Democrats (DEM), further restricting room to negotiate and push for significant increases in taxes.

What to watch

The proposal will now be debated in the Senate, where it also needs to be approved in two-rounds of voting demanding a three-fifths majority to pass. The first vote is scheduled to take place on 29 November, with the second-round expected on 13 December.

The proposal for a pension reform has not yet been presented by the federal government, but is expected to be sent to Congress before 2017.

Outlook

The government will remain committed to implementing its austerity plan, which has as its key cornerstones the approval of limits to public spending and the pension reform. While Temer’s large coalition in Congress will guarantee the approval of such initiatives, negotiations with allied parties and pressure by public opinion will limit the scope of such reforms.

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