Reduction of Brazil's fiscal targets and the change in Congress incentives

Back in February, it was believed that the government would fail to meet the fiscal targets for this and the next two years, and that the very fragmented Congress, coupled with a weak president and supporting party (PT), would make any structural change in fiscal expenditures unlikely. Thereafter, given the commitment of the new economic team in improving the fiscal balance in Brazil, the exit strategy would rely on a higher tax burden, which would hurt growth conditions in the country and lead to markedly low potential growth, which in the medium term would put at risk the investment-grade rating of Brazil.

The fiscal situation increases the risks for the IG rating, adding to the weak growth conditions. Last week the economic team announced the reduction of the fiscal targets not only for this year (to 0.15% of GDP, from 1.1%), but also for the next two years (0.7% for 2016 and 1.3% of GDP for 2017, from 2.0%) arguing that lower-than-expected revenues due to the growth recession made it nearly impossible to meet the former targets. While this is a credible reason for this year, the disappointment with the fiscal measures approved in Congress during the first half of the year, with meaningfully lower benefit reductions, is also to blame.

By reducing the primary surplus target up to 2017, the government removes any urgency for the fiscal consolidation, losing an important bargaining point when negotiating with the Congress. Members of Congress will be even more reticent in discussing and approving unpopular measures of fiscal austerity if the targets are now perceived to be easier to reach. This decision of the economic team, signals a setback from the strong commitment that it has being showing since late last year. 

"Our preliminary assessments are that it also means that the gross debt will not stabilize anytime soon and actually should increase at a faster pace than we had previously estimated," notes Barclays.