Brazilian investors seem confident that the Jair Bolsonaro administration will be able to pull off a successful reform of the pension system. Unlike his predecessor, Mr. Bolsonaro appears to have the political momentum required to pass the austerity package. House Speaker Rodrigo Maia has said he expects the text to be voted on by the floor as early as May. However, doubts still linger in the minds of international investors—who fear that, once again, politicians will block the reform or approve a watered-down version of it.
Colombia, one of our closest neighbors, shows what could happen if Brazil fails to meet the markets’ expectations.[restricted]
Emerging from what essentially was a 50-year-long civil war, Colombia foresees a fiscal deficit of 2.4 percent for 2019, the latest of a non-sustainable fiscal path. Last year, the newly-elected President Iván Duque, a market-friendly conservative, decided to tackle the issue through a sweeping tax reform proposal.
The bill aimed at increasing the government’s tax collection by USD 4.4 billion, raising income tax on middle and high earners from 33 to 37 percent and reducing corporate income tax from 35 to 30 percent. A controversial measure was to increase the value-added tax on a range of basic items, but offering compensation to the poor.
As it turned out, after facing fierce opposition, the approved bill was so diluted that it obtained only half of the promised funds. The final bill increased income tax on high earners, slashed tax for business and didn’t include the levy on basic goods. It managed to solve the problem for 2019, but from 2020 on analysts fear that the country may suffer a downgrade on its sovereign debt rating due to a lack of funding capability.
“It is possible to reach 2019’s fiscal deficit target, but we increasingly doubt Colombia may reach the 2020 goal without additional measures”, said Fitch ratings agency, according to Colombian newspaper El Tiempo. Plenty of international funds avoid countries that do not have investment-grade status, losing it, therefore, means less foreign capital coming in.
Mr. Duque believes that the reduction in business taxes will help boost investments, thus replacing the lost revenue. His latest idea is a development plan estimated at 1.1 trillion Colombian Pesos for 2019-2022, one-third of which would come from the private sector. If the plan is successful, the Colombian economy may grow up to 4.1 percent, versus an estimate of 3.3 percent for 2019.
According to Juliana Inhasz, an economics professor at São Paulo’s Insper Business School, relying on funds from this package to fill the gap is rushed. “What makes investors put money in a country is the return on investment. If they see a cost-benefit that drives their money abroad, it is not a policy that will bring them back.”
The need for a pension reform in Brazil
Meanwhile, Brazil is struggling to grow steadily once again, and the country’s debt-to-GDP ratio is at nearly 80 percent. Both investors and the new government are banking on a comprehensive reform to the pension system—the government’s largest expenditure—to balance the accounts and increase the country’s ability to invest.
Economy Minister Paulo Guedes said during the World Economic Forum that he aims at saving up to BRL 1.3 trillion in a decade with his pension proposal. A draft was leaked to the press last week: according to the plan, men and women would have to contribute for 40 years to obtain their full pensions. Also, there would be a minimum retirement age of 65 years a capitalization system would be introduced. That has already proven to be controversial among members of Congress.
Public outcry has led the Chief of Staff, Onyx Lorenzoni, to dismiss the draft, saying the bill’s final version will be “very different.” As Zeina Latif, chief economist at brokerage XP Investimentos, highlighted in a note to clients, “the episode highlights the view that the government still isn’t a cohesive team.” It is also unclear how the new lawmakers—who are mainly politicians united by conservative social platforms and rampant social media activity—shall behave when their voters start to raise their voices on the proposal.
A lot of it will depend on how the president will use his political capital to convince both congressmen and the population to approve such an unpopular measure. In Mr. Duque’s experience, it led to trouble. After approving the financing law, as it is called in Colombia, his approval ratings fell to only 24 percent in December, according to pollster Yanhaas. In January, it went back to 35 percent, after a terrorist attack and an ongoing border crisis with Venezuela.
Markets suffer the consequences
Not having done its homework, Colombia felt the pressure over emerging markets at the end of last year, with fears of global recession due to slower growth in China and rising interest rates in the US. The Colombian peso fell 9 percent against the USD, following other emerging economies. The Colcap, Colombian benchmark stock index, fell 20.5 percent in dollar terms in 2018, among the worst performers in Latin America.
According to Ms. Inhasz, this movement is related to longer-term perspectives for the country. Without a solid case for investment, the economy ends up vulnerable to external swings, as she explains:
“Colombia got more interesting for investors when it signed the deal with the FARC [Revolutionary Armed Forces of Colombia]. But when you make an incomplete remodeling, it brings in speculative capital. The more the speculation grows, the more short-term investments come in. Since this money is only meant to generate profits and leave, if you have any trouble abroad, it flees.”
With few changes, Colcap keeps following external markets, recovering in 2019 due to oil prices, as highlighted by analysts from bank BTG Pactual. Although Brazil is far from being immune to external trends, the Bovespa benchmark index has been fluctuating according to internal factors.
So far, São Paulo’s stock exchange has climbed more than 4 percent this year. As usual, the market is pricing a good chance of reforms, but the trend is only sustainable “if we are able to show that the government may deliver the reforms. Without them, Ibovespa will probably fall again,” says Ms. Inhasz.[/restricted]