Protest in Bogota

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.

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.

</span></p> <p><span style="font-weight: 400;">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.</span></p> <div id="attachment_14025" style="width: 1010px" class="wp-caption alignnone"><img aria-describedby="caption-attachment-14025" class="size-full wp-image-14025" src="https://brazilian.report/wp-content/uploads/2019/02/shutterstock_1211214160.jpg" alt="Colombian President Ivan Duque " width="1000" height="667" srcset="https://brazilian.report/wp-content/uploads/2019/02/shutterstock_1211214160.jpg 1000w, https://brazilian.report/wp-content/uploads/2019/02/shutterstock_1211214160-300x200.jpg 300w, https://brazilian.report/wp-content/uploads/2019/02/shutterstock_1211214160-768x512.jpg 768w, https://brazilian.report/wp-content/uploads/2019/02/shutterstock_1211214160-610x407.jpg 610w" sizes="(max-width: 1000px) 100vw, 1000px" /><p id="caption-attachment-14025" class="wp-caption-text">Colombian President Ivan Duque approved a watered-down tax reform</p></div> <p><span style="font-weight: 400;">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. </span></p> <p><span style="font-weight: 400;">“It is possible to reach 2019’s fiscal deficit target, but we increasingly doubt Colombia may reach the 2020 goal without additional measures”, </span><a href="https://www.eltiempo.com/economia/sectores/lo-que-cree-fitch-de-la-meta-de-deficit-fiscal-de-colombia-en-2019-315806"><span style="font-weight: 400;">said</span></a><span style="font-weight: 400;"> Fitch ratings agency, according to Colombian newspaper </span><i><span style="font-weight: 400;">El Tiempo</span></i><span style="font-weight: 400;">. Plenty of international funds avoid countries that do not have investment-grade status, losing it, therefore, means less foreign capital coming in.  </span></p> <p><span style="font-weight: 400;">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.  </span></p> <p><span style="font-weight: 400;">According to Juliana Inhasz, an economics professor at São Paulo&#8217;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.” </span></p> <h2>The need for a pension reform in Brazil</h2> <p><span style="font-weight: 400;">Meanwhile, Brazil is struggling to grow steadily once again, and the country&#8217;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. </span></p> <p><span style="font-weight: 400;">Economy Minister Paulo Guedes </span><a href="https://g1.globo.com/economia/noticia/2019/01/23/reforma-da-previdencia-pode-render-economia-de-ate-r-13-trilhoes-em-10-anos-diz-guedes.ghtml"><span style="font-weight: 400;">said</span></a><span style="font-weight: 400;"> 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 </span><a href="https://brazilian.report/money/2019/02/05/pension-reform-leaked-guedes/"><span style="font-weight: 400;">leaked to the press</span></a><span style="font-weight: 400;"> 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. </span></p> <hr /> <p><span style="font-weight: 400;"><img class="alignnone size-large wp-image-14030" src="https://brazilian.report/wp-content/uploads/2019/02/export-aFBFK-1-1024x435.png" alt="pension reform brazil congress" width="1024" height="435" srcset="https://brazilian.report/wp-content/uploads/2019/02/export-aFBFK-1-1024x435.png 1024w, https://brazilian.report/wp-content/uploads/2019/02/export-aFBFK-1-300x128.png 300w, https://brazilian.report/wp-content/uploads/2019/02/export-aFBFK-1-768x326.png 768w, https://brazilian.report/wp-content/uploads/2019/02/export-aFBFK-1-610x259.png 610w, https://brazilian.report/wp-content/uploads/2019/02/export-aFBFK-1.png 1200w" sizes="(max-width: 1024px) 100vw, 1024px" /></span></p> <hr /> <p><span style="font-weight: 400;">Public outcry has led the Chief of Staff, </span><a href="https://brazilian.report/money/2019/02/05/pension-reform-leaked-guedes/"><span style="font-weight: 400;">Onyx Lorenzoni, to dismiss the draft</span></a><span style="font-weight: 400;">, 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. </span></p> <p><span style="font-weight: 400;">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.      </span></p> <h2>Markets suffer the consequences</h2> <p><span style="font-weight: 400;">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 </span><a href="https://lta.reuters.com/articulo/mercados-colombia-idLTAKCN1OR1OP"><span style="font-weight: 400;">fell 9 percent against the USD</span></a><span style="font-weight: 400;">, following other emerging economies. The Colcap, Colombian benchmark stock index, fell 20.5 percent in dollar terms in 2018, </span><a href="https://g1.globo.com/economia/noticia/2018/12/28/brasil-tem-o-melhor-desempenho-entre-os-principais-mercados-acionarios-da-america-latina.ghtml"><span style="font-weight: 400;">among the worst performers in Latin America</span></a><span style="font-weight: 400;">.</span></p> <hr /> <p><img class="alignnone size-large wp-image-14023" src="https://brazilian.report/wp-content/uploads/2019/02/export-rhwZA-1024x683.png" alt="colcap colombia stock market" width="1024" height="683" srcset="https://brazilian.report/wp-content/uploads/2019/02/export-rhwZA-1024x683.png 1024w, https://brazilian.report/wp-content/uploads/2019/02/export-rhwZA-300x200.png 300w, https://brazilian.report/wp-content/uploads/2019/02/export-rhwZA-768x512.png 768w, https://brazilian.report/wp-content/uploads/2019/02/export-rhwZA-610x407.png 610w, https://brazilian.report/wp-content/uploads/2019/02/export-rhwZA.png 1200w" sizes="(max-width: 1024px) 100vw, 1024px" /></p> <hr /> <p><span style="font-weight: 400;">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:  </span></p> <p><span style="font-weight: 400;">“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.”</span></p> <p><span style="font-weight: 400;">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. </span></p> <p><span style="font-weight: 400;">So far, São Paulo&#8217;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.

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BY Natália Tomé Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Most recently, worked as an Editor for Trading News, the information division from TradersClub investor community.