Brazil’s debt ceiling and a possible government shutdown

. Jun 08, 2019
federal budget Brazil Congress could cause a government shutdown

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This issue: The most important facts of the week. The pension reform whip list. How Brazilian markets performed. Brazil’s debt ceiling and possible government shutdown.

The week in review

Privatizations. The Supreme Court has allowed state-controlled companies to sell off their subsidiaries without the need for congressional authorization. Parent companies, however, such as Petrobras, can only be privatized through traditional bidding processes, in which all competitors enjoy the same conditions to reach a deal. Following the decision, Petrobras informed market regulators it will take further steps towards reducing its share in its fuel distribution subsidiary to a minority role.

</span></p> <p><b>Telecom.</b><span style="font-weight: 400;"> Despite intense lobbying from Washington, the Brazilian government has no intention of imposing restrictions on Chinese telecommunications behemoth Huawei—said VP Hamilton Mourão, who was recently in China and met with the firm&#8217;s CEO, Ren Zhengfei. &#8220;I told him that we need to build an environment of trust. While we trust [Huawei], there will be no problem.&#8221; Next year, Brazil plans to </span><a href=""><span style="font-weight: 400;">auction off 5G frequencies</span></a><span style="font-weight: 400;"> in March 2020, hoping to foster investments and make sure there will be enough coverage across the country, something that has been lacking only 20 years after the sector was opened for private actors.</span></p> <p><b>Inflation.</b><span style="font-weight: 400;"> The slow pace of Brazil&#8217;s economic recovery has reflected on the country&#8217;s official inflation rate for May—only 0.13%, the lowest for the month in 13 years. According to the Brazilian Institute of Geography and Statistics, family consumption remains sluggish, and the low demand is what has held prices down. Over the past 12 months, the accumulated inflation rate is at 4.66%—still within the government&#8217;s target band (between 2.75 and 5.75%).</span></p> <p><b>Single currency.</b><span style="font-weight: 400;"> During his trip to Buenos Aires, President Jair Bolsonaro and his Argentine counterpart Mauricio Macri talked about the possibility of a </span><a href=""><span style="font-weight: 400;">common currency shared by South America&#8217;s top 2 economies</span></a><span style="font-weight: 400;">—to be called the Peso Real. An old dream of Economy Minister Paulo Guedes, the idea was called &#8220;absurd&#8221; by experts. It seems to be more of a populist tactic to help Mr. Macri in what promises to be an uphill battle toward re-election.</span></p> <p><b>Why not? </b><span style="font-weight: 400;">Speaking to </span><b>The Brazilian Report</b><span style="font-weight: 400;">, Monica de Bolle, a professor at Johns Hopkins University, explained why the idea won&#8217;t materialize: &#8220;Both economies are extremely different and subject to different kinds of shocks. That alone makes the Peso Real impossible. The monetary policy would always be wrong from one of them, if it catered to the other. Moreover, Mercosur has never properly worked as an adequate free-trade zone.</span></p> <p><b>Environment.</b><span style="font-weight: 400;"> An international group of researchers identified </span><a href=""><span style="font-weight: 400;">68% of environmental protection and indigenous lands</span></a><span style="font-weight: 400;"> in the Amazon are under threat. The menace comes from infrastructure projects, plans of economic development, and land exploitation activities. The most damage is inflicted by projects supported by local and federal governments, such as new roads—of the 136,000 km built so far, 26,000 are within protected areas.</span></p> <hr> <h2>The pension reform whip list</h2> <p><span style="font-weight: 400;">The pension reform bill&#8217;s rapporteur in the House is set to present his report on the proposal this coming week. But the government still lacks the votes to approve it once it hits the House floor. The latest headache is a dispute between lawmakers and governors over the inclusion or not of state-level servants in the new rules. Governors are in favor—as they would face financial collapse otherwise—but congressmen don&#8217;t want to bear the entire political burden of stricter retirement rules. President Bolsonaro has so far been non-committal on the issue.</span></p> <p><span style="font-weight: 400;">Legend: </span><span style="font-weight: 400;">Dark green (full support). Light green (partial support). Red (opposition).</span></p> <p><img loading="lazy" class="alignnone size-full wp-image-18841" src="" alt="pension reform whip list brazil" width="2560" height="2048" srcset=" 2560w, 300w, 768w, 1024w, 610w" sizes="(max-width: 2560px) 100vw, 2560px" /></p> <hr> <h2>Markets this week</h2> <p><span style="font-weight: 400;">While the Supreme Court lifted restrictions on the privatization of state-owned subsidiary firms, <a href="">Eletrobras</a> (Brazil&#8217;s state-controlled power company) is focused on another judicial ruling. The Superior Court of Justice—Brazil&#8217;s 2nd-highest court—is set to resume a trial next week concerning a massive debt the company has with consumers. Between 1963 and 1992, Eletrobras took money from consumers through &#8220;mandatory loans&#8221; added to power bills—and now has already set aside BRL 16.6bn to repay them. The case will decide whether or not the federal government must share the load with the company. Two justices already voted to keep Eletrobras as the sole responsible for the debt.</span></p> <p style="text-align: center;"><b><i>Natália Scalzaretto, TBR markets reporter</i></b></p> <hr> <h2>Brazil&#8217;s debt ceiling and a possible government shutdown</h2> <p><span style="font-weight: 400;">Congress&#8217; Budgetary Committee will make one of its most important decisions of the year on June 11: whether to raise the public debt ceiling or not. The government is asking for BRL 248.9 billion in credit so it can pay current expenses, such as social security benefits, salaries, and agriculture subsidies, among other things. Not having the extra money would prove disastrous in any situation—let alone in an economy flirting with another recession. </span></p> <p><span style="font-weight: 400;">The bill&#8217;s rapporteur is favorable to a higher ceiling, but the government&#8217;s lack of political skills is a reason for concern. This past week, opposition parties managed to stop the committee from forming a quorum to hold a vote.</span></p> <p><span style="font-weight: 400;">Without Congress&#8217; approval, the government would have two options, neither of them appealing. The first is a shutdown —as soon as in two weeks time. That, however, would raise major legal concerns, as most of the expenses the government is unable to pay for are mandatory.</span></p> <p><span style="font-weight: 400;">The other option seems even worse: going ahead and taking more money anyway. The latter option, however, breaks the so-called &#8220;golden rule,&#8221; and is an impeachable offense.</span></p> <h4>Brazil&#8217;s golden rule: how it works</h4> <p><span style="font-weight: 400;">The golden rule is what Brazilians call Article 167 of the Federal Constitution. It was created to prevent sitting elected officials from ballooning public debt. In broad terms, it establishes that current expenses must be financed with revenue from taxes—while loans are only permitted to make investments. The rationale is: future administrations (or even generations) will only pay for expenses of past administrations they profit from—hence investments.</span></p> <p><span style="font-weight: 400;">To understand how the golden rule works, one must dive deeper into how the Brazilian budget works. The government has essentially two types of expenses:</span></p> <ul> <li><b>Current expenses</b><span style="font-weight: 400;"> concern the costs and maintenance of activities of government agencies. This includes salaries and pensions, hiring outsourced companies, water and power bills, and interest on the public debt. None of these can be paid for with loans.</span></li> <li><b>Capital expenses</b><span style="font-weight: 400;"> are investments made by the government to acquire equipment, conduct infrastructure projects, revamp public offices, buy new furniture, or purchase a stake in a company, among others. Amortizing the public debt is considered to be a &#8220;capital expense,&#8221; as it allows the government to roll over its debt, taking out new loans for new investments.</span></li> </ul> <p><span style="font-weight: 400;">There is one major loophole, though: the Constitution authorizes governments to break the golden rule if Congress allows it. In the wake of recent feuds between the branches of government, officials at the Economy Ministry are already thinking of an alternative solution—which would be getting Congress to amend the Constitution and alter the golden rule.</span></p> <p><span style="font-weight: 400;">But the pension reform shows how difficult it is to pass an amendment—which require the support of 60% in both congressional chambers—when lawmakers don&#8217;t seem to be in the government&#8217;s corner.

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