Brazil is set to become a net external creditor by 2009. Brazil just about averted a sovereign default during the 2002 economic and financial crisis. But over the past five years, Brazil’s economic situation and stability have improved dramatically. The public sector became a net external creditor in 2006. The economy as a whole will become a net external creditor by 2008-09 on the back of rapid FX reserve accumulation. A solid current account position and continued net (direct) equity inflows over the next couple of years will lead to a further improvement in the economy’s net external position. Gross external debt currently amounts to a moderate 16.7% of GDP and gross public external debt to a mere 5.7% of GDP. External indebtedness, which used to be Brazil’s most important vulnerability, has ceased to be a risk to economic stability.
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| Source: Banco Central do Brasil |
Public sector debt remains relatively high, though the debt-to-GDP ratio will fall to below 40% of GDP by the end of the decade from currently 45% of GDP. A combination of higher-than-expected economic growth and declining interest rates will lead to a further narrowing of the fiscal deficit and a continued improvement in debt dynamics. The government now talks about running a balanced budget by 2009. But to achieve this, the economy would need to grow at least 5% or the government would need to raise the primary surplus by 0.5% of GDP. Nonetheless, net interest payments currently running at 6.5-7.0% of GDP have been declining recently. If the government maintains the current primary surplus of around 3.5% of GDP, a “virtuous circle” of declining debt ratios and declining nominal interest rates could push the real interest rate down to 5%.
Brazil is closely following Mexico’s example in terms of moving from major economic crisis to lasting economic and financial stability. Domestic fixed-income and equity markets are deepening and becoming more mature. Medium-term (> 5 years) debt sustainability will remain a challenge in spite of favourable near-term (<3 years) debt dynamics. External debt vulnerability may be a thing of the past. But the continued upward pressure on government current expenditure calls for reforms. In addition, if the government wants to achieve medium-term economic growth of 4% a year or more over the medium term, it needs to increase investment spending, especially infrastructure spending. Of course, Brazil is not that different from many other countries except for the fact that its social security outlays are particularly high given its per capita income and its demographic structure. In the short run, declining net interest payments will compensate for increasing social security outlays. But in the medium-term, the social security system needs to be reformed.