Brazilian government debt has been declining over the past decade due to solid, but not spectacular, economic growth and large primary surpluses. Net public sector debt fell from more than 60% of GDP in 2002 to 35% of GDP today. The current fiscal stance, which until recently targeted a primary surplus of 3.1% of GDP, is compatible with a decline of the debt ratio of 1-2 percentage points a year. Gross general government debt, the more widely used indicator for purposes of cross-country comparisons, remains relatively high. But this is to a large extent due to the accumulation of FX reserves by the central bank and sizeable government lending to the state development bank.
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| Source: Banco Central do Brasil |
What about contingent liabilities? The net debt of the non-financial public sector excludes Petrobras and Eletrobras. It also excludes the debt (and assets) of (partially) state-owned financial institutions (e.g. Banco do Brasil, BNDES, Caixa Econômica Federal). However, the state-owned financial institutions are well-capitalised and should, short of a major and sustained economic downturn, be able to absorb losses without being forced to ask for government financial support. Petrobras and Eletrobras have relatively solid credit ratings.
Moreover, even a tangible increase in gross general government debt would be unlikely to cause problems. Assuming, very conservatively, a real interest rate of 7%, real GDP growth of 3%, and taking into account the lower financial return on government assets (mainly FX reserves, loans to BNDES) relative to their financing costs, general government debt could increase by 20-30% of GDP from current levels without jeopardising public-sector solvency. With government debt on a downward trajectory, however, the equilibrium real interest rate is not likely to rise back to its historical average – and each 100bp decline allows the government to reduce its primary surplus by an additional 0.4-0.5% of GDP.
Compared to other Latin American governments (e.g. Mexico, Venezuela), Brazil is not very dependent on (direct) commodity-related revenues – it typically receives 0.2-0.3% of GDP in dividend payments. While a sustained downturn in commodity prices may have non-linear effects on government revenues, revenues have recently experienced a secular increase due to structural changes in the economy (e.g. increasing labour market formality). Even a sustained downturn in commodity prices would leave the government in a financially manageable position. Last but not least, gross borrowing requirements are very high by emerging markets standards (20% of GDP in 2012), according to the IMF. But this should pose little risk as long as the medium-term outlook is for a stable or declining debt ratio.
Over the medium to long term, rising social security and health outlays on the back of aging demographics will put pressure on the evolution of public finances. True, the (private-sector) social security deficit has been falling in recent years due to buoyant labour markets and increasing formalisation. However, the combination of a generous social security regime – Brazil spends way more as a share of GDP than other economies with a comparable level of per capita income and is experiencing, at the margin, a more rapid change of its demographic profile – may turn into an increasingly important fiscal challenge over the medium to long term. The net present value of the increase in pension and health-related expenditure exceeds 100% of GDP in Brazil, according to the IMF. While Brazil does not stand out in this respect, it does start from a tangibly higher government debt level than most other emerging economies.
The government has recently approved a complementary, capitalised pension scheme for civil servants. But more needs to be done to contain long-term pension and social security expenditure. The longer the government leaves this issue unresolved, the politically stronger the so-called ‘grey majority’ will become. A period of solid growth, economic stability, rising incomes and a politically less powerful ‘grey minority’ should be the most opportune moment to introduce such reforms. The problem is, of course, that the short-term political-electoral benefits of such forward-looking reform are very small while the costs are potentially significant.
A rapidly rising (albeit from a low level) old-age dependency ratio combined with generous social security benefits will sooner or later force the government’s hand. The sooner such reform takes place, the better, for large government transfers to households also weigh on the national savings and investment rate, and not just on public finances, and thus help keep real interest rates high. After all, Brazil’s savings ratio stands at less than 20% of GDP, compared with more than 30% and 50% of GDP in India and China, respectively. This is slowing down Brazil’s economic ascent. If the government fails to tackle these issues, what they say about China may equally apply to Brazil: the ‘country of the future’ may well become old before it becomes rich.