Brazil: The 0% Deficit Tale is About to be Forgotten
Despite Finance Minister Fernando Haddad's initial vision of achieving a 0% deficit by 2024 through the New Fiscal Framework, current projections reveal an unattainable target due to limited revenue growth. Expenditures, fueled by investments and social transfers, persistently rise, and factors like declining commodity prices further hinder revenue expansion. The government faces challenges broadening its revenue base, with uncertain measures potentially contributing 1% of GDP by 2024. Implementation of the new fiscal rules in 2025 heightens the significance of 2024 expenditures, impacting debt sustainability and market expectations. Anticipated fiscal deficits persist until 2028, potentially pushing the debt/GDP ratio beyond 90%.
When Finance Minister Fernando Haddad unveiled the New Fiscal Framework, capping expenditure growth at 70% of revenue growth, he anticipated a sustained increase in revenue in line with the rates observed in 2021 and 2022. The objective was to keep expenditures below revenues, ensuring fiscal adjustments and aiming for an ambitious 0% deficit by 2024. However, this target looks unattainable now, despite a projected 3.0% growth this year, revenues growth has been limited. Expenditures, propelled by increased investments, salaries, and social transfers, continued to rise.
Figure 1: Federal Government Primary Revenues and Expenditures (12 months' sum., % of GDP)
Source: STN and BCB
A pivotal factor contributing to diminished revenue growth is the decline in commodity prices. The upswing in commodity prices during 2021 and 2022, bolstered by the lagged effects of pandemic recovery, positively impacted revenues. As the recovery effects wane and commodity prices fall, revenue growth falters. Another aspect is the concentration of GDP growth in the Agriculture sector, primarily oriented toward exports, resulting in a significant portion of sector revenues escaping government taxation.
Given this evolving scenario, with lower commodity prices, the government's only recourse is to broaden its revenue base. Various measures aimed at revenue enhancement have been presented to Congress, including recalculating certain revenues and introducing taxes on funds leaving Brazil by residents. While the impact of these measures remains uncertain, projections indicate they could contribute up to 1% of the GDP in revenues by 2024.
The new fiscal framework rules are slated for implementation in 2025. Consequently, the level of expenditures in 2024 will be pivotal in determining debt sustainability and market expectations. If expenditures align with the fiscal proposal submitted to Congress, a fiscal deficit of 1.2% of the GDP is anticipated, deviating from the targeted 0%. Thus, under current fiscal legislation, the deficit is expected to gradually diminish, albeit with discernible fiscal risks. The review of Precatory payments, currently restricted, is scheduled for 2026. Furthermore, the effectiveness of the upcoming tax system overhaul is contingent on careful design to prevent a potential decrease in revenues.
Based on our revised parameters, we foresee the Brazilian government grappling with primary deficits until 2028. Structural constraints on growth (here), coupled with slow revenue expansion, will likely push the debt/GDP ratio beyond 90%. Notably, a significant portion of Brazil's debt is denominated in the local currency, and the local financial market is anticipated to absorb the government's financial requirements effectively.
Figure 2: Brazil Government Debt/GDP
Source: Continuum Economics