Deficit set to fall to zero?

Net financing requirements (or fiscal deficits) have been on a declining path since 2003. The 2003 fiscal adjustment raised the primary surplus⁴ to 4.25% of GDP (pre-upward revision of GDP). Primary surpluses averaged 3.5 % of GDP in 2003-07 (following GDP revision). Thanks to sustained primary surpluses, declining inflation and accelerating economic growth, the nominal fiscal deficit fell from more than 5% of GDP in 2003 to a low of 1.3% of GDP in late 2008, before widening again in the wake of the 2009 economic downturn. The deficit will settle at 2-3% of GDP this year, subject to the authorities meeting their announced primary surplus target. The authorities project the nominal deficit to fall to zero within the next few years. This looks unlikely unless a very significant decline in net interest payments occurs. And this looks unlikely given continued low G3 rates and continued high domestic interest rates, the recent Selic rate cut notwithstanding. Declining deficits and the improved government solvency they imply were instrumental in lowering nominal and real interest rates. Although real interest rates remain very high by international standards, they are far below the levels seen during the second half of the 1990s and the first half of the 2000s. The government is often criticised for frequent changes to the way in which it calculates the primary balance. It is fair to say that the changes thus far do not jeopardize government solvency. That said, the authorities do keep changing the way in which they measure the deficit and this certainly reduces transparency, unnecessarily so.

First, in 2006 the IMF and the authorities agreed to allow to “abate” from the primary surplus a pre-determined amount for purposes of growth-enhancing public investment. This possibility was introduced for purposes of IMF conditionality. If the government failed to meet the surplus target, it was allowed to subtract a pre-agreed amount of generally 0.25-0.75% of GDP without being considered in violation of its fiscal targets, provided it managed to implement the pre-agreed investments. Actually, this “abatement” was only used in 2009 and 2010 when the government had trouble meeting its primary surplus due, first, to the economic downturn and, then, to pre-electoral surge in public spending. The 2012 LDO, for instance, allows the government to “deduct” a portion (BRL 40.6 bn or 1% of 2011 GDP) of PAC investments from the primary surplus target.

Second, and more controversially, the government booked the Petrobras capitalisation worth 1% of GDP as revenue. In this asset-liability transaction Petrobras received the rights to explore oil (from the government) and the Treasury (via the BNDES and BSF) received shares and booked them as counting against its primary surplus target. Clearly, this has no impact on the underlying fiscal stance of the public sector and only helps embellish the reported 2010 deficit and thus bring it closer to the (revised) 2.5% of GDP target.

Third, the government has also resorted to using so-called “restos a pagar” (“leftovers to be paid”) to embellish fiscal outcomes. As the primary surplus in Brazil is still calculated on a cash basis, that is, expenditure is only appropriated when paid for, not when it is effectively executed, the primary balance may be raised in any given year by simply postponing the payment of expenditures. This has helped inflate primary surpluses somewhat on several occasions.
Fourth, the authorities excluded Petrobras, and later Electrobras, from the public sector debt definition. This is legitimate to the extent that, while the government is a majority shareholder, it is not on the hook for its debt. That said, it would be difficult to envision a scenario where Petrobras were to get into financial difficulties and the government would not bail it out.

Fifth, in 2008 the authorities transferred 0.5% of GDP worth of primary surplus to capitalise the newly-created sovereign wealth fund (BSB). Whatever the merits of the sovereign wealth fund, which are somewhat questionable, this arguably reduces the transparency of fiscal policy and public debt. The funds were ultimately invested in Banco do Brasil and Petrobras shares.

Last but not least, it is worth noting that in terms of accounting Treasury lending to the BNDES helps embellish fiscal outcomes. The PS primary surplus does not take into account interest paid (on securities issued to provide loans to BNDES) or received (sub-market TJLP received on loans from BNDES), but it does include dividend payments received from the BNDES. This embellishes the primary surplus performance, while adding to the overall balance.