Brazil’s attempts at reform point the way out of junk status for SA
Policies aim to strengthen fiscal accounts, macroeconomic stability, competitiveness and productivity
SA lost its final investment grade rating (from Moody’s Investors Service) on March 27 after years of fiscal largesse by the government and low growth compounded by the impact of Covid-19. Brazil lost its final investment grade rating — also from Moody’s — on February 24 2016.
Brazil’s downgrade journey looks remarkably similar to that of SA. Before the downgrade both countries suffered from extensive corruption, a lack of structural reform, high unemployment and high fiscal deficits. Upon closer inspection of some of the key economic indicators for the five years leading to the loss of their final investment grade ratings, it is clear that the countries followed a similar path.
Given the similarity of their journeys to junk status, it may serve SA well to take a critical look not only at Brazil’s economic policies before the downgrade but also at its subsequent attempts at structural reform. There may be valuable lessons to be learnt as we take our first tender steps forward through junk status territory.
From 2010 Brazil’s economic growth slowed significantly, from an annual growth rate of 4.5% between 2006 and 2010 to 2.1% between 2011 and 2014. There was a significant contraction in economic activity in 2015 and 2016, with year-on-year GDP dropping 3.6% and 3.4%, respectively. This phase of highly depressed economic activity led to a severe recession from 2014 to 2017. By 2016 the country had lost its last investment grade rating, and it has stayed in junk status territory ever since.
The economic crisis was ultimately the result of falling commodity prices, notably oil, and Brazil’s limited ability to carry out necessary fiscal reforms at all levels of government, thus undermining consumer and investor confidence. Structural sources of pressure on fiscal spending — a bloated government pension system and high unit labour costs stemming from the country’s minimum wage policy — necessitated a high tax burden.
Progress on structural economic reforms has been severely limited since the advent of democracy in 1994
Unwarranted microeconomic interventions contributed to reduced dynamism and increased financial stress in key sectors. A high regulatory burden slowed implementation of Brazil’s infrastructure investment programme, especially in its initial phases.
Compounding the already significant woes in its key energy sector, Petrobras, the state-controlled oil major, ran into significant trouble of its own. A sustained period of lower oil prices and years of corruption and mismanagement all came to a head.
Brazil’s bloated government expenditure, troublesome state-owned enterprises (SOEs), poor policy reform and disjointed regulation in the energy sector, as well as years of political corruption and mismanagement, sound awfully familiar to South Africans.
SA’s downgrade to junk status occurred amid widespread fiscal pressures and persistently low growth due to social and political obstacles to reforms. Progress on structural economic reforms has been severely limited since the advent of democracy in 1994, and the role of state capture, mismanagement of SOEs (notably Eskom and SAA) and the inability to cut public wage expenditure during SA’s economic decline have all been well documented.
Restoring fiscal sustainability remains the most pressing economic challenge for Brazil. To address the country’s unsustainable debt levels, the government has enacted Constitutional Amendment 95/2016, which limits the rise of public spending. The amendment imposes a fiscal adjustment of 4.1% of GDP through to 2026 and aims to stabilise debt at about 81.7% of GDP in 2023. Implementing this fiscal adjustment requires reducing the rigidity of public spending and revenue-earmarking mechanisms, which makes more than 90% of the federal government’s primary spending mandatory.
Since assuming office in January 2019, the administration of President Jair Bolsonaro has repeatedly emphasised its commitment to policies and structural reforms that strengthen Brazil’s fiscal accounts, foster macroeconomic stability, and improve competitiveness and productivity throughout the economy. Brazil is still mired in debt, with government debt now at 91.6% and projected to increase in the next two years to 93.9% in 2020 and 94.5% in 2021.
Bolsonaro states that the main reason for the country’s persistent debt problem remains the government pension system, as he believes people retire too early with too many benefits. The Senate has passed the bill needed for pension reform, but its effects are yet to be felt.
Other policy proposals include a programme of concessions and privatisations, a potential revision of the minimum wage policy, efforts to open the economy, and formal central bank autonomy.
Despite high approval ratings since assuming office, Bolsonaro’s administration faces the challenge of passing legislation in a fragmented Congress that will require astute political negotiations. Fiscal reforms are not popular, and the process of constructing a pro-reform coalition could take time.
While SA has only just begun its journey in junk status, the country is already facing similarly difficult negotiations — notably with the country’s leading trade unions on SOE reform and cutting public sector wage expenditure. The Covid-19 pandemic may provide the SA government with a unique opportunity to push through its structural reform agenda, but it remains too early to tell if this will indeed be the case. Regardless, it remains imperative that the government implements a credible fiscal consolidation plan forthwith, thus leading to a durable, albeit slow, pickup in growth.
It would be naive to discount the effect of the global Covid-19 pandemic on Brazil and SA’s downgrade recovery plans. For Brazil, growth prospects had looked optimistic at the start of the year, but intensifying headwinds, mainly from the coronavirus outbreak, have since slowed its momentum. The pandemic’s effect on the global economy, commodity markets and global financial conditions appear set to curtail Brazilian economic activity in the first half of the year, particularly in manufacturing, tourism and trade.
A full-on outbreak of the virus in Brazil could cause the reform agenda to take a back seat. With Congress having declared a state of “public calamity” on March 20, the government’s obligation to comply with the primary balance target in 2020 has since been lifted.
For SA, the immediate sharp downturn in 2020, led by the pandemic, was the final nail in the coffin for the country’s hold on its last investment grade rating. The government placed the country under a strict lockdown, and on April 21 President Cyril Ramaphosa unveiled a R500bn package to boost the ailing economy and to support those worst affected by the pandemic.
Given the highly fluid nature of the global economic situation, only time will tell what impact the Covid-19 pandemic will have on the economies of Brazil and SA, and the trajectory of their respective recovery plans afterwards.
• Delport and Hendricks are investment analysts with Anchor Capital.