Brazil’s tinkering to meet fiscal target threatens to dent credibility

Brasilia — As Brazil struggles to meet its year-end budget target, the government has become increasingly creative with how it accounts for spending, tax exemptions and fresh revenue, raising concerns among experts about the credibility of its new fiscal regime.

While most private economists say President Luiz Inacio Lula da Silva needs to cut spending programmes to erase the budget deficit as promised, the leftist has been loath to lift his foot from the gas pedal. Instead, his government has been pushing to meet its budget target with additional revenue and an array of unconventional proposals: cleaning out forgotten bank accounts, using a state lender to provide subsidies that lower the cost of cooking gas, and even inventing a new tax exemption for Olympic medallists — measures that have drawn criticism for bending the rules in fiscal legislation.

Asked about the concerns, the finance ministry said it is committed to hitting the budget target while following fiscal rules rigorously to “guarantee the soundness of public accounts”. While the government’s measures have fallen well short of the accounting tricks that were grounds for the impeachment of an ally from Lula’s Workers Party in 2016, economists warn they could hurt private investment and push up financing costs.

“Once bitten, twice shy. Everyone has seen the extent of fiscal data distortions under previous Workers Party administrations, which is why this affects market sentiment,” said Marcos Mendes, economics researcher at the Insper Institute of Education and Research.

“You have a large arsenal of manoeuvres to avoid the hard task of controlling mandatory expenses,” he said.

To calm market jitters last year, Lula committed to a new fiscal framework capping spending growth and creating a budget surplus by 2026. For this year, he vowed to eliminate the primary deficit, which excludes debt payments.

With just a few months left, most private economists still see this year’s target as out of reach, projecting a primary deficit of 0.6% of GDP in a central bank poll, down from last year's 2.4% deficit.

More worrying, perhaps, many say the scramble for one-time revenue and off-book spending to meet the target may distract from the more difficult work required to rein in public debt.

“Adding value (to the primary result) just to meet the target won't change our fiscal position, it will only undermine the target's credibility,” said former treasury secretary Jeferson Bittencourt, an economist at ASA Investments. Since the start of Lula’s term in January 2023, the government’s gross debt has risen by nearly 7 percentage points to 78.5% of GDP in July.

A member of the government’s economic policy team, who spoke on condition of anonymity, said most officials recognise that short-term measures to rein in expenditures, such as clamping down on fraudulent beneficiaries of social programmes, will not be enough to sustain the new fiscal framework in coming years.

’Something more structural needs to be done,” the source said, adding that more dramatic efforts to rein in social spending would meet stiff resistance from Lula’s Workers Party.

Working the ref

Instead, the impending year-end target has spurred a string of minor debates over the letter of Brazil’s fiscal law. When government-allied legislators moved to appropriate over 8-billion reais ($1.45bn) left in forgotten bank accounts by the Treasury, the central bank issued a note arguing the funds should not count towards the fiscal target. The government’s coalition in the lower house responded with a provision to include those funds in the budget.

The government has also leant on state lenders to boost social programmes without booking the costs in the federal budget. In August, officials proposed a cooking gas subsidy for poor families funded with resources from offshore oil exploration, routed through public lender Caixa Economica Federal. After criticism, they promised to redesign the idea.

A similar manoeuvre, routing funds from the National Civil Aviation Fund through state development bank BNDES to provide loans for airlines, now awaits a presidential signature.

While some of the government’s budget exemptions have been widely accepted, such as excluding the cost of emergency flood relief and combating forest fires, others have raised eyebrows.

When social media influencers complained about Brazil taxing the financial rewards of Olympic medallists returning from Paris, Lula signed an executive order that exempted the earnings. However, the government argued it did not constitute a tax waiver that needed to be offset in the budget.

A technical note from the lower house’s budget and financial oversight consulting office said that the measure violated fiscal legislation and a supreme court precedent by granting a targeted tax exemption without compensating the fiscal affect.

Another official on the government’s economic policy team said the size of such a manoeuvre was less important than the precedent of brushing aside fiscal rules.

“A little accounting trick here or there might give a taste for it, and that could grow,” warned the official, requesting anonymity to speak freely about internal debates.