Brazil on rough road to reform

Political tit-for-tat will encumber already contentious negotiations

Last month the Brazilian government presented its ‘New Social Security’ proposal to Congress. The government says the reforms are necessary to spark economic growth, though critics argue the new system would put excessive strain on the poor.

In an attempt to broaden popular support for the proposal, a key focus of the draft is to reduce the privileges of special regimes, such as those enjoyed by public sector workers, approximating them to the less generous regime available to private sector workers. The adoption of progressive rates, which would allow low-wage earners to contribute slightly less than they do now while demanding more from higher earners, could also brighten of the government’s communication strategy. But, despite some of the appealing rhetoric, the reform remains a tough sell.

The proposal’s guiding principle is to delay retirement by introducing stricter criteria, including a minimum age of 62 for women and 65 for men, and higher minimum years of contribution into the system. Retirement rules for special regimes for teachers, police, rural workers and the elderly poor would become stricter. The transition into the new regime would last until 2033.

The administration estimates this would generate Brl1.2tn in savings in the first 10 years, not including potential savings in states and municipalities. Ultimately, 75% of the savings would come from changes to the private sector regime, with federal workers and the military covering the remaining 25%.

The local consensus is that the proposal is ambitious enough to accommodate moderate watering-down by law-makers. But, if Brazil’s budget spending cap is kept in place, any dilution would have to be compensated later by alternative budget-tightening measures.

The most critical takeaway from the new Congress’s first legislative votes in mid-February, involving the creation of US-style consumer credit bureaus, is that the opposition is not large enough to block the government’s legislative goals. That being said, Congress rejected an executive decree issued by President Jair Bolsonaro’s administration, indicating that congressional support cannot be taken for granted.

The votes indicated that the qualified 60% majority needed for approval of the social security reform is achievable. But it will depend on savvy political negotiations with law-makers, whose support will have to be won.

Bolsonaro is resisting negotiations with congressional leaders on the basis of the traditional tit-for-tat that has long-prevailed in Brasília, as illustrated by the large presence of non-politicians (military men and technocrats) in cabinet and in the leadership of state-owned enterprises and regulatory agencies. This suggests the legislative approval process may follow a less certain path. The consensus in Brasília is that politicians still expect to exchange congressional support for some control of the budget, either indirectly through the appointment of allies to (second- or third-tier) executive positions, or directly through outright budget allocations.

Law-makers and the government are expected to hold more intense negotiations in the coming weeks. But with the biggest prizes, such as first-tier executive positions as heads of ministries, already awarded, and the fact that tight fiscal constraints impede much leniency on budget allocation, it is unclear how much Bolsonaro must ‘give back’ in exchange for votes, complicating the future of negotiations.

Law-makers are demanding, as a pre-condition to begin the reform debate, that the government submits its separate proposal for the special retirement regime enjoyed by the military. This will follow a separate approval process in Congress, but is seen as politically crucial, to add legitimacy to the reform.

Government leaders are aiming to conclude proceedings in the Chamber of Deputies (the lower house of Congress) before the mid-year recess that starts in mid-July. In my view, late-August appears to be a more realistic timeframe for final approval in the Chamber. Once approved by the lower house, the reform must be approved by the Senate, which could take another three to four months.

Overall, despite optimistic assessments from government leaders about the support for the reform and its timeframe for approval, I remain sceptical that the debate process will be smooth. The reform will eventually be accepted, but investor sentiment towards its probable approval should fluctuate, adding volatility to local assets in the coming months.

Gustavo Rangel is Chief Economist for Latin America at ING Global Markets. This is an abridged version of an article that first appeared on ING THINK.

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