Chanting and drumming as they marched, thousands of Brazilians took to the streets of Brasilia and Rio in October to protest against President Michel Temer’s economic austerity plan, PEC 241, which imposes 20-year caps on government spending in areas like public health and education. Some protesters accused Temer of “imposing his fascist and cruel capitalism” after coming to power last May, in what has been described as a parliamentary coup. Temer rose to prominence after elected president Dilma Rousseff was removed from office following an impeachment trial in the Senate.

Photo by luni39 (Pixabay)

Why does Temer’s team, which replaced the left-leaning administration of Rousseff, argue that Brazil needs to rein in its public sector deficit? What are the odds that the government’s new spending caps will actually revive foreign confidence in the Brazilian economy, which has continued to contract in 2016? What other reform measures will Brazil need to enact in order to revive the country’s growth and economic attractiveness?

As recently as 2010, Brazil’s GDP was humming along at an annual rate of 7.5%, not far below the growth rates of China and India. Last year, according to the Brazilian Institute of Geography and Statistics, Brazil’s GDP shrank by 3.8%, thanks to collapsing levels of investment, lower commodity prices and constrained government spending. For 2016, the IMF expects the economy to contract by about 3.5%. Moreover, according to its Central Bank, in 2015 Brazil’s primary budget deficit (before interest payments) – was roughly $27.29 billion, equivalent to 1.88% of its GDP. Including interest payments, it was $150.36 billion, equivalent to 10.34% of its GDP. Temer has warned that the pension system’s deficit will hit 100 billion reais ($31 billion) this year and could reach 150 billion by the end of 2017.

Felipe Monteiro, senior fellow at Wharton’s Mack Institute for Innovation Management, argues that while spending caps are painful, they are necessary for reviving Brazil’s economic health. “It is always healthy if you go to the gym [when you are not sick], rather than having to undergo drastic measures like surgery [after you are sick]. Are the drastic measures that Brazil is taking [now] the ideal solution? I don’t think so. But in the current situation, I am not sure you can avoid something as drastic as [these spending caps]. If Brazil had done its homework early on, they could probably have avoided a measure in which they would have to place a big freeze on everything. But, for many reasons, they did not do their homework. So we are at the point where, if we don’t do this, the consequences will be even worse.”

Monteiro adds that it is fair to question whether the Temer team’s austerity measures will be for “for real,” or only “for show.” During the early nineteenth century, Great Britain pressured Brazil to impose a ban on the slave trade, but Brazil continued to import slaves even though that ban was officially the law there. In Brazil, that sort of ban – nominal but not seriously intended — is still said to be the sort of measure that is “para inglês ver” – only “for the English to see.” The expression applies to any measure merely intended to create the convenient illusion that real progress is taking place. Despite the deep roots of suspicion that are commonplace in Brazilian history, Monteiro is optimistic that the austerity plan will indeed be “for real.”

However, Monteiro voices concern about the fact that “Brazil is a country of exceptions,” in which there are numerous legal exceptions to each rule. Thus, it might be said that “this provision is the law, but in the case of X situation, this provision is not applicable. And as for conditions Y and Z, this provision does not apply at all.” He explains further: “And so, something that is supposed to be straight-forward is no longer straight-forward. The entire tax system is like this.” Monteiro recalls one Brazilian executive who said there were so many exceptions to the tax regulations, he wound up employing more people in his accounting department, sorting out the complexities of the Brazilian tax code, than he hired as employees in his marketing department — despite the fact he operated in a sector that typically required a large marketing staff.

“We are at the point where, if we don’t do this, the consequences will be even worse.” –Felipe Monteiro

What does that imply for the Brazilian economy? While the new austerity measures will likely not be simply “for show,” there may remain major risks in a measure of this sort. For example: Will this measure really be applied to everyone? Or will there be so many exceptions written into this spending freeze that it becomes completely ineffective – and does little to boost confidence in the economy? It’s too early to answer such questions.

On the positive side, notes Monteiro, “Temer is a very experienced politician; he has been in the Congress forever. And his team is doing “a much better job than Dilma” Rousseff did, in terms of knowing how to negotiate and win approval for the expenditure cap. “He is much more experienced and has much better channels with the Congress than his predecessor.”

Monteiro is also optimistic about the credentials of Temer’s economic team. “The problem is not easy but at least you have credible people in those positions – well-trained and experienced. So on that front, things have a positive look.”

The Consequences of No Action

According to Monteiro, the worst-case scenario for Brazil is that the spending freeze won’t be approved — an outcome he believes is unlikely. Second-worst: It is approved but it never really takes off. “If this [freeze] doesn’t happen for real, there is a risk of a time bomb, because you just have an immense fiscal deficit that is not bearable anymore.”

Monteiro stresses the psychological importance of the budget freeze when it comes to jump-starting the revival of Brazilian growth. “There are a lot of things in Brazil that depend on what people believe — how confident people are in terms of the economy moving forward. If the level of confidence returns, it means getting foreign investors returning and investing in the infrastructure. I think economic growth will come back, but it really depends on the confidence people have about whether the government will be able to implement tough measures.”

As for the leftist opposition, Monteiro says that in recent municipal elections, the labor party “was the big loser all over the country. Today, those supporters are really a minority. Obviously there is a concern that Temer needs to have an open channel with other parties; he cannot rule with just one or two. There are so many other political parties in Brazil. Whatever he is doing in terms of austerity measures will not mean that all of the social programs that Brazil did in the past are to be discontinued [under Temer].” Temer’s leftist opponents circulated “big propaganda” to the effect that Temer would revoke all the socialist programs currently undertaken by the government, but “I don’t think that’s what he wants to do. Yet it is important that he provides those reassurances” about his intentions

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