Brazil: Waiting for the important pension reform

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Brazil: Waiting for the important pension reform

Jair Bolsonaro won the presidential election in Brazil last October. His promise to rule the country with a strong hand, and to fight against corruption and crime, created hope for many Brazilians after painful years, dominated by scandals and economic crises. During the election campaign, several international media branded Bolsonaro as the Brazilian Donald Trump, due to his extremist discourse, anti-establishment stance, love for arms and politically incorrect statements – to put it mildly.

Somehow, the comparison with Trump was validated in the short time of his governance. Controversies about two of Bolsonaro’s sons dominated the headlines and in a recent survey among 109 congressmen, 61% said that the relationship with the administration is bad or very bad. For bad luck, the economic outlook has worsened. Before the elections, the consensus of economists projected an economic growth of 3% for 2019. Now the consensus is at only 2.2%. However, the slowdown can be mainly attributed to external factors (trade tensions, recession in Argentina, currency volatility). It would be wrong to blame the president.

In any case, it is clear that the future of the Bolsonaro administration depends on the economic situation. It is essential to continue and even accelerate the reform process initiated by his predecessor, Michel Temer. The most important piece is the reform of the pension system that has created a huge deficit in the nation’s public finances. The current pension system is completely unsustainable, the government currently spends 12% of GDP on pensions, compared to 8% among developed countries. According to a recent UBS report, if nothing changes, in 2026 the expenses for pensions will represent 79% of the national budget.

Bolsonaro awoke hopes of a profound reform by appointing Paulo Guedes, a former investment banker, as his minister of economy. The proposal presented by the president on February 20 has exceeded high expectations. His plan foresees a saving of 1,167 trillion reais in 10 years. This amount is significantly higher than that originally proposed by the previous president, which was 780.8 trillion. Most of the savings will come from changes in the rules for the retirement of public and private workers, since the minimum age increases to 62 years in the case of women and up to 65 in the case of men. The proposal also includes an increase in the contribution rate for households with higher incomes, while decreasing the contribution rate for workers with lower incomes.

The next step is the approval of the proposal by Congress, a process which is quite complicated. The recent tensions between Bolsonaro and Rodrigo Maia, the president of the Chamber of Deputies, have created doubts and nervousness among investors. There are also tensions within the cabinet, which is divided into three groups: technocrats, ideologues and the military, including General Hamilton Mourão, the vice president, who has often contradicted the sons of Bolsonaro.

However, it is very likely that the reform will be approved. The government seems to continue to enjoy a honeymoon period. The technocrats and military in the administration have the technical capacity that Bolsonaro lacks. Meanwhile, the president still maintains a high level of approval (although it has dropped a bit recently) that gives him political capital to push for reform. In addition, it enjoys broad support among a number of key interest groups, such as governors who face serious problems in their own pension systems and the private sector, which believes that economic conditions will not improve without the much-needed pension reform.

The most important point is that the deputies and senators probably do not want to be blamed for possible economic turbulence and the likely negative reaction of the financial markets by not approving any reform. Taking this into consideration, the main risk is not a failure, but rather a dilution of the proposal or a delay in the approval process. The good news is that, if the reform passes, Brazil would be much better positioned to finally recover from the deep recession that I experienced between 2014 and 2016.

For the new government, the starting point is not as bad many commentators express. Inflation remains at historically low levels, interest rates are relatively low (and unlikely to rise this year) and commodity prices continue to recover. With a trade agreement between the USA and China in the making, the economic outlook in Brazil looks very favorable, after all.

Real GDP Growth in Brazil (YoY)

Source: Bloomberg

By Pascal Rohner – Katch Investment Group CIO

April 10, 2019

 

Apr 22, 2019