Low confidence is holding back a stronger recovery in domestic demand, and confidence will improve only with tangible progress on reforms that ensure fiscal sustainability. Gross public debt remains high at 77% of GDP and the primary deficit of 1.5% of GDP falls short of the estimated 2% surplus required to stabilise public debt. The expenditure rule introduced in 2016 will not be met in 2020 without implementing decisive action to reduce the growth of public spending.
While some progress has been made on other expenditure items, the deterioration in the fiscal accounts continues to be driven by rising social security expenditures, most notably old-age pensions. Therefore, pension reform, along the lines of the proposal submitted to congress, remains the key priority to ensure debt sustainability, restore investor confidence and avoid higher financing costs.
The reform proposal would also improve the redistributive impact of pensions and allow for a recalibration of social spending towards more effective social benefits. Due to an indexation to the minimum wage, rising pension benefits have benefitted mostly middle-class households, leaving fewer resources for well‑targeted social benefits to fight inequality and poverty, which is concentrated among children and youth. Raising income thresholds in the conditional cash transfer programme Bolsa Família, which costs only 0.5% of GDP, would broaden eligibility and raise benefit levels. This would lift more people out of poverty and strengthen incentives for school attendance and medical check-ups, thus reducing inequalities with respect to education and health.
Reducing the public sector’s high wage bill is also a key priority, as salary levels exceed private sector pay in many areas, particularly at the entry level. However, the recently decided rise in military remunerations is likely to make the case for savings in other parts of the administration more difficult. Efforts to reduce tax expenditures and credit subsidies for private-sector enterprises, which have created fertile grounds for corruption without generating clear benefits for either well-being or productivity, should continue.
With inflation projected to be below target in 2019 and 2020, monetary tightening now appears unlikely before 2020 and financial conditions are projected to remain favourable. Credit has been growing for households, but continues to decline for the corporate sector. Current reform plans to strengthen competition in the financial sector are a promising step to reduce borrowing costs.
Productivity growth will be the main engine of growth in the longer term. Strengthening it will require more competition in many sectors to allow labour and capital to move to activities with strong potential. Closer integration into the global economy would raise efficiency by exposing more firms to foreign competition and improving access to lower cost intermediate and capital goods. Efficiency would also be enhanced by reducing domestic barriers to entry and implementing policies to reduce costs, such as easing tax compliance or improving contract enforcement. A substantial overhaul of the fragmented indirect tax system, with a view towards a unified value added tax, could raise the competitiveness of firms across the country.
