A pension reform has been approved by Congress and will help to contain rising pension spending. Nonetheless, the fiscal outlook continues to be challenging, leaving fiscal policy no additional room to support the incipient recovery. Gross public debt remains high at almost 80% of GDP and the primary deficit of 1.4% of GDP falls short of the estimated 1.5% surplus required to stabilise public debt.
The deficit continues to be driven by mandatory expenditure items, including wages, pensions and other social security benefits. Discretionary spending has receded to achieve the necessary consolidation, but at only 6% of total spending it now has little scope for further reductions. Reforming mandatory spending and indexation rules has become crucial to ensure compliance with fiscal rules. So far, the expenditure rule adopted in 2016 has not generated the expected political momentum for such reforms. In particular, reducing the public sector’s high wage bill is instrumental, as is revisiting widespread tax expenditures.
Recent expenditure trends have also reduced the quality of public spending. Indexed to the minimum wage, rising social security benefits have benefitted mostly middle-class households, leaving fewer resources for well-targeted social benefits to fight 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, reduce income inequality and strengthen incentives for school attendance and medical check‑ups, thus reducing inequalities with respect to education and health. Public investment has also been crowded out, but would potentially have high pay-offs.
Scope for further monetary easing has arisen in the short term as inflation is projected to remain below target in 2020. Real interest rates have already reached a long-time low. Rising credit is improving household liquidity, and new rules to access individual unemployment insurance accounts will continue to reinforce this in 2020. However, corporate credit continues to decline. 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, but is currently held back by low levels of competition in many sectors. More competition-friendly domestic regulation and closer integration into the global economy, including through a ratification of the EU-Mercosur trade agreement, could address this, while simultaneously reducing the cost of intermediate and capital goods. Improving contract enforcement by enhancing judicial efficiency and reducing tax compliance costs through a substantial overhaul of the fragmented indirect tax system, with a view towards a unified value added tax, would also raise productivity. Preserving valuable natural assets such as the Amazon rainforest for future generations will require stronger efforts to enforce existing laws, building on past progress in enforcement.
