Brazil Economy Update: Austerity Plan Alone Won't Fix Recession, Analysts Say

Brazilian lawmakers are in a high-stakes tug-of-war over an austerity plan aimed at plugging a gaping hole in the budget that threatens a chain of ratings downgrades. The program announced this week is a last-ditch effort to restore some confidence in President Dilma Rousseff’s government, which has been pummeled by relentless bad economic news this year.

But analysts say austerity alone is not Brazil's ticket out of a recession that's been deepened by slowing Chinese demand for its exports. Business groups have long been calling for large-scale fixes to make it easier for companies to operate in Brazil, in the form of downsizing labyrinthine tax and outdated pension systems. With public faith in Rousseff at an all-time low, however, they say it may be too late for her to tackle the roots of Brazil’s economic crisis and pull it out of its gloom.

“It’s so well known what Brazil has to do to get growth going again,” said Peter Hakim, president emeritus of the Inter-American Dialogue, a think tank in Washington. “But it’s very hard to do. There’s no coalition of forces behind it.”

Economic troubles have plagued Brazil all year, but the pain reached new depths in recent weeks: The country slipped into a technical recession last month, shrinking by a steeper-than-expected 1.9 percent. Forecasts say it’s on track to contract by around 2.2 percent this year. The pro-austerity finance minister, Joaquim Levy, has been pushing for tax hikes and spending cuts to stem the tide of bad news, but has faced strong resistance from opposition parties in Congress.

That austerity push is back in full force now after the government, for the first time in its modern history, openly projected a deficit in its annual budget plan Aug. 31. Days later, ratings agency Standard and Poor’s downgraded Brazil to junk status, a move that came months earlier than expected. Levy unveiled a new round of tax hikes and spending cuts Monday, totaling $17 billion in savings, in a bid to shore up the budget and prevent other ratings agencies from downgrading Brazil and prompting a further drain in investment.

The austerity package slashes subsidies for the agrarian and chemical sectors, raises capital gains taxes to up to 30 percent, freezes salary for civil servants and eliminates 10 government ministries. It also slashes spending for the low-cost housing program and popular cash transfer program, Bolsa Familia, that made up the cornerstone of Rousseff’s Workers’ Party’s agenda to combat poverty and income inequality. Perhaps the most controversial measure, however, is the proposed revival of a tax that would collect 0.2 percent of nearly all banking transactions. Opposition lawmakers in Congress have already signaled that they may not approve that tax, which is aimed at bringing $8.4 billion back into the budget.

The cuts and tax increases are needed to balance Brazil’s books, said Marcos Troyjo, director of BRICLab, a forum on emerging economies at Columbia University in New York, in a telephone interview from Brazil. “But this set of adjustments does not seem to be part of a well-thought-out, well-structured plan to reduce the size of the state vis-à-vis Brazil’s economy,” he said.

Brazil’s problems are closely tied to the economic slowdown in China, its top trading partner, but critics say the Rousseff government bears its own share of responsibility for its slump. Brazil, once a darling of emerging market economies, coasted on a commodities boom in the early 2000s, driven largely by Chinese demand for Brazilian iron ore and soybeans. Business groups say Rousseff squandered an opportunity during that time to make long-term fixes that could have helped keep the country afloat as demand from China began to fall in recent years.

“What Brazil ultimately needs is a pro-growth agenda that will end this recession,” said Brian Winter, policy director at the Americas Society/Council of the Americas, a think tank in New York City, who spent a decade as a Brazil correspondent for Reuters. “You can’t cut your way to growth.” The sorely needed measures come in the form of long overdue systemic changes that would make it easier for businesses to operate in the country, Winter said.

Brazilian business interests have long lobbied for changes in what they say is a bloated tax system weighted down by needless bureaucracy. The government collects more than 60 types of taxes, each with its own rate, that flow to different agencies, and there is a maze of fees and complex processes for each taxpayer to consider. Domestic businesses spend 2,600 hours on average just to calculate what taxes they owe in a year, according to World Bank estimates.

Rousseff also needs to revise what they consider onerous labor regulations, business groups say. Companies have to pay costly fees in order to fire workers, with severance payments and fines totaling up to a year of salary. Generous unemployment insurance provisions also encourage high employee turnover, and court rulings on labor disputes often side with workers, according to a 2012 report by the Inter-American Development Bank.

On top of those problems, the country has a pension system that is underprepared to deal with an aging society. Brazil spends around 13 percent of its GDP on pensions, and those who pay into the system for 15 years and retire in their early 60s can receive their full salaries during retirement. That system will become painfully unsustainable as Brazil’s workers continue to age, analysts say.

Rousseff delivered a proposal in June to gradually scale back Brazilians’ access to full pensions, which observers saw as a temporary fix to plug a deficit. But larger-scale changes still haven’t been a priority, Winter said. “The problem is that right now, you just don’t hear any indication from the Rousseff government that they’re willing to take up these reforms,” he said. “It doesn’t depend just on Rousseff, but it has to start with her.”

In the meantime, political chaos is casting a large shadow over the fate of the latest austerity package and prospects for those larger fixes. A corruption scandal involving dozens of politicians and former executives from state-run energy Petrobras has badly tarnished the government’s approval ratings. And Rousseff, who is currently under investigation for allegedly doctoring public accounts to meet budget targets, is awaiting a court ruling in just a few weeks that will determine whether she could eventually be impeached. With such an explosive political backdrop, it’s hard to see any unity among lawmakers to pass through the big reforms Brazil needs, said Hakim of the the Inter-American Dialogue.

“Everybody is fighting, not with the objective of a stronger, faster-growing Brazil, but in terms of their own party and their own personal ambitions,” Hakim said. “This is really a sort of free-fall.”