29/10/2018/Fitch Ratings
The victory of Jair Bolsonaro in the second round of Brazil’s presidential election marks a significant political transition, but uncertainties remain over the pace and depth of reforms at a time when deficit and debt pressures are high, says Fitch Ratings. Deep structural challenges that are contributing to weak growth, large fiscal deficits and rising general government debt will severely constrain the new government’s policy flexibility.
Early results indicate that Bolsonaro won with about 55% of valid votes cast, defeating Fernando Haddad of the left-wing Worker’s Party by a considerable margin. Momentum for Bolsonaro also helped to lift support for his right-wing Social Liberal Party (PSL) in congressional elections held earlier in the month. The PSL made significant gains, winning 52 seats in the lower house, making it the second largest party in Congress.
The strong electoral showing for Bolsonaro and his party could boost the new government’s political capital and enable the building of a working legislative majority should centrist parties provide support. How effectively the new administration is able to use the honeymoon period to prioritize and pass its economic agenda remains uncertain. The ability of the president-elect to form an effective coalition to pass key economic bills early in the term will be an important early gauge for the overall commitment and direction of economic policy and the extent of reforms likely to be passed under his administration. The cohesiveness of the economic team will also be important, including economic cabinet appointments and any changes at the central bank.
Bolsonaro ran on a broadly business friendly agenda including formal independence of the central bank, privatizations, reduction in tax exemptions, tax simplification, pension reform, compliance with the spending cap, and faster fiscal consolidation. However, the exact details of how his administration plans to achieve these objectives are limited. Structural reforms to improve the business climate, liberalize the economy and develop infrastructure will likely be necessary to increase Brazil’s potential growth rate. At the same time, reforming social security, which accounts for over 40% of primary spending, as well as taking other measures to control spending will likely be key for deficit consolidation.
A broad-based reform agenda faces execution challenges even after the conclusion of the election cycle. Congress remains fragmented despite the surge in support for Bolsonaro’s party, and structural reforms to the pension system and fiscal policy remain unpopular and have proven politically challenging in the past. Political negotiations and overcoming vested interest groups will be important to achieve material reforms (without significant dilution) and a durable fiscal adjustment.
The lack of fiscal space, a high unemployment rate and a sluggish economic recovery will also likely limit economic policy options while posing risks to the new government’s political capital. Fitch has long highlighted that without sustained structural fiscal reform, Brazil’s fiscal and general government debt dynamics will worsen. A weak reform implementation could undermine investor confidence, increase the sovereign’s borrowing costs and adversely affect the medium term growth outlook.
Brazil’s general government deficit is significantly higher than the ‘BB’ median, at around 8% of GDP in 2017. We forecast gross general government debt to rise to reach closer to 80% of GDP in 2018 and continue rising in 2019-20 due to continued, although declining, primary deficits in the baseline. Lackluster growth remains a significant challenge to reining in the deficit and halting further expansion of the government debt ratio. Real GDP growth is improving but is likely to remain just over 1% in 2018; we forecast it rising to 2.2% and 2.7% in 2019 and 2020, respectively.
Fitch downgraded Brazil’s ratings in February 2018 to ‘BB-‘ from ‘BB’ and revised the Negative Rating Outlook to Stable.