Reforming Brazil’s Reforms: The Ever-Looming Possibility...

by Alcides Ferreira Jul 26 - Aug 01, 2003

Last May, I wrote here about the tax and pension reforms the
government had just sent to Congress. So it’s time for a
follow-up. Soon, Congress will hold the first-round vote on
pension reform - because it involves a constitutional
amendment, the bill needs to be voted on twice. Once it clears
the Lower House, the Senate then has to approve it, again in a
two-round vote.

The pension reform bill is slightly different from the text I
commented on back in May*. The negotiation process in
congressional committees changed the proposal, but it’s not
worth going into the minutiae. The bottom line is that some
public servant privileges that the original proposal would
have done away with, are now not only being kept in place but
reinforced.

There may be additional adjustments during the voting process,
since general reaction against reforming the pension system is
huge. Even federal judges and district attorneys are
threatening to go on strike as of August 5 to protest against
the proposed reform. But even with all the pressure being
applied to stop it or deface it, I still believe this reform
will be approved. And I also reaffirm the conclusions of my
May article, primarily that the reform is an important
development, but soon Brazil will need to start considering
additional repairs to the pension system.

Financial markets and analysts, mainly abroad, will take a
while to digest the pension reform package once it passes. But
it is almost a consensus that it will benefit government
finances, saving significant amounts of money at both the
federal and state levels. Although there’s no way to say yet
how much will be saved, there will certainly be important gains.

Once this specific aspect is absorbed, investors will bring
expected future results to the present. The risk Brazilian
securities pay abroad, or the country risk, will diminish.
That will allow for the exchange rate to fall, as will
domestic interest rates. In addition, Brazilian securities,
bonds and equities will have better prices. When will this
positive wave actually happen? Well, if I knew that, I
wouldn’t be here writing articles… The timing is very
difficult to predict, but perhaps sometime next year might be
a good bet.

Then there’s the other reform package - tax reform, and the
government is sure to have trouble getting that one through.
In this case, the negotiating process has been poorly managed
by the government, as has been the case with most of the tasks
on the Workers’ Party (PT) administration’s agenda this year.

The main hurdle is the fact that the proposed bill delivered
to Congress does not represent an agreement between the
federal government and state governors, contrary to what
happened with the pension reform proposal. There was a deal
between the two levels, which didn’t happen with tax reform,
so the government will clash with state governors in Congress
– an ideal path to a disastrous result.

It is unclear so far just how President Luís Inácio Lula da
Silva will manage the situation. He can accept the changes
requested by state governors to ease approval of tax reform.
However, the changes called for by governors would mean less
funds for the federal budget, and more resources transferred
to state administrations. Lula could also backtrack, and keep
in the proposal only what the federal government needs to
balance its budget over the next few years. That would mean
giving up some important changes, such as the unification of
value-added tax legislation. Of course, a third path would be
to simple battle it out and see what happens in Congress.

I believe Lula will try to negotiate tax reform, and in doing
so, the proposal might just become a "Frankenstein" of sorts.
If the original text was less than ideal, certainly a
Frankestein version will be a monster. Unfortunately, the
whole idea behind pursuing a reform of the tax system was
technical. The point was to mend and adjust details in
Brazil’s chaotic tax system. But the government was unable to
conduct the debate and avoid controversy at the same time. As
with any tax discussion, someone feels they’re getting the
short end of the stick. At the end of the day, governors
started to request more money from the federal government, and
the tax reform package became a mess.

How it’ll all end is anyone’s guess at this point. An eventual
failure in this attempt to reform the tax system may
negatively affect the gains from pension improvements. Which
means the road to that possibly rosy scenario I am predicting
for next year may turn out to be rather bumpy.