Framework would weaken LRF by making blocking optional – 05/10/2023 – Market

The end of the mandatory contingency of resources in case of risk to the primary result target, as proposed by the government in the new fiscal framework, weakens the principles of the LRF (Fiscal Responsibility Law), say the Legislative and Budget consultants of the Chamber of Deputies.

The project prepared by the team of the Minister of Finance, Fernando Haddad, stipulates a growth limit for expenditures and a primary target with tolerance bands, but does not oblige the manager to adopt measures to rebalance the accounts during the year, if compliance of any of these rules is threatened.

The proposal means a flexibility in relation to the current norm. The LRF requires the government to block funds if there is an unexpected increase in mandatory expenses, putting pressure on the spending ceiling, or revenue frustration that makes it difficult to reach the result target —obtained by the difference between revenue and expenses.

The government’s text even changes the frequency of the Budget evaluation report, which is now released every two months. By design, it would be quarterly.

“The end of the mandatory contingency weakens the basic principle of the LRF that requires planned action and the correction of deviations. It is important to rescue the bimonthly monitoring that determines the risk of non-compliance with the primary goal”, says the technical note from the Chamber’s consultancies released this Wednesday -Friday (10).

The optional contingency and the absence of cost containment triggers have been the constant target of criticism from parliamentarians and financial market agents.

The project’s rapporteur, Deputy Cláudio Cajado (PP-BA), has indicated that he intends to strengthen the adjustment measures that will be mandatory in the conduct of fiscal policy, but has avoided giving details in recent days.

On Tuesday (9), when questioned about the possibility of including triggers to prohibit the granting of new tax breaks and increase in personnel expenses in case of non-compliance with the target, he said that he was “studying” the matter. The deputy also avoided anticipating whether or not he will resume the mandatory blocking of resources.

In the technical note, the Chamber’s consultants also assess that the fiscal framework is credible, but warn of excessive dependence on new revenues for its effective success.

The government has set ambitious goals, which aim to zero the deficit in 2024 and reach a surplus of 1% of GDP (Gross Domestic Product) in 2026.

The numbers aroused some skepticism in the market, which sees the need to strongly boost collections for this scenario to materialize.

In the 2024 LDO (Budget Guidelines Law) project, whose projections were prepared already with the approval of the new framework, the government estimated a primary revenue of BRL 2.2 trillion next year, BRL 2.3 trillion in 2025 and BRL 2.44 trillion in 2026.

According to the consultancy, however, there is “low statistical probability” of achieving the expected revenue in the new fiscal framework, considering the current legislation.

“Absent changes in the revenue reference system that could lead to increases in federal revenue, the probability of realization of values ​​in the magnitude expected by the Executive Power, in the next three years, is close to 35%”, says the consultancy.

With revenues at risk, technicians estimate that public debt could exceed 80% of GDP.

“It is unlikely that the expected primary results will be effectively achieved if there is not a substantial increase in the government’s primary revenues. Naturally, this low probability contaminates the public debt evolution scenario outlined by the government in the context of the new fiscal regime, given that primary result decisively influences the trajectory of the debt”, states the text.

The government outlined an optimistic scenario for the evolution of the public debt, which, although continuing to rise until the end of the term of Luiz Inácio Lula da Silva (PT), would end 2026 at 76.6% of GDP. This estimate predicts the fulfillment of the target in all years.

Chamber technicians, in turn, carried out simulations assuming that the primary result remains at the bottom of the tolerance margin —that is, with a deficit of 0.75% of GDP this year, gradually rising to a surplus of 0.75% of GDP GDP in 2026.

In this scenario, consultants estimate that gross debt would reach 82.3% of GDP at the end of Lula’s term.

“The probability that DBGG [dívida bruta do governo geral]in 2026, is equal to or less than the number projected in the government’s scenario is approximately 36%”, says the technical note.

“In short, the materialization of the scenario for the evolution of the debt derived from the new fiscal framework depends on achieving more robust primary surpluses and economic growth, as well as more moderate real interest rates”, he says.

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What the tax framework provides

• Limit of real growth of expenses, above inflation, equivalent to 70% of the real increase in revenues. The final percentage needs to be within the range of 0.6% to 2.5%.

• Primary result target, obtained from the difference between income and expenses, with a tolerance margin of plus or minus 0.25 percentage points. Government has signaled that it intends to reach a surplus of 1% of GDP in 2026.

• If the target is not met, the real growth limit for expenses drops to 50% of the real increase in revenues in the following year. But the contingency of resources in the year is optional, and there is no specific requirement of adjustment measures to be adopted by the government.

What the Chamber’s Advisors Say

• The optional blocking of funds violates a basic principle of the Fiscal Responsibility Law, which requires planned action to correct deviations from targets.

• The design of the fiscal framework is overly dependent on revenue growth, and the government’s projections for revenue are unlikely to materialize.

• The government’s gross debt may exceed 80% of GDP, precisely because there is a risk of frustration in expected revenues.