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Can Brazil Reforms Spur Growth?

Latin America Advisor

Brazilian Finance Minister Guido Mantega last week presented several measures designed to boost economic growth, including tax cuts and reductions in government spending. To what extent would Mantega's proposals spur more growth? Do you think they will be implemented? How will the Lula government get state governors, whose support for the proposals is crucial to their adoption, to back the measures?

Lisa Schineller, director of the sovereign group at Standard & Poor's: Raising Brazil's rate of potential growth from a modest 3 percent to a more robust 5 percent requires a higher level of investment, both public and private, and hence a combination of macroeconomic and microeconomic policies. Key among them is a fiscal policy that generates less crowding out of private-sector activity by the government. Debt at 49 percent of GDP impedes the availability of affordable financing for Brazil's private sector, both firms and households. The high level of government spending demands a significant tax burden that has risen ten percentage points of GDP since 1998 to 38 percent of GDP. Measures to rationalize current government spending could provide fiscal space to lower the overall tax burden. Expenditure at all levels of government, including states, is extremely inflexible—weighed down by payroll, pensions, and other earmarked items—and limits fiscal room for maneuver; cuts in current spending in national and state budgets could facilitate higher expenditure on human and physical capital, which would be more conducive to higher rates of growth. Meaningful simplification of Brazil's distortionary tax regime could enable firms to divert resources from tax planning to more economically productive activities. Some progress on these 'fiscal fronts' is likely, given: 1) that growth continues to disappoint; 2) how stifling the tax burden apparently is; and 3) members of the administration, Congress, and state governors understand these linkages. The politically sensitive nature of redirecting and cutting spending, however, coupled with Brazil's track record of reform 'at the margin' versus deep-sweeping change tend to support the likelihood of incremental progress."

Arturo Porzecanski, scholar of international finance at American University (Washington, D.C.):  As far as it is known, the measures proposed by Minister Mantega are fairly timid, involving cuts in taxes and spending that represent a fraction of 1 percent of GDP. This suggests that they have a higher probability than otherwise of being approved and implemented, but by the same token one should not expect them to have much of an economic impact—especially in the next couple of years. What Brazil really needs, beyond a series of microeconomic reforms to enhance market forces, is a major fiscal restructuring to prune the government bureaucracy and refocus government spending on the poor; simplify and reduce the tax burden (for instance, by adopting a nationwide value-added tax); eliminate the deficit of the pension system; and open up opportunities for the private sector to build up and manage efficiently the country's physical infrastructure. Realistically, the only hope for faster economic growth in 2007-08 (on the order of 4-5 percent per annum) hinges on a faster-than-consensus relaxation of monetary policy—which I favor—and on a weaker-than-expected exchange rate. Brazil's high interest rates and overly strong currency, the real, have created a hurdle that prevents the kind of quantum leap in private investment that is necessary for any meaningful acceleration of economic growth.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter.

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