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Brazil's Temer Faces Tough Budget Reform Tests

08/31/2016 - 11h50



As the impeachment of Brazil's suspended leftwing President Dilma Rousseff entered the final strait on Tuesday (30), diehard supporters blocked highways in São Paulo, burning tyres and clashing with police.

The protests probably achieved little, however, other than to annoy commuters. The nine-month long impeachment process will climax on Wednesday (31) with a historic vote in which more than two-thirds of the 81-seat senate are expected to remove Ms Rousseff from office for manipulating the budget.

Ms Rousseff's replacement, former vice-president Michel Temer, will not have long to savour the historical moment. If he had thought the impeachment was challenging, his next task promises to be even more formidable - how to push through a series of unpopular reforms and end one of the world's deepest recessions.

"The impeachment is important, of course, it does remove one source of uncertainty from the scenario, but it continues to be an uphill battle," said João Augusto de Castro Neves of Eurasia Group.

The interim president has already managed to instil some confidence in what was once the world's second-largest emerging market after China, with signs that Brazil's economy has started to bottom out after contracting 3.8 per cent last year.

A savvy political operator from the largest party in congress, the centrist Brazilian Democratic Movement party, Mr Temer has used his months as interim president to install a strong economic team. Ms Rousseff was suspended from office in May to prepare her defence.

With the impeachment done, Mr Temer's finance minister Henrique Meirelles is expected to begin implementing one of the interim government's main promises to markets - a constitutional amendment that will eliminate real increases in budget spending for up to 20 years.

The thorniest part of the bill, which is designed to restore Brazil's sinking public finances, is that it would require ending rules that directly link increases in health and education expenditure to rises in tax revenue.

This would be deeply unpopular with Brazil's lower-middle classes, who complain bitterly about the quality of the country's public hospitals and schools.

"The government is announcing measures that have been defeated at the ballot box many times, for example, the ceiling that would freeze spending in socially important areas for 20 years," said senator Fátima Bezerra of Ms Rousseff's Workers' party, the PT, adding it was doing so without a popular mandate. "This is a tragedy."

Most expect, however, the Temer government to tweak the measure to grant some leeway to increase education and health spending and to pass the law this year, probably after municipal elections in October.

"Most people recognise September will be rather on the quiet side regarding implementation and possibly even October," said Alejo Czerwonko, emerging markets strategist at UBS Wealth Management.

The agenda is expected then to move to an area considered even more essential if the budget freeze is to be viable - social security reform. Brazil's pension system is unfunded and is one of the most generous in the world with the minimum age of retirement just 55 years for men and 50 for women compared with 66 for both in the US.

The pension reform is expected to be outlined this year and passed during the first half of 2017.

"The expenditure ceiling without the means to achieve it would not be very effective," said David Beker, economist at Bank of America Merrill Lynch in São Paulo. "The social security reform will create the means to get there."

But he said few details of the pension reform had yet been announced, making this a point of uncertainty for the markets.

Other more distant reforms could include labour and tax changes. In the meantime, the government will look to push through privatisation of oilfields, highways and other infrastructure concessions.

On the political front, Mr Temer would need to publicly show that he would not try to impede investigations into a vast corruption scandal at Petrobras, the state-owned oil company, even if this implicated his allies in congress, said Mr Castro Neves of Eurasia Group. Any attempt to do so could erode his already low support.

In Mr Temer's favour will be signs of a bottoming out of the economy. Maersk Line, the world's largest shipping company, said on Tuesday that Brazilian container exports hit a record high in the second quarter of this year.

This was driven by a weaker currency and growing Chinese demand for containerised beef, pork and chicken. Imports were also starting to rebound.

"It's important for business to stock up now ahead of Christmas because there could be a bottleneck before the end of the year," said João Momesso, regional head of trade and marketing for Maersk Line.

But even if the economy recovers and his reforms pass, the next two years promised to be a thankless task for Mr Temer, said Mr Castro Neves.

"Success will make him an unpopular leader because the fiscal and pension reforms are part of an unpopular agenda," he added.

Copyright The Financial Times Limited 2016

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