Brazil’s Problems are Much Bigger than Dilma

With impeachment proceedings underway, it looks like President Dilma Rousseff is on the way out. But budget deficits, out-of-control welfare spending, rampant corruption, and political gridlock greet her successor.

BRASILIA, BRAZIL - MAY 10:  Embattled Brazilian President Dilma Rousseff waves as she enters to speak at a women's rights conference on May 10, 2016 in Brasilia, Brazil. Rousseff is facing an impeachment vote in the Senate tomorrow that could force her to step down from the presidency for 180 days and face trial.  (Photo by Mario Tama/Getty Images)
BRASILIA, BRAZIL - MAY 10: Embattled Brazilian President Dilma Rousseff waves as she enters to speak at a women's rights conference on May 10, 2016 in Brasilia, Brazil. Rousseff is facing an impeachment vote in the Senate tomorrow that could force her to step down from the presidency for 180 days and face trial. (Photo by Mario Tama/Getty Images)

Only a miracle can save Brazilian President Dilma Rousseff. On April 17, the lower house of Brazil’s National Congress voted for her impeachment, stemming from allegations that she tried to camouflage the country’s fiscal deficit by borrowing money from state-run banks. Then, on May 9, Waldir Maranhão, the acting speaker of the lower house, abruptly annulled the ongoing impeachment process, claiming there were procedural errors in the April 17 vote. The next day, he suddenly reversed himself, offering no reason. His walk-back came only one day before the upper house, known as the Federal Senate, began deliberating whether Rousseff should face trial for impeachment. Such is the chaos of Brazilian politics these days. With the Supreme Court’s rejection of an appeal by the government to try to stop the political trial, Rousseff is now a step closer to leaving office.

In the Senate, 52 out of 81 lawmakers are set to vote on Wednesday night in favor of an impeachment trial for Rousseff, more than the simple majority needed to suspend her as president for 180 days while the hearings take place. Vice President Michel Temer, a member of the opposition Brazilian Democratic Movement Party (PMDB), would step in during this period and, ultimately, could become president until the next elections in 2018 if Rousseff is impeached. Ironically, the budget deficit threatening to bring her down, equal to about 2.28 percent of GDP, will remain one of the country’s biggest economic problems — regardless of her eventual fate — and will continue to be a major headache for Temer.

So far, financial markets have sent Temer encouraging messages. Recently, Brazil’s Bovespa stock index, as well as its currency, the real, has risen to its highest levels in months on the prospect of political change. The announcement of Maranhão’s now-annulled annulment incited a sell-off in local markets: The Bovespa and the real fell 3.5 and 4.6 percent, respectively, but pared back losses after the Senate asserted that it would continue with its plan to vote on Rousseff’s impeachment. Investors, in other words, want the president gone. The market is watching for Rousseff’s free fall: Despite the political volatility today, the Bovespa is surging 0.5 percent, and the Brazilian real is appreciating 0.2 percent

But measures to stabilize the economy with or without Rousseff will still be difficult to implement and certainly won’t produce immediate results. A Temer-led government will have to contend with long-standing structural weaknesses. Growth could remain elusive, as significant budgetary tightening is required. Because more than 85 percent of federal spending is constitutionally guaranteed, the necessary changes will require amendments passed by Congress. Temer’s immediate hurdle, then, will be to gather enough political support from lawmakers who, for months, haven’t had the stomach to approve a package of much-needed, broadly unpopular austerity measures.

Brazil’s deeper problems, in other words, go far beyond its immediate crisis. The country’s fractured political system, rife with corruption, poses a serious challenge to structural reform. With the dramatic impeachment proceedings underway amid the most fragmented Congress in Brazil’s history, economic reform will remain out of reach until the country restores political stability.

A new executive branch under Temer will be tested on several fronts. Hit by China’s slowdown and the end of the commodity supercycle, Brazil’s GDP contracted 3.8 percent in 2015 — the biggest dip in 25 years — and the IMF expects a similar drop this year. The good news? At current rates, growth could level off to zero in 2017. But that’s about it. Despite the fact that inflation in March declined the most in a month since 2004, prices are rising 9.28 percent annually, way above the maximum target of 6.5 percent.

Unemployment has more than doubled in the past two years, from 5.1 percent in 2014 to an estimated 11 percent this year. What’s more, Brazil carries a heavy overall public sector deficit of 10.8 percent of GDP — an increase on last year’s 6.6 percent deficit — and a rising gross government debt of 68 percent. Debt payments are as high as 8 percent, since the relatively high interest rate of 14.25 percent makes the cost of borrowing very expensive.

Although analysts say Brazil has weathered the worst of its economic crisis, the decline in government revenues and surging debt call for a big fiscal adjustment. Brazil’s generous pension system, for instance, is one of the many factors imposing a heavy burden on state accounts. Today, expenses for the General Social Security Regime constitute the biggest source of pressure on public spending, according to a report from Bank of America published on April 13.

How heavily does the pension system weigh on Brazil’s overall economic health? The 2015 primary deficit — a way of calculating the deficit that does not include interest payments on loans taken out to finance the operation of the government — of 1.9 percent of GDP would have been 0.4 percent without the social security deficit, according to the Bank of America report. The country’s social security deficit could reach 13 percent of GDP by 2060 if no measures are taken, the bank alerted. Analysts argue that Temer should raise the minimum age for retirement and separate the pension payment adjustments from increases in the minimum wage.

Fixing the fiscal deficit will also require more budget cuts and tax hikes, a plan that didn’t work out very well for ex-Finance Minister Joaquim Levy. His attempts to tighten public spending were scuttled last year when lawmakers blocked most of his reforms. Temer, then, must find a way to build political consensus while avoiding political suicide.

While Rousseff spends what could be her final days in office, she has warned that Temer’s plans to cut social programs instituted by her Workers’ Party (PT) won’t be tolerated. In fact, she’s doubling down. On May 1, she increased pressure on the vice president, announcing a slate of tax cuts, expanded public housing, and a 9 percent increase in the monthly stipend of Bolsa Família, the most popular welfare program, further complicating the upcoming budget negotiations.

Investors see Temer as a more market-friendly politician with a more liberal agenda versus Rousseff’s state interventionism, but his economic advisors have said he won’t make radical changes. Instead, they say, he’ll look for gradual improvements on fiscal accounts while maintaining existent welfare programs. It won’t be that easy if Temer wants to keep Brazil’s public debt from rising further. Hopes now rest on Henrique Meirelles, a former Brazilian Central Bank president, who holds a high level of credibility to lead the new economic team.

The true test of strength for Temer’s new cabinet will be its ability to get Congress to approve economic reforms in a historically challenging political environment. The suspension of former lower house speaker Eduardo Cunha, the architect of the impeachment campaign against Rousseff, for money laundering and corruption in connection with the massive Petrobras scandal was only the latest twist in the ongoing political conflagration. Both Cunha’s PMDB and Rouseff’s PT are entangled in the mess. Indeed, above and beyond the ongoing impeachment, Brazil’s chief prosecutor has asked the Supreme Court to authorize an investigation into Rousseff in connection with Petrobras. Rousseff denies any wrongdoing, despite serving as chairwoman of the company’s board while the corruption scheme played out.

The removal of Cunha doesn’t make life easy for Temer, who’s also a member of the PMDB. At the same time, it clears the way for the vice president to have a softer landing in government. But if the Supreme Court decides to slap corruption charges against the president of the Senate, Renan Calheiros, then Temer will lose his two main allies in Congress.

The potential change in Brazil’s government could break the political gridlock that has been in place since at least Rousseff’s re-election. But it will not be enough for a fresh start for an eventual new administration, given the grimy political environment. Rousseff’s impeachment will ultimately determine whether 13 years of PT government rule ends, though it won’t be enough to change the economic front in the near future.

A new cabinet with a strong political willingness might be able to implement fundamental measures to increase the chances for economic reform. But Brazilians will have to wait years to benefit from the results. And there will certainly be some pain they’ll be forced to tolerate with the curtailing of welfare programs. In the end, it’s not as simple as throwing the bums out. Even a purge of the current political class isn’t enough to force Congress to rethink, at least for now, how to mend the ailing economy.

Photo Credit: Mario Tama / Staff