The Daily Update - Brazil & Pension Reform

Reforming Brazil’s pension system is not only an important pledge of Jair Bolsonaro’s administration but it is also critical for putting Brazil on a more sustainable fiscal path: the Brazilian sovereign is rated Ba2/BB-/BB- by Moody’s/S&P/Fitch such has been the deterioration in its credit metrics in recent years.

Moody’s note the need for fiscal consolidation and thus the need for social security reform to put Brazil’s growing government debt burden (~76% of GDP) on a more sustainable path: ‘Mandatory primary spending represents over 90% of total central government primary spending, with social-security-related expenditures accounting for 57% of primary spending. Moreover, the growth in mandatory spending, particularly social security and pension-related spending, has outpaced economic growth over the past 20 years.’

This week the pension reform bill made some progress with the Lower House Constitution and Justice Committee voting that the legislation is constitutional and can proceed to Congress. The reform bill now needs to be reviewed by the congressional commission before it can proceed to the Chamber of Deputies and then to the senate. However, Congress is fractured with over 30 parties in the Lower House and as the bill entails a constitutional amendment it will need 308 out of 513 votes in two votes in the Lower House and then 49 out of 81 votes in the Senate in two votes to pass. Bolsonaro’s PSL party controls 52 seats in the Lower House so it is likely the bill may end up being watered down from the proposed BRL1tn in savings (~14% of GDP) over the next decade. In terms of timing and the number of stages for approval it seems likely to be some months before the bill could potentially be approved.

Brazil’s weakening credit profile has seen it reduced to sub-investment grade and our estimates put its net foreign liabilities close to our cut-off of 50% of GDP. IMF research indicates that countries with net foreign liabilities in excess of 50% of GDP are associated with increasing risk of external crises. Moreover, from a valuation perspective Brazilian sovereign bonds do not look compelling on our models: e.g. USD denominated 4.625% 2028 Federal Republic of Brazil using a bond BB- rating is trading ~3 notches expensive.

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