Brazil's Fiscal Performance Weakens in 1Q14

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Wednesday, April 30, 2014
Weakening Fiscal Performance in the 1Q14
Highlights
• The public sector’s primary budget surplus was slightly better than expected in March
(actual: 3.6 billion real; consensus: 3.1) on higher non-tax revenues. Year-to-date, the
fiscal performance lags behind last year’s result (1Q14: 2.1% of GDP; 1Q13: 2.8%);
• Central government’s real expenditures kept moving fast in the first quarter (+7.4%
YoY), apace from late 2013 and outpacing (estimates of) trend GDP, around 2—3%;
• An expansionary fiscal stance remains in place. Our estimates of adjusted primary
fiscal results point to a “core” balance below 1% of GDP. We estimate that the primary
surplus required to stabilize the public debt in the long run is 2.0—2.5% of GDP;
• We continue to see headwinds for the government to achieve this year’s consolidated
primary balance target (1.9% of GDP). We forecast a primary surplus of 1.3% of GDP.
Public Sector Primary Surplus: Weakening Performance in the 1Q14
According to a Central Bank report, the public sector posted a primary fiscal surplus of 3.6
billion real in March, topping our forecast (a null surplus) and market consensus (3.1 billion
real). The surprise vis-à-vis our forecast is due to: (i) 2.4 billion real in revenues from the
Telecommunications Surveillance Fund (Fistel); (ii) tax refunds 1.6 billion real less than we
had penciled in; (iii) better than expected primary result from regional governments.
March’s headline is equivalent to 0.9% of the month’s GDP, similar to last year’s figure but
below the post-Lehman1
average for the month (2009-2013: 2.3% of GDP).
The central government posted a (“below the line”2
) primary surplus of 3.2 billion real in March
(0.8% of the month’s GDP), below the 2009-2013 average for the month (1.3%), but above
last year’s figure for the month (0.3%). States and municipalities added 482 million real (0.1%
of GDP; 2009-2013: 1.0%; 2013: 0.6%). Government-owned companies posted a small deficit
(-64 million real).
Year-to-date, the public sector primary surplus stands at 2.1% of GDP, below the 2009-13
average (3.2%) and the 1Q13 result (2.8%).
So far, the weakening fiscal effort this year stems from the federal government (1Q14: 2.0% of
GDP; 1Q13: 3.1%). On the other hand, states and municipalities showed higher figures than
1
Choosing the post-Lehman as a basis of comparison for the monthly fiscal performance reflects the search for a
parameter that better signals consistency of the result with a narrower primary surplus target seen in recent years. Thus, we
usually compare the monthly fiscal print to a less challenging benchmark, as compared to the elevated primary surplus
recorded in the years of 2003-2008.
2
The below the line (“abaixo da linha”) primary fiscal balance follows the Brazilian Central Bank (BCB) methodology, which
obtains its final number through monthly net debt changes for each public sector entity. This approach is somewhat different
from the one used by the National Treasury Secretariat (STN, in Portuguese acronym), the above the line criteria (“acima
da linha”). The latter follows the analysis of revenues and expenditures to calculate the central government primary fiscal
surplus (before the interest payments).

Macro Brazil – Wednesday, April 30, 2014
last year (1Q14: 1.1%; 1Q13: 0.9%), on higher transfers from the federal government (some of
those had been delayed late last year).
The trailing 12-month consolidated, conventional primary fiscal surplus (i.e., not adjusted for
economic cycles or non-recurring transactions) inched down to 1.75% of GDP in March from
1.76% in February. The recurring primary surplus (stripping out atypical revenues and
expenses) remained stable at 0.9% of GDP in the twelve months to March (Graph 1). This is
one of the lowest levels since the series started in 2002.
1.75%
0.88%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14
Conventional Primary Surplus
Recurring Primary Surplus
Graph 1: Public Sector's Primary Fiscal Balance (12m)
Source: Brazilian Central Bank, Itaú
% GDP
March’s fiscal data points to a decline in regional governments’ fiscal performance, after a
significant budget improvement over the first two months of this year. The 12-month primary
surplus of states and municipalities fell to 0.38% of GDP in March, from 0.42% in February.
Even though it is necessary to gather more information to see a trend, today’s numbers seem
to confirm our expectations that the increase in federal transfers to states and municipalities
would imply in higher expenditures, and not a higher primary balance.
Central Government: Higher Non-Tax Receipts; Fast-Rising Expenditures
According to Treasury data, the central government posted a primary surplus of 3.2 billons
real in March, topping our forecast (+0.7 billion real) and market consensus (+1.1 billion real).
The federal primary surplus is equivalent to 0.8% of the month’s GDP, a weaker print than the
average federal deficit of 1.2% of GDP recorded for the same period in the Post-Lehman
years (2009—2013). In March 2013, the federal surplus was 0.1% of GDP.

Year-to-date, the central government primary surplus stands at 1.1% of GDP, below the 2009-
13 average (2.1%) and the 1Q13 budget result (1.8%).
Real federal revenues grew 9.3% from a year ago, led by non-tax income (+64% YoY in
March; 1Q14: +32% YoY). Non-tax takings were boosted by dividends from state-owned
banks, which added 3.0 billion real to federal coffers last month. Year-to-date, the dividends
sum up to 5.9 billion real, more than the 767 million paid over the same period in 2013. There
was also a relevant contribution from proceeds related to an inspection fee by Fistel (adding
2.4 billion real).
Real tax revenues upped 4.1% YoY, accumulating a 2.0% growth over 1Q14. This suggests a
cyclical loss of steam, as the tax collection trend has been following closely the GDP growth
rate (Graph 2).
2.1%
-9%
-6%
-3%
0%
3%
6%
9%
12%
15%
18%
21%
-5%
-3%
-2%
0%
2%
3%
5%
6%
8%
9%
11%
Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14
%yoy, 6m,
IPCA-adjusted
Itaú Monthly GDP
(PIBIU)
Core tax receipts
%yoy, 6m, IPCA-adjusted
Graph 2: Federal Tax Collection and Real Activity
Source: Brazilian Revenue Service, Itaú
2.0%
Core tax collection, which accounts for 85% of total central government revenues, continues
to underperform the official government forecast for the full-year (around 4% in real terms).
We believe that the (moderate) pace of activity in coming months and (the lack of adjustment
in) the tax policy will prompt a slow growth in tax collection ahead. Altogether, suggests there
is a risk that revenues will come below the official projection. We project an increase of 1.0—
1.5% in real federal tax receipts this year. (For further details on March’s tax collection, refer to
our April 29 LatAm Talking Points)
Transfers to regional governments (including shared revenues and other disbursements)
increased 5.2% YoY in real terms (1Q14: +11%). The data indicates a natural slowdown in
federal transfers after a sharp increase at the beginning of the year (offsetting retentions made
at the end of last year). The slower federal transfer growth is one more reason to estimate a
lower tax effort of local governments in the coming months.

Federal expenses maintained a fast pace in March: +6.1% YoY. In the first quarter,
expenditures grew at a real clip of 7.4% YoY, keeping the strong trend as of late 2013 (Graph
3). We see no signs of spending adjustments in the meantime, as the growth rate in central
government outlays continues to outdo potential GDP growth estimates (2—3%).
1.1%
7.0%
1.3%
4.1%
5.8%
7.6%
5.1%
2.6%
4.9%
5.4%
6.8%
7.3% 7.4%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
Graph 3: Central Government Expenses (% annual, 3m, IPCA-Adjusted)
Source: National Treasury, Itau
Among the main expenditure drivers, we highlight the strong expansion in government costs3
(+26% YoY in March; +34% in 1Q14) and investments (+11% YoY in March; +15% in 1Q14).
These are spending lines with more flexibility for adjustments in the short run. Adjusting for
inflation, subsidies also grew strongly: 81% YoY in March (1Q14:+54% YTD). Payroll are also
picking up: +4% YoY in March (1Q14: +6% YTD).
On the opposite direction, transfers to families (i.e., including mandatory expenditures such as
pensions, entitlements) are decelerating fast. Real transfers to families4
fell 2.5% YoY in
March and 3% YoY in 1Q14. Anecdotal news suggest that some mandatory social security
disbursements are being delayed, which could be an evidence that this slowdown in transfers
could be temporary.
Graph 4 illustrates the main contributions to the expenditure increase of 0.9p.p. to 19.2% GDP
in 2014. Government costs (“custeio”) (+0.4p.p. to 4.0% of GDP), investments excluding
“Minha Casa Minha Vida” (+0.2p.p. to 1.2% of GDP), and payroll (+0.2p.p. to 4.3% of GDP)
are the main factors behind this federal spending increase.
3
Excludes “Bolsa Família” expenditures from administrative costs (“custeio”)
4
Includes expenses such as unemployment insurance, pensions and entitlements.

4.3%
0.4%
4.0%
1.2%
0.5%
8.7%
19.2%
4.1%
0.3%
3.6%
1.0%
0.5%
8.7%
18.3%
Personnel
Subsidies
Administrative Costs
Other Capital
Expenditures
Housing Investment
(MCMV)
Government
Transfers
Total Spending
YTD'14 YTD'13
% GDP, Up to March
Graph 4: Central Government Spending (% GDP)
Source: National Treasury, Itaú
We forecast a significant slowdown in real spending for the remainder of the year, reaching an
average annual rate of 2—3% over the next nine months. This number compares to the 7—
8% so far this year. Implementing such an expenditure deceleration is a challenging task,
which imparts an upside risk to our federal expenditure projection for this year. We forecast a
real spending growth of 4% in 2014, compared to 6.5% in 2013.
Nominal Deficit and Public Debt
The public sector’s nominal deficit in twelve months (a fiscal measure that includes interest
expenses) was 3.2% of GDP in March (February: 3.3%). The recurring nominal fiscal gap (i.e.,
adjusting for atypical primary revenues and spending) also inched down 0.1p.p. to 4.1% of
GDP.
The public sector’s interest expenses fell to 5.0% of GDP in the same period, from 5.1% in
February. For this year, we continue to forecast a lower primary surplus and a continued
increase in the Treasury’s financing costs. These factors should add pressure on the nominal
deficit, which we expect to widen to somewhere above 4.0% of GDP until the end of 2014.
The public sector’s net debt upped to 34.2% of GDP in March from 33.7% in February,
reflecting the unfavorable effect of the BRL appreciation on the public debt (i.e., through the
decrease in the BRL value of the central bank international reserves, computed as a public
sector asset). The exchange rate appreciation over the period (3.0%, using the PTAX rate)
contributed to an increase of 0.5 p.p. in the net public debt last month.
The gross debt of the general government (excluding government owned-companies and the
BCB) edged down to 57.5% of GDP in March from 57.6% in the previous month. The gross
debt adjusted to exclude central bank international reserves increased to 40.2% of GDP in

March from 39.6% in February. Year-to-date, the gross debt ex-reserves grew by 1.6p.p (the
headline gross debt increased to 0.7p.p.).
Assessing The Fiscal Stance and the Outlook for the Year
We still see an expansionary fiscal stance in place, as the 12-month recurring primary surplus
(stripping out atypical revenues and expenditures) remains below its equilibrium level. We
estimate that the threshold to stabilize the net public debt stands at 2.0% (or a bit higher).
Primary results below equilibrium signal fiscal stimuli still in place, implying the necessity of
budget adjustments sometime in the future to avoid a continued debt accumulation.
Our estimates of the structural primary surplus (i.e., adjusting the conventional primary surplus
to economic cycles) run around 0.5—1.0% of GDP at the end of 2014, confirming the
presence of fiscal stimuli. Another way of observing this point is to look to the core tax
collection (“receitas administradas”), which has been growing in line with potential GDP (2—
3%) while public spending growth remains well ahead of that level.
We believe that a moderate activity growth will continue to weigh on government revenues
ahead. In turn, that should lead to a slower pace of public spending in coming months. Still,
given the difficulties to implement a tight budget adjustment this year, the slowdown in federal
expenses should not suffice to bridge this year’s fiscal gap. As an upshot, we project the
public sector will miss this year’s primary surplus target of 1.9%.
So far, as the table below shows, fiscal results are consistent with our forecast year-end
primary surplus forecast of 1.3% of GDP (2013: 1.9%).
% GDP 2012 2013
1Q14
(12m)
2014e
(Budget)
2014e
(Itaú)
Dif.
(Itaú - Gov.)
Primary Surplus - Public Sector 2.4% 1.9% 1.7% 1.9% 1.3% -0.6%
Primary Surplus - Central Government 1.7% 1.6% 1.4% 1.6% 1.1% -0.5%
Net Revenues 20.0% 20.4% 20.3% 20.8% 20.4% -0.4%
Total Expenditures 18.3% 18.8% 18.9% 19.2% 19.3% 0.1%
Primary Surplus - Regional Governments 0.5% 0.3% 0.4% 0.3% 0.2% -0.1%
Primary Surplus - Other Government Entities 0.2% 0.0% 0.0% 0.0% 0.0% 0.0%
Recurring Primary Surplus - Public Sector 1.8% 1.0% 0.9% - 0.7% -
Mauricio Oreng
Luiz Felipe Priolli

Macro Research – Itaú
Ilan Goldfajn – Chief Economist
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