June 4, 2012
The outlook for debt sustainability in Brazil is favourable. Net public-sector debt has fallen tangibly. Brazil’s gross debt remains relatively high compared with most of its emerging markets peers, however. Interestingly, gross government debt has remained substantially unchanged in the past five years – in spite of solid real GDP growth and a reasonably tight fiscal stance reflected in large primary surpluses. This can be attributed to public-sector asset accumulation financed by domestic debt issuance. Had the government refrained from accumulating assets, gross (domestic) government debt would be 10-15 percentage points lower than it is today. A fundamental change in policy appears unlikely, as it would conflict with the government’s revealed policy preferences.
Many advanced economies are facing debt sustainability challenges. The emerging economies, by and large, are not. The average gross government debt-to-GDP ratio in the EM G-20 is 37% of GDP, as opposed to 110% of GDP in the advanced G-20 economies. This ratio is projected to decline to less than 30% by 2016, while in the advanced economies it will climb by five percentage points.
Brazil is a case in point. The outlook for debt sustainability is favourable. Net public-sector debt has fallen from a peak of nearly 60% of GDP in 2002 to less than 40% now. If Brazil maintains a primary surplus of 3% of GDP, registers an average real interest rate of 6% and generates real GDP growth of 4% in 2012-15, net debt will fall to less than 30% of GDP by 2015. It remains to be seen if the Brazilian government will be able to resist the temptation to switch to a less disciplined fiscal policy once debt approaches the 30% mark.
The government understandably focuses on the (lower) net debt ratio rather than the higher gross debt ratio. Not only has gross general government debt fallen by less, declining from a peak 82% of GDP in 2002 to 65% of GDP. It would be highly desirable to reduce the government debt burden more aggressively. Brazil faces relatively large contingent liabilities in the guise of rising age-related expenditures. While Brazil’s demographic profile is relatively favourable, its old-age dependency ratio will double by 2030 and then (almost) double again by 2050, reaching nearly 40%. The IMF estimates the net present value of age-related pension and health expenditure at 70% and 40% of GDP, respectively. Only Russia and Ukraine, two countries with incomparably worse demographic dynamics, face larger pension and health-related liabilities. Other emerging economies will be confronted with rapid increases in age-related expenditure, but they will generally start from a better debt position and/or benefit from higher underlying economic growth (e.g. Russia, China, Saudi Arabia and Turkey).
Brazil’s gross debt also remains relatively high by emerging economies standards compared with most of its emerging markets peers. It is about 20 percentage points higher than the EM G-20 average. Net debt remains around 10 percentage points above the EM average. Among the major emerging markets, only Hungary (80%) and India (69%) have higher gross debt ratios. Brazil’s gross government debt, including gross domestic government debt, has remained substantially unchanged in the past five years – in spite of real GDP growth of 4.2% per year and a reasonably tight fiscal stance reflected in a primary surplus of 3% of GDP (chart). Net debt, by contrast, has fallen by a full 10 percentage points since 2006.
This apparent discrepancy is largely explained by below-the-line transactions related to public-sector asset accumulation. More specifically, domestic debt issuance tied to sterilised FX intervention and loans to official financial institutions have helped prevent a decline in domestic debt, while the related asset accumulation has not (materially) affected the decline in net debt (chart). Not only has this kept gross (domestic) debt high. It also has resulted in higher-than-otherwise net interest payments. After all, the negative carry on FX reserves has averaged around 1,000 bp in the past few years. The negative carry on lending to official institutions is roughly Selic minus the TJLP (or government-determined long-term interest rate) and has thus averaged around 500 bp. This has helped keep net interest payments high, thus preventing a more rapid decline in debt levels. Admittedly, there are difficult-to-quantify benefits related to FX reserve accumulation (up to a point) and there may be broader economic benefits (which are more difficult to prove) related to subsidised lending. Undeniably, however, public-sector asset accumulation has been costly in strictly fiscal-financial terms.
After all, had the government refrained from accumulating FX reserves and extending loans to official financial institutions after the 2008 financial crisis, gross (domestic) government debt would be 10-15 percentage points lower than it is today. If the resulting lower interest payments and resulting lower interest rates are factored in, gross government debt could today be as low as 35-37% of GDP rather than 52% of GDP. A lower level of domestic debt would almost certainly translate into lower interest rates, leading to a further acceleration in debt reduction. If the government is serious about reducing interest rates, it should not only run a tighter policy but also reduce the speed of asset accumulation and related below-the-line debt issuance. The related slowdown in government-subsidised credit and a stronger nominal exchange rate would similarly help lower interest rates, albeit at the risk of conflicting with the government’s revealed policy preferences.
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