Brazil Details Austerity Plan: Package of Tax Hikes, Spending Cuts Wins IMF Endorsement

By Anthony Faiola, Washington Post, Thursday 29 October 1998; Page A42

BUENOS AIRES, Oct. 28 - The Brazilian government today disclosed full details of its long-anticipated three-year, $84 billion fiscal austerity package, winning praise from the International Monetary Fund and the Clinton administration. But the plan to save the country from economic collapse was criticized by some private economists, who said it relies too heavily on tax increases and will be difficult to implement.

The package of tax hikes, spending cuts and fiscal reforms is central to Brazil's quest for a loan of about $30 billion from the IMF and other international lenders, approval of which is seen as critical to restoring international confidence in the country. The plan would cut $20 billion from the public deficit in 1999 in line with targets agreed to by the IMF, which is anxious to keep the global financial crisis from hitting Brazil lest it spread to the rest of Latin America and beyond.

In a statement issued today in Washington, the IMF said the main elements of the plan represent important progress in the implementation of Brazil's stabilization and reform program, which will be supported by the IMF and other members of the international community.

Deputy Treasury Secretary Lawrence H. Summers, at a luncheon with Washington Post editors and reporters, praised Brazilian President Fernando Henrique Cardoso for having proposed quite substantial deficit reduction measures. He noted that the measures total nearly four percent of Brazilian output, which in U.S. terms would be like a $320 billion reduction in the budget deficit over an 18-month period.

But at the same time, Summers cautioned that it is crucial for the government's plan to be implemented swiftly -- a point of considerable concern to private analysts, who fear the plan relies too heavily on reforms that will require bargaining with Brazil's unpredictable Congress and powerful state governors.

I would even call parts of the plan unrealistic, said Mauro Schneider, an economist with ING Bank in Sao Paulo. I'm surprised the government decided to look to the state and local levels for so much of the package. I think the market would have preferred the federal government take a total leading role.

Economists also criticized the plan for making overly optimistic assumptions about Brazil's ability to quickly lower interest rates, which were almost doubled last month to 49.75 percent to stop the bleeding of foreign investment. An estimated $30 billion in foreign capital has already fled the world's eighth-largest economy since the Russian crisis erupted in August. The plan assumes the lowering of interest rates in the next few months will help Brazil stimulate its economy and reduce its debt.

Even if everything goes according to plan, officials concede for the first time in forecasts made within the package that the besieged Brazilian economy will likely shrink by 1 percent next year. But Cardoso, the architect of free-market reforms in Brazil, promised Brazilians in a national address Tuesday night that many of the measures are only temporary and that the painful downturn will be brief.

The austerity package, the details of which were released today by Finance Minister Pedro Malan, calls for savings of $23.5 billion in 1999, with greater savings forecast for 2000 and 2001. In 1999 -- the most important year in terms of IMF targets -- about $7.3 billion in federal spending cuts are planned. But economists pointed out that changes in the federal budget would account for less than 70 percent of the total adjustments in 1999; the plan relies on local and state governments for the rest.

The bulk of the savings would be realized by increasing taxes or imposing new fiscal restraints on local and state governments -- considered very unpopular and difficult to achieve in Brazil, especially since Cardoso lost key political allies in several states during Sunday's runoff elections.

While economists had largely anticipated the contents of the plan, it still drew fire today for looking more toward tax increases than cutting Brazil's bloated public sector. It's obvious that raising taxes is easier than cutting spending in Brazil, but it will have the effect of slowing down Brazil's economy even more, said Joyce Chang, emerging-market analyst with Merrill Lynch in New York. While this isn't a total surprise, I think the preferred course would have been to cut spending more than increase taxes, and it's worked out the other way around.

One controversial part of the plan calls for increasing one form of corporate tax and extending it to new sectors -- such as utilities and financial companies -- that were previously exempt. Taxes would also be levied on some financial transactions, such as writing checks. But the plan also won praise for addressing some of the lingering problems economists see in Brazil's relatively generous public-sector benefits. Cardoso's plan is once again calling for administrative reform of the social security system in Brazil, including hikes in the amount of money civil servants contribute to their pension funds. It also would require retirees to start paying taxes on the benefits they are already receiving.

Shedding light on the forthcoming IMF aid package, Summers said it will have a contingent, precautionary character that will differentiate it from other recent IMF-led rescues for Asian countries and Russia. This suggests that instead of providing a big up-front loan, with further loans disbursed according to a fixed schedule, the IMF will give Brazil access to a large line of credit to be drawn whenever the money is needed. Thus, Summers said, Brazil will in some ways be a test case for a proposal advanced last month by President Clinton to provide new forms of IMF help for countries threatened by the global financial crisis but not yet engulfed by it.

Staff Writer Paul Blustein in Washington contributed to this report.

Brazil's Reform Package

Brazil's new austerity plan, under which it plans to save almost $24 million next year, aims at extricating the nation from economic crisis. Here are the principal provisions, which still need to be approved by Congress:

• Government spending cuts: Savings worth $7.3 billion next year. Spending cuts is a condition for Brazil to obtain $30 billion in emergency credits from the International Monetary Fund.
• Federal revenues: Federal government will double the revenues it retains from states and municipalities.
• Social Security: Extra revenue $2.2 billion. Corporate tax to fund the social security system will go up. Social security tax paid by government workers will rise, and retired civil servants will have to pay the tax for the first time.
• Financial transaction tax: Extra revenue more than $6 billion. Tax to increase to 0.38 percent from 0.2 percent. This will affect bank withdrawals, check writing and stock market transactions.
• Tax on corporate earnings: It will rise to 3 percent from 2 percent, and the government will submit a bill to levy the tax on banks, which were previously excluded.
• Government will propose law to prevent public overspending and deregulate fuel prices.