Brazil government coalition risks unraveling

Analysis

The Petrobras scandal is having a serious economic effect on a range of economic sectors (see BRAZIL: Petrobras fallout hits business and politics - April 24, 2015).

Lower economic activity results in lower tax collection, forcing additional spending cuts and putting the projected primary surplus at risk with only five months left in the fiscal year.

The government must also be careful not to resort to accounting practices (known as 'fiscal pedal-pushing measures') such as unauthorised public spending and delayed payment to state banks in order to use funds to boost social welfare programmes.

Downgrade doubts

Moody's is currently re-evaluating Brazil's investment grade rating, currently at Baa2 (the same as Italy and Spain). It is likely to downgrade but it is hoped it will maintain its stable outlook.

A downgrade will not only seriously hamper the country's ability to expand its economy but also make credit more expensive for companies and the government.

Vulnerable politicians

The scope of the Petrobras bribery investigation appears to have advanced from an initial focus on corporate leaders to include political figures. Most recently, Senator (and former President) Fernando Collor de Mello's home was raided on July 14 and three luxury cars seized.

More importantly, the preliminary inquiry into alleged illegal influence-peddling by former President Luiz Inacio Lula da Silva after he left office in 2011, has now turned into a formal criminal investigation.

Lula is accused of influencing the National Development Bank (BNDES) to approve loans to leading construction conglomerate Odebrecht in its dealings in Cuba, Dominican Republic, Ghana and Angola (see AFRICA/BRAZIL: Woes set back ambitious Africa policy - July 17, 2015).

Rousseff investigations

Rousseff herself is faces two federal investigations.

The Superior Electoral Tribunal is investigating allegations of violation of electoral laws during the presidential campaign last year, including illicit donations from major construction companies and from Petrobras.

In a historic precedent, the government budget's watchdog, the federal Court of Accounts (TCU), is investigating allegations that the 2014 government accounts are in violation of Brazil's fiscal responsibility laws.

Rousseff denies any wrongdoing in both cases. The administration is expected to present its arguments regarding the accounting discrepancies by July 22 and the TCU is expected to decide on the matter in August. If the accounts are not approved, Congress will then consider the case for impeachment under the fiscal responsibility law.

This would allow for Cunha to take over as speaker of the Lower House.

Cunha, who recently threatened to press for impeachment proceedings over the campaign finance issue, has upset the PMDB's timetable for gradual withdrawal from the governing coalition in preparation for the 2018 elections by his own defection.

However, this was not unexpected -- he is also under investigation in the Petrobras scandal and was accused recently by a former Petrobras consultant of seeking a 5-million-dollar bribe.

Fiscal fortunes

Finance Minister Joaquim Levy continues to seek ways to meet this year's primary surplus target of 1.2% of GDP as part of his fiscal adjustment package, in order to maintain investor confidence, restore balance to public finances and prevent Brazil from losing its investment grade rating.

The "battle of the budget" pits Levy against Planning Minister Nelson Barbosa and other "national developmentalists" in the government.

On July 22 the government will publish revised revenue and expenditure figures which will determine whether additional spending cuts are necessary. The surplus issue is viewed by many as a 'make-or-break' decision for the long-term success of Rousseff's second mandate.

Accordingly, the government is searching for additional funds to meet its surplus target:

• Levy is pushing a plan to repatriate and regularise funds held abroad illegally.
• Brazil's sovereign wealth fund has started to shed its holdings, including its stake in Banco do Brasil in order to improve the fiscal balance.

While most of the Workers's Party (PT)-led coalition is against Levy's recommendations, business feels that the public sector has not been sufficiently trimmed, given the overall size of the government which, over the last twelve years, has become the fiefdom of the PT.

Levy has insisted on sharp cuts in public investment, employment, pension benefits, and in energy subsidies as well as a significant reduction of state-bank subsidised lending.

Contrary Congress

Congress has rendered the government's budget balancing exercise much more difficult, approving a salary adjustment for workers in the judiciary and pension increases. It is now considering a proposal to establish 200 new municipalities.

Vice-President Michel Temer, juggling loyalty to his party (PMDB), his role as Rousseff's point man in Congress and a possible presidential candidacy for the PMDB in 2018, has called for a period of "institutional tranquility".

On the horizon, however, are new congressional investigations looking into suspicious activities in the finance ministry's tax ajudication body; the BNDES; and the pension funds of some of the largest state-owned companies.

Outlook

On the economic front, the government is expected to review its policies regarding airport, road, port, and railway concessions and allow a higher minimum rate of return as requested by foreign investors (see BRAZIL: Rousseff reforms risk running onto the rocks - July 3, 2015).

The controversial local content law and guidelines regarding the exploration of the pre-salt oil deposits are also under review since both are viewed as not having achieved their stated objectives.

Local-content rules require companies to buy as much as 65% of their goods and services from domestic companies and the original production-sharing system of new oil fields required a minimum 30% share for Petrobras.

Several of these service and construction contracts are at the origin of the Petrobras scandal and the company no longer has the necessary funds to bid on the new pre-salt areas. Future legislation may, however, reserve a right of first refusal over the operation of pre-salt fields for the national oil company.

Politically, Petrobras and other scandals may do long-term damage to the PT. If Lula, the party's founder and leader, were to be incriminated the party could face a serious leadership vacuum and questions over its continuity.