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Hit by the lowest approval ratings in history, cornered by an increasingly hostile Congress, and faced with widespread demonstrations against her government, President Dilma Rousseff recently sealed a pact with one of the least reliable members of her flailing coalition for a sweeping set of proposals to stave off the political crisis. Brazil's new positive agenda includes no fewer than 43 measures, ranging from contentious labor and social security reform to strict adherence to the Fiscal Responsibility Law. The law, enacted in 2000, provides for the creation of an independent fiscal council to oversee budget and debt management, as well as for the adoption of limits on public sector gross and net debt. These provisions have never been put into effect.
While strengthening the fiscal framework, as well as reforming social security and the labor market, are crucial for Brazil, significant questions remain over the ability to implement ambitious measures at a time of growing instability. The long list of policy proposals comes at a time when massive protests are calling for the president's ouster. Public anger was sparked not only by the bribery scandal at the oil company Petrobras, but also by a rapidly deteriorating economy. The latest monthly activity indicators compiled by the Central Bank of Brazil reveal that the economy contracted by 3 percent in the second quarter compared to the same period last year, following a drop of 1.9 percent in the first quarter, thus marking two consecutive quarters of negative GDP growth. The most recent market projections suggest that Brazil's slump will extend into 2016, making it the longest-running GDP contraction since the early 1930s. Tax revenues are plunging—as of July, they have fallen by more than 6 percent this year in real terms, placing the recently revised fiscal target of only 0.15 percent of GDP at risk.
Following weeks of mounting tensions, in mid-August President Rousseff agreed with the leader of the Senate, Renan Calheiros of the Brazilian Democratic Movement Party (PMDB), on a so-called "Brazil Agenda" ("Agenda Brasil"). Not long ago, Calheiros made the headlines when he publicly repudiated a crucial bill that might have improved the fiscal accounts this year, possibly postponing the recent ratings downgrade by Moody's and S&P's negative outlook for Brazil. Calheiro's previous opposition to Rousseff's proposed fiscal adjustment revealed the extent of her political isolation. His most recent about-face on the need to restore fiscal sustainability and his newly-found endorsement of the government have caused strains within PMDB, Brazil's largest political party and a member of the governing coalition. The pact for Agenda Brasil has put Calheiros in opposition to Eduardo Cunha, PMDB's leader of the Lower House. Cunha does not favor the government's fiscal adjustment efforts, and has declared himself to be in opposition to Rousseff and her Worker's Party, PT.
While Cunha continues to pursue measures aimed at damaging Rousseff's ability to govern, presumably to draw attention away from his probable indictment in the Petrobras bribery investigations, Calheiros is trying to portray the Senate as the last bastion of stability in a rapidly unfolding political drama.
The 43 measures of Agenda Brasil were negotiated with Finance Minister Joaquim Levy following an understanding reached with Calheiros that fiscal adjustment will be brought to the Senate floor in late August. The bill reverses tax breaks introduced in 2012 and 2013, thus recouping revenue losses in a move that would help achieve the revised fiscal targets for 2016 and beyond. Although the bill was initially designed to take effect this year, Calheiros' previous opposition postponed its approval by Congress.
The "Agenda Brasil" envisages significant changes to social security, both by changing the indexing rules that currently determine readjustments to unemployment and other benefits, as well as by raising the retirement age to 65 years. It also aims to undo current revenue earmarks by decoupling constitutionally-mandated revenues from expenditures. Finally, it seeks to reform labor market legislation by formulating regulations for outsourced and self-employed workers. Strong leadership and significant political coordination between the executive and legislative branches are needed for approval of reforms that could do much to improve Brazil's medium-term outlook but that involve issues that have long divided labor unions, pensioners, and the government itself.
The agreement struck between President Rousseff and Calheiros gives the government a window of 60 days to find new footing and restore viability to the 8-month old administration. Within this timeframe, President Rousseff would need to seek congressional approval for at least five of the 43 measures contained in Agenda Brasil. These measures would include: reforming the PIS/Cofins,1 two of the most complex taxes in Brazil's taxation system; reducing the scope of constitutionally-mandated ties between revenues and expenditures, thereby making the budget more flexible,2 reverse tax breaks introduced in 2012 and 2013, one of the cornerstones of proposed fiscal adjustment in the agenda; and promote greater labor market flexibility. The list of measures to be approved in the coming weeks and months would also possibly contemplate increasing Brazil's retirement age to 65 years, a move that would reduce the looming social security deficit over the next several years. Notably, every one of these highly contentious and important measures has been under discussion for decades. Hence, it is unrealistic to expect that a weak government with extremely low approval ratings facing the threat of widespread demonstrations and the loss of its electoral strongholds—as revealed by the most recent protests and the impressive turnout in the Northeast, the governing party's electoral base—would be able to pull this off. Additionally, since some measures under Agenda Brasil are likely to have a negative short-term impact on an already flailing economy, it is even harder to believe that the population would support such measures.
The pact between the government and Calheiros thus underscores the severity of Brazil's current drama: Although fears of impeachment proceedings against President Rousseff have subsided in recent days, the scenario remains extremely unpredictable. The "Agenda Brasil" and its immediate future ultimately rest on the sustainability of Calheiros' gestures of goodwill towards the government, which should not be taken for granted. The Senate leader has not been cleared from involvement in the Petrobras bribery scandal, and if his name figures alongside other prominent PMDB politicians in the federal prosecutor's soon-to-be-released list of Petrobras-related indictments, any understanding between the Senate and the government could soon unravel. The rapidly deteriorating economic situation adds further insult to injury: It might well undo any intention the government still has of implementing additional unpopular measures, such as changes to labor market laws or increases to the retirement age.
In recent days, there has been an increased perception that it is up to President Rousseff to give the country direction by showing greater leadership and improving dialogue with Congress. That perception falls flat once Agenda Brasil is recognized for what it is: A stitched-together set of important measures that rest on a whimsical pact and that are unlikely to receive the public support they deserve. The government's solution to resolve one of the worst political crises to befall Brazil is thereby setting it up for failure when it can no longer afford it. Even worse, the ill-conceived strategy might kill the public debate on much-needed medium-term reforms contradicting the established wisdom: Never let a serious crisis go to waste.
Notes
1. PIS is a tax paid by companies to finance unemployment insurance for the lowest-paid workers. Revenues from the Cofins, a federal tax, are used to fund retirement and healthcare costs. The two taxes have a cumulative component that makes their calculations excessively complex.
2. Brazil's 1988 constitution instituted a system of earmarked revenues that makes cutting expenditures exceedingly difficult: Specific taxes are directly related to certain government programs or spending items, implying that the scope for budget savings when tax collections increase is low. Moreover, constitutionally-mandated expenditures on social benefits require that taxes be used to fund them, leaving little room for maneuver on budget execution.
