Brazil's economy minister won't bow to political pressure

Former fund manager Paulo Guedes wants economic reforms to curb government debt in the world's ninth-largest economy.

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    Brazil's economic recovery remains anaemic and unemployment stuck in the double digits, but economy minister Paulo Guedes is not giving up on his planned reforms [File: Patricia Monteiro/Bloomberg]
    Brazil's economic recovery remains anaemic and unemployment stuck in the double digits, but economy minister Paulo Guedes is not giving up on his planned reforms [File: Patricia Monteiro/Bloomberg]

    When Paulo Guedes became Brazil's economy minister in January, investors hoped it would be the former fund manager rather than President Jair Bolsonaro steering the world's ninth-largest economy.

    Ten months on, both Guedes and his cheerleaders are getting a reality check on how government really works as Bolsonaro, the former Army captain who once declared he knows nothing about economics, pulls rank.

    The president has nixed several proposals from the minister, effectively depriving the financial markets of their darling. Bolsonaro threatened to do away with the cap on public spending -- much to the horror of the 70-year-old alumnus of the free-market economics school of the University of Chicago. He also shot down Guedes' proposal to simplify Brazil's tax system.

    Still, the minister, who publicly threatened to quit in the early months of his tenure, now says he's in the race for the long run. "As long as the president trusts me, I'll be there," he said in an interview in his office in Brasilia.

    Members of his team say he has become accustomed to the president's style and is looking to stay in office with the aim of pursuing some of the pro-market policies he's been advocating since the 1980s. These include the pension reform passed this week, increased privatization and more disciplined government spending to pare "snowballing indebtedness."

    "Interest rates collapsed since we came in and said we'd keep the spending cap," he said. "We said enough with public expenditure. We are going to reduce taxes, reduce energy costs."

    Long wait

    "He's waited 30 years for this moment," Fabricio Taschetto, the partner and investment director of Ace Capital, said. "Since redemocratization, Brazil has implemented the opposite of the policies Paulo Guedes believes in. Now is his moment to implement his ideas and see the result."

    While investors are impressed by the government's progress on overhauling Brazil's overstretched pension system, they are starting to grow itchy for results elsewhere.

    "So far, the economic agenda has advanced very little aside from pension reform. That's the biggest problem," Richard Back, head of Latin America political strategy at XP Investimentos, said.

    Recovery remains anemic and unemployment stuck in the double digits. While the economy is forecast to pick up pace next year, risks are to the downside, with the International Monetary Fund last week cutting its estimate for 2020 growth to 2% from 2.4%.

    BRAZIL GDP BBG CHART

    But Guedes says he's "in no hurry". The most important thing is for Brazil's economy to grow in a healthy way, he added, saying that the president appreciates his position, despite the pressure to show results.

    "All politicians are in a hurry," he said. "The president understands that if we are in a hurry now, we might end up like Argentina." Brazil's southern neighbor is now enduring yet another financial crisis after President Mauricio Macri's stalled reform program.

    Growing pressure

    But what investors fear more than anything is Guedes' sudden departure. Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc., calls him a "reference point for Brazilian economy policy." Taschetto said the administration's whole economic agenda depends on the minister and warned that his exit would trigger a "total collapse".

    Pressure on the minister is already increasing as Bolsonaro grows impatient with the faltering recovery and with the lack of funds available for public investment, according to a member of his team who requested anonymity to speak freely. Guedes' answer, according to the person, is that results are starting to show and that August -- when a central bank index of economic activity rose only 0.07% from the prior month -- may have been the low point.

    For now, Bolsonaro remains, in his own words, "100%" committed to his minister.

    If Guedes has no shortage of fans in financial markets, in Congress he has far fewer friends, and not just because his economic philosophy represents a sharp break with Brazil's statist traditions.

    His bullish and abrasive style tend to rub lawmakers up the wrong way, and in one congressional hearing he almost came to blows with a deputy who accused him of being easy on the rich and hard on the poor.

    Occasionally the minister also tends to run ahead of himself. He started the year by promising to eliminate the primary public deficit, which then stood at nearly 1.6% of gross domestic product. That deficit, which excludes interest payments, narrowed only modestly since then, to nearly 1.4% of GDP.

    Tax trouble

    One of the most public spats between the president and his so-called 'super minister' followed Guedes' proposal to introduce a financial transactions tax as a means of cutting levies elsewhere. But such a tax has a long and infamous history in Brazil and Bolsonaro was quick to rule it out categorically.

    The disagreement postponed the introduction of the government's overall tax reform proposal -- the second-most important economic measure of the Bolsonaro administration after pension reform.

    In the absence of an executive blueprint, the Senate and the lower house are already debating their own tax reform plans, leaving Guedes and his team out of the spotlight.

    Another key policy area -- the constitutional limit on public spending -- has also become a bone of contention.

    The president has repeatedly signaled his frustration with the rule that many investors regard as an important check on loose fiscal policy.

    Alarmed, Guedes called Bolsonaro to tell him that ditching the spending cap would harm the country's image among investors. Instead, he argued, the president should back an idea to scrap the earmarking of funds in the federal budget. Currently, more than 90% of Brazil's 1.4 trillion-real budget spending is mandatory.

    But as with tax reform, Guedes' team has yet to put forward a concrete proposal on how to ditch the allocation of government cash. The official explanation is that it would be better to wait until after the full approval of pension reform.

    Guedes resorted to a tried and tested metaphor to explain why reanimating the leviathan of the Brazilian state is such a painful process.

    "They harpooned a whale for 40 years," he said. "They made it bleed until it was almost dead. And so far we've just pulled out one harpoon: pensions."

    SOURCE: Bloomberg