Brazil must ditch index links or risk spending cap breach: economy minister

BRASILIA (Reuters) - Brazil will inevitably break its spending cap rule at some point unless mandatory public expenditure tied to inflation and other rules is de-indexed, Economy Minister Paulo Guedes said on Monday.

Speaking in an online event on tax reform hosted by the National Confederation of Municipalities, Guedes also said he would ideally like to pull taxes on goods and services into a single levy, and repeated his view that taxes on dividends will go up and corporate tax will come down.

Guedes said politicians must show “courage” and rethink budgets in the future, deciding for themselves where best to allocate resources rather than have public spending growth rigidly linked to inflation and other metrics.

If not, the automatic rise in mandatory public expenditure will eventually breach the spending cap, which limits the growth in spending to the previous year’s inflation rate and is widely seen as the government’s most important fiscal anchor.

“Indexation doesn’t protect anyone,” Guedes said.

The government’s 2021 budget proposal showed projected spending of 1.5 trillion reais next year, of which almost 94% is mandatory outlays on budgets such as public-sector salaries, education and health.

Brazil’s public-sector deficit this year is on course to top 12% of gross domestic product due to the emergency spending and lost tax revenue triggered by the COVID-19 pandemic.

Some economists say the spending ceiling could be breached next year unless budget cuts are made somewhere, although given the huge share of mandatory spending, the room for this is severely limited.

A breach of the cap could spook financial markets and hit Brazilian asset prices, particularly the exchange rate, and push up market-based interest rates, Guedes and other officials warn.

“We are on the edge of a volcano, we must show huge fiscal responsibility,” Guedes said, adding that the federal government cannot afford to offer any more guarantees to local governments.

Reporting by Jamie McGeever and Marcela Ayres; Editing by Chizu Nomiyama and Jonathan Oatis