## cr17292 ## Source details **Canonical URL:** [cr17292](https://www.imf.org/-/media/files/publications/cr/2017/cr17292.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17292.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17292.pdf.json) --- ### Mission background and contacts - IMF technical assistance mission visited Brasilia, Brazil during March 8–24, 2017. - Mission leadership and participants: Dr. Teresa Curristine (mission leader); Fabien Gonguet, Matthew Crooke and Jorge Baldrich (FAD experts); Fabian Bornhorst (IMF Resident Representative). - High-level meetings: Minister of Finance Mr. Henrique de Campos Meirelles (presentation of preliminary report). - Key National Treasury contacts: Secretary Ms. Ana Paula Vescovi; Undersecretary for Fiscal Planning and Statistics Mr. Pedro Jucá; General Coordinators Mr. Daniel de Araujo; Mr. André Proite; Mr. Felipe Bardella; Mr. Renato Andrade; Coordinator for Financial Planning Ms. Roberta Pereira. - Other MOF and ministry contacts and institutional meetings listed in source. ### Executive summary — context, recent reform progress, and rule design - Context and objective - Brazil has faced "its deepest economic recession in decades" since 2015, with a sharp deterioration in the fiscal situation: a significant drop in revenues and debt increasing above the emerging market average. - Government is reforming its fiscal framework to promote fiscal sustainability and reduce debt. - Recent reform progress - New expenditure rule established in late 2016. - Independent Fiscal Institution (IFI) created in December 2016. - Ongoing reform: new public financial management (PFM) law currently with the legislature. - Design of the new expenditure rule (MTER) - Rule "limits the growth in federal expenditures to the rate of inflation for the next twenty years with a possibility of revision after ten years." - Establishes multiyear expenditure caps, restricts Congress’ ability for upward adjustment in revenue forecasts, and shifts decision making to the budget preparation process. - Expected effects: more realistic budgets, greater prioritization of expenditures, and, if adhered to and supporting sustained primary surpluses, assistance with stabilizing and reducing public debt. - Implementation requirements - Structural, institutional, and procedural changes required: - Structural reforms and efficiency measures to stabilize debt and create fiscal space. - Major social security reform announced as essential for future adherence. - Institutional reforms to strengthen medium-term fiscal and budgetary management, notably implementing a medium-term framework and addressing budgetary rigidities. ### Improving budget flexibility — rigidities, effects, and recommended measures - Sources and consequences of rigidities - Major sources: mandatory spending, revenue earmarking, and indexation. - Rigidities contributed to rising expenditures in upturn phases that are difficult to reverse in downturns. - Public investment "has been cut in half in the budget between 2013 and 2017." - Rigid expenditures amounted to around 78 percent of the budget in 2016. - Almost 80 percent of central government revenues are earmarked. - Social security and wage pressures - Social security expenditures: 35.5 percent of total expenditures in 1998 to 41.3 percent in 2016. - Social security projected growth: expected to grow by 3.9 percentage points per annum as a share of total central government expenditures and reach 63 percent of the total budget in 2023. - Drivers: beneficiaries growing at 3-3.5 percent annually; some 64 percent of social security payments linked to the minimum wage; minimum wage adjustments linked to inflation and lagged real GDP growth. - Personnel measures: government and public sector trade unions agreed to an annual salary increase of 5.5 percent for 2017-2019; automatic personnel progression drives a 3 percent increase in aggregate salaries annually; therefore an 8.5 percent annual increase in personnel expenditures envisaged for the next two years. - Recommended processes to create flexibility and efficiency - Review mandatory expenditures and indexation practices; commence reviews of mandatory spending and indexation practices in excess of constitutional limits as a priority. - Establish a rolling program of spending reviews for large and fast growing programs. - Apply efficiency dividends on ministries’ operational expenses (example: reduce operating funding growth by e.g., 0.5 percent below the indexation factor). - Tax expenditure review: committee established; consider winding back or phasing out certain tax expenditures, introducing sunset clauses, and applying offset rules. - Strengthen medium-term forecasting of the public-sector wage bill and introduce regular benchmarking of public and private sector wages; prepare terms of reference for an independent report on public sector compensation. ### Strengthening medium-term fiscal and budgetary management (MTFF/MTBF/FSS) - Need for a Medium-Term Fiscal Framework (MTFF) - MTFF needed to support implementation of the expenditure rule by linking medium-term fiscal objectives to the budget process. - Key technical improvements and tools - Improve macroeconomic forecasts by embedding macro-fiscal linkages and setting up an iterative macro-fiscal forecasting process between SPE (Secretary of Economic Policy) and fiscal/budget sides (MOF, SOF). - Develop medium-term fiscal forecasts: Treasury to build a medium-term projection tool maintained by the Strategic Fiscal Planning Unit. - Strengthen revenue forecasting methods: RFB to assess costs and yields of current tax measures; conduct detailed analyses of forecast errors; involve Treasury and SOF in annual pre-PLOA forecast meeting. - Publish a Medium-Term Fiscal Strategy (MTFS) / Fiscal Strategy Statement (FSS) to guide the budget process: - FSS could accompany the Draft Budget Guidelines Law (PLDO) and be repeated in the Presidential Message attached to the Draft Annual Budget Law (PLOA). - Purpose: explain medium-term fiscal targets, priorities, and plans for adhering to the rule; communicate fiscal sustainability to stakeholders and the public. - Adopt a credible debt path (debt anchor) to guide fiscal policy and reinforce fiscal sustainability efforts. - Institutional coordination - Establish Ministerial Fiscal Committee (Minister of Finance, Minister of Planning, President’s Chief of Staff) to: - Agree on the primary balance and expenditure rule targets, the MTFS, budget priorities, and aggregate ceilings for ministries. - Ensure effective and timely public communication of the fiscal strategy. - Support with a Technical Committee representing macroeconomic policy, fiscal planning, and budget and planning functions. - MTBF sequencing - Starting 2017 develop expenditure baselines (forward estimates) for major sectors; Technical Committee with Budget Office to develop baseline methodology. - By early 2018 prepare medium-term bottom-up projections for major sectors and reconcile with the top-down macro-fiscal constraint. - Publish forward estimates in annual budget papers and adopt the updated baseline as the planning ceiling for the annual budget process. ### Embedding the expenditure rule in the budget process — procedures, timelines, and RAP - Two-stage, more strategic budget process - Stage 1: set ministerial expenditure ceilings earlier, before the LDO is considered by Congress. - Stage 2: discuss adjustments or reallocations of any fiscal space to priorities or allocate reductions. - Indicative calendar highlights (integration with budget cycle) - January: Technical Committee prepares updated macro and fiscal forecasts; MTBF when operational collects ministry bottom-up baselines. - February/March: Ministerial Fiscal Committee first strategic meeting — determines primary balance and expenditure targets, approves pre-ceiling allocations for PLDO. - April: FSS released when PLDO introduced. - July: Ministerial Fiscal Committee second strategic meeting — approves adjustments to ceilings; August PLOA introduced accompanied by updated FSS. - Restos a Pagar (RAP) management and dynamics - RAP stock amounted to some 2.4 percent of GDP at the beginning of 2017 and represents some 12 percent of annual expenditures. - Recommendation: develop a plan to gradually reduce the stock of RAP to no more than 3 percent of the aggregate level of expenditures; develop a detailed financial plan, updated annually, to track towards this target. - RAP types, cancellation rules and execution implications described in source (commitment, accrual, payment; processed/unprocessed RAP; cancellation rules with specific decrees cited). - Reporting and disclosure improvements - Enhance fiscal reporting: new tables on compliance with the rule, explanations on revisions and reconciliations in fiscal reports, budget documents, and the MTFS. - Provide regular information linking LOA’s aggregate appropriations and the rule’s paid expenditures (table in bimonthly execution reports). - Provide an annual performance assessment (tables and written explanations) against the rules in the MTFS and the citizens’ budget. - Legislative amendments and oversight changes - Proposals for new mandatory spending or tax expenditures must be accompanied by fiscal and financial impact assessments; Congress can block for 20 days. - Parliamentary amendment cap: since 2015 capped at 1.2 percent of net current revenue, half assigned to health; under the new rule from 2018 amendment reserve calculated as a share of the 2017 ceiling, adjusted for inflation. ### Ensuring compliance, transparency, independent oversight, and sanctions - Transparency and public access - Public access to compliance information is relevant ex ante, in-year, and ex post. - Treasury intends to report compliance in its monthly fiscal bulletin and in four-monthly reports on fiscal rules; use bimonthly execution reports to explain sequestrations. - Reports should explain exclusions from the rule, differences with scope of primary balance target, and reconcile commitments and payments. - Technical note: payments in primary balance target = outward flows from Treasury Single Account; payments for expenditure rule = recorded in SIAFI database; average one-day timeframe difference noted. - Independent oversight: IFI and TCU roles and resourcing - IFI established December 2016 by senatorial resolution; comprises six staff including Executive Director; four functions enumerated in source. - IFI intends to publish monthly reports with macro-fiscal forecasts and assessments of compliance; recommended to focus on assessment of compliance, long-term debt projections, and major fiscal reform studies. - Resource mismatch: peer institutions have far more staff (examples cited). - TCU mandated by Article 71 to conduct annual examination of final accounts; TCU intends bimonthly monitoring of compliance which may duplicate IFI work. - Sanctions, automatic adjustments, and escape clauses - Constitutional amendment lists automatic adjustments for non-compliance but is vague on triggering and ending mechanisms (who, when, how). - Practical options: - Triggering agency: Treasury well-placed, complemented by independent opinion (IFI, TCU). - Timing: either as soon as reason exists or at annual LOA application; include in bimonthly execution reports. - Escape clauses exist for natural disasters, war, civil unrest, but procedures to initiate and end them are unspecified; international experience recommends strict definitions and return plans. ### Medium-term projections (IFI projections — exact figures) - Primary revenue projections (R) (R$ BN): - 2017: 1152 - 2018: 1227 - 2019: 1313 - 2020: 1396 - 2021: 1484 - 2022: 1569 - 2023: 1660 - 2024: 1748 - 2025: 1840 - Primary expenditure projections (E) (R$ BN): - 2017: 1330 - 2018: 1390 - 2019: 1452 - 2020: 1518 - 2021: 1579 - 2022: 1642 - 2023: 1699 - 2024: 1759 - 2025: 1811 - Primary balance projection (R – E) (R$ BN): - 2017: -178 - 2018: -163 - 2019: -140 - 2020: -122 - 2021: -95 - 2022: -72 - 2023: -39 - 2024: -11 - 2025: 29 - Primary balance target (LDO) (R$ BN): - 2017: -139 - 2018: -79 - 2019: 0 - 2020: 0 - 2021: 0 - 2022: 0 - 2023: 0 - 2024: 0 - 2025: 0 - Need for consolidation (R$ BN): - 2017: 39 - 2018: 84 - 2019: 140 - 2020: 122 - 2021: 95 - 2022: 72 - 2023: 39 - 2024: 11 - 2025: -29 - IFI assumptions: revenues grow in line with nominal GDP; expenditures grow with inflation (reach expenditure ceiling); assumes social security reform has taken place. ### Summary of recommendations (prioritized) - High priority (***) - Review mandatory spending and indexation practices. - Develop a fully-fledged MTFF by improving medium-term macro-fiscal forecasting and publish a regular Fiscal Strategy Statement (FSS). - Adopt a credible debt path to guide fiscal policy. - Establish a Ministerial Fiscal Committee supported by a standing Technical Committee. - Develop an MTBF with multiyear expenditure baselines and guidelines on new policy costings. - Set top-down expenditure ceilings and examine priorities against available fiscal space. - Ensure transparent fiscal reporting on compliance (monthly bulletin, bimonthly execution reports, four-monthly reports). - Medium priority (**) - Establish and coordinate spending reviews, efficiency dividends, and tax expenditure reviews. - Produce more analyses on in-year revisions and reconciliations in execution reports. - Improve revenue forecasting by assessing past tax measures and setting up a forecast review process. - Publish forward estimates in annual budget papers and adopt updated baselines as planning ceilings. - Develop plan to reduce RAP stock to no more than 3% of aggregate expenditures. - Provide regular information linking LOA appropriations and the rule’s paid expenditures. - Low priority (*) - Strengthen medium-term forecasting of the public-sector wage bill and introduce regular public/private wage comparisons. - Focus IFI on compliance assessment, studies on major fiscal reforms and long-term sustainability analyses. - Consider procedures for triggering, implementing and ending automatic adjustments and escape clauses. ### Annex guidance — Outline for a Fiscal Strategy Statement (FSS) - Purpose: strategic communication tool to place fiscal debate on a medium-term footing and hold government accountable. - Elements to include: - Core fiscal targets: primary balance and expenditure targets in context; supplementary targets (education, health, indicative public investment). - Indicative primary balance target over a longer horizon; consider firmer translations (rolling average, structural balance). - Indicative revenue and expenditure as share of GDP. - Projections for growth in mandatory, non-discretionary and other expenditure showing discretionary fiscal space. - Projections for revenue with tax expenditure estimates. - Assessment of aggregate reforms required to deliver on fiscal rules and profile of gross and net debt. - Projections of main fiscal aggregates for 5 and ultimately 10 years, updated annually and compared to prior vintages. - Macro-fiscal analysis, risks, alternative scenarios and potential formal debt anchor over time. *Source: IMF technical assistance mission report (cr17292).* ### PREFACE _________________________________________________________________________________________________ 5 ### PREFACE — cr17292 ### Mission background and contacts - An IMF technical assistance mission visited Brasilia, Brazil during the period March 8–24, 2017. - The mission was led by Dr. Teresa Curristine and comprised of Fabien Gonguet, Matthew Crooke and Jorge Baldrich (all FAD experts). Fabian Bornhorst (IMF Resident Representative) also participated. - The mission met with the Minister of Finance, Mr. Henrique de Campos Meirelles, and presented its preliminary report. - Key National Treasury contacts: Secretary Ms. Ana Paula Vescovi; Undersecretary for Fiscal Planning and Statistics Mr. Pedro Jucá; General Coordinators Mr. Daniel de Araujo; Mr. André Proite; Mr. Felipe Bardella; Mr. Renato Andrade; Coordinator for Financial Planning Ms. Roberta Pereira. - Other MOF and ministry contacts: Secretary for Economic Affairs Mr. Mansueto Almeida; Secretary for International Affairs Mr. Marcello Estevao; Secretary for Social Security Mr. Marcelo Caetano; Undersecretary for Economic Policy Mr. Jeferson Bittencourt; Mr. Claudemir Malaquias; Mr. Paulo Ricardo Cardoso (Federal Revenue Authority). - Ministry of Planning contacts: Secretary of the Infrastructure Development Office Mr. Hailton Almeida and directors Messrs. Manoel Filho and Bruno Leal; Deputy Federal Budget Secretary (SOF) Mr. Geraldo Juliao; General Coordinator for Macroeconomic Evaluation Mr. Luiz Henriques. - Other institutional meetings included: Ministry of Defense, Ministry of Transport, Ministry of Health, Casa Civil of the Presidency, TCU (Mr. Leonardo Albernaz), World Bank Country Director (Mr. Martin Raiser), Independent Fiscal Institution (Messrs. Gabriel Leal de Barros and Carlos Eduardo Gasparini), Advisor of the Chamber of Deputies (Mr. Helio Tollini), and Central Bank of Brazil officials Messrs. Fernando Rocha, Edric Martins Ueda and Luiz Gonzaga de Queiroz Filho. - The mission thanked Brazilian authorities for cooperation and noted special assistance from Mr. Daniel de Araujo e Borges, Mr. Luis Felipe Vital Nunes Pereira, and Ms. Thayssa Mendes Tavares Pena and their staff. ### Executive summary — key findings and policy implications - Context and objective - Brazil has faced "its deepest economic recession in decades" since 2015, with a sharp deterioration in the fiscal situation: a significant drop in revenues and debt increasing above the emerging market average. - The government is reforming its fiscal framework to promote fiscal sustainability and reduce debt. - Recent reform progress - In late 2016, a new expenditure rule was established and a new Independent Fiscal Institution (IFI) was created. - Reforms are ongoing, including a new public financial management (PFM) law currently with the legislature. - Design of the new expenditure rule - The rule "limits the growth in federal expenditures to the rate of inflation for the next twenty years with a possibility of revision after ten years." - It establishes multiyear expenditure caps, restricts Congress’ ability for upward adjustment in revenue forecasts, and shifts decision making to the budget preparation process. - Expected effect: create more realistic budgets, promote greater prioritization of expenditures, and, if adhered to and supporting sustained primary surpluses, assist with stabilizing and reducing public debt. - Implementation requirements - Successful implementation requires structural, institutional, and procedural changes: - Structural reforms and efficiency measures to stabilize the debt and create fiscal space. - The government has announced a major social security reform deemed essential for future adherence to the rule. - Institutional reforms to strengthen medium-term fiscal and budgetary management, notably implementing a medium-term framework and addressing budgetary rigidities. ### Improving budget flexibility — reducing rigidities (findings and recommended measures) - Sources and consequences of rigidities - Major sources: mandatory spending, revenue earmarking, and indexation. - These rigidities contribute to rising expenditures during economic upswing phases that are difficult to reverse in downturns. - Short-term consolidation efforts have focused on discretionary spending; public investment "has been cut in half in the budget between 2013 and 2017." - Recommended processes to create flexibility and efficiency - Review mandatory expenditures and indexation practices. - Establish a rolling program of spending reviews for large and fast growing programs. - Apply efficiency dividends on ministries’ operational expenses. - Tax expenditure review: a committee has been established and should consider winding back or phasing out certain tax expenditures, introducing sunset clauses, and applying offset rules. ### Strengthening medium-term fiscal and budgetary management (actions and sequencing) - Need for a Medium-Term Fiscal Framework (MTFF) - An MTFF is needed to support implementation of the expenditure rule by linking medium-term fiscal objectives to the budget process. - Key steps and technical improvements - Improve macroeconomic forecasts by embedding macro-fiscal linkages and setting up an iterative macro-fiscal forecasting process. - Develop medium-term fiscal forecasts by building a medium-term projection tool enabling assessment of available fiscal space. - Strengthen revenue forecasting methods and processes by assessing costs and yields of current tax measures and enhancing revenue forecasting skills and forecast review procedures. - Publish a Medium-Term Fiscal Strategy (MTFS) / Fiscal Strategy Statement (FSS) to guide the budget process: - The MTFS/FSS could accompany the Draft Budget Guidelines Law (PLDO) and have the core strategy repeated in the Presidential Message attached to the Draft Annual Budget Law (PLOA). - Purpose: explain medium-term fiscal targets, priorities, and plans for adhering to the rule; communicate the importance of fiscal sustainability to stakeholders and the public. - Adopt a credible debt path to guide fiscal policy and reinforce fiscal sustainability efforts. - Institutional coordination - Create a Ministerial Fiscal Committee (Minister of Finance, Minister of Planning, President’s Chief of Staff) to: - Agree on the primary balance and expenditure rule targets, the MTFS, budget priorities, and aggregate ceilings for ministries. - Ensure effective and timely communication to the public of the government’s fiscal strategy. - Support the Ministerial Committee with a Technical Committee representing macroeconomic policy, fiscal planning, and budget and planning functions. - Medium-Term Budget Framework (MTBF) steps - Starting in 2017 develop expenditure baselines (forward estimates) for major sectors or areas of expenditure; the Technical Committee with the Budget Office to develop the baseline methodology working with spending ministries. - By early 2018 prepare medium-term bottom-up projections for major sectors or economic levels and reconcile with the top-down macro-fiscal constraint. - Publish forward estimates in annual budget papers and adopt the updated baseline (adjusted for parameter changes) as the planning ceiling for the annual budget process. ### Embedding the new expenditure rule in the budget process (procedural changes and monitoring) - Budget process redesign - Move to a more strategic, two-stage budget process: - Stage 1: set ministerial expenditure ceilings earlier, before the Budget Guidelines Law (LDO) is considered by Congress. - Stage 2: discuss adjustments or reallocations of any fiscal space to priority areas or allocation of reductions. - Link the rule to budget execution and cash management. - Restos a Pagar (RAP) management - Develop a plan to gradually reduce the stock of Restos a Pagar (RAP) to no more than 3 percent of the aggregate level of expenditures. - Reporting and disclosure improvements - Enhance fiscal reporting: include in fiscal reports, budget documents, and the MTFS new tables on compliance with the rule and explanations on revisions and reconciliations. - Provide regular information on the link between LOA’s aggregate appropriations and the rule’s paid expenditures. - Provide an annual performance assessment (tables and written explanations) against the rules in the MTFS and in the citizens’ budget. - Role of the Independent Fiscal Institution (IFI) - The IFI will play a key role in monitoring the rule. - Given limited resources, the IFI’s activities should focus on: - Assessment of compliance with the fiscal rules. - Studies on major fiscal reforms. - Long-term sustainability analyses. - Escape clauses and sanctions - Consider developing procedures for triggering, implementing and ending escape clauses and automatic adjustments in case of non-compliance with the rule. - Apply sanctions consistent with transparent reporting and independent oversight (discussed later in the document). ### Summary of Recommendations (selected items and priorities) - High priority (***) - Review mandatory spending and indexation practices. - Develop a fully-fledged MTFF by improving medium-term macro-fiscal forecasting and publishing a regular fiscal strategy statement (FSS) to guide the budget process. - Adopt a credible debt path to guide fiscal policy and reinforce fiscal sustainability efforts. - Establish a Ministerial Fiscal Committee supported by a standing Technical Committee. - Develop a MTBF with multiyear expenditure baselines (forward estimates) for major sectors and guidelines on new policy costings. - Bring a medium-term perspective to the budget process by setting top-down expenditure ceilings and examining priorities against available fiscal space. - Ensure transparent fiscal reporting on compliance (monthly bulletin, bimonthly execution reports, four-monthly reports on compliance with fiscal rules). - Medium priority (**) - Establish and coordinate processes including spending reviews, efficiency dividends, and tax expenditure reviews. - Produce more analyses on in-year revisions and reconciliations of macro-fiscal aggregates in execution reports. - Improve revenue forecasting methods and processes by assessing the cost or yield of previous tax measures and by setting up a forecast review process. - Publish the forward estimates in annual budget papers and adopt the updated baseline as the planning ceiling for the annual budget process. - Develop a plan to gradually reduce the stock of RAP to no more than 3% of the aggregate level of expenditures. - Provide regular information on the link between LOA’s aggregate appropriations and the rule’s paid expenditures. - Low priority (*) - Strengthen medium-term forecasting of the public-sector wage bill and introduce regular comparisons of public and private sector wages. - Focus IFI on the assessment of compliance with the fiscal rules, studies on major fiscal reforms and long-term sustainability analyses. - Consider procedures for triggering, implementing and ending automatic adjustments in case of non-compliance and to activate escape clauses. *Source: IMF technical assistance mission report (cr17292) — Preface and Executive Summary.* ### 1. The 2000 Fiscal Responsibility Law (FRL) remains the backbone of Brazil’s fiscal ### 1. The 2000 Fiscal Responsibility Law (FRL) remains the backbone of Brazil’s fiscal framework ### FRL and the budget framework - The FRL sets the framework and procedures for fiscal management and the budget process. - Objectives: containing fiscal deficits and rising debt through overall targets (primary balance) and limits on the wage bill, debt and guarantees for all levels of government. - Primary balance targets are set every year at the beginning of the budget process. - The primary balance target is specified in the PLDO for the current year and, indicatively, for two additional years. The PLDO is sent to Congress for approval in April and includes a statement of the budget’s goals and the rules governing cost control and evaluation of programs. - The PLOA is submitted by end-August and contains the detailed statement of annual budget programming compatible with the PLDO. ### Historic performance and emerging weaknesses - 2000s: FRL plus high economic growth delivered fiscal discipline at Federal and lower government levels, enabling a sizeable reduction of federal government net debt and control of payroll expenditures. - Buoyant revenues during high growth masked underlying weaknesses. - Pre-recession cracks included: - Unrealistic budgets based on optimistic revenue forecasting. - Congress’ use of a Constitutional loophole to correct “errors and omissions” to further inflate revenue forecasts, creating artificial headroom for spending while remaining within primary balance targets. - Fiscal slippage averted through Presidential Decrees to contain expenditure execution, compromising smooth and predictable budget execution. - Other weaknesses: widespread earmarking of revenues, large mandatory spending items, generous indexation practices, and a fragmented, short-term budget process. - Brazil has aspects of a medium-term framework, but these are fragmented and do not guide the budget process nor drive strategic fiscal decision making. ### 2016 fiscal position and immediate reforms - 2016 projections: overall fiscal deficit projected to reach 9.7 percent of GDP with a non-financial public sector (NFPS) primary deficit of 2.6 percent and a public sector gross debt of 74.8 percent of GDP. - Government actions: adopting structural measures (mainly social security reform ongoing in Congress) and reforms to the fiscal framework. - Recent complementary reforms to the FRL (within the past year): - New medium-term expenditure rule (MTER) enshrined in the Constitution. - Establishment of the IFI in December 2016 (based in the Senate; four-member board, one member appointed; five permanent staff). IFI remit includes regular analysis of government fiscal performance; elaboration of medium-term forecasts of macro parameters, fiscal indicators and fiscal impacts; advice to Congress on fiscal issues. - Treasury improvements: better fiscal forecasts and new models; expanding the LDO’s fiscal risk annex to include fan charts and more scenarios. - Legislative developments: new public finance law to replace 1964 legislation passed in the Senate and soon before the lower house to modernize and standardize budgetary processes and bring a medium-term perspective. - MOF committees: evaluation of major investments, existing expenditure programs, and tax expenditures; Federal Budget Office (SOF) started spending reviews. - IMF FAD missions: March 2016 (Developing a More Resilient Fiscal Framework) and June 2016 (Fiscal Transparency Evaluation) — government has implemented several recommendations (IFI, expenditure rule, improved Fiscal Risk Statement). ### The new medium-term expenditure rule (MTER) — rationale - Constitutional Amendment No. 95 (adopted December 15, 2016) establishes a new expenditure rule for the next twenty years; the MTER essentially stabilizes real primary spending (with some exceptions) at its 2016 level. - Rationale: - Improve fiscal discipline and rebuild fiscal credibility after rapid revenue collapse and strong expenditure growth. - Signal commitment to fiscal discipline: clear (highest legal status) and ambitious (requires structural reforms and overcoming expenditure rigidities). - Change political economy of budget process by reducing inefficiencies specific to Brazil: - LDO fiscal targets guided by resource availability rather than optimistic revenue assumptions. - Expenditure ceilings should elicit more realistic proposals from line ministries earlier in the process. - Less incentive for Congress to inflate revenue forecasts; debate shifts to resource reallocations within ceilings. - Improved budget credibility should reduce sequestration requirements and limit formation of new arrears by applying ceilings to both appropriations and payments. ### Key features of the new fiscal regime (MTER) - The rule sets ceilings on actual primary expenditure for the next twenty fiscal years, with a mid-term review process. - Trajectory definition: - Base = total of primary expenditures paid in 2016. - Annual growth rate applied to base = 12-month inflation rate for the period ending in June of the year prior to the budget year. - Result: rule freezes real primary expenditure roughly at its 2016 level. - Note: An inflation rate of 7.2 percent was applied to the 2016 base to calculate the 2017 ceiling to roughly stick to the 2017 budget. - Scope and application: - Ceiling applied to actual payments including RAP (unpaid commitments carried over) and to appropriations voted in the annual budget. - Applies to all branches of federal government (Executive, Legislature, Judicial) with each branch receiving its own ceiling within the overall ceiling. - Excludes extraordinary credits for urgent and unpredictable events (natural disasters, war, civil unrest). - Binding from the fiscal year 2018. - Coverage specifics: - Constitutional transfers (essentially to states and municipalities) and bailouts of non-financial state-owned enterprises explicitly excluded. - Preservation and changes to sector protections: - Education and health protection maintained but mechanism changed: - Previously: minimum percentage of revenue (education 18 percent of net tax revenue; health 15 percent of net current revenue). - From 2018: floors defined—expenditure for each sector should be superior to their respective shares in the 2017 total primary expenditure ceiling. Additional funds may be allocated as long as within the overall expenditure ceiling. - Legislative and judiciary branches: for first three years, ability to exceed their ceilings for a maximum cumulative total of 0.25 percent of the Executive branch’s ceiling; excess offset by corresponding decrease in Executive branch budget. - Safeguards for compliance: - Ex ante: obligation to accompany any legislative proposal for new mandatory spending or new tax expenditure with an assessment of fiscal and financial impact; Congress can block for 20 days and review bills suspected of incompatibility with the rule. - Ex post: automatic adjustments/sanctions for non-compliance including freezes on new mandatory spending items, salary increases and new hires, expansion/creation of credit lines, programs or tax incentives, and increases to mandatory spending beyond inflation. ### Implementation challenges and risks - Three categories of challenges: - Expenditure policy challenges: need structural reforms, increased expenditure flexibility, and improved macroeconomic fundamentals to benefit fully from the rule. - Political economy challenges: stakeholders may resist necessary changes in budget procedures. - Evasion risk: possibility of creative mechanisms undermining the rule. - Specific risks: - Even with proposed social security reform passage, future adjustments will be needed to reach a balanced budget in the medium term because financial benefits from social security reform will not emerge immediately. - By 2020, given trajectory of mandatory expenditure, without additional adjustments it will be difficult to comply with the expenditure rule. - Potential outcomes if spending rigidity persists: - (i) Rule non-compliant or amended; or - (ii) Rule complied with but at the expense of public investment. - Economic cycle risk: - Expenditure rules are more efficient in good times due to countercyclical discipline; in slow/negative growth periods they can limit capacity for fiscal stimulus. - The new rule contains no economic “escape clause” defining conditions to temporarily suspend the rule and procedures for return. - Stakeholder preparedness and communication: - MOF and MPB should proactively prepare stakeholders for rule consequences. - Drafting involved highest Executive authorities, Congress and Senate, but explanations about Executive compliance strategy have been scarce. - Line ministries may not be fully aware of impacts on their future budget envelopes, risking budget negotiations. - Financial ministries and the Presidency must coordinate with line ministries and provide clearer strategic communication to reduce political costs of consolidation. ### Medium-term projections (Independent Fiscal Institution (IFI) projections — Table 3) - Primary revenue projections (R) (R$ BN): 2017: 1152; 2018: 1227; 2019: 1313; 2020: 1396; 2021: 1484; 2022: 1569; 2023: 1660; 2024: 1748; 2025: 1840. - Primary expenditure projections (E) (R$ BN): 2017: 1330; 2018: 1390; 2019: 1452; 2020: 1518; 2021: 1579; 2022: 1642; 2023: 1699; 2024: 1759; 2025: 1811. - Primary balance projection (R – E) (R$ BN): 2017: -178; 2018: -163; 2019: -140; 2020: -122; 2021: -95; 2022: -72; 2023: -39; 2024: -11; 2025: 29. - Primary balance target (LDO) (R$ BN): 2017: -139; 2018: -79; 2019: 0; 2020: 0; 2021: 0; 2022: 0; 2023: 0; 2024: 0; 2025: 0. - Need for consolidation (R$ BN): 2017: 39; 2018: 84; 2019: 140; 2020: 122; 2021: 95; 2022: 72; 2023: 39; 2024: 11; 2025: -29. - IFI assumptions: revenues projected to grow in line with nominal GDP, expenditures grow with inflation (reach the expenditure ceiling), under the assumption that the social security reform has taken place. ### Focus going forward (report emphasis) - Implementing the new expenditure rule is the government’s priority to make the budget more realistic by imposing a multiyear ceiling on expenditures and improving expenditure prioritization during budget preparation. - The government must combine primary balance targets and expenditure ceilings in fiscal planning; authorities consider primary balance targets will be more binding until 2019, but from 2020 mandatory expenditure trajectory makes compliance with the expenditure rule difficult without additional structural adjustments. - This report focuses on institutional and procedural reforms needed to support implementation of the new rule, requiring a more medium-term focus for fiscal policy and budgeting. Succeeding chapters (as organized in the report) address: (i) the new expenditure rule and implementation challenges; (ii) sources of budget rigidity and options to improve spending efficiency; (iii) strengthening medium-term frameworks to support fiscal sustainability and strategic budget decision making; (iv) embedding the new rule within the budget process; and (v) reporting and procedural measures to ensure compliance with the new rule. *Source: IMF staff report content (cr17292).* ### 23. International experience shows that budget stakeholders may be naturally tempted ### 23. International experience shows that budget stakeholders may be naturally tempted ### Risks to the expenditure rule and current rule design - Budget stakeholders may seek ways around rules and their objectives; compliance difficulties can lead to attempts to work around rules or transform their purpose. - The expenditure rule covers a limited part of the non-financial public sector expenditure. - Fiscal discipline may be hindered by increases in spending items excluded from the ceiling or by the creation of new tax expenditures, despite apparent compliance with the MTER. - This risk is amplified if the primary balance target is adjusted annually to make room for these measures. - There is no medium-term debt anchor or target complementing the current rules. - No mechanism ensures that working around the expenditure rule will not result in a ramp-up in public debt. - International experience shows medium-term expenditure ceilings usually go together with debt rules. - 84% of countries implementing an expenditure rule also implement a debt rule. - 36% of all countries implement a debt rule, a budget balance rule and an expenditure rule at the same time. - Only 24% of countries which set medium-term expenditure ceilings at an aggregate level do so without also having a debt rule. - Treasury monitoring has reduced the stock of RAP in recent years, but: - Even if appropriations cannot cross the expenditure ceiling, line ministries could, at the sequestration stage, be provided with more commitments than payments, potentially leading to arrears. ### PFM and institutional reforms needed to support the expenditure rule - Effective implementation of the rule requires fulfillment of preconditions: - Setting up strong medium-term strategic planning and allocation processes. - Integrating the new rule with the budget process. - Ensuring compliance with the new rule in a transparent manner. ### International experience in adopting expenditure rules (Box 1 — key points) - The most common combination of fiscal rules is a debt and a budget balance rule. - In 2015, out of 96 countries covered by the IMF Fiscal Rules Dataset, close to 80 implement either a debt rule, a budget balance rule, or both. - Expenditure rules have grown more common since the 2008-09 global financial crisis as a complementary way to constrain discretionary spending. - In the 38 countries implementing both an expenditure rule and a debt rule, only 4 implemented an expenditure rule on its own before later adopting a debt rule. - The option to adopt an expenditure rule with a simultaneous debt rule is usually preferred. ### Improving budget flexibility — reducing rigidities (overview) - Three major sources of rigidity in government spending: earmarking of revenues, mandatory spending, and constitutional provisions for indexation. - Rigid expenditures amounted to around 78 percent of the budget in 2016; their growth rate is determined by legally mandated indexation. - Growing obligatory expenditures and recession-constrained revenues caused a sizable decline in public investment in both nominal and real terms over the last two years referenced in the source. - Between 2013 and 2016 central government revenues increased by 11.5% whereas the wage inflation of the combined period was 26.3%. ### Earmarking and constitutional floors - Almost 80 percent of central government revenues are earmarked. - Constitutional mandates: - Article 212: mandatory education spending floor equivalent to 18 percent of net current revenue for the federal government. - States, the federal district and municipalities must assign no less than 25 percent of their revenues including federal transfers to education. - Minimum expenditure on health: constitutional mandate increases the percentage of net current revenues from 13.2 percent in 2016 to 15 percent in 2017. - The basis for calculating the floor has changed with the expenditure rule, but a floor remains. ### Social security and wage-driven pressures - Social security expenditures increased from 35.5 percent of total expenditures in 1998 to 41.3 percent in 2016. - Social security outlays are expected to grow by 3.9 percentage points per annum as a share of total central government expenditures and reach 63 percent of the total budget in 2023. - Drivers: - Number of beneficiaries growing at a 3-3.5 percent annually. - Some 64 percent of social security payments are linked to the minimum wage. - Last year’s rate of inflation and two years lag real rate of economic growth are used to adjust the minimum wage; the inflation-linked adjustment is constitutional while the real GDP growth link is established in legislation. - Personnel and social charges: - In 2013-2016 the growth rate of personnel and social charges was 2.2 times the growth rate of total revenues. - Government and public sector trade unions agreed to an annual salary increase of 5.5 percent for the 2017-2019 period. - Automatic personnel progression drives a 3 percent increase in aggregate salaries annually. - Therefore, an 8.5 percent annual increase in personnel expenditures is envisaged for the next two years. ### Effects on public investment and in-year adjustments - High and growing budget rigidity makes it increasingly difficult to comply with fiscal rules without endangering public investment. - Government frequently conducts in-year expenditure adjustments to meet its primary balance target; limited room to maneuver focuses adjustments on discretionary spending, mainly public investment. - Planned public investment as a share of planned total PLOA expenditures halved between 2013 and 2017, with even greater reductions during budget execution. ### Use of the DRU to increase flexibility - Release of Union’s Revenues (Desvinculação de Receitas da União — DRU) used to increase flexibility. - 1994: Social Emergency Fund launched and funded by the financial release of 20 percent of earmarked revenues. - 2000: the fund’s name changed to DRU. - Most DRU receipts stem from Social Security Contributions and are discretionarily assigned as financing sources to expenditures decided by the MOF. ### Need for options to reduce rigidities - Demographic and structural drivers of key programs require declining real expenditure trajectories. - Near-term compliance with the new expenditure rule requires creating fiscal space through a range of policy measures. ### Improving spending efficiency — objectives and mechanisms - Aim: regain space for priority spending, particularly public investment with positive spillovers. - Regular and comprehensive program reviews can improve value for money and quality of public service provision; savings could be reinvested in areas such as health and education. - Suggested ancillary mechanisms linked to the budget cycle for quicker, modest results: Review of mandatory spending and indexation practices - Gradually slow growth in some mandatory or legislatively-indexed spending items while remaining within constitutional limits. - Key targets: annual adjustments to the minimum wage and public sector salaries; using lower indexation factors could produce significant savings over time. - Central agency–led review to identify other areas for gradual adjustments (e.g., subsidies). Spending reviews linked to the budget process - Spending reviews establish processes to pursue explicit savings targets to be delivered by ministries or programs for the budget process. - Example: United Kingdom rolling reviews contributed to reducing the spending-to-GDP ratio by five percentage points in five years. - In “business as usual” cases, more modest savings targets can build fiscal space or allow headroom for new priorities. - Reviews examine baseline/recurrent spending of each ministry to assess outcomes. - Leadership models: - Line ministry–led: ministries identify preferred savings within a specific envelope; incentives align if ambition is modest and ministries can reinvest in new priorities. - Central-agency led: used for larger or thematic exercises (e.g., reducing the size of government). Tax expenditures review, sunset clauses, one-in-two-out methodology - Extensive use of tax expenditures offers options to reclaim fiscal space; tax expenditures have been used to bypass expenditure rules in some countries. - MOF is proposing a broad-ranging review of tax expenditures and establishing a committee to conduct it. - Consider winding back or phasing out concessions with no standing legal basis or those no longer serving intended purposes. - Policy mechanisms to contain tax expenditures: regular reviews, fixed term (sunset clause), or rules requiring offsets for new tax expenditures. - Space from such exercises could facilitate broader tax reforms to improve efficiency and competitiveness. Efficiency dividends - Across-the-board constraints on operating expense growth can incentivize ministries to find savings. - Example mechanism: reduce growth in operating funding by a small amount each year (e.g., 0.5 percent below the indexation factor). - The efficiency factor level is arbitrary but can be informed by expected productivity improvements, gradual headcount reductions, or general wage restraint. - Caution: overuse or long-term use can have unintended consequences on smaller ministries or those with less flexible budgets. ### Institutional requirements for spending reviews - Joint effort with SOF, active cooperation by relevant line ministries, and involvement of external experts will facilitate spending reviews. - Presidential Office authority in establishing initial savings targets is important. - Policy options and savings from these processes should be presented to ministers early in the budget process to inform compliance with the expenditure rule and space for priorities. ### Recommendations (summary; elaborated in Action Plan Annex 1) Reducing rigidities and improving spending efficiency - MOF should initiate a review of mandatory spending and indexation practices. - Reviews of mandatory spending and indexation practices in excess of limits defined by the Constitution should commence as a priority. - Additional changes to legislation and norms to disconnect spending and indexation could be implemented in parallel to the 2018 budget. - SOF and MOF should establish and coordinate a suite of policy processes to build budget flexibility over time, including: - Spending reviews linked to the budget process with specific savings targets for ministries and/or large and fast-growing programs; - Reviewing all tax expenditures to consider winding back or phasing out certain expenditures, introducing sunset clauses and/or applying offset rules; and - Applying efficiency dividends to ministries’ operational expenses. - Strengthen medium-term forecasting of the public sector wage bill and introduce regular benchmarking and comparisons of public and private sector wages. - Prepare terms of reference for an independent report on public sector compensation; propose recommendations to the Cabinet with legislation to follow if required. ### Strengthening medium-term fiscal and budgetary management - Strong case for fiscal frameworks that shift debate to the medium term, especially with fiscal rules. - Medium-term frameworks reduce shortsighted incremental allocations and support strategic, forward-looking fiscal decision-making. - Types of medium-term frameworks: - Medium-term fiscal framework (MTFF): sets aggregate fiscal targets and broad expenditure ceilings. - Medium-term budget framework (MTBF): adds strategic prioritization of expenditure by sector, ministry and/or program. - Medium-term performance framework: links budget to medium-term performance indicators, targets and results. - A medium-term framework is primarily an institutional arrangement for setting and enforcing multiyear fiscal objectives across formulation, approval and execution. Brazil’s existing instruments and gaps - Brazil has several medium-term instruments but they are not sufficiently coordinated to constitute a full medium-term framework. - Multiyear Plan (PPA): published in the first year of a government, defines strategic targets and programs for four years and includes a detailed macro-fiscal scenario and broad resource estimates; in practice relies on optimistic assumptions and does not provide a policy anchor. - Program for the Acceleration of Growth (PAC): prioritization process for investment projects; has allocated space for projects but recent downturn led to cuts to comply with primary balance targets. - Budget Guidelines Law (LDO): submitted annually to Congress; includes economic assumptions, fiscal targets for the primary budget balance, debt levels, and revenue forecasts for the budget year and two years forward. - Limitations: - PPA does not rely on a realistic macro-fiscal scenario and does not guide the budget process. - LDO lacks detailed information on projections and policy choices required to reach fiscal targets. - Neither document presents expenditure estimates at program or ministry level; they do not constitute MTBFs. *IMF staff summary based on cr17292 content.* ### 40. Building on existing initiatives, it is important for Brazil to develop a fully-fledged ### cr17292 - 40. Building on existing initiatives, it is important for Brazil to develop a fully-fledged ### B. Strengthening Macro-Fiscal Forecasting and Processes - Purpose of MTFF: - A MTFF is not only multiyear projections, but also refers to the principles, objectives, rules, targets and practices (formal or otherwise) that instill discipline and transparency in fiscal policy and budget planning. - The new expenditure rule is intended to be a binding, multiyear constraint that will guide all aspects of budget planning, preparation and execution. - Implementation tasks identified: - Strengthen macroeconomic forecasting and develop a MTFS to guide the budget process. - Simultaneously build on existing work to develop a MTBF. ### Macroeconomic forecasting - Institutional responsibilities and timing: - The Secretary of Economic Policy (SPE), within the MOF, is responsible for the macroeconomic forecasts underlying all budget and fiscal documents. - Some SPE macro-econometric forecasting models have been used for the last fifteen years. - Macroeconomic forecasts for the current year are updated every other month to underlie revenue projections and expenditure targets set in the bimonthly execution reports. - Macroeconomic forecasts for the budget and forward years are finalized in April for inclusion in the PLDO, and subsequently revised for the PLOA. - Forecast quality issues and recommendations: - Between 2011 and 2015, the average deviation between one-year-ahead real GDP growth forecasts and outturns has been systematically negative, reaching -3.9 percentage points on average over the period (-0.7 percentage point over 2001-2010). - The optimism bias may reflect outdated model specifications; more extensive analyses on how to explain forecasting errors in recent years should be carried out to identify potential sources for bias. - The ex post reconciliation between forecasts and outturns should also be published, possibly in the Presidential message attached to the PLOA, to improve credibility. - Transparency and breadth of published indicators: - Only a limited number of macroeconomic indicators are currently communicated to fiscal and budget departments (Treasury, Federal Revenue Secretariat, SOF): mainly real GDP growth, GDP deflator, inflation, wages, payroll and consumption of a selection of products (e.g., cigarettes, cars). - The demand or supply breakdown of the GDP growth forecasts is neither sent to other departments and agencies nor released to the public. - Recommendation: share a wider selection of projected macroeconomic indicators, over a longer period, with the Executive and release them publicly to support revenue forecasting methods and fiscal policy decisions. ### Macro-fiscal linkages - Importance and current gap: - Fiscal consolidation measures differ in macroeconomic impact; tax increases and different types of expenditure cuts have distinct growth effects. - Macro-fiscal linkages are currently not taken into account in the macroeconomic forecasts in Brazil; except for a few ad hoc SPE studies, there is no structured mechanism to reflect the economic effect of new fiscal policies in SPE-produced macro indicators and consequent revenue and expenditure forecasts. - Recommended actions: - The SPE should progressively build on the existing macroeconomic model to include macro-fiscal linkages by: - Conducting systematic analysis of the macroeconomic impact of new fiscal policy measures, based on macro-econometric simulations and the estimation of main elasticities of macroeconomic indicators to fiscal changes. - Participating in the proposed Technical Committee so that the macroeconomic impact of the fiscal strategy is part of the debate. - Establish an iterative forecasting process between macroeconomic (SPE) and fiscal/budget (MOF and SOF) sides to allow a longer back-and-forth (ideally over a few weeks) to integrate interactions between the real sector and the fiscal sector.7 ### Revenue forecasting - Institutional roles and methods: - The Federal Revenue Secretariat (RFB) forecasts all tax and customs revenue items it collects (i.e., close to two thirds of total nonfinancial federal revenue).8 - For each tax or customs revenue, RFB applies the macroeconomic indicator it deems most appropriate to the base; the impact of new revenue policy measures is then added. - Depending on the measure, RFB uses simple extrapolations or microsimulations based on individual tax information; RFB also assesses the impact of tax expenditures. - Main forecasting exercises occur ahead of the PLDO and the PLOA; forecasts for the current year are revised ahead of the bimonthly execution reports based on early-year revenue collection. - Recent performance and suggested improvements: - Revenue forecasting errors have been significant in recent years, in particular due to the economic downturn.9 - Recommendations for RFB: - Identify macroeconomic indicators it would like to use as first-best assumptions for revenue forecasts and communicate them to the SPE; where SPE cannot provide them, use other sources transparently. - Assess the impact of major tax and customs measures decided in the past ten years to distinguish them from natural tax evolution and to review costs and yields of past policies. - Conduct detailed analyses of forecast errors to distinguish errors due to macroeconomic indicators (SPE responsibility) from other causes (wrong estimation of new measures, variations in revenue collection, etc.). All revisions presented in bimonthly execution reports should be explained to the public. - Governance recommendation: - Involve other stakeholders (Treasury, SOF) more in revenue forecasting; hold an annual meeting ahead of the PLOA to structure exchanges, shape a budget “storyline,” and result in MOF decisions on forecasts to be proposed in the budget bill. ### C. Implementing a Medium-Term Fiscal Framework: Strengthening Medium-Term Forecasts and Developing a Fiscal Strategy - Purpose and upstream orientation: - The new multiyear expenditure rule requires developing a MTFF, improving medium-term forecasts and developing a fiscal strategy to guide the budget process. - Upstream aspects of the MTFF should adopt a more medium-term orientation including overarching fiscal objectives, fiscal strategy, fiscal stance, and associated government policy priorities, requiring improved coordination across government. ### Medium-term fiscal forecasts - Tools and responsibilities: - Fiscal aggregate projection methodologies (medium- to long-term estimates of revenue, expenditure, budget balance and debt) are needed to illuminate fiscal implications of existing policy settings and risks to fiscal sustainability. - Medium-term fiscal forecasts should remain mainly under the responsibility of the Treasury because longer horizons entail higher macro-fiscal uncertainties and the Treasury has the expertise to conduct such projections. - Medium-term revenue forecasts, being less reliant on collection and more on macroeconomic projections, could primarily fall under the Treasury (with input from RFB on measures or collection trends). - Proposed Treasury tool and current work: - The Treasury should build a medium-term projection tool, maintained by the Strategic Fiscal Planning Unit, for swift assessment of available fiscal space and discussion of macro-fiscal scenarios. - The Treasury is currently stepping up medium-term fiscal projections. The Department of strategic fiscal planning is working on a simplified revenue forecasting model based on econometric evaluations of tax elasticities to GDP; similar work could be done on the expenditure side for the most rigid items. - Caveats: such a tool does not replace (i) more detailed macro-fiscal analyses by other departments using macro and micro-simulations, and (ii) a full-blooded assessment of debt sustainability and fiscal space.10 ### Medium-term fiscal objectives - Strengthening commitment mechanisms: - Even the traditional primary balance target could be buttressed by stronger medium-term commitment mechanisms. - Currently, the primary balance target is set only for the budget year with subsequent-year evolution being indicative; clearer forward guidance on the pace of consolidation and the resulting debt trajectory is desirable. - Debt anchor: - A medium-term debt anchor would complement the expenditure rule by making the pathway to debt stabilization clearer and reinforcing fiscal sustainability. - The FRL allows for establishment of a debt target for the federal government, however in practice it has only been established for sub-nationals. - Extension of the framework could involve requiring the government to identify policy measures undertaken to keep fiscal outcomes in line with strategy. ### Medium-term fiscal strategy statement (FSS) - Purpose and timing: - Regular publication of a medium-term FSS at the start of the annual budget cycle would integrate MTFF elements and strengthen strategic alignment between fiscal policy and the budget process. - The FSS could be presented as a statement to Congress by the Finance Minister conveying main fiscal objectives, including indicative multiyear targets, projections, economic assumptions, assessment of recent forecast performance, fiscal risks and alternative scenarios. - Format and initial proposal: - The mission proposes the FSS be initiated as a non-legislative instrument accompanying the PLDO and replicated or updated ahead of the annual budget law introduction; it would be a major plank of budget documentation without being legislative or requiring Congressional approval or amendment. ### Improving coordination and governance - Ministerial and technical coordination: - Consider clearer roles for responsible ministers in framing fiscal strategy, determining the budget envelope and setting priorities, supported by technical capabilities of their ministries. - Strategic coordination could be overseen by a Ministerial-level Fiscal Committee involving the Finance and Planning and Budget ministers and the President’s Chief of Staff. - A standing technical committee of officials, led by the strategic fiscal planning function and involving macroeconomic, budget, revenue and debt office representation, would support the Fiscal Committee and improve budget process coordination. - Protect the impartiality of technical inputs (macroeconomic assumptions or fiscal forecasts) and ensure regular reporting on fiscal outturns against initial forecasts to provide positive reinforcement. *cr17292 - 40. Building on existing initiatives, it is important for Brazil to develop a fully-fledged* ### Box 3. Malaysia’s Fiscal Policy Committee ### Box 3. Malaysia’s Fiscal Policy Committee ### Overview - Malaysia’s Fiscal Policy Committee (FPC) was established in 2013 as the premier committee for fiscal management in the country. - It aims to strengthen public finances, and ensure fiscal sustainability and long-term macroeconomic stability. - It is chaired by Malaysia’s Prime Minister. ### Mandate - The FPC’s mandate includes: - endorsing guiding principles for sound fiscal policy and fiscal strategy formulation; - approving Malaysia’s MTFS; - reviewing fiscal performance and tracking towards fiscal targets; - endorsing policies to meet fiscal targets and manage fiscal risks; and - ensuring alignment across ministries and agencies on fiscal discipline and compliance. ### Secretariat and Support Functions - The FPC is supported by a secretariat in the Fiscal and Economic Division of the Treasury which coordinates: - development of the MTFF and MTFS; - production of the macro-fiscal forecasts, parameters and projections; - liaison with other government agencies; and - periodic studies on long term fiscal trends and drivers of expenditure and revenue. *Source: IMF Staff.* ### 81. This section deals with some broad changes in budget procedures and timelines ### cr17292 - 81. This section deals with some broad changes in budget procedures and timelines ### Overview - Purpose: embed a more medium-term horizon for budget planning to support earlier strategic decision making to implement the new expenditure rule. - Approach: deliberate shift in emphasis to engage responsible ministers at critical points in the budget cycle and promote changes in thinking and practices underpinning budget planning and preparation, with clearer focus on expenditure prioritization as line ministries’ budgets are produced. - Observation on current timetable: existing budget process is quite protracted (commencing in February with the fiscal year beginning the following January), with the key targets being locked in relatively early (April unless amended). ### Indicative timeline to integrate changes with the budget process (Box 6) - January - The Technical Committee oversees preparation of updated macroeconomic and fiscal forecasts. - When the MTBF is operational, ministries contribute detailed bottom-up estimates of the expenditure baseline; meantime top-down fiscal projections or some blend can be used. - February/March — Ministerial Fiscal Committee first strategic meeting - Considers previous outturn, latest fiscal forecasts and draft FSS. - Determines levels of fiscal aggregates consistent with the two fiscal targets (determines primary balance and expenditure targets; accepts technical advice on macroeconomic and revenue forecasts). - Approves allocation of pre-ceiling to ministries for PLDO preparation purposes and reserves a buffer for contingency purposes. - Discusses emerging policy priorities and sets savings targets for expenditure reviews and other related mechanisms. - April - FSS is released by the Minister of Finance when PLDO introduced. In 2017, it may need to be issued later, to accompany the PLOA. - April–June — Working meetings of the Ministerial Fiscal Committee - Committee considers marginal allocations or reductions to accommodate new policy and the results of spending reviews. - June - Technical Committee oversees preparation of updated forecasts and expenditure baselines. - July — Ministerial Fiscal Committee second strategic meeting - Considers updated macroeconomic and fiscal forecasts (including inflation outturn for expenditure cap, and latest revenue forecasts). - Considers aggregate impact of new policy measures and any necessary adjustments or reallocations for the final annual budget proposal. - Approves adjustments to aggregate and detailed expenditure ceilings if necessary. - August - The PLOA is introduced, accompanied by an updated FSS. - Source attribution in Box 6: IMF Staff. ### Multiyear reconciliation tables and tracking - Maintain a multiyear reconciliation table showing movements in the primary balance and expenditure since the last budget, broken down into parameter variations and new policy. - Aggregate version can be published in budget papers to show key drivers of changes over the forward estimates period. - Technical Committee should maintain a more detailed internal version during budget preparation. - When a new expenditure baseline is prepared, analyze which ministries, programs or objectives produced the largest variations due to changing economic parameters. - Update the detailed reconciliation table after each Ministerial Fiscal Committee meeting and incorporate formal updates of economic parameters or revenue forecasts to provide a rolling estimate of the primary balance and level of expenditure. ### Impact on legislative amendments and oversight - The new primary expenditure rule limits aggregate spending voted by Congress by the rule’s ceiling, addressing the common pool problem of budgetary design and approval. - Parliamentary amendment cap: since 2015, parliamentary amendments to the budget bill are capped at 1.2 percent of the net current revenue, half of which should be assigned to the health sector. - Under the new rule, from 2018 on the amendment reserve will be calculated as a share of the 2017 ceiling, adjusted for inflation. - New restrictions: - Proposals for new mandatory spending or tax expenditures must be accompanied by an estimate of the budget and any financial impact. - Bills not compatible with the rule can be suspended for 20 days. - Oversight implication: because compliance of the rule will be assessed on a cash basis (pagamento), present a table linking the rule’s primary expenditure payments and the LOA budget envelope to explain observance transparently. - A methodology is required to explain the discrepancy between approved and cash disbursed budgets. ### Linking the rule to budget execution and cash management - EC 95 requirements: - The expenditure rule ceiling must be consistent with the budget. - The PLOA should show the aggregate level of budgetary expenditures compatible with the rule’s ceiling. - Primary expenditures included in the budget must not be higher than the rule’s ceiling. - Fragmentation problem: coexistence of two parallel budgets - (1) Budget approved by Congress (LOA). - (2) Execution of a sizable amount of committed but not paid expenditures dating from previous budgetary years executed in parallel (Restos a Pagar — RAP). - Stock of RAP: amounted to some 2.4 percent of GDP at the beginning of 2017. - Execution stages and RAP types: - Commitment stage (empenho), accrual stage (liquidação), payment stage (pagamento). - Unprocessed RAP: committed but not accrued expenditures (similar to carryovers). - Processed RAP: accrued but not paid expenditures (goods and services received). - Cancellation rules cited: - Processed RAP are cancelled (Prescrição) after 5 years of existence (Decree 93.872, art. 70). - Unprocessed RAP are cancelled on June 30th of the second year of existence (Decree 7.654, art. 1, §2). - Presidential Decree merges approved budget appropriations and RAP to be paid during the year, creating a single execution timetable and consolidating the two budgets into the execution ceiling communicated to line entities. - Consequence: some LOA appropriations must be removed to compensate for RAP payments programmed in the year; as a result, primary expenditures executed at year-end may not fully link to programs and activities approved by the LOA. ### RAP dynamics and fiscal implications - The stock of RAP represents some 12 percent of annual expenditures, imposing a challenge to aggregate fiscal management. - If carryovers become large, conflict can arise between government spending priorities and budget manager actions because committed expenditures compete with the current budget at accrual and payment stages. - Recent dynamics (2006–2016 and 2014–2016 notable changes): - The rate of unprocessed RAP creation significantly lagged behind the rate of RAP elimination in 2015 and 2016; processed RAP experienced similar lag in 2016 (Figure 6, Tesouro Nacional data). - Factors reducing RAP stock in recent years: - Increase in RAP cancelled during 2015, some due to Federal Court of Accounts (TCU) intervention. - Increase in RAP paid during 2014–2016. - Tighter commitments (empenho) control applied in 2015–2016 reducing new RAP flow. - Policy challenge: RAP compete with approved budget in use of financial resources and represent a permanent aspect of the budgetary process when excess commitments over payments persist. ### Changes for spending ministries - Differential exposure: entities are not equally exposed to expenditure cost drivers (social security typical example). - Budget preparation must coordinate the top-down aggregate (consistent with the rule) with differential growth of the budget base at entity level. - Ministerial programs must be re-prioritized to be consistent with entity ceilings. - Ministerial Committee should analyze how to equalize marginal social benefits of expenditure among entities under the budget constraint. - Medium-term consideration: apply medium-term thinking as the economy is expected to gradually recover from the recession and government revenues recover. - Administrative action: SOF enacted Circular (Portaria) 9/2017 defining new budget deadlines related to PLOA 2018 and instructing line entities on budgetary observance of the expenditure rule while flagging limited fiscal space available for the next years. ### Recommendations (excerpted; elaborated in Action Plan in Annex 1) - Changes in budgetary procedures and timelines - Bring a more strategic approach in two distinct stages: - First: setting ministerial expenditure ceilings earlier before the LDO is approved by Congress. - Second: discussing adjustments or reallocations of any fiscal space to priority areas or allocation of reductions. - Tools needed to allow tracking of the fiscal position as decisions are made and to permit reconciliations of the main fiscal aggregates to be published in each budget. - Impact on legislative amendments and oversight - Provide regular information on the link between LOA’s aggregate appropriations and the rule’s paid expenditures. - Develop a table, published in the bimonthly execution reports, linking the rule’s primary expenditure payments and the aggregate budget envelope approved by Congress. - Develop a methodology reconciling the discrepancy between appropriations and payments, to be included in the annual execution report. - Linking the rule to budget execution and cash management - Develop a plan to gradually reduce the stock of RAP to no more than 3 percent of the aggregate level of expenditures. - Develop a detailed financial plan, updated annually, to track towards this target; a focus could be on the investment projects pipeline to improve operational forecasting methods. ### Ensuring compliance with the new expenditure rule (introductory note) - Key issues raised by the new rule’s implementation: - (A) how to ensure transparent reporting of compliance with the rules; - (B) how independent watchdogs should be involved in monitoring compliance; - (C) how to apply sanctions. - Authorities plan to follow similar monitoring and reporting procedures as with the primary balance rule, but the implementation raises the questions above and requires further design of monitoring, reporting, and sanction frameworks. *Source: IMF Staff.* ### 101. The public should have regular access to information on compliance with the rule. ### cr17292 - 101. The public should have regular access to information on compliance with the rule. ### Transparency and public access to compliance information - Purpose: public access is relevant (i) ex ante, to explain how the fiscal strategy chosen by the government is coherent with the rule; (ii) in-year, to justify potential budget sequestrations; (iii) ex post, to make the government accountable for its fiscal policy and management choices. - Channels: information can be made available in fiscal reports, in budget documents (including the MTFS), in budget execution reports, and in ad hoc communication devices decided by the Executive. - Treasury plans: - The Treasury intends to report past compliance with the new expenditure rule in its monthly fiscal bulletin, as well as in the four-monthly reports on compliance with the fiscal rules, in a similar format to what is published for the primary balance rule. - The Treasury will also use bimonthly execution reports to explain how proposed sequestrations on commitments and payments may allow for compliance with the rule. - Need for explanations: although the expenditure rule may look simple at first, specific explanations are needed to account for exclusions from the rule and differences with the scope of the primary balance target, and gaps between commitment and payment targets. - Reports should contain explanations on all revisions applied to the targets in relation with the rule, a technical note on the scopes of the different fiscal rules and aggregates, and a reconciliation effort between the various targets at play. - Footnote: Payments used in the primary balance target are the outward flows from the treasury single account, while payments considered for the expenditure rule are those which have been recorded in the SIAFI database. There is on average a one-day difference in terms of timeframe between both rules, which may create a very slight gap. ### Independent oversight: Independent Fiscal Institution (IFI) and Federal Court of Accounts (TCU) - IFI establishment and mandate: - Established in December 2016 by a senatorial resolution. - Comprises six staff members, including the Executive Director. - Four functions: (i) produce its own macroeconomic forecasts as a basis for its fiscal scenario; (ii) assess compliance with fiscal targets; (iii) evaluate the fiscal impact of government policies, including monetary, credit and foreign exchange policies; and (iv) project the evolution of fiscal indicators that are relevant for long-term fiscal sustainability. - The IFI intends to publish monthly reports, containing macro-fiscal forecasts, assessment of compliance with the expenditure rule and ad hoc studies. - The IFI will not provide normative analysis or recommendations. - Resource mismatch: - Councils with comparable remits usually enjoy a larger number of staff (see Box 7). Example: CPB and OBR host 117 and 17 technical staff respectively, compared with the Brazilian IFI’s 5 (technical staff). - Operational priorities and risks: - Though the quality and breadth of its first two monthly reports is impressive, the IFI may run the risk of spreading its resources too thin. - Suggested focus areas: - Emphasize assessment of compliance with fiscal rules (timed around bimonthly execution reports and ahead of the PLDO and PLOA). - Further develop long-term debt projections (IFI is currently the only institution which publishes long-term debt projections). - Focus analytical work on major fiscal reforms under discussion. - Cooperation with the Executive: - The Executive should work with the IFI and ensure regular and timely exchanges of information while preserving IFI independence. - The IFI should offer a platform for the Executive to discuss its own forecasts when there are divergences. - TCU role: - Article 71 of the Federal Constitution mandates the TCU to conduct annual examination of the final accounts and inspections/audits “of an accounting, financial, budgetary, operational and patrimonial nature”. - TCU already provides an ex post analysis of compliance with the primary balance targets in its annual report; a similar analysis could be produced for the expenditure rule. - TCU intends to monitor compliance with the rule on a bimonthly basis, which may duplicate IFI analysis. ### Applying sanctions, monitoring automatic adjustments, and escape clauses - Constitutional amendment: - Details a series of automatic adjustments to be applied in case of non-compliance, but is vague on how to trigger or end sanctions. - Unclear elements: who should trigger the mechanism, when it should be triggered, whether the non-compliant branch may provide explanations, when adjustments should stop and who decides. - Practical considerations: - Who? Treasury seems well-placed to trigger since it will regularly assess compliance; this should be complemented with an independent opinion (IFI, TCU) to ensure transparency. - When? Options include applying/ending adjustments as soon as there is reason to do so, or waiting for the LOA to apply/end adjustments on an annual basis to avoid a gap between the budget and actual payments. - How? Bimonthly execution reports should contain a section on the triggering and ending of the automatic adjustments. - Monitoring implementation: - Little or no information is provided on how to monitor implementation of automatic adjustments. - Non-compliant branches should provide explanations on strategies to return to a compliant fiscal trajectory, in particular as part of the overall MTFS. - Bimonthly execution reports should monitor implementation of this strategy. - Escape clauses: - The rule includes escape clauses for natural disasters, war, and civil unrest, but procedures for initiating and ending these escape clauses are unspecified. - International experience highlights the importance of strict definitions of escape clauses, defined procedures for initiating them, and plans on how the government will return to compliance. ### Recommendations (summary) - Improving reporting - Ensure transparent fiscal reporting on compliance by the National Treasury: - Include new tables and written explanations analyzing compliance with the expenditure rule in the Treasury’s monthly bulletins and four-monthly reports on fiscal rules. - Explain revisions applied to commitment and payment targets in relation with the rule in each bimonthly execution report. - Attach to the four-monthly report on compliance with fiscal rules a technical note about the scopes of the different fiscal rules and expenditure aggregates, and explaining how the reconciliation can be achieved. - Provide an annual performance assessment (tables and written explanations) against the rules in the MTFS and in the citizens’ budget. - Monitoring compliance - Focus IFI on the assessment of compliance with the fiscal rules, studies on major fiscal reforms and long-term sustainability analyses. - Applying sanctions and escape clauses - Consider developing procedures to trigger, implement and end automatic adjustments in case of non-compliance and to activate and end escape clauses. ### Action Plan highlights (selected items relevant to compliance and reporting) - VI. Ensuring compliance with the new expenditure rule - Ensure transparent fiscal reporting on compliance (monthly bulletin, bimonthly execution reports, four-monthly reports on compliance with fiscal rules): - Include tables and explanations on compliance with the rule in the monthly RTN bulletins and four-monthly reports. - Explain revisions applied to targets in relation with the rule in bimonthly reports. - Attach to the four-monthly reports a technical note reconciling the different fiscal rules. - Responsible agency: STN. - Provide an annual performance assessment (tables and written explanations) against the rules in the MTFS and in the citizens’ budget: - Publish the annual performance assessment in the FSS and in the citizens’ budget. - Responsible agency: STN. - Focus IFI on the assessment of compliance with the fiscal rules, studies on major fiscal reforms and long-term sustainability analyses: - Request a systematic assessment of compliance with the rules, simultaneous to the bimonthly execution reports. - Include long-term sustainability analyses on a regular basis (at each revision of the macro-fiscal forecasts). - Focus the 2018 analytical work program on studies on major fiscal reforms. - Ensure sufficient resources for the IFI to fully achieve its mandate. - Responsible agencies: IFI, Senate. - Consider a procedure to trigger, implement and end automatic adjustments in case of non-compliance and to activate escape clauses: - Consider options for the procedure to trigger, implement and end automatic adjustments, and to activate escape clauses. - Publish information on implementation of automatic adjustments in fiscal / budget documents. - Set up the preferred procedures. - Responsible agencies: MOF / SOF. *IMF — cr17292 (section on public access, independent oversight, sanctions, and action plan).* ### Annex 2. Outline for a Fiscal Strategy Statement ### Annex 2. Outline for a Fiscal Strategy Statement ### Purpose and framing - The primary purpose of the proposed FSS is to serve as a strategic communication tool which helps to place the fiscal policy debate on a medium-term footing, but also as something to which the government is willing to be held directly accountable. - The annex is intended to be neither prescriptive nor exhaustive, but rather to assist authorities to think through how the elements of such a Statement could come together in the Brazilian context. ### Fiscal policy and related targets and objectives - Specify the core fiscal targets – place the primary balance and expenditure targets in context. - Nominate any supplementary fiscal targets – these may or may not be legally binding, but are still important in framing the fiscal strategy (such as floors for education and health, as well as indicative guidance on desired allocations towards public investment). - Present the indicative primary balance target over a longer-term horizon - this communicates the intended pace of fiscal consolidation, absent economic shocks. Consider how this might be translated into a firmer target (e.g., rolling average, structural balance). - Present the indicative target levels of revenue and expenditure as a share of GDP – this communicates the broad policy directions regarding the overall size of government (declining as a share of the economy under the new rule) and the overall tax burden. - Show projections for the profile for growth in mandatory, non-discretionary and other expenditure which indicates the discretionary fiscal space for national priorities (e.g., health, education, public investment). - Show projections for revenue with estimates of relevant tax expenditures. - Assess the aggregate value of reforms required to deliver on the fiscal rules - this could be done both over the coming budget year and over the projection period and include some discussion of major policy themes which will be pursued. - Present a profile of gross and net debt – this may include an indication of the government’s desirable / tolerable levels of debt or annual borrowing requirements as well as help to illustrate the links to the nominal balance trajectory. - Estimate the size of primary surplus that would be targeted to help achieve fiscal objectives, such as stabilizing and paying down debt and as insurance against future economic shocks. ### Macro-fiscal analysis - Analyze recent domestic and international economic developments and illustrate how changes in the economy have impacted upon the fiscal situation. - Track progress against the core and key supplementary medium-term fiscal targets. - Present a transparent assessment of recent economic and revenue forecasts vs outcomes. ### Projections and risks - Include projections of main fiscal aggregates for 5 and ultimately 10 years (updated each year and compared to previous vintage), including: - Primary and nominal balance - Gross and net debt - Public sector net borrowing - Primary surplus required to stabilize and reduce gross/net debt - Mandatory expenditures as a share of total ### Additional elements which could be added over time - Formal debt anchor – implement the legislated targets for gross and net debt. - A more detailed list of the government’s preferred policy measures which will be pursued in the 1-3 years ahead to preserve discretionary fiscal space, help repair the budget and give more flexibility in prioritization and budget execution. - Alternative fiscal scenarios which show the impact of varying economic assumptions on the likely fiscal outcomes (e.g., a terms of trade shock; or a fall in global growth). *Source: Annex 2. Outline for a Fiscal Strategy Statement* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17292.pdf_