Tuesday, May 9, 2017

Brazil's Looming Pension Crisis?

Joe Leahy and Andres Schipani of the Financial Times report, Brazil takes step closer to pensions overhaul:
Waldo Mermelstein knows better than most the sacrifices his generation made in the 1970s fighting to overturn Brazil’s military dictatorship in favour of democracy and social benefits for all.

The founder of the Liga Operária, a former Trotskyist organisation that represented metalworkers, Mr Mermelstein was imprisoned by the military and went into hiding.

But just as the ageing activist is retiring from his public service job, what he sees as the fruits of the struggle are under attack from reforms such as a proposal to change the country’s pension system, which gives everyone the right to retire in their early to mid-50s.

“There are millions of Brazilians who will never be able to retire [under the new scheme] because they would never be able to make enough contributions for retirement,” Mr Mermelstein said.

This week, a lower house committee passed the landmark reform that will raise the minimum retirement age to 65 for men and 62 for women in an important victory for the centre-right government of President Michel Temer.

The controversial bill — the vote was marred when prison guards, angry at their inclusion in the changes, stormed the Congress — must go before a plenary session of the lower house and then the Senate.

But while the left has attacked the changes, the government and investors say the reforms are essential to restoring the fiscal health of a country that is running a budget deficit of 9.2 per cent of gross domestic product. “Our history has been one of a continuous rise in public spending that has been strangling society; this process will be reversed in the coming years,” Dyogo Oliveira, minister of planning, told the FT (click on image).


The International Monetary Fund estimates that without an overhaul, Brazil’s ageing population will push pension spending to about 14 per cent of GDP by 2021, 18 per cent by 2030 and 26 per cent by 2050 (click on image).


Brazilian unions staged a general strike against the bill last week and seven out of every 10 Brazilians are opposed to it, an opinion poll by Datafolha showed.

But the growing pension bill was one reason why Brazil’s budget spending was expanding 4 per cent a year or 0.3 per cent of GDP, said Pedro Castanheira Schneider, an analyst at Brazilian investment bank Itaú BBA.

“There have never been two consecutive years in which it has fallen,” he said.

Brazil’s pension system is rife with distortions. Not only can Brazilians retire early by international standards — after 30 years of work for women and 35 years for men — but retired civil servants continue to receive full pay rises awarded to active colleagues in their area, not just inflation adjustments.

Some Brazilians with parents in the military can also inherit pensions. Private sector retirees face a ceiling of about R$5,000 (US$1,570) a month while public servants can receive far above that.

“This reform is better than nothing: a half step forward but short of the full decisive leap that we need to get the fiscal accounts in shape,” said Goldman Sachs economist Alberto Ramos. He and other economists said budget savings from the reform were being whittled down by bargaining in Congress.

The government argued the bill in its current form retained 76 per cent of the envisaged savings. But dilutions such as a reduction of the retirement age for women and a watering down of rules governing the transition of existing workers to the new system had reduced the savings from the reform to about 57 per cent of the R$755bn by 2025 originally envisaged, said Mr Schneider.

He said even in its current form, the bill was enough to stabilise spending on social security. But the Temer government last year passed a law that requires real increases in total public spending to be limited to zero for up to 20 years. The dilutions to the pension bill would make that target harder to meet (click on image).


Markets wanted to see some version of the reform passed, said David Beker, economist at Bank of America Merrill Lynch in São Paulo. “The more you dilute the reforms, the more you will have to do in the future to compensate for the dilution.”

For those on the left, such as Mr Mermelstein, however, the best result would be no pension reform at all. “The whole thing is actually horrible,” he said.
Some worry that Brazil's pension reforms are going to be heavily watered down to appease unions. Bruno Federowski of Reuters reports, Verde hedge fund warns Brazil pension bill could be further weakened:
Verde Asset Management SA, Brazil's largest hedge fund, sees lingering risks that Brazilian lawmakers will further water down government efforts to streamline the social security system, a move that could hamper austerity efforts in Latin America's largest economy.

Investors have been "complacent" with the negotiations as the Temer administration seeks to gather lawmaker support for the so-called pension reform, Verde money managers led by Luiz Stuhlberger said in a monthly investor letter for April.

There is growing investor doubt over whether President Michel Temer can implement his ambitious reform agenda, seen as critical to curbing public debt growth and lifting Brazil from its deepest recession ever, according to the letter obtained by Reuters.

"Exacerbated optimism with Brazil - and emerging markets in general - continues to permeate the universe of global and local investors," the money managers wrote.

Brazil's stocks and currency ranked among the world's best-performing assets last year, but the rally has since stalled on concern over the shape of a final pension reform measure. The real has moved away from two-year highs touched in February, while the Bovespa stock index has been nearly flat since the end of March.

A committee approved the bill last week after the government agreed to budge on several controversial points, including lowering the minimum retirement age for women. A lower house plenary vote originally planned for this week has been pushed back to allow Temer's base to muster the necessary two-thirds support to pass the bill.

"Now, more than any time in the last seven years, it is very hard to find cheap assets available for purchase," the letter said.

The Verde FIC FIM fund returned a consolidated 0.43 percent in April, extending gains to 3.04 percent so far this year. Still, it underperformed the benchmark CDI interbank interest rate in both periods.

São Paulo-based Verde said last month that gains came from local and global equity positions, as well as foreign exchange trades involving the Brazilian real and the Korean won. It booked a 0.3 percent loss on its fixed-income book as market interest rates spiked due to jitters over the pension reform talks.
When I read these articles, the first thing that came to my mind was my ancestral home and something my Greek-Canadian buddy once told me a while ago, a few years before the crisis hit Greece.

He was swimming one summer in Greece and noticed a very fit older man swimming in the sea and coming out to rest. My buddy, a doctor, approached him and told him he's in phenomenal shape and asked him how old he is, thinking the man was no more than 65 years old.

The man looked at him and said he turned 85 and feels great. My buddy was speechless and asked him what's his secret. The man turned to my friend and said: "I worked in the civil service for 20 years and retired at the age of 45 and never worked another day in my life."

Again, this all happened before the crisis hit Greece and public (and private) pension benefits were savagely slashed to bring some fiscal order into a pension system run amok. But it gives you an idea why the Greek pension system was on a collision course and set to crash.

If you look at that last chart above, you'll notice that Brazil's spending on public pensions is outpacing that of Greece which continues to be unacceptably high even after the crisis when pensions were slashed. In third place comes France (I wish Emmanuel Macron and his economic advisors the best of luck bringing France's public sector beast under control).

Those of you who read this blog regularly know that I am an ardent defender of large, well-governed public defined-benefit pensions. I also believe in protecting the rights of minorities and our most vulnerable, especially children, the elderly, the poor, sick and disabled.

I also believe that a well-functioning democracy needs to provide access to decent public education, accessible and affordable healthcare for all and in my opinion, a secure retirement so people can retire in dignity and security. I call those the three pillars of a well-functioning democracy.

But I'm a fiscal conservative and also fundamentally believe in the primacy of the private sector over the public sector. When spending on the latter runs amok and threatens the expansion of the former, it hurts productivity and economic growth over the long run.

Importantly, you cannot have a solid public sector without a thriving and growing private sector. This is something that successive (left-wing and right-wing) governments in Greece failed to realize over decades as they bought votes by expanding the public sector, and now the country is paying a heavy price for years of gross fiscal profligacy.

Why am I sharing this? Because while I empathize with Brazil's public sector workers, the country needs to tackle its growing expenses on public pensions or else it risks becoming the next Greece or something far worse.

I am all for sustainable public pensions but they have to be based on solid foundations, have realistic assumptions and risk-sharing or else they won't be sustainable over the long run.

What worries me about Brazil and other emerging markets is the lack of transparency and governance when it comes to their public pensions. Basically, there is none or it's a farce, leaving these public pensions very vulnerable to corruption and gross mismanagement.

So, reforming Brazil's public pensions is a must but they need to reform them properly, getting rid of distortions and gross abuses, but also introducing greater transparency and accountability to bolster their retirement system and make it sustainable over the long run.

Earlier this month, hundreds of thousands of Brazilians took to the streets and millions more stayed home in a general strike. Airports, factories, schools, public services were all shut down (watch the clip below).

Also, Al-Jazeera examines why Brazil's media outlets treated a national strike that paralyzed much of the country as a non-story. It's an interesting report worth watching below.

Lastly, bond king Jeffrey Gundlach told CNBC on Monday he has a pair trade betting on further gains for emerging markets and against US stocks. Gundlach said he is long the iShares MSCI Emerging Markets ETF (EEM) and short the SPDR S&P 500 ETF (SPY) specifically. Gundlach expects interest rates to rise and stocks to temporarily fall this summer

On Tuesday, Gundlach's book is up as emerging market stocks are rallying hard, especially relative to US stocks, but given my views on the reflation trade being doomed, I wouldn't expect this rally to continue in the second half of the year.

In fact, I'm short emerging markets and see the recent rally in the US dollar (DXY) continuing in the second half of the year, spelling big trouble ahead for emerging market stocks which rallied sharply since early 2016 but have yet to make a significant breakout to the upside on the weekly chart (click on image):


Remember, Gundlach is the bond king, and while I typically agree with him, I disagree with him on rates (think bond yields are headed lower), the US dollar (headed back up) and I'm openly worried about a major bear market ahead and think some risk assets (like emerging market stocks, bonds, and currencies) will be a lot more vulnerable than others when the next crisis strikes (Gundlach's long emerging market stocks/ short US stocks pair trade will get clobbered).

This comment on Brazil's looming pension crisis provides you with a glimpse of why many emerging markets are struggling and will likely continue to struggle in the years ahead.



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