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Need a Reason to Sell Brazil? Try Two Words: Pension Overhaul

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As hopes fade that Brazil will fix its costly and inefficient pension system before next year’s presidential election, Schroders PLC is already eyeing the exit.

“Pension reform is a key to Brazil getting their medium-term fiscal house in order,” said Jim Barrineau, co-head of emerging-markets debt at Schroders, who said he’ll cut his overweight position on local debt should the revamp stall. “Without it, there is almost no path to stabilizing debt-to-GDP ratios over a five-year time frame and we would expect the country to be a candidate for a credit rating downgrade.”

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Brazil’s stocks, bonds and currency declined last week as President Michel Temer, whose drive to revamp pensions has enraged voters, obtained a smaller margin than markets anticipated to defeat a second attempt to try him for corruption. Lawmakers voted 251 to 233 to block the charges, below the 257 votes that JPMorgan Chase & Co. termed the lowest level for a positive result.

The real dropped yesterday, leading losses among major currencies, as markets priced in increased political risk and slimmer chances the pension bill will pass before the election.”We had previously argued that the chances of significant reforms to the pension system had fallen to something like 50/50,” Capital Economics analysts led by Neil Shearing wrote in a note after last week’s vote. “This now looks too generous.”

Brazil’s pension system doesn’t have a minimum retirement age and offers high salary replacement rates at a time life expectancy is growing. Brazil spends a higher percentage of its gross domestic product (GDP) on pension obligations than Japan, even though the proportion of Brazil’s elderly population is less than half that of the Asian nation.

Finance Minister Henrique Meirelles reaffirmed the government’s expectation the overhaul will be approved this year and said the bill will head to Congress for a vote by mid-November. Yet Moody’s Investors Service said last week that a major revamp isn’t likely. At best, the government will end up saving about half the money it originally sought, the ratings company said.

Government spending on pensions account for about 13% of gross domestic product, according to official figures. Left unchanged, the cost of private industry pensions would more than double by 2060 to 17.2% of GDP from 8.1% currently. An estimate from the national statistics agency shows that, while the active population will fall 6.7% by 2060, the number of retired people will grow 263%.

–With assistance from Mario Sergio Lima and David Biller.

—Read 5 Ways to Make the Most of Slow Growth: Kleintop on ThinkAdvisor.