US embassy cable - 03BRASILIA3910

UNCLAS SECTION 01 OF 03 BRASILIA 003910 
 
SIPDIS 
 
NSC FOR DEMPSEY 
TREASURY FOR SSEGAL 
PLS PASS FED BOARD OF GOVERNORS FOR WILSON, ROBATAILLE 
USDA FOR U/S PENN, FAS/FAA/ITP/TERPSTRA 
USDOC FOR 4322/ITA/IEP/WH/OLAC-SC 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, PGOV, EINV, SOCI, BR 
SUBJECT:  LULA'S PENSION REFORM PASSES.  WHEN'S THE NEXT ONE? 
 
REF: (A) BRASILIA 3734, (B) BRASILIA 3684, (C) BRASILIA 3682 
 
1.  After seven-plus months of legislative tussle, Lula's 
pension-reform bill passed its required second Senate floor 
vote on December 11 by 51 votes to 24, two votes over the 
minimum 49 (three-fifths) required.  The twelve votes of 
opposition-party PSDB and PFL senators -- spurred by the 
fiscal self-interest of PSDB and PFL state governors -- were 
vital to the GoB's success.  Most of its Senate base voted 
obediently, with the predictable exception of a few PT 
radicals due to be expelled from the party this weekend. 
Later on December 11, the GoB's tax-reform bill in turn 
passed the first of two required Senate floor votes.  Lula 
is thus almost all the way towards meeting his top declared 
legislative twin goal for his first year in office. 
 
2.  An essential step in the pension-reform process was the 
GoB's agreement to introduce a parallel amendment embodying 
features on secondary issues (state-salary sub-ceiling 
levels; benefit and taxation limits on individual pensions, 
et al), arrived at in the latter stages of Senate debate but 
not incorporated into the main bill for reasons of 
procedural expediency.  The bill now awaits just formal 
promulgation in the `Diario do Congresso' to become law. 
Voting on the parallel amendment by Congress is due to start 
as early as Monday, December 15 but will not be completed 
before 2004. 
 
3.  Though the pension bill has been steadily watered down 
since June, this result remains Brazil's broadest pension- 
system reform since the 1988 Constitution.  Former president 
Fernando Enrique Cardoso contrived to introduce changes in 
Brazil's private-sector pension (INSS) system, but failed to 
make true inroads in reforming its public-sector pension 
fiscal disaster, whereby some three million retired civil 
servants have drained close to four percent of GDP from the 
GoB's Previdencia (Social Security Administration 
equivalent) budget in recent years.  By contrast, Lula's 
team took on public-sector-pension vested interests from the 
start, despite the PT's historical ties to those interests. 
The espousing and progress of pension reform under Lula's 
GoB was one of the latter's great confidence-builders for 
"the market." 
 
4.  Main changes introduced by the pension bill as passed: 
 
--  (i) current pensioners or survivors to start 
contributing 11 percent of their benefits above a defined 
floor towards the Previdencia system, starting next March; 
 
-- (ii) future pension ceiling for new public-sector 
employees of 2,400 Reals per month, the same as for private- 
sector social-security recipients (vs. the existing 
"integrality" principle that a public-sector pension equals 
top lifetime salary); 
 
--(iii) 30% cut in survivor benefits above 2,400 Reals per 
month, with immediate effect; 
 
-- (iv) public-sector workers already eligible to retire 
under previous rules with pensions equal to full salary will 
be exempted from the existing 11 percent Previdencia 
deduction from their salaries if they continue to work; 
 
--  (v) introduction of the principle of ceilings and sub- 
ceilings on public-sector salaries at all government levels; 
 
-- (vi) lengthening of the minimum requirements for current 
public servants to receive their "integral" salaries, to, 
e.g., minimum age of 60 (55 for women), time of service 35 
years (30), 20 years in public employment, of which at least 
10 in career specialty and five in last position. 
 
--(vii) current public functionaries who retire earlier than 
the new minimum age limits of 60 and 55 years to receive 
3.5% per year less pension if they take retirement before 
December 2005 or 5.0% less if after January 1, 2006. 
 
5.  The GoB projects that its new pension law will yield 
fiscal savings of fifty billion Reals, net present value, 
over the next couple of decades (albeit the methodology has 
never been convincingly laid out.)  Already in 2004, savings 
are meant to be of the order of 1.0 billion Reals from new 
taxation of public-sector retirees' pensions, plus 1.7 
billion Reals from taxing private-sector workers' salaries 
up to the raised ceiling of 2,400 Reals a month vs. the 
previous ceiling of 1,869 Reals.  Modest though this fiscal 
economy may seem, market interlocutors have consistently 
assured us that it meets their litmus test of "staunching 
Previdencia's budget bleeding" and leaves them content. 
 
6.  Meanwhile, however, an ugly new cloud has formed on 
Brazil's pension skyline.  Deficits on Previdencia's INSS 
(private-sector pension) side, which until 1995 was always 
in surplus, are rocketing up ever more steeply.  Indeed, the 
INSS deficit in 2004 will reportedly for the first time in 
history be larger, easily, than the public-sector pension 
system's notorious fiscal crater.  The 2002 INSS deficit, a 
nominal 18 billion Reals, accounted for only about a quarter 
of Previdencia's overall fiscal gap.  For 2003, though, INSS 
is projected to be 27.5 billion Reals in the red; for 2004, 
31.7 billion Reals, vs. a forecast 29.7 billion Reals for 
the public-sector side.  In other words, the 2004 increase 
in INSS's deficit will likely more than swallow up the 2.7 
billion Reals in savings that year which the GoB itself 
estimates its public-sector pension reform will bring, and 
so on for the indefinite future. 
 
7.  The following table illustrates the evolution of INSS 
yearly deficits according to official Previdencia Ministry 
data re-printed under a December 7 `Estado de Sao Paulo' 
headline "Hole in the INSS Will Require a New Reform Soon": 
 
1995 -- 0.46 billion Reals 
1996 -- 0.40 
1997 -- 4.57 
1998 -- 10.2 
1999 -- 12.8 
2000 -- 12.9 
2001 -- 15.2 
2002 -- 18.3 
2003 -- 27.2 
2004 -- 31.5 (estimated) 
 
(Embassy translation of the text of the `Estado de Sao 
Paulo' article being sent Septel.) 
 
COMMENT 
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8.  This previously unpublicized trend towards giant INSS 
deficits on the private-sector side seems to hold somber 
implications for Lula.  First, the tangible if modest 
immediate savings from this year's pension reform which the 
GoB might have hoped to put towards social programs or 
investment in 2004-2005, have already evidently evaporated. 
Second, the rate of increase of the INSS deficit looks set 
to outstrip public-sector savings from the reform through 
the medium term, based on the GoB's own projections. 
 
9.  As the GoB reduced its pension-reform ambitions in the 
course of this year's legislative horse-trading, it became 
near-conventional wisdom that pension reform would need to 
be re-visited within, say, a half-dozen years.  The updated 
INSS arithmetic may pose the necessity for such re-visiting 
to take place in the medium, not long, term -- perhaps even 
during Lula's current administration, rather than the 
politically more palatable prospect of 2007/08.  Otherwise, 
market nerves over Brazil's fiscal prospects and debt 
sustainability could eventually re-commence to jangle. 
 
VIRDEN