LULA'S PENSION REFORM PASSES. WHEN'S THE NEXT ONE?

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