Brazil details budget cuts to cool economy

BRASILIA Mon Feb 28, 2011 1:29pm EST

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BRASILIA (Reuters) - Brazil's government will slash defense spending and freeze the hiring of civil servants as part of $30 billion in budget cuts this year aimed at cooling red-hot economic growth and slowing a spike in inflation.

Officials said the cuts would spare the government's flagship infrastructure and social welfare programs -- raising questions about whether the cuts will be deep enough to stop the central bank from implementing a sustained cycle of interest rate hikes that could begin as soon as this week.

Finance Minister Guido Mantega said the cuts were designed to ensure sustainable economic growth after gross domestic product likely expanded by 7.5 percent last year -- a pace Mantega said was "excessive" for Brazil.

"(The cut) aims to slow the economy without knocking it out," Mantega told a news conference.

The government of President Dilma Rousseff, who took office on January 1, hopes the budget cuts will cool domestic demand and stop a recent spike in inflation that has hit Brazil as well as other emerging markets, due in part to rising food prices.

The announcement was timed to this week's meeting of the central bank's monetary policy committee. The bank is widely expected to raise the benchmark Selic rate by 50 basis points, but Mantega and other officials have expressed hope that the budget cuts will reduce the need for future hikes.

The cuts will reduce total government spending by 1 percentage point to 17.1 percent of gross domestic product. A reduction in current expenditures accounts for roughly two-thirds of the cuts.

The government would slash around 18 billion reais from legislators' slush funds, making up the remaining one-third of the total cuts.

Federal spending in cities would be hit hardest, with a cut of 8.6 billion reais ($5.2 billion), Planning Minister Miriam Belchior said. The ministry of cities invests in a range of public works projects, from waste water treatment plants to roads and soccer pitches in shanty towns.

FOCUS NOW TURNS TO IMPLEMENTATION

Brazil's military will have to do with 4.4 billion reais less this year. The Air Force will likely need to wait until at least next year to get new fighter jets worth more than $4 billion, Mantega said. The deal is being disputed by companies from the United States, France and Sweden.

Many investors will want to see the impact of the measures on the real economy and more evidence that they won't be reversed -- as has happened in the past.

"The expenses that they are trimming are discretionary expenses whose impact on aggregate demand could be small," said Pedro Tuesta, a senior economist with the Sao Paulo-based consultancy 4Cast.

Rousseff is certain to come under pressure to ease some of the cuts, particularly by legislators whose discretionary spending allowances have been slashed.

In response to demands from union leaders, the administration is expected to adjust personal income tax brackets, forfeiting around 2 billion reais in revenue.

Also Mantega's track record as guarantor of fiscal discipline has been inconsistent. Last year he flung public coffers wide open ahead of October presidential elections. As a result, Brazil missed its full budget target in 2010, despite what many called creative accounting methods.

Inflation expectations for 2011 have risen for 12 straight weeks, albeit at a slowing pace, to 5.8 percent, well above the center of the government's target of 4.5 percent.

Investors generally expect the central bank to raise interest rates on Wednesday by half a percentage point to 11.75 percent.

($1 = 1.65 reais)

(Additional reporting by Guillermo Parra-Bernal)

(Writing by Raymond Colitt; Editing by Brian Winter and Andrew Hay)

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