El informe de Moody´s sobre el gasto en Latinoamérica.

SOVEREIGN AND SUPRANAT SUPRANATIONAL IONAL

SECTOR IN-DEPTH 18 October 2017

High compulsory spending levels to impede fiscal consolidation, especially in Brazil

Analyst Contacts Michael Brown

212-553-4515

 Associate Analyst Analyst

[email protected] Renzo Merino

Sovereigns – Latin America

212-553-0330

 AVP-Analyst  AVP-A nalyst

[email protected] Mauro Leos VP-Sr Credit Officer/  Manager  [email protected]

212-553-1947

Atsi Sheth MD-Sovereign Risk  [email protected]

212-553-7825

A number of governments in Latin America (LatAm) have started to consolidate public finances in response to a deterioration in their fiscal positions. Efforts have most often focused on revenues, since mandatory spending often limits a government's ability to adjust expenditures. From a sovereign credit standpoint, budget flexibility – a government's ability to adjust revenues and/or expenditures – is a factor that can strongly influence fiscal prospects. We use an 'expenditure flexibility index' to illustrate how the composition of  central government spending across 16 LatAm countries enhances - or impedes - budget flexibility. Our main findings are: » Ecuador is best positioned to adjust spending; Brazil has the least flexibility to stable), Peru (A3 stable), stable), Nicaragua (B2 positive) and positive) and Panama (Baa2 do so. Ecuador (B3 stable), positive) have positive)  have the greatest budgetary flexibility given that compulsory expenses – i.e., wages, transfers and interest payments – account for about 50% of total government spending. In contrast, Brazil (Ba2 negative), Argentina (B3 positive), positive), Colombia (Baa2 stable) and Costa Rica (Ba2 negative) have negative) have the most rigid budgets, with mandatory spending accounting for more than 80% of government spending, and as much as 90% in the case of Brazil. » Government spending declined as a share of GDP In only three of 16 LatAm countries from 2010-16.  The median increase in government spending was 1.6% of GDP in the region during the six-year period. Argentina's spending increased the most, with outlays going up by 5% of GDP, closely followed by Paraguay (Ba1 stable). stable). Guatemala (Ba1 stable) reduced stable)  reduced spending the most, achieving a decrease equivalent to 2.5% of GDP, while Panama (Baa2 stable) made stable) made the second-largest reduction. Nearly half of the countries in the sample were able to reduce transfers, and several reported lower interest bills. » The level and structure of spending vary across countries, reflecting both institutional arrangements and policy decisions.  Brazil, Ecuador and Argentina report the highest level of spending at 25% of GDP, or more. By contrast, spending by Guatemala, Mexico (A3 negative) and negative) and Bolivia (Ba3 stable) is stable) is the lowest, amounting to 17% of GDP, or less. On average, LatAm governments allocate 39% of their spending to operating expenses, 33% to transfers, 19% to capital expenditures and 9% to interest payments. The share of interest expenses is relatively uniform, with the notable exception of Brazil, which allocates 25% of central government expenditures to servicing its debt.

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Briefing: Flexibility index highlights easier choices for Ecuador, challenges for Brazil The expenditure flexibility index tracks central government spending from 2010 to 2016 and classifies outlays as operating expenses (wage and other), transfers, investment or interest payments.1 For the index, spending on interest, wages and transfers are considered to be mandatory and the share of mandatory outlays to total spending is calculated for each country. The index is scaled using the regional average for mandatory spending as a share of total spending, creating a relative ranking. We believe that governments with more flexible expenditures will have more options to reduce spending if needed, while inflexible expenditures will limit policy choices to reduce deficits, a constraint on sovereign credit profiles. The sovereigns divide into three categories: those with the most flexible expenditures, the most inflexible, and a neutral middle cohort (see Exhibit 1). Exhibit 1

Ecuador has the most spending flexibility, while Brazil is severely constrained Flexibility index, 100 = LatAm average for flexibility 200 Most Flexible

180

Least Flexible

160 140 120 100 80 60 40 20 0 Ecua Ecuado dorr

Peru Peru**

Nica Nicara ragu gua a

Pana Panama ma**

Hond Hondur uras as

Mexi Mexico co**

Guat Guatem emal ala a Parag Paragua uay y El Salv Salvad ador or

Chil Chile* e*

Boli Bolivi via a

Urug Urugua uay* y*

Arge Argent ntin ina a

Colo Colomb mbia ia** Cos Costa ta Rica Rica

Braz Brazil il

* indicates investment-grade rating Source: Moody's Investors Service

Ecuador enjoys the most flexibility to adjust its expenditures

Ecuador ran a fiscal deficit equal to 5.6% of GDP in 2016, a figure we expect to decline to 4.2% in 2017 and 3.8% in 2018. Reducing any fiscal deficit that sizeable is daunting, but Ecuador's flexible spending composition helps smooth the path to consolidation. Compared Compared to the regional average, Ecuador's expenditures are nearly twice as flexible, for two reasons. First, investment is high, accounting for an average of  42% of the government's budget from 2010 to 2016. This is the highest share in Latin America and provides a large pool of spending that can be delayed or canceled without the political sensitivities of reductions to wages or subsidies. Second, Ecuador's transfers are low, with only 6% of its budget being spent on transfers. This is the lowest level in LatAm and 4x less than the regional median of 28%. Together, Ecuador's spending on investment and transfers position it with politically palatable options to pursue fiscal consolidation. Its budget structure is credit supportive. Brazil's faces very difficult choices to reduce its deficit

Brazil's fiscal picture is sobering. The government ran a fiscal deficit equal to some 9% of GDP in 2016, a number we believe will deteriorate in 2017 to 9.4% before improving marginally marginally in 2018. Unlike Ecuador, whose budget contains line items that are easier to reduce, it is extremely difficult for Brazil to reduce its fiscal deficit by cutting spending. From 2010 to 2016, the Brazilian government spent an average of 55% of  its budget on transfers and 25% on interest payments – interest payments in Brazil take up 3x more of the budget than the regional average. There was very limited government investment averaging less than 1% of the budget. As a result, Brazil's expenditures are much less flexible than in the other countries, making decisions on cutting expenditures politically difficult for the authorities. Accordingly, the overall structure

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Section I: Index identifies Ecuador as the most flexible; Brazil B razil severely constrained Government spending structure determines extent to which expenditures can be cut

A government’s ability to respond to adverse conditions and prevent – or limit – the deterioration of its credit profile is related in part to the degree of budget flexibility that is available to it. In this report, the concept of budget flexibility is linked to the structure of government spending. The idea underlying this approach is that budget flexibility is strongly influenced by the composition of  government expenditures, bearing in mind that some spending components are more difficult to adjust than others. In this respect, two categories sit at opposite ends of the spectrum when it comes to budget flexibility. Interest payments are at one extreme because the possibility of “adjustment” is nil from a credit perspective, since doing so would entail a credit event with adverse rating implications. At the other extreme, capital expenditures appear as the most flexible category with strong evidence that governments have frequently exercised this option when a fiscal adjustment has been required. In between those two extremes sit operating expenses (primarily wages) and transfers. While their degree of flexibility is not as limited as that of interest payments, they are closer in this respect to interest payments than to investment expenditures, as political sensitivities limit the authorities’ ability to significantly adjust wage- and transfer-related expenses (see Exhibit 2). Exhibit 2

Stylized breakdown of the budget classification scheme Wages, transfers and interest payments are considered mandatory

Note: “Transfers” is broadly defined to included social programs, pensions and subsidies Source: Moody's Investors Service

Index ranks countries according to degree of spending flexibility

The expenditure flexibility index rank orders sovereigns. The calculation of the index only differentiates between “flexible” spending components (investment and non-wage operating expenses) and “non-flexible” items (interest, wages, transfers). Although further differentiations between spending categories are possible to try to reflect their perceived flexibility, this binary approach is sufficient as the ranking is not overly sensitive to various weightings. The index calculates the budget share of mandatory spending for each country and then divides by the regional average share of mandatory spending to scale the scores. The objective of the index is not to generate a precise measure of flexibility, but simply to rank order credits according to their flexibility and, consequently, to offer an insight into whether expenditure flexibility supports, or constrains, the sovereign's credit profile. For sovereigns whose credit profiles are already associated with weak fiscal strength, limited budget flexibility implies that

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Flexibility Index Table and Graph Exhibit 3

Exhibit 4

Expenditure Flexibility Index by Country

Expenditure Flexibility Index: 100 = LatAm Average

Country

Rating

% of Budget that is Mandatory

Flexibility Index

Argentina

B3

85%

53

Bolivia

B a3

75%

85

Brazil

B a2

93%

24

Chile*

A a3

74%

88

Colombia*

B aa2

85%

50

Costa Rica

B a2

88%

43

Ecuador

B3

49%

176

El Salv ador

Caa1

71%

99

Guatemala

Ba1

70%

103

200

180

Most Flexible

Least Flexible

160

140

120

100

Honduras

B1

65%

121

Mexico*

A3

70%

104

Nicaragua

B2

54%

158

Panama*

B aa2

55%

156

Paraguay

B a1

70%

102

Peru

A3

53%

161

B aa2

78%

75

80

60

40

Uruguay*

* Denotes investment-grade rating in both exhibits

20

0

Source: Moody's Investors Service

Ecuador and Peru are the most flexible, while Costa Rica and Brazil have few easy choices

The index reveals that budget flexibility is highest in Ecuador, Peru, Nicaragua and Panama, all of which are 50% or more flexible than the median country. Both Ecuador and Panama's scores benefit from high levels of government investment. Investment averaged 42% of spending from 2010 to 2016 in Ecuador and 38% in Panama. Ecuador is nearly twice as flexible, landing it atop the index. In contrast, the governments of Brazil, Costa Rica, Colombia and Argentina are the most constrained, each about 50% or less flexible than the median country. Transfers weigh heavily on all four of these countries and interest payments are a significant burden in Brazil. Strikingly, Brazil is only 25% as flexible as the regional average. In between these two groups, there are a relatively large number of countries – eight altogether – that are essentially neutral in terms of expenditure flexibility. El Salvador, ranking 99 on the index, scores closest to the regional average.

Flexible expenditures enhance fiscal strength, while inflexibility impedes reforms

We view a government's ability to address budget pressures through spending cuts as a positive feature of a sovereign's credit profile. From a group of four sovereigns with high budget flexibility, two are investment grade – Panama (Baa2) and Peru (A3) – and the other two are low-rated non-investment grade sovereigns – Nicaragua (B2) and Ecuador (B3).

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budget flexibility is somewhat limited. For Ecuador, the story is different. A severe oil-related commodity shock led to a deterioration of  the government accounts, but the authorities have been taken advantage of budget flexibility to adjust spending reducing government investment by 2% of GDP during the last three years. Looking at countries placed at the low end of the flexibility scale, three out of four are non-investment-grade sovereigns – Brazil (Ba2), Costa Rica (Ba2), Argentina (B3) – with Colombia (Baa2) standing as the only investment grade sovereign. Limited expenditure flexibility is particularly relevant in the case of Brazil and Costa Rica, where low flexibility denotes the presence of structural constraints that limit the authorities' ability to address fiscal pressures that have undermined creditworthiness. For Argentina, a low degree of flexibility operates more like a constraint on the rating given its “Low (-)” fiscal strength. Finally, in addition to revenue-related challenges, the Colombian authorities have to deal with limitations imposed by relatively low expenditure flexibility in their efforts to comply with the fiscal rule and assure a declining trend in government debt ratios.

Section II: Government spending reported reductions in only three countries from 2010 to 2016 Government spending rose across from 2010 to 2016 in most countries...

Since 2010, central government spending has increased across the region as a percentage of GDP, although generally at a moderate pace. Median central government spending rose to 19.4% of GDP in 2016 from 18.5% in 2010. On a country-by-country basis, Argentina saw the largest increase, as government spending rose by about 5% of GDP from 2010 to 2016, followed by Paraguay (+4%) and Bolivia (+3%). It is noteworthy that government spending declined in three countries over the same period. In Guatemala, the reduction was equivalent to 2.5% of GDP, followed by Panama and El Salvador where the reduction was about 1% of GDP (Exhibit 5). Exhibit 5

Spending has risen the fastest in Argentina and declined the most in Guatemala Percentage point change in total spending as a share of GDP, 2016 vs. 2010 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 Arge Argent ntin ina a

Para Paragu guay ay

Boli Bolivi via a

Mexi Mexico co

N ica icara ragu gua a

Ecua Ecuado dorr

C hil hile e

C olo olomb mbia ia

H ond ondur uras as

U rug rugua uay y

C ost osta a R ica ica

Braz Bra zil il

Peru Peru

El Salv Salvad ador or

Pana Panama ma

Guate G uatema mala la

Source: Moody's Investors Service

… changes in government spending associated with different expenditure categories

The specific drivers behind changes in spending varied by country. Spending on transfers in Argentina was the single largest increase for any single line item in Latin America over the past seven years. At the other end, Honduras cut operating expenses by 2.1% of GDP over the same period, the single largest decrease in spending. In Peru, decreases in transfers, interest costs and capital expenditures were outweighed, just slightly, by increases in operating costs. And while increased spending was the general trend, 14 of the 16 countries covered in this report cut spending in at least one area of the government. The cuts most frequently occurred in capital expenditures, but almost half of the countries cut transfer spending and several were able to lower their interest bill despite generally increasing debt burdens (see Exhibit 6).

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Exhibit 6

Median spending has increased, but the drivers are varied Percentage point change in spending categories as a share of GDP, 2016 vs. 2010 Oper Operat atin ing g Expe Expens nses es

Tran Transf sfer ers s

Inte Intere rest st

Capi Capita tall Expe Expend ndit itur ures es

7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 Arge Argent ntin ina a

Para Paragu guay ay

Boli Bolivi via a

Mexi Mexico co

Nica Nicara ragu gua a

Ecua Ecuado dorr

Chil Chile e

Colo Colomb mbia ia

Hond Hondur uras as

Urug Urugua uay y

Cost Costa a Rica Rica

Braz Bra zil il

Peru Peru

El Salv Salvad ador or

Pana Panama ma

Guate G uatema mala la

Source: Moody's Investors Service

Increased spending reflects either policy choices or existing institutional arrangements

With the exception of Honduras, Ecuador and Costa Rica, higher interest payments had a minor effect on the overall level of spending. Increased government expenditures reflected either policy choices by the authorities or, alternatively, the workings of institutional arrangements that tend to determine the evolution of mandatory expenditures – mostly transfers – over time. In the case of Nicaragua, Peru and Paraguay, increased spending was the result of higher operating expenses. Alternatively, in Bolivia, the driver was increased investment spending, which was also true in the case of Mexico and Honduras. Transfers were the single most important driver behind increased government spending in Argentina and the largest single line item for all LatAm countries in our sample. Three countries reported reductions of government spending of 1% of GDP or more in one area. For Guatemala, spending cuts were centered on capital expenditures; for Honduras, they involved operating expenses; and transfers in Peru. A deep dive into expenditures by category Operating expenses increased the most in Nicaragua, Peru and Paraguay, going up by some 1.5% of GDP from 2010 to 2016 (see

Exhibit 7). In most cases, public salaries were the culprit behind increased payrolls. Strikingly, the government of Honduras is at the other extreme on account of an adjustment that involved cutting operating expenses by 2.1% of GDP, a development rarely seen in the region. A substantial reduction in the wage bill due to the removal of “ghost” employees drove the change. Exhibit 7

Operational costs increased the most in Nicaragua and fell sharply in Honduras Change as a % of GDP, 2010 vs. 2016 2.0 1.5 1.0 0.5 0.0 -0.5

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Regarding transfers, countries are almost evenly distributed between those that were able to reduce them (seven), and those where transfers increased (nine), with changes in the order of ±1% of GDP for most. Argentina is in a category of its own on account of a +4.5% of GDP increase that dwarfs those observed in other countries. The reason behind this involved the previous administration’s move to aggressively increase pensions and, simultaneously, provide broad-based energy and transportation subsidies. Transfer spending in Argentina reached 17.1% 1% of GDP in i n 2016 from 12.6% in i n 2010. Even though the t he current Macri administration has taken steps to reduce subsidies, a decision to not only preserve but expand pension benefits is preventing a reduction in the overall level of  transfers, an element that will limit budget flexibility in the coming years. The government aims to reduce gas and electric subsidies to 0% of GDP in 2020 from 4% in 2015 and the 2018 budget contains cuts to subsidies equal to 0.6% of GDP (see Exhibit 8). Exhibit 8

Transfer spending increased the most in Argentina but declined in many countries Change as a % of GDP, 2010 vs. 2016 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 Arge Argent ntin ina a

C olo olomb mbia ia

Mexi Mexico co

Para Paragu guay ay

C hil hile e

U rug rugua uay y

Braz Bra zil il

C ost osta a R ica ica H Hon ondu dura ras s

N ica icara ragu gua a

Boli Bolivi via a

Guat Guatem emal a la a El Salv Salvad ador or Ecuad Ecuador or

Pana Panama ma

Peru Peru

Source: Moody's Investors Service

The evolution of capital expenditures denotes a push by six governments to increase investment spending, which can support growth. Bolivia led the region in this area with investments increasing the most (+2.4% of GDP). Honduras and Mexico increased investments as well (+1.5%), along with 1% percentage point increases in Paraguay and Ecuador (see Exhibit 9). Other countries instead cut capital expenditures, albeit by modest amounts (0.5% of GDP). Guatemala was an outlier because the authorities sharply reduced government investment (-2% of GDP) to prevent a deterioration of the fiscal balance. Exhibit 9

Investment increased the most in Bolivia to support growth Change as a % of GDP, 2010 vs. 2016 3.0

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Government spending on interest payments rose as a share of GDP in most countries, but by relatively modest amounts (see Exhibit 10). Interest payments rose the most in Honduras and Ecuador – more than 1% of GDP – as both sovereigns went to international markets, issuing global bonds that paid relatively high yields. Steady increases in government debt burdens over the last six years further contributed to interest costs. Exhibit 10

Interest burdens increased the most in Honduras and Ecuador while declining in Panama Change as a % of GDP, 2010 vs. 2016 2.0

1.5

1.0

0.5

0.0

-0.5

-1.0 H ond ondur uras as

Ecua Ecuado dorr

C ost osta a R ica ica Par Parag agua uay y

C olo olomb mbia ia

Braz Bra zil il

U rug rugua uay y

Arge Argent ntin ina a

C hil hile e

Mexi Mexico co

El Salv Salvad ador or Guat Guatem emal a la a N ica icara ragu gua a

Peru Peru

Boli Bolivi via a

Pana Panam ma

Source: Moody's Investors Service

Section III: Spending allocations vary based on policy priorities and institutional arrangements Spending levels and compositions are influenced by the institutional arrangements and national priorities of each country. Countries with highly centralized governments, such as Chile, organize their budgets differently than countries with federal systems, such as Mexico. For instance, in Brazil, state-owned enterprises make significant public investments that are not included in central government accounting. However, comparisons at the central level do capture meaningful differences in spending decisions by national governments, which are ultimately responsible for the sovereign bonds Moody's rates. Across Latin America, the median level for central government spending averaged 19% of GDP from 2010 to 2016 (see Exhibit 11). The ratio of spending to GDP ranges from a high of 27% in Brazil to a low 13% in Guatemala. Along with Brazil, the governments of  Ecuador and Argentina report the highest spending levels in the region, while Bolivia and Mexico together tend to be at the low end. Exhibit 11

Central government spending is highest in Brazil and lowest in Guatemala Central government spending as a share of GDP, 2010-16

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LatAm governments allocate 72% of their budgets to current expenditures on average

For the region as a whole, looking at the structure of government spending from 2010 to 2016, operating expenditures (wages + other operating expenses) accounted for 39% of total spending, while transfers (subsidies + pension payments + other transfers) represented 33% of the total. During the same period, capital expenditures were 19% of total spending with interest payments accounting for the remaining 9% of expenditures (see Exhibit 12). Exhibit 12

Current spending dominates the budgets of Latam governments Average spending, 2010-16 Interest 9% Current Transfers 33%

Capital Expenditures 19%

Operating Expenses 39%

Source: Moody's Investors Service

Significant variations are present in the composition of government spending

Clear differences emerge when looking at the composition of central government spending on a country-by-country basis. Three distinct groups can be identified: the first group includes countries in which operating expenses account for the bulk of total government expenditures; in the second group current transfers dominate the spending picture; the third group includes governments whose share of capital expenditures is high relative to the rest. The first group is the largest and includes seven countries for which operating expenses account for more than 40% of government spending. The second group includes six countries in which the share of transfers is 45% or higher. The third group, by far the smallest, comprises countries in which capital expenditures amount to some 40% of total government spending. Exhibit 13

Paraguay has the highest share of operating expenses; Argentina the most transfers

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A deep dive into government spending by category Operating expenses are primarily wages, with the remainder corresponding to goods and services. The median share of operating

expenses is 42%, with the range spanning a maximum of 53% in Paraguay to a minimum of 16% in Colombia (see Exhibit 14). Along with Paraguay, the governments of Bolivia and Nicaragua sit at the top of this group, with the shares of operating expenses exceeding the 50% mark. Honduras, Ecuador, El Salvador, Peru and Guatemala follow closely behind, with operating expenses representing about 45% of total government spending. At the opposite end of the spectrum, Colombia (16%), Brazil (20%) and Argentina (21%) have low levels of operating expenses. In lower-income countries, operating expenses tend to report a high share of total spending. Peru appears out of place amongst the seven countries with the highest share of operating expenses because its income is about 50% higher than the average for the rest of its peers in this group. Exhibit 14

Share of operating expenses highest in Ecuador, Honduras and Paraguay Operating expenses (% of central government spending, 2010-2016) Operating - Wages

60%

Operating - Non-Wage

Median

50%

Median = 42% 40% 30% 20% 10% 0% Para Paragu guay ay

Boli Bolivi via a

N ica icara ragu gua a H ondu o ndura ras s

Ecua Ecuado dorr

El Salv Salvad ador or

Peru Peru

Guat Guatem emal a la a C ost osta a R ica ica

U rug rugua uay y

Mexi Mexico co

Pana Panam ma

C hil hile e

Arge Argent ntin ina a

Braz Bra zil il

C olo olomb mbia ia

Source: Moody's Investors Service

Current transfers are a broad category that includes unemployment benefits, subsidies and pension payments, among other items.

The median share of current transfers is 26%, with the range spanning a high of 62% (Argentina) to a low of about 20% (see Exhibit 15). Ecuador appears as a special case, with a share that comes to only 6%. In addition to Argentina, countries in which transfers account for the highest share of government spending include Colombia (56%), Brazil (55%), Chile (50%) and Uruguay (47%). Ecuador aside, several countries report shares in the order of 20%, which are at the low end of the scale. Countries where the spending share for current transfers is high are those with elevated per-capita income in the region - and vice versa - denoting a strong correlation between income levels and governments transfers. For some governments, social security benefits, pension payments in particular, account for the bulk of their transfers. Exhibit 15

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Two countries – Ecuador and Panama – stand out in the region when it comes to capital expenditures. Both sovereigns allocate about 40% of total spending to this category, a share that is twice as large as the 18% regional median (see Exhibit 16). Peru is third in line but with a significantly lower share (24%), followed by four countries (Nicaragua, Guatemala, Honduras, Paraguay) that report shares of around 20%. Argentina, Costa Rica and Uruguay are positioned at the other extreme, with shares of 10% or less. Brazil is far behind everyone, given a 1% share. It is interesting to see that countries like Paraguay, Bolivia and Honduras, in which the share of operating expenses is relatively high were positioned at the median, while the countries in which the share of transfers was high reported the lowest shares, indicating that transfers have been more of a constraint on capital expenditures than operating expenses. Exhibit 16

Investment is highest in Ecuador and Panama Investment (% of central government spending, 2010-2016) Capital Expenditures

Median

50% 45% 40% 35% 30% 25%

Median = 18%

20% 15% 10% 5% 0% Ecua Ecuado dorr

Pana Panama ma

Peru Peru

N ica icara ragu gua a G Gua uate tema mala la Hon Hondu dura ras s

Para Paragu guay ay

Mexi Mexico co

C hil hile e

El Salv Salvad ador or C olo olomb mbia ia

Boli Bolivi via a

Arge Argent ntin ina a C o sta sta R ica ica

U rug rugua uay y

Braz Bra zil il

Source: Moody's Investors Service

Regional differences are not as marked for interest payments. With the regional median placed at a 9% share, interest expenditures account for 5% to 14% of total government spending in most countries, Brazil being a notable exception given its 25% share (see Exhibit 17). For countries as diverse as Mexico, El Salvador, Uruguay and Panama, the corresponding share is between 10% and 15%. Alternatively, for an equally diverse group of countries that includes Argentina, Honduras, Ecuador and Peru the range is between 5% and 10%. Chile and Paraguay report the lowest shares coming to 3% in each case. Brazil’s record-high share for interest payments reflects both high – and increasing – indebtedness coupled with steep domestic rates typically associated with government paper. Exhibit 17

Brazil has the highest interest burden by far Interest (% of central government spending, 2010-2016) Interest

Median

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Methodology and data collection For this report, we analyzed data on annual spending for 16 central governments in Latin America in the 2010-16 period.2 The countries included in this analysis reflect major markets and availability of data. The focus is on the central government level – rather than at broader levels of government – because of greater data availability availability.. Governments report fiscal spending data with varying degrees of granularity making direct comparisons across specific line items challenging. For that reason, spending was reclassified into four standard categories: operating expenses, current transfers, capital expenditures and interest expenses. These broad categories allow for more uniformity and allows for more accurate comparisons that better capture differences in government spending structures. Operating expenses are further divided into spending on wages and other current expenditures, which include goods and services. This spending category is subdivided to highlight the challenges governments face in cutting wage bills. Current transfers is a broad category that includes pensions, subsidies, social programs and transfers to regional/local governments. governments. This category serves as a catch-all because some countries do not report disaggregated data to allow a more granular detail on the type of transfer. Capital expenditures include investments as well as other capital spending. The former includes investments made directly by the central governments and also includes capital transfers to local levels of government that are specifically earmarked for investment spending (generally in infrastructure). The other category includes miscellaneous non-investment charges, most prominently the sale of non-financial assets. For most countries this is negligible; for that reason capital spending and investment are used interchangeably unless otherwise noted Interest expenses do not include principal payments. For a small number of countries a category of other financial charges are included. Exhibit 18

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Moody's Related Research Sector In-Depth:

» Political Risk - Latin America: Political risk poses major challenges to regional credit prospects, prospects, 29 August 2017 » Sovereigns - Latin America: Odebrecht Case Illustrates Pervasiveness of Corruption, But Could Prompt Reform, Reform, 16 May 2017 » Monetary Policy - Brazil: Disinflation supporting lower interest rates, offering relief to Brazil’s fragile economy, economy, 27 July 2017 Sector Comment

» Latin America & Caribbean: Credit Trends: Regional Outlook Remains Negative, Negative, 31 March 2017 Issuer In-Depth

» Government of Ecuador: FAQ on government debt prospects and the potential impact of off-balance sheet liabilities, liabilities, 11 August 2017 » Government of Brazil – FAQ on current political turmoil, prospects for social security reform and sovereign credit risk, risk, 18 July 2017 Issuer Comment Comment

» Peru's Planned Boost in Public Investment in 2018 Is Credit Positive, Positive, 11 September 2017 » Government of Brazil: Proposed privatization program can help achieve fiscal targets in 2018; need for social security reform remains,, 30 August 2017 remains » Brazil's Increase in Fiscal Deficit Targets Is Credit Negative, Negative, 21 August 2017

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Endnotes 1 Current transfers vary greatly across the region and include transfers to local levels of g overnment, universities, private companies (for example, for transportation subsidies), social programs programs and pensions. In this report, this category serves as a catch-all because some countries do not report disaggregated data to allow further subdivision by type of transfer. 2 Brazilian data is from 2010 - 2014, the years for which IMF standardized data is available. Venezuela is excluded from this report due to challenges in the availability and quality of data.

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