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Brazil freezes US$22.6b in spending after raising taxes

President Dilma Rousseff is trying to rein in the largest budget gap in 16 years that threatens Brazil's investment grade.

[RIO DE JANEIRO] Brazil is stepping up efforts to shrink a widening budget gap by cutting spending and raising taxes on banks.

The government is freezing 69.9 billion reais (S$30.2 billion) in spending from this year's budget, the Budget Ministry said on Friday. It made the announcement hours after the government said it would raise taxes on profits at banks, brokerages and credit-card processors to 20 per cent from 15 per cent.

President Dilma Rousseff is trying to rein in the largest budget gap in 16 years that threatens Brazil's investment grade. While Friday's measures will help, the slowing economy and reluctance among lawmakers to approve tax increases and cuts to labor benefits are hindering her efforts, Newton Rosa, chief economist at Sul America Investimentos Dtvm SA, said.

"Whether the freeze will be enough is a question mark," he said. "You can't work miracles in a budget where 90 percent is earmarked. There is limited discretionary space." Stocks in Brazil's largest banks fell sharply on Friday after the government raised taxes on industry profits, sending the benchmark Ibovespa index down 1.3 per cent on the day. The index fell 5 per cent this week, the worst decline since December.

In the currency markets, the real dropped as much as 2.1 per cent and ended the day at 3.09 per US dollar. The cost to insure the nation's debt for five years rose less than 1 basis point to 222 basis points.

"There were no great surprises, and the announcement came almost at the close of markets,"said Joao Pedro Brugger, a money manager at Leme Investimentos in Florianopolis, Brazil.

The budget freeze, which doesn't require approval from lawmakers, focuses on cutting current expenditures, discretionary spending in Congress and some infrastructure programs, Planning Minister Nelson Barbosa told reporters. For example, the government is reducing 5.6 billion reais from its subsidized-housing programme.

"It's a considerable fiscal effort," Mr Barbosa said, adding that the government is focused on preserving spending on health, education and other social-security benefits.

The tax measure on banks, which becomes effective Sept 1, will boost tax collection by about 750 million reais in 2015 and 3.8 billion reais next year, according to the tax agency. Itau Unibanco Holding SA estimates the increase may cost banks as much as 8 percent of their earnings in the long term, according to a report it published Friday.

The Brazilian banking federation Febraban declined to comment on the tax increase in an e-mailed response.

The tax hike shows that Finance Minister Joaquim Levy is taking the initiative to meet his targets, said Carlos Kawall, chief economist at Banco Safra.

"It reinforces the expectation that the government will do whatever it takes to reach the budget target," Mr Kawall said in a phone interview before the budget announcement.

Levy pledges to reverse last year's deficit and post a 2015 budget surplus that excludes interest payment of 1.1 per cent of gross domestic product. The target was revised from 1.2 per cent due to a change in methodology for calculating GDP. Barbosa said Levy was ill and couldn't attend Friday's press conference.

Levy has been pushing proposals in Congress to cap social security benefits worth as much as 27.3 billion reais in a year. The Senate on Wednesday delayed until next week the vote on a key portion of Levy's austerity package after several members of Rousseff's coalition balked at the belt tightening.

"There's agreement on the direction of the proposals," Mr Barbosa said about the government's fiscal-tightening measures. "There's disagreement, as in any democracy, on their intensity." While the higher taxes will help the government hit is target, it's also an additional brake on an economy that is heading to its deepest recession in 25 years, according to Edward Glossop, emerging market economist at Capital Economics.

"It should help to shore up the public finances over the medium term, but it's more bad news for consumers," Mr Glossop said by phone.

The government forecasts GDP will shrink 1.2 per cent this year as inflation surges 8.2 per cent, exceeding the 6.5 per cent ceiling of the target range, according to the Budget Ministry. Brazil lost jobs in April for the first time on record, the Labor Ministry said Friday, surprising analysts.