SOVEREIGN AND SUPRANATIONAL

SECTOR IN-DEPTH Sovereigns – Latin America

18 October 2017
High compulsory spending levels to impede
fiscal consolidation, especially in Brazil
A number of governments in Latin America (LatAm) have started to consolidate public
Analyst Contacts 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
Michael Brown 212-553-4515
Associate Analyst adjust expenditures. From a sovereign credit standpoint, budget flexibility – a government's
michael.brown@moodys.com ability to adjust revenues and/or expenditures – is a factor that can strongly influence fiscal
Renzo Merino 212-553-0330 prospects. We use an 'expenditure flexibility index' to illustrate how the composition of
AVP-Analyst central government spending across 16 LatAm countries enhances - or impedes - budget
renzo.merino@moodys.com flexibility. Our main findings are:
Mauro Leos 212-553-1947
VP-Sr Credit Officer/ » Ecuador is best positioned to adjust spending; Brazil has the least flexibility to
Manager do so. Ecuador (B3 stable), Peru (A3 stable), Nicaragua (B2 positive) and Panama (Baa2
mauro.leos@moodys.com positive) have the greatest budgetary flexibility given that compulsory expenses – i.e.,
Atsi Sheth 212-553-7825 wages, transfers and interest payments – account for about 50% of total government
MD-Sovereign Risk spending. In contrast, Brazil (Ba2 negative), Argentina (B3 positive), Colombia (Baa2
atsi.sheth@moodys.com
stable) and Costa Rica (Ba2 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). Guatemala (Ba1
stable) reduced spending the most, achieving a decrease equivalent to 2.5% of GDP, while
Panama (Baa2 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 Bolivia (Ba3 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.
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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

180 Most Flexible Least Flexible

160

140

120

100

80

60

40

20

0
Ecuador Peru* Nicaragua Panama* Honduras Mexico* Guatemala Paraguay El Salvador Chile* Bolivia Uruguay* Argentina Colombia* Costa Rica Brazil

* 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 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 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
of government spending is a negative element of Brazil's credit profile.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.

2 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Section I: Index identifies Ecuador as the most flexible; Brazil 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
additional pressures may further undermine their credit prospects relative to others that do not confront this condition. Alternatively,
for sovereigns that report higher-than-average flexibility, this is a condition that can reinforce their credit standing relative to those
with similar fiscal strength (see Exhibits 3 and 4).

3 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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 200

Argentina B3 85% 53 Most Least

180 Flexible Flexible
Bolivia Ba3 75% 85
Brazil Ba2 93% 24
160
Chile* Aa3 74% 88
Colombia* Baa2 85% 50 140

Costa Rica Ba2 88% 43

120
Ecuador B3 49% 176
El Salvador Caa1 71% 99
100
Guatemala Ba1 70% 103
Honduras B1 65% 121 80

Mexico* A3 70% 104

Nicaragua B2 54% 158 60

Panama* Baa2 55% 156

40
Paraguay Ba1 70% 102
Peru A3 53% 161 20
Uruguay* Baa2 78% 75
0
* Denotes investment-grade rating in both exhibits
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).

For Peru and Panama, expenditure flexibility reinforces the notion that robust fiscal profiles –fiscal strength scores are “Very High (-)”
and “High (+)” respectively – provide important credit support to their ratings. Alternatively, in the case of Ecuador and Nicaragua,
expenditure flexibility mitigates credit risks limiting the potential effect of adverse shocks on the fiscal accounts. In the case of
Nicaragua, given low fiscal deficits (2.3% of GDP in 2016) and moderate debt ratios (31.5% of GDP in 2016) the credit upside of

4 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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
Argentina Paraguay Bolivia Mexico Nicaragua Ecuador Chile Colombia Honduras Uruguay Costa Rica Brazil Peru El Salvador Panama Guatemala

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).

5 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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
Operating Expenses Transfers Interest Capital Expenditures
7.0

6.0

5.0

4.0

3.0

2.0

1.0

0.0

-1.0

-2.0

-3.0
Argentina Paraguay Bolivia Mexico Nicaragua Ecuador Chile Colombia Honduras Uruguay Costa Rica Brazil Peru El Salvador Panama Guatemala

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

-1.0

-1.5

-2.0

-2.5
Nicaragua Peru Paraguay Bolivia Argentina Ecuador Uruguay Chile El Salvador Panama Costa Rica Colombia Brazil Guatemala Mexico Honduras

Source: Moody's Investors Service

6 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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% of GDP in 2016 from 12.6% in 2010. Even though the 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
Argentina Colombia Mexico Paraguay Chile Uruguay Brazil Costa Rica Honduras Nicaragua Bolivia Guatemala El Salvador Ecuador Panama 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

2.5

2.0

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5

-2.0

-2.5
Bolivia Mexico Honduras Paraguay Ecuador Nicaragua Chile Colombia Panama Brazil Uruguay Peru Costa Rica Argentina El Salvador Guatemala

Source: Moody's Investors Service

7 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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
Honduras Ecuador Costa Rica Paraguay Colombia Brazil Uruguay Argentina Chile Mexico El Salvador Guatemala Nicaragua Peru Bolivia Panama

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
30%

25%

20%
Median = 19%

15%

10%

5%

0%
Brazil Ecuador Argentina Uruguay Honduras Chile Costa Rica Paraguay Peru Panama Colombia Nicaragua El Salvador Bolivia Mexico Guatemala

Source: Moody's Investors Service

8 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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
Composition of government spending by country, 2010-2016
Operating Expenses Current Transfers Capital Expenditures Interest
100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%
Paraguay Bolivia Nicaragua Honduras Ecuador El Salvador Peru Guatemala Costa Rica Uruguay Mexico Panama Chile Argentina Brazil Colombia

Source: Moody's Investors Service

9 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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 Operating - Non-Wage Median
60%

50%
Median = 42%
40%

30%

20%

10%

0%
Paraguay Bolivia Nicaragua Honduras Ecuador El Salvador Peru Guatemala Costa Rica Uruguay Mexico Panama Chile Argentina Brazil Colombia

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
Share of transfers highest in Argentina, Brazil and Colombia
Transfers (% of central government spending, 2010-2016)
Current Transfers Median
70%

60%

50%

40%

30% Median = 26%

20%

10%

0%
Argentina Colombia Brazil Chile Uruguay Costa Rica Mexico Bolivia Peru El Salvador Paraguay Guatemala Honduras Panama Nicaragua Ecuador

Source: Moody's Investors Service

10 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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%

20% Median = 18%

15%

10%

5%

0%
Ecuador Panama Peru Nicaragua Guatemala Honduras Paraguay Mexico Chile El Salvador Colombia Bolivia Argentina Costa Rica Uruguay Brazil

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
30%

25%

20%

15%

Median = 9%
10%

5%

0%
Brazil Colombia El Salvador Costa Rica Mexico Guatemala Uruguay Panama Honduras Bolivia Argentina Peru Nicaragua Ecuador Chile Paraguay

Source: Moody's Investors Service

11 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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.

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. 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
Stylized breakdown of the classification system

Source: Moody's Investors Service

12 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Moody's Related Research

Sector In-Depth:

» Political Risk - Latin America: Political risk poses major challenges to regional credit prospects, 29 August 2017

» Sovereigns - Latin America: Odebrecht Case Illustrates Pervasiveness of Corruption, But Could Prompt Reform, 16 May 2017

» Monetary Policy - Brazil: Disinflation supporting lower interest rates, offering relief to Brazil’s fragile economy, 27 July 2017

Sector Comment

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

Issuer In-Depth

» Government of Ecuador: FAQ on government debt prospects and the potential impact of off-balance sheet liabilities, 11 August 2017

» Government of Brazil – FAQ on current political turmoil, prospects for social security reform and sovereign credit risk, 18 July 2017

Issuer Comment

» Peru's Planned Boost in Public Investment in 2018 Is Credit 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

» Brazil's Increase in Fiscal Deficit Targets Is Credit Negative, 21 August 2017

» Argentina's Primary Election Results Support Macri Government's Credit-Positive Policy Reform Efforts, 17 August 2017

» Chance of Brazil’s Social Security Reform Wanes after President Is Charged with Corruption, 3 July 2017

» Government of Colombia – Medium-term fiscal plan envisions lower deficits and higher growth, but reaching targets may be
challenging, 24 July 2017

» NAFTA Renegotiation Is Unlikely to Significantly Alter Trade Deal, a Credit Positive for Mexico, 24 July 2017

» Government of Peru – Government Outperforms 2016 Fiscal Target, Allowing for a Slower Pace of Consolidation in 2017, 17 January
2017

» US Sanctions Against Venezuelan Officials Have Little Credit Relevance, 31 July 2017

Methodology

» Sovereign Bond Ratings, December 2016

Research Support
Matthew Bridle

AVP- Research Writer

Katrina Knisely

Summer Associate

13 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

Endnotes
1 Current transfers vary greatly across the region and include transfers to local levels of government, universities, private companies (for example,
for transportation subsidies), social 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.

14 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil
 MOODY'S INVESTORS SERVICE SOVEREIGN AND SUPRANATIONAL

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16 18 October 2017 Sovereigns – Latin America : High compulsory spending levels to impede fiscal consolidation, especially in Brazil