When Cristina Teixeira Stevens’ father, a second world war veteran, passed away three years ago, she and her sister started receiving a share of his pension payments.

In a quirk of Brazil’s retirement system, military daughters in certain circumstances are entitled to inherit half their father’s pension, with the rest going to his spouse.

“To cope with my uncomfortable feeling about this, I chose some charity projects to which to donate the money,” says Ms Teixeira Stevens, a professor of English literature at the University of Brasília.

She is not the only one to feel discomfort with Brazil’s overly generous pension system. Its extravagant cost contributes to distortions in the country’s economy that analysts say prevent Brazil from achieving higher potential rates of gross domestic product growth.

The government’s huge expenditures on items such as pensions and payrolls and its lack of savings are often blamed for the economy’s stop-start growth pattern – illustrated by the rapid overheating and slowing down of the economy over the past two years.

Congress passed a bill last week that will help reduce Brazil’s long-term pension deficit by placing a cap on the government’s liability for federal public servants’ pensions. Yet the proposed law, which must go to the Senate, is also an illustration of just how difficult such reforms are in Brazil – it has been in the making since 1998.

“The speed of deterioration of the social security account is happening very fast in Brazil,” says Raul Velloso, a specialist in public finances in Brasília, underlining the urgency of the changes.

Brazil’s pension system is characterised by imbalances. In 2010, the general social security system for private sector workers, providing pensions for 24m people, cost the equivalent of 6.8 per cent of GDP.

Meanwhile, the system for public sector workers cost 2.1 per cent of GDP but only covered fewer than 3m people, according to research by Itaú-Unibanco, a Brazilian bank. That meant civil servants’ pensions were costing the government far more than those of private sector workers per person.

Overall, social security payments dominated by pensions were a major contributor to the country’s 2.6 per cent fiscal deficit last year. This burden will only get worse. As living conditions improve in Brazil, its relatively youthful population will start to age.

“Demographic tailwinds [in Brazil] should start to reverse by the middle of the next decade,” said Mauricio Oreng, economist at Itaú-Unibanco, in a research note.

While the new system will only solve these problems in the long term, it is a step in the right direction, analysts say. New entrants to the federal public service will have their pension payments capped at nearly R$4,000 ($2,275) per month. Anything they receive above that will depend on how much they contribute to a special fund. Under the existing system, by contrast, retired civil servants are paid an average of 80 per cent of the salary they received during their last decade of employment.

The federal system is likely to be copied by state and municipal pension systems, which are also running large deficits, say analysts at Fitch analysts Rita Gonçalves and Paulo Fugulin.

Capping the pension deficit and giving people incentives to save more money for their retirement will bring huge benefits to the economy, economists say.

The huge outlay on pensions restricts the money that the government has available for investment in infrastructure, education and other areas, contributing to inflation by restricting the capacity of the economy to supply goods and skilled labour.

Higher inflation means leads to higher interest rates. The high recurring pension bill also creates a need for lofty taxes, raising the cost of doing business in Brazil and putting more upward pressure on prices.

“The new system should bring about a higher level of domestic savings,” says Mr Oreng of Itaú. “Improving savings should help make room for yet lower interest rates.”

The law still has some way to go through Brazil’s contorted political process. But at least the will is there to change a system that Brazilians are realising they cannot afford. Even the hereditary pension being received by Ms Teixeira Stevens is a thing of the past – it has been phased out for new public servants.

“This demographic bonus we are enjoying now will last only for another 10 years. We have to plan for that,” she says.

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