BY ALONSO SOTO AND LUCIANA OTONI

BRASILIA Thu Feb 20, 2014 4:37pm EST

(Reuters) – Brazil set a more modest fiscal savings target for 2014 on Thursday in a bid to recover investors’ credibility, but economists remain skeptical that President Dilma Rousseff will be able to deliver in an election year.

In a much-anticipated announcement, the Rousseff administration lowered its primary budget surplus target to 1.9 percent of gross domestic product, a “conservative” target that officials said would still help Brazil reduce its debt burden.

The primary surplus, or revenues after expenditures but before interest payments, is a gauge of a country’s capacity to repay debt. It is also watched closely by rating agencies, which are threatening to downgrade Brazil’s credit grade because of concerns about its worsening economic fundamentals.

Brazil, where successive governments embraced fiscal discipline over much of the past decade, failed to achieve its primary budget goal in the last two years: of 3.1 percent of GDP in 2012 and 2.3 percent of GDP in 2013.

“Unfortunately, distrust in ‘fiscal austerity’ and the search for balanced public accounts will continue to be the Achilles’ heel of the government’s effort to maintain its credit rating this year,” said Alex Agostini, chief economist at Austin Rating agency, based in Sao Paulo.

The government also said it will freeze 44 billion reais ($18.44 billion) in public spending to meet the primary surplus target, up from 38 billion reais last year. Brazil typically announces a budget freeze early in the year in an attempt to signal to wary investors that the government remains committed to keeping public spending in check.

Financial markets reacted positively to the announcement. Brazil’s currency, the real, gained almost 1 percent and yields of Brazilian interest rate futures dropped.

Still, most economists remain skeptical and want to see if the government will follow through.

Twenty-two out of 35 economists surveyed by Reuters on Thursday believe that the government will miss the new target, but most of them expect Brazil to avoid a credit downgrade this year.

Brazil’s finances have deteriorated steadily under Rousseff, who has increased public spending and foregone billions of dollars in revenues by granting a slew of tax breaks aimed at reactivating the economy.

Shrinking primary surpluses have raised the country’s overall budget deficit, which includes interest payments, to a three-year high of 3.28 percent of GDP. In 2012, the deficit was 2.48 percent of GDP.

The widening deficit and increased debt servicing costs have left limited room in the budget to bolster public investment at a time when the economy is struggling to take off.

“ATTAINABLE AND REALISTIC”

A realistic and transparent primary surplus goal is crucial for Rousseff to regain investors’ confidence as she struggles to attract more investment to revive the economy, which may have slipped into a recession in the second half of 2013.

Well aware of investor skepticism, Finance Minister Guido Mantega took pains to stress the government’s commitment to limit public spending as he announced the new fiscal target.

“Our projections are attainable and pretty realistic and conservative, so we should deliver this result in December,” Mantega said at a news conference.

Mantega, whose own credibility has been eroded in recent years because of his penchant for giving what investors see as overly optimistic economic forecasts, said the new fiscal target will not stop the downward trend in Brazil’s debt-to-GDP ratio.

Thursday’s fiscal announcement included a GDP growth projection of 2.5 percent, above most market forecasts but down sharply from a previous estimate of 3.8 percent. It forecast inflation at 5.3 percent for 2014, down from 5.8 percent previously estimated.

Many economists doubt Rousseff will be able resist spending pressures ahead of the October 5 elections in which she plans to seek a second term. Tax income will probably continue to disappoint with the economy slowing to a crawl, depleting government accounts.

“The goal is feasible, but the market may question the government’s willingness to make tough fiscal decisions in an electoral year,” said Alberto Ramos, Goldman Sach’s head of Latin America research.

The fiscal deterioration of the last two years has stoked already-high inflation and raised worries that Standard & Poor’s could cut the Brazil’s much-coveted investment rating one notch.

In an interview with Reuters on Wednesday, S&P analyst Lisa Schineller said the agency would assess how “realistic” the new goal is to decide on the country’s grade.

Shelly Shetty, head of Fitch Ratings Latin America sovereigns, said in a note that the spending freeze is a “step in the right direction” but warned that it will keep a close eye on its implementation.

Moody’s Brazil analyst, Mauro Leos, agrees that the focus should be on the end result, but stressed that the new goal is in line with the stable outlook for Brazil’s rating.

Brazil’s central bank has been forced to raise interest rates from record lows to contain inflation, bringing its benchmark Selic rate close to three-year highs.

DROUGHT RAISES FISCAL RISKS

The government faces a series of risks that will make it even more difficult to achieve the new fiscal target.

A severe drought that has sapped hydroelectric output and increased the government’s spending on energy subsidies has put extra pressure on fiscal accounts.

Another threat looms in Brazil’s Supreme Court. Next week, a legal battle is expected to resume in the court over lawsuits brought against banks by thousands of depositors over government policies dating back two decades.

An unfavorable ruling could cost state and private banks up to 150 billion reais, or about a third of their market value, further shaking a weak economy by shrinking credit.

(Editing by Anthony Boadle, W Simon and Jonathan Oatis)