BRASILIA, Feb 28 (Reuters) - Pension reform will be the "litmus" test of Brazil's ability to bring its fiscal deficits under control and avoid unsustainable growth of its already high public debt, the Organization for Economic Cooperation and Development (OECD) said on Wednesday.
In its annual survey of the Brazilian economy, the OECD said the streamlining of Brazil's generous social security system was urgent because it costs 12 percent of GDP.
"Aligning Brazil's pension rules with those practiced in OECD countries would imply a minimum pension lower than the minimum wage, with eligibility to some prorated pensions for shorter periods," the survey said.
Brazil's President Michel Temer failed to muster enough support for his pension reform proposal this month and it has been put off until after the October elections and will likely be left for the next government to deal with.
The OECD warned that if Brazil fails to reduce mandatory public spending and the government's primary deficit is not turned to a surplus, the country's debt relative to GDP "will continue to rise without bounds and not be sustainable."
Failure to comply with a spending cap introduced by the Temer administration, that limits real growth in public spending to the rate of inflation for 20 years, would undermine confidence in the Brazilian economy and trigger a return to recession.
"Successful implementation of the pension reform, without which the expenditure rule cannot be met in the medium term, will be a litmus test for the ability of the authorities to implement further structural reforms," the survey said.
The OECD said higher volatility on financial markets related to a normalization of U.S. monetary policy could also present risks for Brazil, though its Central Bank has well managed bouts of volatility in the past.
Substantial reserves and an expected strong inflow of foreign direct investment would cushion any related exchange rate risks, the survey said.
The OECD sees the Brazilian economy growing by 2.2 percent this year and 2.4 percent in 2018, a lower forecast for next year than the government's projection of 3 percent.
As Brazil puts its worst recession in decades behind it, inflation will creep up to 4.2 this year and next, from 3.9 last year, the OECD estimates.
Gross public debt, assuming that the current fiscal reform plan will advance, will rise to 77.1 percent of GDP this year and to 81.1 percent in 2018, according to the OECD's forecast.
(Reporting by Anthony Boadle Editing by Nick Zieminski)