(Adds economic data and context)
By Alonso Soto and Luciana Otoni
BRASILIA, Feb 12 (Reuters) - A severe drought stretching Brazil's finances by pushing up its energy bill could force the government to lower its primary budget surplus target this year, a senior official told Reuters.
President Dilma Rousseff's credibility has been damaged by her government's failure to meet its fiscal targets and investors doubt Brazil will be able to even repeat last year's primary surplus of 1.9 percent of gross domestic product, which was considered disappointing.
A primary budget surplus is the surplus before debt payments and is seen as a measure of the country's ability to repay debt.
Just a few months ago, the government had been eyeing a slightly more ambitious primary surplus target for 2014, but a drop in hydroelectric output caused by the drought will force it to spend more on subsidizing power supplies.
"We need to have an internal discussion about the energy bill and its trade-offs," said the official, a member of the government's economic team, who asked not to be named.
"We need to find a balance between our fiscal position and (energy) prices," the official told Reuters late on Tuesday, adding that a decision on a primary surplus goal could be taken as soon as next week.
A credible surplus goal is crucial for Rousseff to reassure rating agencies threatening to downgrade Brazil's debt rating this year.
A more realistic surplus target could help calm investors rattled by the recent selloff in emerging markets, which was triggered by a slowdown in China's economy and the withdrawal of U.S. monetary stimulus, analysts say.
The drought has depleted reservoirs in Brazil's industrial southeast and sapped output at hydroelectric plants, forcing utilities to turn to more expensive thermal energy to guarantee power supplies and avoid further blackouts or even rationing.
The government plans to pick up part of the bill to avoid passing the cost on to consumers, which could stoke inflation and stunt economic growth.
The extra cost, which could be as high as 5 billion reais according to local media, will weigh on fiscal accounts in an election year in which the government will be under pressure to spend more.
Rousseff, who is planning to run for re-election in October, is trying to persuade investors that she has not abandoned the prudent fiscal policies that brought economic stability to Brazil, which was plagued by debt crises in the 1980s and 1990s.
Although Brazil is in better fiscal shape than many developed nations, its primary surplus has shrunk in the last three years to 1.9 percent of GDP from 3.1 percent.
Fiscal erosion under Rousseff has undermined the credibility of her economic policies in the eyes of some investors and raised fears that the commodities powerhouse is now more vulnerable to the financial turmoil buffeting emerging nations.
The primary surplus has been dragged down by a slowing Brazilian economy and a slew of tax breaks offered by the government in an attempt to revive activity.
Meanwhile, Brazil's consolidated public-sector fiscal accounts, which include debt payments, are running a deficit that swelled in 2013 to 3.28 percent of GDP, the highest since 2010, from 2.48 percent of GDP in 2012.
An increase in the transfer of government capital to state-run development bank BNDES, which is not included in the budget, has increased Brazil's gross debt over the last few years and worried rating agencies.
Rousseff has promised to reduce transfers and rein in spending this year to regain fiscal credibility, which many economists believe is key to lowering inflation expectations and to reigniting economic growth in coming years.
Higher public spending has forced the central bank to raise its benchmark Selic rate by 325 basis points to 10.50 percent since April to curb a surge in prices.
The aggressive monetary tightening cycle, which is expected to continue, could further cool an economy expected to post a fourth year of subpar growth. (Reporting by Alonso Soto; Editing by Kieran Murray; and Peter Galloway)
Our Standards: The Thomson Reuters Trust Principles.