Public Information Notice: IMF Concludes 2003 Article IV Consultation with Brazil

March 24, 2003

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On March 14, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Brazil.1


The Brazilian economy came under considerable stress in 2002. The volatile external environment and concerns about the continuity of macroeconomic policies following the change in government led to a sharp decline in external capital flows, a depreciation of the real, and a drop in rollover rates on domestic debt. The depreciation of the currency contributed to a sharp rise in the trade balance to US$13.1 billion, five-times the level recorded the previous year, despite a collapse in exports to Argentina. Similarly, the current account deficit fell to US$7.8 billion, from more than US$23 billion in 2001. The rapid adjustment in the current account made possible by the floating exchange rate regime allowed the economy to absorb the significant shocks experienced in 2002 without a decline in output growth, which equaled 1.5 percent for the year. However, the impact of the shock is still being felt in the form of higher inflation. Consumer price inflation reached 12.5 percent for the year, driven largely by increases in tradable goods prices and in administered prices.

Capital inflows to Brazil were severely affected by developments in 2002. Foreign direct investment, while still more than sufficient to finance the current account gap, amounted to about US$16.6 billion in 2002, US$6 billion below the previous year's total. Net foreign portfolio flows also fell significantly, dropping by about US$4 billion from their previous year's level. Net international reserves, as defined under the Stand-By Arrangement with the Fund, stood at US$14.2 billion at end-year (US$9.2 billion above the program floor) while gross international reserves reached US$37.8 billion.

Financial market indicators were volatile through most of 2002. Between April and October—when election-related concerns reached their peak—the currency depreciated by 60 percent and sovereign risk spreads reached 2,400 basis points. However, the strong commitment of the incoming administration to maintain sound macroeconomic policies and an improvement in the external environment led to a reversal in the deterioration of Brazil's financial variables in the last two months of the year. As of mid-March, the exchange rate had recovered more than 10 percent of its value relative to last October and risk spreads had fallen by more than half.

Fiscal performance remained strong in 2002. The 12-month accumulated primary surplus of the consolidated public sector reached 3.9 percent of GDP in December, in line with the program target. Net public debt rose to 56 percent of GDP at end-December 2002 from 52.6 percent of GDP at end-2001 reflecting primarily the depreciation of the real.

Weak domestic demand kept price pressures under control for the early part of the year, but inflation picked up markedly in the last quarter. The central bank gradually loosened monetary policy in the first half of the year when price pressures seemed benign. However, this stance was reversed as signs emerged that the impact of the depreciation of the currency was being passed through to nontradable goods prices. The central bank moved aggressively to tighten policy, raising the overnight interest rate by 700 basis points during the fourth quarter of 2002 and an additional 150 basis points so far in 2003. Nevertheless, inflation expectations for 2003 remain above 12 percent, compared to the central bank's operational target of 8.5 percent for the year.

Progress on the structural reform agenda in 2002 was mixed. Legislation was approved initiating the conversion of domestic turnover taxes into a value added type tax and measures were introduced to improve bank supervision. However, progress on other items such as pension reform and the new central bank law was delayed owing in part to the election-related congressional recesses.

Executive Board Assessment

Executive Directors noted that Brazil has made considerable progress in addressing economic imbalances and improving social indicators, while maintaining disciplined fiscal and monetary policies. Nevertheless, Directors observed that events in 2002—when Brazil confronted a sudden turnaround in capital flows due inter alia to concerns about the future course of economic policies and the sustainability of the debt—demonstrated that Brazil remains vulnerable to shifts in investor sentiment. Sources of this vulnerability include the size and structure of the public debt, the external borrowing requirement, and slow economic growth.

Directors commended the new government's decisive actions to deal with Brazil's economic uncertainties and vulnerabilities. They noted that these actions, and the authorities' commitment to maintain policy discipline and push ahead with structural reforms, have resulted in an improvement in market sentiment in recent months, with risk spreads declining and the currency strengthening. They recognized that the authorities face the challenge of delivering fundamental reforms, and were encouraged by the authorities' efforts to maintain the momentum for reform.

Directors welcomed the authorities' decision to raise the primary fiscal surplus target for 2003 to 4¼ percent of GDP, and their public commitment to maintain primary surpluses over the medium term at levels sufficient to keep the public debt on a sustainable path. They encouraged the authorities to operationalize this goal by setting ambitious fiscal targets for the medium-term. Attainment of these targets would afford greater insurance against shocks, and could generate a virtuous circle of lower risk spreads and interest rates, faster output growth, and further declines in the debt ratio.

Directors commended the authorities' efforts to build a consensus in favor of pension and tax reform, noting the agreement reached with all 27 state governors in this regard. They considered pension reform to be an important step toward maintaining primary fiscal surpluses over the medium term and narrowing differences between the public and private systems. They noted that, while aiming at ambitious measures whose benefits will be substantial in the long-run, the government is mindful of the importance of making the reform compatible with short and medium term fiscal objectives.

Directors also noted that the rigid structure of the budget limits the ability of fiscal policy to respond to shocks and leads the burden of adjustment to fall disproportionately on investment spending, as is the case in 2003. Accordingly, they were encouraged by the authorities' commitment to increase budget flexibility and to limit earmarking in the context of a broad tax reform to be submitted to the Congress in June 2003. As the current high revenue ratio leaves little room for tax increases, especially given the need to reduce business costs and increase competitiveness, Directors agreed with the authorities that the objective of tax reform should be to streamline and simplify the tax system in order to reduce distortions and administrative costs and make the system more transparent and equitable. Directors also welcomed the authorities' intention to continue reducing the degree of indexation of the public debt stock to the exchange rate and to interest rates, as market conditions allow, noting that this would reduce vulnerability as well.

Directors observed that, following the depreciation-led increase in the prices of traded goods last year, inflation had spilled over to nontraded goods' prices, and inflation expectations risked becoming entrenched. They supported the authorities' policy response, and advised the authorities to remain vigilant and to be prepared to act if and as needed. Directors welcomed the authorities' commitment to formalize the operational autonomy of the central bank.

Directors noted that sustained implementation of structural reforms to complement sound fiscal and monetary policies would help achieve the government's economic growth and poverty reduction objectives. Particularly important, in addition to the tax and pension reforms mentioned earlier, will be measures to improve governance, transparency, the investment climate, and to boost trade. In this context, Directors welcomed the authorities' intention to seek reductions in trade barriers at the bilateral, regional and multilateral levels, as further increases in Brazil's outward orientation have the potential to significantly boost prospects for medium-term investment and economic growth and to reduce external vulnerabilities. However, Directors agreed with the authorities that addressing the needs of the poorest would require, in addition to economic growth, more effective targeting of social spending. They commended the authorities' initiatives in this area. Directors also welcomed moves by the authorities to reduce very high banking spreads through reforms of the bankruptcy law, and encouraged them to continue with the reforms in the labor market. Directors observed that Brazil has made significant progress in establishing a comprehensive anti-money laundering institutional framework, and is committed to ratifying and implementing the main anti-terrorism and anti-money laundering agreements.

It is expected that the next Article IV Consultation with Brazil will be held in accordance with the provisions of the decision on consultation cycles.

Brazil: Selected Economic Indicators








(in percent)

Domestic economy


Change in real GDP






Unemployment rate





7. 1

Inflation (IPCA, end-year)






(in billions of U.S. dollars)

External economy


Exports, f.o.b.






Imports, f.o.b.






Current account balance


-25. 3




Capital account balance






o/w Foreign direct investment






Gross official reserves






Current account balance (in percent of GDP)







(in percent of GDP)

Financial variables


Public sector borrowing requirement 1/






Public sector primary balance






Gross external public debt







Change in broad money (in percent)






Average overnight interest rate (in percent)







Source: Brazilian authorities and IMF staff estimates.

1/ Harmonized public sector borrowing requirement (excluding the impact on the debt stock of exchange rate movements occurred during the reference period that will not be paid until the bond matures).

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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