Public Information Notice: IMF Concludes Article IV Consultation with Brazil

August 23, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

The IMF Executive Board on July 28, 1999 concluded the Article IV consultation and the third review of the Stand-By credit with Brazil.1


Developments in the Brazilian economy during the first half of 1999 have been, on the whole, significantly better than expected under the revised IMF-supported program that was approved by the Executive Board at the end of March 1999. Real GDP, which had stagnated in 1998, partly reflecting the adverse impact of the Asian and Russian crisis, began to recover, and grew (on a seasonally adjusted basis) at annualized rates of 3.2 percent and 3.8 percent in the first and second quarters of 1999 respectively, relative to the preceding quarters. GDP is now expected to decline by 1 percent or less in 1999. Following the decision on January 15, 1999 to float the Brazilian Real, the initial overshooting of the exchange rate was corrected relatively quickly. The pass-through of the depreciation to prices has been relatively modest so far, and consumer price inflation in the first seven months of 1999 remained around 5 percent.

The external trade deficit declined to US$618 million in the first half of 1999, from US$1.8 billion in the corresponding period of 1998 and US$6.6 billion (0.8 percent of GDP) for 1998 as a whole. The improvement was limited by a significant terms of trade loss, which was mainly the result of the recovery in oil prices, and weakness in the prices of Brazil's major commodity exports. The current account deficit in the first half of 1999 declined to under US$12.3 billion from US$13.4 billion in the corresponding period of 1998, and US$33.6 billion (4.3 percent of GDP) for the year 1998.

The capital account of the balance of payments, which had suffered significant outflows in the initial part of the year, benefited from a recovery of confidence from March 1999 onward, as reflected in Brazil's renewed access to international capital markets and continued strong foreign direct investment. As a result, the deficit in the overall balance of payments was contained to around US$11 billion in the first half of 1999, about US$4 billion less than had been projected under the revised program. Net international reserves (excluding drawings under the IMF program and the facility arranged by the Bank for International Settlements) stood at US$24.4 billion at end-July 1999. On the same date, gross international reserves amounted to about US$42.2 billion (equivalent to nearly 9 months of imports of goods and nonfactor services, and to over 180 percent of short-term external debt).

Available data on the nonfinancial public sector (NFPS) show the substantial degree of fiscal adjustment that has taken place thus far this year. For the first 5 months of 1999, the consolidated primary surplus of the NFPS amounted to R$11.0 billion, compared to R$3.7 billion in the same period of 1998, and virtual equilibrium in 1998 as a whole. The public sector borrowing requirement (PSBR), which amounted to R$72.4 billion in 1998 (8.0 percent of GDP), reached R$65.1 billion in the first 5 months of 1999, mainly reflecting the adverse impact of the depreciation of the real. Net public sector debt, which had amounted to R$388.7 billion (42.6 percent of GDP) at end-1998, increased to R$484.2 billion at end-January 1999, reflecting the depreciation of the exchange rate, but declined slightly to R$483.1 billion by end-May 1999.

Following a brief unsettled period at the beginning of the year, when the exchange rate regime was changed, the Brazilian authorities have maintained a firm monetary policy stance in the last several months. After raising the overnight interbank (SELIC) interest rate to 45 percent in early March to prevent an acceleration of inflation, and to promote an early correction of the initial overshooting of the exchange rate, the Central Bank has reduced gradually interest rates in subsequent months, as the rate of inflation remained relatively low and the exchange rate firmed. Growth in the monetary and credit aggregates has also been restrained, with M2 (IMF definition) rising by about 6 percent in the 12 months to May 1999 and bank credit by about 3 percent in the 12 months through June.

Executive Board Assessment

Directors noted that the performance of the Brazilian economy since the approval of the revised program supported by the Stand-By credit in March 1999 has been significantly better than projected. For the year as a whole, real GDP is expected to decline by 1 percent or less (compared with the decline of almost 4 percent projected in the revised March program), and consumer price inflation is expected to be contained at around 8 percent. Directors welcomed the fact that these more favorable developments will help minimize the social costs of the crisis.

Directors considered that the authorities' commitment to the policy framework of the program, along with the strong official international support and the constructive voluntary involvement of the private sector, had been instrumental in securing an early recovery of confidence, correcting the initial overshooting of the exchange rate, and allowing an incipient pick up in activity with relatively low inflation. They stressed that, to lay the foundation for sustained recovery, the authorities' principal challenges are to build on the progress already achieved in implementing fiscal consolidation and to accelerate structural reforms.

Directors welcomed the fact that the fiscal performance so far during the year had matched or exceeded the program targets, and that the authorities had taken corrective actions to counteract emerging risks, including on account of higher international petroleum prices. Some pending court challenges to revenue measures enacted earlier in the year and the finances of the states and municipalities were noted as possible areas of risk for the fiscal accounts. Directors urged the authorities to continue monitoring fiscal developments closely, and to stand ready to take further measures as needed to ensure that the targeted public sector primary surplus of 3.1 percent of GDP is strictly adhered to.

Directors also stressed the importance of ensuring that the federal budget for 2000, due to be presented to Congress in August, is consistent with the targeted further improvement of the public sector primary surplus to 3.25 percent of GDP, and that it is based on prudent assumptions concerning revenues at the federal level and the finances of the subnational governments and the public enterprises. A few Directors considered that a more ambitious fiscal target would be appropriate, especially in view of the higher-than-expected level of activity. Directors also emphasized the importance of keeping the adequacy of the social safety net under review, and of continuing efforts to safeguard well-targeted and cost-effective social spending. They considered these efforts important in their own right, and in ensuring continued broad support for the authorities' adjustment program.

Directors stressed that fiscal sustainability over the medium term depends heavily on the progress in pending structural fiscal reforms, especially regarding the social security and tax systems, and in the implementation of administrative reform. Therefore, they strongly urged the authorities to intensify their efforts to ensure early and substantial progress in these areas. Directors also encouraged the authorities to persevere in their broad-based privatization program, which is important not only in reducing the public debt, but even more in promoting efficiency and modernization of the economy.

Directors commended the authorities for their prudent conduct of monetary policy in recent months. They also welcomed the adoption of a formal inflation targeting framework, which should provide a new anchor to inflationary expectations, following the introduction of a floating exchange rate regime. They looked forward to further consideration of an improved framework to incorporate an inflation targeting monetary regime in IMF programs.

Directors noted that the announced targets for inflation through 2001 were relatively conservative, and that it would be essential to ensure their achievement, to reinforce the credibility of monetary policy. They felt that the Central Bank would need to be especially vigilant as the recovery of demand gathers momentum. Consideration of any further interest rate reductions should be approached carefully and, to ensure the credibility of the new framework, the authorities should stand ready to raise rates if expected inflation turns upwards. Some Directors believed that a narrower band for the inflation target would be appropriate.

Directors welcomed the authorities' efforts in recent months to both lengthen the average maturity of the public debt and the share of fixed rate securities in it, and encouraged them to persevere in these efforts in the months ahead, as well as to reduce gradually the share of external and foreign exchange-indexed debt in the total public debt.

Directors welcomed the indications that Brazil's financial system had withstood quite well the impact of the devaluation, and that of the high interest rates in 1998 and early 1999. They commended the authorities for their continuing efforts to strengthen the regulatory framework and bank supervision, as well as to reduce the role of public banks in the financial system, and they looked forward to further progress in these areas in the months ahead.

Directors welcomed the flexible management of the exchange rate under the new regime, with limited central bank intervention. They emphasized that the use of the central bank's reserves should be limited to countering disorderly market conditions. Directors welcomed the significant improvement in competitiveness that had been achieved so far, which, in conjunction with a firm implementation of the program, they believed would facilitate a progressive further strengthening of the external trade and current account balances over the short- to medium- term.

Directors encouraged the authorities to liberalize the trade regime further. Noting that the timetable for Brazil's acceptance of the obligations under Article VIII, Sections 2, 3, and 4 of the Articles of Agreement has been extended to November 1999 to allow sufficient time for the IMF to undertake a comprehensive analysis of the relevant legislative and regulatory framework supplied by the authorities, Directors urged strict adherence to this revised timetable.

Directors noted that Brazil's statistical infrastructure was generally adequate for surveillance purposes and that financial market statistics were quite well developed. Nonetheless, weaknesses in certain areas, especially the national accounts, needed to be addressed. They welcomed the authorities' intention to take the necessary steps to enable Brazil to subscribe to the Special Data Dissemination Standard, and urged that this be done as rapidly as possible.

Brazil: Selected Economic Indicators

  1995 1996 1997 1998 1999

  (in percent)
Domestic Economy
Change in real GDP 4.2 2.8 3.7 0.1 -1.0
Unemployment rate1 4.6 5.4 5.7 7.6 7.6
Change in consumer prices (IPCA; year end) 22.4 9.6 5.2 1.7 8.0
  (in billions of U.S. dollars)2
External economy
Exports, f.o.b. 46.5 47.7 53.0 51.1 52.0
Imports, f.o.b. 50.0 53.3 61.4 57.7 49.0
Current account balance -18.0 -23.0 -33.3 -33.6 -22.2
Capital account balance 31.5 32.0 25.4 16.2 14.2
o/w Foreign direct investment 3.9 9.4 16.9 26.1 19.8
Gross official reserves 51.5 60.1 51.7 44.0 ...
Current account balance (in percent of GDP) -2.6 -3.0 -4.1 -4.3 -4.0
  (in percent of GDP)2
Financial variables
Public sector borrowing requirement 7.2 5.9 6.1 8.0 9.0
Primary balance of the federal government 0.6 0.4 -0.3 0.6 2.4
Net public debt 30.5 33.3 34.5 42.6 51.0
Change in broad money (in percent)3 26.2 13.0 14.9 7.6 11.1
Average overnight interest rate (in percent) 53.1 27.4 24.8 28.8 ...

Source: Brazilian authorities and IMF staff estimates.
17-day reference period
2Unless otherwise noted.
3M2, based on IMF definition.

1Under 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. In this PIN, the main features of the Board's discussion are described.


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