Brazil and the IMF

News Brief: IMF Completes First Review of Stand-by Arrangement with Brazil

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Brazil—Letter of Intent,
Memorandum of Economic Policies, and
Technical Memorandum of Understanding

Brasília, November 30, 2001

The following item is a Letter of Intent of the government of Brazil, which describes the policies that Brazil intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Brazil, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, DC 20431
United States of America

Dear Mr. Köhler:

In its letter dated August 23, 2001, the Government of Brazil requested support from the Fund in the form of a stand-by arrangement (SBA) for a period of 15 months. That letter had attached a Memorandum of Economic Policies (MEP) describing the government's program of policies supported under the SBA. The Government remains fully committed to that program. The MEP attached to this letter outlines recent progress in implementing the Government's economic policies and discusses its current economic program, as well as the economic outlook for 2002. Also attached is a Technical Memorandum of Understanding that sets out the specific quantitative targets (in the form of performance criteria, indicative targets, and structural benchmarks) that are to be observed under the SBA, which expires on December 13, 2002.

The strong macroeconomic and structural policies implemented by the Government under the current and previous SBAs have enabled the Brazilian economy to weather recent turbulence in global financial markets. The continued implementation of these policies and further progress on the Government's structural agenda, as detailed in the attached MEP, will leave Brazil poised to resume more rapid growth of output and employment as the global economic environment improves next year. The Government stands ready to take additional policy measures as appropriate to ensure the attainment of its objectives.

During the period of the arrangement, the authorities of Brazil will maintain the usual close policy dialogue with the Fund.

Yours sincerely,

Pedro Sampaio Malan
Minister of Finance
Armínio Fraga Neto
President of the Central Bank of Brazil


Brazil—Memorandum of Economic Policies

Since the preparation of the last Memorandum of Economic Policies (MEP) in August 2001, the global economy has suffered from a series of economic shocks that are likely to result in slower economic growth and a more difficult external environment than previously expected. Nevertheless, the more depreciated real exchange rate is already stimulating an improved trade balance, partially offsetting soft domestic demand growth, while monetary and fiscal policy have kept inflationary pressures in check and contributed positively to external confidence. The maintenance of these policies, along with further progress on the structural reform agenda, will leave Brazil poised to resume more rapid growth of output and employment as the global economic environment improves over the course of 2002.

I. Recent Performance of the Brazilian Economy

1. Data released since the preparation of the last MEP confirm that a combination of negative economic shocks and necessary policy responses had slowed growth in Brazil even before the events of September 11. Real GDP growth decelerated from 4.5 percent in the first quarter to 1.8 percent in the second quarter of 2001 (over the corresponding quarters of 2000), mainly due to a slowdown in the manufacturing sector. However, growth in demand for domestically-produced and imported capital goods, principally energy-generating equipment and agriculture machinery, indicates that investment was strong in the first half of 2001. Economic performance remained weak through the third quarter, with industrial production falling on a seasonally-adjusted basis by 1.8% relative to the second quarter and capacity utilization in industry reaching its lowest level since 1999. Consumer confidence recovered during the third quarter after a steep fall in June following the announcement of energy rationing, but gave up much of that gain in October as the extent of the deterioration in the external environment and its implications for Brazil became clearer.

2. Labor market conditions have begun to reflect the economic deceleration. Employment fell by 0.1 percent in August and 0.6 percent in September compared to the same months in 2000, interrupting a sequence of 22 consecutive monthly increases. However, an even sharper decline in the labor force meant that the 7-day unemployment rate fell by ½ percentage point to 6.2 percent from September 2000 to September 2001. Despite recent labor market sluggishness, performance accumulated over the year remains positive: the 7-day unemployment rate averaged 6.2 percent during the first nine months of 2001, well below the 7.5 percent observed during the same period of 2000; average employment was 0.9 percent higher comparing the same periods; and nearly 250 thousand new jobs were created in the formal sector during the last 12 months.

3. The impact of the energy crisis on economic activity has been smaller than initially expected, as households have substantially reduced energy demand in response to price incentives and overconsumption penalties implemented by the Government. Investment by firms in private generation capacity and energy-saving equipment, and the fostering of market mechanisms for buying and selling firms' energy consumption quotas, contributed to minimizing the potential impact of the energy shortage on aggregate supply.

4. The government expects the need for energy savings next year to be considerably lower than in 2001, with a reduction of quantitative restrictions in most of the country and greater reliance on price mechanisms to restrict demand. Reservoir levels of hydroelectric power stations have recovered satisfactorily in most regions, reflecting the success of the energy saving program and increased rainfall.1 Furthermore, the potential supply of electricity is expected to increase 13.4 thousand MW in 2001-02 by the purchase of electricity from neighboring countries and the beginning of operation of 23 thermoelectric and 15 hydroelectric plants. In addition, as a result of contracting of companies using readily available thermoelectric power generators, electricity supply can potentially be increased by approximately 4.0 thousand MW. The Government will contract capacity up to a limit to be established by the High Level Energy Committee (GCE) on a precautionary basis: the equipment will be installed, but will be operated only if necessary. The fixed costs associated with this installation will be passed on to tariffs nationwide. If operation of these generators becomes necessary, the marginal operating costs will initially be borne by the distributors that purchase this energy and be passed to tariffs at the next adjustment date.

5. Other measures have been taken to spur increases in electricity supply over the medium term. The government has included 9 additional thermoelectric plants in its priority energy program, which now guarantees the supply of natural gas to 32 thermoelectric plants that are expected to increase the total supply of energy in the period 2001/2003. Auctions for licenses to build 7 new hydroelectric plants are scheduled to take place before the end of the year.

6. The progress made in improving the regulatory framework in the electricity sector will reduce uncertainty about the financing of long-term projects and stimulate new investment in the sector. The tariffs charged by distribution companies will be adjusted according to more realistic estimates of cost increases. The new formula will take into account the financial impact of changes in costs incurred within the tariff adjustment period.

7. Inflation has been higher than expected in 2001, largely reflecting the impact of increases in food and administered prices. The passthrough to prices of the depreciation of the real of nearly 40 percent until October has been limited both by macroeconomic policies and by weakening domestic demand. The 12-month rate of consumer price inflation (IPCA) stood at 6.5 percent in September, within the 5.0-7.0 percent bands established under the Stand-By Arrangement for informal consultations with IMF staff. The cumulative increase in the IPCA during the first nine months of the year amounted to 5.35 percent, of which about 2.14 percentage points reflected adjustments in contractual prices (including electricity, telecommunication, and transport tariffs, and prices of petroleum products).

8. Wholesale petroleum product prices were increased in early October in line with the formula for quarterly price adjustments, which is based on changes in the exchange rate and in international oil prices. In addition, a schedule for adjustments in electricity tariffs was defined so as to better reflect marginal costs of production and stimulate private investment in the electricity sector. The adjustment will also seek to reduce or eliminate cross-subsidies to the business sector, which should contribute to increased allocative efficiency while minimizing the impact on consumer price inflation.

9. The external current account has strengthened in recent months, in line with the more depreciated real and the deceleration of the economy. The trade balance, which was close to equilibrium in the first half of 2001, registered a US$1.3 billion surplus in the third quarter of 2001, compared to a deficit of US$ 0.1 billion in the same quarter of 2000. This improvement of the trade balance was brought about by an 8.0 percent decline in imports and a 1.3 percent increase in exports in the third quarter (year-on-year). For the first nine months of the year, however, the current account deficit was higher than in the same period of the previous year (US$17.4 billion, compared to US$15.6 billion). The major reason underlying this performance was the increase in the remittances of profits and dividends (US$ 1 billion), equipment rentals (US$ 0.9 billion) and interest payments (US$ 0.6 billion).

10. The events of September 11 had a very negative impact on capital market access for emerging markets in general. Nevertheless, net FDI flows to Brazil amounted to US$1.5 billion in September, slightly above the August level. For the first nine months of the year, net FDI stood at US$15.3 billion, down from the extraordinary level of US$22.6 billion recorded in the same period last year. External bond issues earlier in the year have allowed the government to more than cover its external amortization needs for 2001. The private sector continues to have access to international capital markets, although typically through collateralized or securitized operations at higher interest rates, and some private sector entities have chosen to repay external obligations with domestic resources rather than renew external obligations at higher interest rates. For the four weeks ending October 19 the rollover rate on interbank credit lines averaged 103 percent.

11. Gross international reserves, which stood at US$35.6 billion at end-July, increased to US$40.1 billion as of end-September, reflecting mainly the drawdown of funds made available under the new Stand-By Arrangement, which was approved on September 14. Gross reserves rose from 56 percent of short-term debt (on a residual maturity basis) at end-2000 to 78 percent at end-September 2001. Also at end-September 2001, net international reserves (NIR), as measured under the program, stood at US$31.5 billion, US$11.5 billion above the program floor.

12. At end-September, total external debt amounted to US$214.1 billion (40 percent of estimated GDP), broadly unchanged from end-2000, and its public sector component also remained stable, at US$95.9 billion. The short-term component of the external debt, measured on an original maturity basis, decreased to US$25.3billion at end-September from US$27.4 billion at end-2000. Net of debt to the Fund, the nonfinancial public sector external debt stood at US$87.4 billion, below the ceiling under the Stand-By Arrangement of US$95.0 billion (a performance criterion under the program), while the short-term external debt of the nonfinancial public sector equaled US$0.5 billion, also below the ceiling under the Stand-By Arrangement.

13. Fiscal performance remains above programmed levels. The accumulated primary surplus of the consolidated public sector reached R$41.2 billion in September, R$6.8 billion (about 0.6 percent of estimated annual GDP) higher than the program target. However, reflecting primarily the more depreciated exchange rate, the accumulated public sector borrowing requirement (PSBR) reached 7.5 percent of period GDP (R$65.9 billion) in September. The BCB now publishes harmonized PSBR statistics, which exclude from the PSBR depreciation- or appreciation-induced changes in the valuation of the domestic foreign exchange-indexed debt stock incurred but not actually paid during the reference period. Using this harmonized methodology, the PSBR was R$20.5 billion, about 2.3 percent of GDP. In line with the increase in the public sector borrowing requirement, the net public debt rose to 51.9 percent of GDP at end-September from 49.4 percent of GDP at end-2000, still below the indicative target ceiling for the net public debt.

14. All levels of government have contributed to the improved fiscal position. For January-September 2001 the central government primary surplus reached 2.9 percent of period GDP, reflecting strong revenue performance and continued expenditure restraint. The states and municipalities posted a primary surplus of 1.1 percent of period GDP in January-September 2001 (municipalities accounted for 0.8 percent of period GDP) in compliance with the Fiscal Responsibility Law and the debt rescheduling agreements with the Treasury. The primary surplus of the public enterprises - at 0.8 percent GDP in January-September 2001- reflects not only the favorable impact of the more depreciated exchange rate on the profits of Petrobrás (the federal oil company) and Itaipu (the bi-national hydroelectric power plant) but also the strong performance of other public enterprises at all levels of government. On August 31, the government submitted to Congress the 2002 budget proposal, which envisages an increase of the public sector primary surplus to 3.5 percent of GDP while preserving social expenditures and capital investment in key areas such as energy generation and transmission.

15. The debt management strategy continued to lengthen maturities and increase duration, despite market turbulence. The average maturity of competitively-placed outstanding securitized federal debt rose from 15.8 months at end-2000 to 24.8 months at end-September 2001 (from 29.9 months to 35.7 months for all securitized federal debt), while average duration grew from 6.3to 11.2 months over the same period. However, in light of increased foreign exchange pressures, the government was unable to further reduce the share of its outstanding foreign exchange-indexed debt or to increase the share of its fixed-return instruments. By end-September, the share of foreign exchange-indexed debt had increased to 31.4 percent of outstanding securitized federal debt, up from22.3 percent at end-2000. This reflects the depreciation of the exchange rate (6 percentage points) as well as the impact of sales of dollar-indexed debt that took place mainly after September 11 (4 percentage points).

16. Mindful of the potential impact of a continuing decline in the real on inflation, the Central Bank (BCB) adopted a series of regulatory measures to relieve pressure on the exchange rate. At the end of September, the BCB established a 10 percent reserve requirement on time deposits and increased from 60 percent to 80 percent the minimum proportion of required reserves on demand deposits that banks must maintain at the BCB on a daily basis. These measures have substantially reduced the scope for banks to enter into short-term operations that could result in greater exchange rate volatility. In addition, capital requirements on banks' net foreign exchange positions were recalibrated through an increase in the requirement rate from 33 to 50 percent of exposure, and a reduction in exemption limits from 20 percent to 5 percent of banks' required capital. With a view to reducing accounting-driven private sector demand for hedge, the stock market regulatory agency (CVM) and the tax authority (SRF) introduced a regulation allowing listed companies to amortize balance sheet losses associated with the depreciation of the real in 2001 over the next four years. The BCB has continued its policy of increasing liquidity in the spot foreign exchange market through daily sales of US$50 million. In addition, on September 11-13 the BCB responded to extraordinary illiquidity in foreign exchange markets by selling a further US$220 million in the spot market.

17. Bank credit continued to expand, albeit at a slower pace, driven mainly by the deceleration in aggregate demand, uncertainties regarding the domestic and international scenario, and an increase in bank lending rates. Total credit increased by 10.5 percent in the 12 months to September, compared to 16 percent in the 12 months to May 2001. Total credit increased by just 7.2 percent in the third quarter of 2001 (year-on-year), mainly reflecting the debt restructuring and recapitalization of the four main federal banks in June 2001.

18. As a result of the tightening of monetary policy and increased risk aversion associated with the slowdown in economic growth, average bank lending rates increased from 54.7 percent in May to 62.9 percent in September, while average spreads rose from 38.2 percent to 44.0 percent in the same period. The share of loans with interest payments overdue for 120-180 days fell from 7.2 percent of total credit in May to 5.3 percent in September. Prudential indicators remained broadly stable, with the share of illiquid loans (risk category H) declining to 3.6 percent of total loans and total bank provisions equaling R$21.7 billion at end-September, more than fully meeting minimum provisioning requirements.

19. Notwithstanding the adverse economic and political environment, the government continued to implement important structural reforms. In November, after congressional approval, the President signed a new corporate law that strengthens the rights of minority shareholders, makes the CVM operationally independent, and improves corporate transparency and governance. The Lower House of Congress approved a constitutional amendment introducing the explicit domestic taxation of petroleum products, paving the way for the full liberalization of the domestic oil market in 2002. This proposed constitutional amendment is now being considered by the Senate. The Government also continued to implement its privatization program, successfully auctioning various oil prospecting licenses and concessions for hydroelectric power plants. In September, the Brazilian Statistical and Geographical Institute (IBGE) began regular publication of quarterly GDP data by expenditure category, and the BCB has begun publication of broad monetary aggregates as redefined on an internationally comparable basis, satisfying the Stand-By Arrangement's two statistical benchmarks.

II. Policies and Prospects for the Remainder of 2001 and 2002

20. The economic shocks that hit emerging markets underscore the need for firm but flexible management of macroeconomic policies and continued progress on structural reforms, in order to increase the resilience of the economy and to sustain market confidence. As has been the case for many years, the Government therefore remains fully committed to its economic and structural reform program, including the policies and measures outlined in the previous MEP. Thus, fiscal policy will continue to target consolidated public sector primary surpluses of 3.35 percent of GDP in 2001 and 3.5 percent of GDP in 2002; monetary policy will remain geared toward the achievement of the inflation target of 3.50 percent for 2002 minus and plus 2 percentages points; and the structural reform agenda will maintain its focus on the fiscal and financial sectors.

21. The macroeconomic framework for 2001 and 2002 is based on real output growth of 2 percent in 2001 and 2-2½ percent in 2002, below the levels projected in the previous MEP. These reduced growth projections reflect the impact of a more difficult external environment. Despite slower import growth in partner countries, the external sector's contribution to growth is projected to increase in 2002, due in large part to the significant depreciation of the real. On the supply side, growth in 2001 and 2002 is expected to be led by agriculture. The services sector is projected to grow moderately, while growth in the industrial sector--which has slumped in recent months--is expected to recover over the course of 2002.

22. Overall, the current account deficit is projected to narrow marginally, from US$24.6 billion in 2000 to US$23.8 billion in 2001, on the strength of the improved trade balance. Export volumes are projected to rise by about 9 percent in 2001, thanks to the depreciated real and efforts to increase access by Brazilian enterprises to foreign markets, while import volume growth is projected to fall to 6 percent, from 13 percent in 2000, due to relative price effects and the slowdown in domestic demand growth. The terms of trade are expected to improve moderately, reflecting a decline in import prices.

23. The current account balance is expected to improve substantially in 2002, recording a deficit of less than US$20 billion, with the help of continued growth in the trade surplus. While real export growth is projected to slow to 6 percent due to slack international demand, continued weak domestic demand and the lagged impact of the sizable depreciation in 2001 are projected to lead to a fall in imports in volume terms of about 2 percent. In addition, a further improvement in the terms of trade of about ½ percent is forecasted. As a result, the trade surplus is projected to widen to about US$6 billion next year, consistent with recent monthly trends.

24. The capital account projections for the remainder of this year and for 2002 are based on conservative assumptions about investment flows and rollover rates for lending. Net FDI is expected to slow from the record level of US$32.8 billion in 2000 to about US$19 billion in 2001 and US$16 billion in 2002, implying monthly flows over the next 15 months about equal on average to those recorded in September of this year. Even at these reduced annual levels, net FDI is expected to cover some 80 percent of the current account deficit in 2001 and 81 percent in 2002. Reflecting the assumption of lower rollover rates, the sum of portfolio and other short- and long-term capital flows is expected to turn slightly negative in the fourth quarter of 2001 and in 2002. Nevertheless, the balance of payments is expected to record an overall surplus of slightly more than US$6 billion in 2001, leaving gross reserves at about US$39 billion and NIR at about US$30 billion. For 2002, the overall balance of payments is forecasted to run a deficit of about US$4 billion, leaving gross reserves at US$35 billion and NIR at about US$29 billion.

25. The Government aims at achieving a primary surplus of the consolidated public sector of at least 3.35 percent of GDP in 2001 and 3.5 percent of GDP in 2002, as set out in the attached TMU. The achievement of these fiscal targets, in a less favorable economic environment, underscores the Government's firm commitment to fiscal consolidation. Achievement of the fiscal targets will be facilitated by the strong performance of all levels of government so far this year, expenditure restraint, and continued efforts to improve the efficiency of the tax system in support of macroeconomic sustainability--an area in which technical assistance will be received from the Fiscal Affairs Department of the IMF. Prioritized social programs will be preserved in line with the government's on-going efforts to strengthen social policies. The Fiscal Responsibility Law will continue to be instrumental in guiding fiscal policymaking.

26. Further improvements in state and municipal finances are expected within the framework of the debt rescheduling agreements with the National Treasury and the Fiscal Responsibility Law. The central government will continue to monitor the fiscal performance of the subnational governments and remains committed to adjust its fiscal targets to offset slippages at that level. The public enterprises will continue to perform strongly, helped by the improved prospects for easing the energy saving program in most parts of the country, and the impact of a more depreciated exchange rate on the revenues of Petrobrás and Itaipu.

27. Reflecting primarily the more depreciated exchange rate, the public sector borrowing requirement (PSBR) is expected to rise to 8.2 percent of GDP in 2001(or 3.6 percent of GDP in the BCB's new harmonized methodology), bringing the domestic debt of the consolidated public sector to approximately 56.3 percent of GDP this year. Public debt management will continue to seek to reduce rollover costs, lengthen maturities, increase duration, and diversify the indexation composition of the outstanding debt stock. The fiscal targets for 2001 and 2002 are consistent with the stability, and subsequent gradual decline, of public sector indebtedness over the medium term.

28. The Fiscal Affairs Department of the IMF has just concluded a Report on the Observance of Standards and Codes (ROSC) on fiscal transparency for Brazil. The report recognizes that in the last few years Brazil has achieved a high degree of fiscal transparency, together with major improvements in the management of its public finances. As the main elements of these improvements, the report highlights: a) the Fiscal Responsibility Law, enacted in May 2000, which sets out for all levels of government fiscal rules designed to ensure medium-term fiscal sustainability, and strict transparency requirements; b) the medium term expenditure framework aimed at better aligning the allocation of budgetary resources over time to the government's priorities and regional development strategy; c) and the firm enforcement of the debt restructuring agreements with most states and a large number of municipalities which has been instrumental in promoting sustained fiscal adjustment of subnational governments. The report also stresses that Brazil scores highly with respect to main indicators of fiscal management and transparency; that the coverage of both its fiscal targets and fiscal statistics is commendably broad; that the mechanisms of internal and external control are generally well developed; that fiscal statistics at the federal level are of high quality, timeliness, and detail; and that Brazil is at the forefront of countries at comparable level of development in the use of electronic means for the dissemination of fiscal data.

29. In support of fiscal policies, the Government remains committed to its structural reform agenda. It will seek congressional approval of the constitutional amendment allowing for the explicit domestic taxation of petroleum products, replacing the budget's oil account and paving the way for the liberalization of the domestic oil market in early 2002. In line with efforts to reform the social security system, the Government will also seek congressional approval of legislation allowing for complementary pension funds for the public sector. Moreover, the Government will continue to work with Congress towards approval of a proposed constitutional amendment to extend the bank debit tax (CPMF) from June 2002, when it is scheduled to expire, through the end of 2004, while implementing measures to avoid or mitigate the negative impact of the CPMF on capital markets.

30. Monetary policy will continue to be conducted within the inflation-targeting framework. Given the shocks that have occurred this year end-year inflation will exceed the upper limit of 6.0 percent for the BCB's inflation target, and it may also exceed the Stand-By Arrangement's threshhold for consultation with the Fund staff. Based on current policies, end-2002 inflation is likely to be slightly above the Government's central target of 3.5 percent. Midpoints and consultation bands established in the previous TMU for end-2001 and March, June, and September 2002 will remain in effect (see the attached TMU). Inflation prospects will continue to be among the aspects considered during quarterly reviews of the program, and the BCB will continue its regular exchange of views with the Fund staff about the evolution of monetary policy.

31. The BCB remains committed to the floating exchange rate regime, and will continue to avoid targeting any particular level of the exchange rate. Nevertheless, because of concern about the inflationary implications of exchange rate depreciation and volatility, the BCB has sought to offset recent pressures on the exchange rate arising from the extraordinary circumstances since early September by intervening in the foreign exchange market through the sale of foreign exchange-indexed debt. However, the BCB continues to believe that net increases in the stocks of these instruments should be limited to extraordinary circumstances, and maintains the goal of reducing the stock of these instruments as market conditions allow. The BCB stands ready to tighten monetary policy, if necessary, to defend the inflation target.

32. The Government is continuing to work with Congress toward the approval of a new bankruptcy law. In addition, the BCB continues to work to enhance the regulatory framework for banks and to strengthen its off-site supervision systems (see the attached TMU). The BCB is making further progress in its program for the privatization of six federalized state banks: auctions for three of the banks are expected to be completed by year end and those for the remaining banks by June 2002. The Government has committed to participate in the Financial Sector Assessment Program (FSAP), and preliminary work with IMF and World Bank staff on the FSAP has already begun. Reforms to the system of housing finance are being implemented that pursue efficiency on market term transactions and that provide better protection to both lenders and homeowners. Moreover, the Government is working on measures to reduce differences between internationally-accepted accounting standards and those used in Brazil.

33. Brazil continues to pursue trade liberalization at the regional and multilateral levels, while working to enhance the institutional framework of Mercosur. Discussions within Mercosur have been undertaken to design a safeguard mechanism that would allow some flexibility in the implementation of the common external tariff. In addition, the list of exceptions to the common external tariff for member countries has been expanded to 100 tariff items (except for Paraguay, which retains additional exceptions) that can be maintained until end-2002. The tariff surcharge of 2.5 percent will be reduced by 1 percentage point in January 2002 and maintained until end-2002. In addition, there are ongoing reviews of the structure of the common external tariff with Mercosur members. Brazil is pursuing further regional trade liberalization with other members of Mercosur by negotiating preferential trade arrangements as a block with the EU and other countries interested in a FTAA. It is also exploring the possibility of negotiating bilateral trade arrangements with Mexico and China. Brazil is committed to full participation in the upcoming discussions for the possible launch of a new trade round within the World Trade Organization. Seeking the removal of trade restrictions placed by advanced countries on Brazil's most competitive exports, such as certain agricultural products, steel, textiles and footwear, is a major priority for the Government.

34. Brazil has continued to improve its statistical database, including (as noted above) through the satisfaction of the two statistical benchmarks under the Stand-By Arrangement. In addition, work continues on the preparation of a producer price index.

35. In summary, Brazil has not been immune to the shocks that hit the international economy, and the expected decline in economic activity mirrors that occurring in the global economy. In this context, in order not to have the earliest availability date of the purchases associated with the second review close to when the performance criteria of the first quarter apply, we are asking that this earliest availability date be advanced from March 29 to March 22. The measures outlined in this MEP, building on previous policy actions of the Government, will contribute to further enhancements in economic stability and improvements in the well being of the Brazilian people, and will leave the economy poised for more rapid growth of output as the global environment improves over the course of 2002. In addition to the measures described in this MEP, the Government stands ready to adjust policy as needed to ensure the achievement of the objectives of its economic program, and looks forward to a continued close and constructive dialogue with the Fund.

1Low rainfall and a recent decline in savings in the Northeast required implementation of additional energy saving measures in that region, including the decree of three official holidays in October and November and stiffer penalties for noncompliance with the electricity consumption quotas.

Brazil-Technical Memorandum of Understanding

1. This Technical Memorandum of Understanding (TMU) sets out the specific performance criteria (PCs), indicative targets (ITs), structural benchmarks (SBs) and assumptions that will be applied under the Stand-by Arrangement during 2001 and 2002.

I. Phasing of Purchases and Reviews

2. The general phasing of purchases and reviews for the remainder of 2001 and 2002 is shown in Table 1 below.

Table 1. Brazil: Phasing of Purchases and Reviews

Amounts Available
(In millions of SDRs)
and Sources
Earliest Availability Dates Conditions and Remarks

358.625 from CT December 15, 2001 Completion of the first review, and observance of the relevant PCs under the arrangement (end-September, 2001).
358.625 from CT
3316.958 from SRF
March 22, 2002 Completion of the second review and observance of the relevant PCs under the arrangement (end-December, 2001).
358.625 from CT
3316.958 from SRF
June 14, 2002 Completion of the third review and observance of the relevant PCs under the arrangement (end-March, 2002).
379.513 from CT August 30, 2002 Completion of the fourth review and observance of the relevant PCs under the arrangement (end-June, 2002).
379.513 from CT November 29, 2002 Observance of the relevant PCs under the arrangement (end-September, 2002).

II. Quantitative Targets

A. Fiscal Targets

(i) Performance criterion for the primary balance of the consolidated public sector 1


(In billions of R$)

Cumulative fiscal year primary balance of the consolidated public sector


January 1, 2001-September 30, 2001 (preliminary)



January 1, 2001-December 31, 2001 (performance criterion)


January 1, 2002-March 31, 2002 (performance criterion)


January 1, 2002-June 30, 2002 (performance criterion)


January 1, 2002-September 30, 2002 (performance criterion)


1As defined below.
2Minimum cumulative primary surplus of the consolidated public sector.

3. The cumulative primary balance of the consolidated public sector is defined as the sum of the cumulative primary balances of the various entities that make up the public sector. The public sector is defined to comprise the central government, state and municipal governments, and the public enterprises (including federal, state and municipal enterprises); the central government includes the federal government, the social security system, and the Central Bank of Brazil (BCB).

4. For any given month, the primary balance of the consolidated public sector is measured, in Brazilian reais (R$), as the total net interest (i.e., net interest accrued on the consolidated net domestic debt of the public sector, plus the net interest due (competência contratual) on the net external debt of the public sector) minus the borrowing requirement of the consolidated public sector, where the public sector is defined as above. For foreign-exchange indexed government securities, the interest rate is the accumulated rate of change of the U.S. dollar vis-à-vis the R$, plus the fixed coupon rate. The fixed coupon rate applies to the nominal value of the security revalued by the rate of change of the U.S. dollar vis-à-vis the R$ from the issuance date to the relevant date. For any given month, the borrowing requirement of the consolidated public sector is defined as the change in the nominal outstanding net domestic debt plus the change in the net external debt, converted into R$ at the actual period average R$/US$ exchange rate.1 The stock of the U.S. dollar-indexed domestic debt is revalued at the end of a given month to reflect any change in the value of the real vis-à-vis the U.S. dollar that has taken place during the month. The proceeds from privatization during that period are added to these results; amounts representing the recognition of unregistered liabilities during that period are subtracted from these results. The cumulative primary balance from January 1 of a given year to the relevant date of the same year is the sum of the monthly primary balances of the consolidated public sector for that period.

(ii) Indicative target on the net debt of the consolidated public sector1

(In billions of R$)

Total net debt outstanding of the consolidated public sector  
End-September, 2001 (preliminary) 671.9
End-December 2001 (indicative target) 700.0
End-March 2002 (indicative target) 720.0
End-June 2002 (indicative target) 730.0
End-September 2002 (indicative target) 750.0

1The public sector is defined as above; the net debt includes the monetary base.
2Maximum stock outstanding of total net debt of the consolidated public sector.

5. Total net debt outstanding of the consolidated public sector (dívida líquida total) equals the public sector's gross debt (including the monetary base), net of its financial assets; it is defined as the sum of the registered net domestic and net external debt (all valued in R$), of the central government, state and municipal governments, and the public enterprises (including federal, state and municipal enterprises); the central government is defined as above.

6. Total net debt outstanding of the consolidated public sector is measured on an accrual basis (including accrued interest) for the domestic debt component, and on an interest-due basis (competência contratual) for the external debt component. The stock of external debt and of foreign-exchange indexed domestic debt is valued at the actual R$/US$ exchange rate prevailing at the end of each period.

7. The central government will continue to incorporate into its registered debt various unregistered liabilities that are currently outstanding. The above ceilings for the total net debt outstanding of the consolidated public sector are predicated on the paths for privatization receipts (defined here to exclude concession revenue) and the recognition of unregistered liabilities that are shown in Table 2 below. These ceilings will be adjusted downward (adjusted upward) to the extent that privatization receipts exceed (fall short of) the amounts implied by Table 2 below; they will be adjusted upward (adjusted downward) to the extent that the recognition of unregistered liabilities exceeds (falls short of) the amounts implied by Table 2 below.

B. External Sector Targets

(i) Performance criterion on external debt of the nonfinancial public sector1

(In billions of US$)

Stock of total external debt of the nonfinancial public sector at


End-September 2001 (performance criterion)


End-December 2001 (performance criterion)


End-March 2002 (performance criterion)


End-June 2002 (performance criterion)


End-September 2002 (performance criterion)


1The data in this table apply to all external debt of the nonfinancial public sector that is disbursed and outstanding. The nonfinancial public sector includes the federal, state, and municipal governments, the public enterprises, and the social security system. Excluded from measured debt stocks are any liabilities vis-à-vis the Fund.

8. For any given quarter, the stock of debt2 disbursed and outstanding is defined as the stock of debt disbursed and outstanding at the end of the previous quarter, plus gross disbursements that take place during the quarter in question, less the gross amortization payments made during the quarter in question.

9. The above limits will be adjusted upward to accommodate new external borrowing that is made in order to undertake a voluntary early or advance repurchase to the Fund.

(ii) Performance criterion on publicly guaranteed external debt of the private sector1

(In billions of US$)

Stock of publicly guaranteed external debt outstanding


End-September, 2001 (performance criterion)


End-December 2001 (performance criterion)


End-March 2002 (performance criterion)


End-June 2002 (performance criterion)


End-September 2002 (performance criterion)


1The limit applies to all private external debt guaranteed by the public sector. The public sector includes the nonfinancial public sector (as defined above), the BCB and the financial public sector.
2These ceilings will be adjusted upward for publicly guaranteed external debt that is actually transferred to or assumed by the private sector in the context of the privatization of public enterprises.

10. For any given quarter, the stock of external debt guaranteed by the public sector is defined as the stock of external debt guaranteed by the public sector that is outstanding at the end of the previous quarter, plus the net addition to external debt guaranteed by the public sector during the quarter in question.

(iii) Performance criterion on nonfinancial public sector short-term external debt1

(In billions of US$)

Stock of total short-term external debt of the nonfinancial public sector as of
End-September 2001 (performance criterion) 3.5
End-December 2001 (performance criterion) 3.5
End-March 2002 (performance criterion) 3.5
End-June 2002 (performance criterion) 3.5
End-September 2002 (performance criterion) 3.5

1The data in this table apply to all external debt (disbursed and outstanding) of the nonfinancial public sector with original maturities of strictly less than one year. The nonfinancial public sector includes the federal, state, and municipal governments, the public enterprises, and the social security system. Excluded are any liabilities incurred vis-à-vis the Fund.

11. Short-term debt3 is defined as all debt with an original maturity of strictly less than one year. For any given quarter, the stock of short-term external debt (disbursed and outstanding) is defined as the stock of short-term external debt (disbursed and outstanding) at the end of the previous quarter, plus the net flows associated with the disbursements and amortizations of short-term debt that take place during the quarter in question.

12. The above limits will be adjusted upward to accommodate new external borrowing that is made in order to undertake a voluntary early or advance repurchase from the Fund.

(iv) Performance criterion on net international reserves (NIR) in the BCB1

(In billions of US$)

Stock net international reserves in the BCB as of July 31, 20012 32.1
End-September 2001 (preliminary) 31.7
End-October 2001 (preliminary) 29.1
End-November 2001 (performance criterion) 20.0
End-December 2001 (performance criterion) 20.0
End-January 2002 (performance criterion) 20.0
End-February 2002 (performance criterion) 20.0
End-March 2002 (performance criterion) 20.0
End-April 2002 (performance criterion) 20.0
End-May 2002 (performance criterion) 20.0
End-June 2002 (performance criterion) 20.0
End-July 2002 (performance criterion) 20.0
End-August 2002 (performance criterion) 20.0
End-September 2002 (performance criterion) 20.0
End-October 2002 (performance criterion) 20.0
End-November 2002 (performance criterion) 20.0

1NIR are measured as defined below.
2Measured at constant cross exchange rates and gold prices as specified in EBS/01/36.

13. The NIR in the BCB are equal to the balance-of-payments concept of net international reserves in the BCB (reservas internacionais líquidas ajustadas) and include gross official reserves minus gross official liabilities.

14. Gross official reserves are defined as liquid foreign currency denominated claims in the BCB. Gross official reserves include (i) monetary claims, (ii) free gold, (iii) holdings of SDRs, (iv) the reserve position in the IMF, and (v) holdings of fixed income instruments. Items (i) through (iv) will be valued at the end-period prices shown in Table 3 below. Item (v) will be valued marked to market. Gross official reserves will exclude participation in international financial institutions, the holdings of nonconvertible currencies, and the holdings of precious metals other than gold.

15. Gross official liabilities in foreign currencies include (i) foreign currency liabilities with original maturity of one year or less, (ii) the use of Fund resources, and (iii) any forward foreign exchange (FX) liabilities on a net basis-defined as the long position (posição comprada) minus the short position (posição vendida)-directly undertaken by the BCB or by other financial institutions on behalf of the BCB. Items (i) through (iii), will be valued at the prices shown in Table 3 below. Any increases in foreign currency-denominated claims (both spot and forward) against residents, or against foreign branches or subsidiaries of Brazilian institutions, do not count toward NIR in the BCB.

(v) Performance criterion on the BCB's exposure in FX futures markets

16. The BCB will continue to refrain from entering into FX futures contracts, either directly or through any institution it uses as its financial agent. This constitutes a performance criterion under the arrangement.

(vi) Performance criterion on the BCB's exposure in FX forward markets

17. The BCB will continue to refrain from entering into FX forward contracts, either directly or through any institution it uses as its financial agent. This constitutes a performance criterion under the arrangement.

C. Monetary Targets

(i) Consultation mechanism on the 12-month rate of inflation

18. The quarterly consultation bands for the 12-month rate of inflation in consumer prices (as measured by the Indice de preços ao consumidor ampliado (IPCA)) are specified as follows:

Consultation bands for the 12-month rate of change of the IPCA (in percent)

2001 (actual)

Outer band (upper limit)   7.8 7.8 7.3 6.2

Inner band (upper limit)   6.8 6.8 6.3 5.2
   Central point 6.5 5.8 5.8 5.3 4.2
Inner band (lower limit)   4.8 4.8 4.3 3.2
Outer band (lower limit)   3.8 3.8 3.3 2.2

19. Inflation prospects will be an important part of each review under the arrangement. In addition, the BCB will discuss with the Fund staff the appropriate policy response should the 12-month rate of IPCA inflation exceed the upper limit of the inner band specified in the table above. Should the 12-month rate of IPCA inflation exceed the upper limit of the outer band specified above, the authorities will complete a consultation with the Executive Board of the IMF (henceforth the Board) on their proposed policy response.

III. Structural and Statistical Benchmarks

A. Structural Benchmarks

By end-December 2001

  • The central bank to begin putting in place the framework to develop a rating system for banks on the basis of a private consultant's report.

  • Design of the new off-site banking supervision system to be completed.

  • Presentation of enabling legislation to Congress to introduce explicit taxation of oil products after enactment of the relevant constitutional amendment.

  • Further progress in the auctioning of the federalized state banks.

  • Completion of a revision and upgrade to international standards of the plan of accounts for financial institutions.

By end-March 2002

  • Further progress in the auctioning of the federalized state banks.

  • Develop a systematic monitoring system of operational limits, including the measurement of the Basle capital index, minimum net worth, foreign exchange exposure, and provisioning of the credit portfolio of banks with the data provided by banks to the Off-Site Banking Supervision Department of the Central Bank.

  • The Central Bank to begin releasing on a more frequent basis consolidated analysis reports of banking system compliance with the fixed-asset limit and the Basle capital ratio.

By end-June 2002

  • Further progress in the auctioning of the federalized state banks.

  • Presentation of enabling legislation to Congress to create complementary pension funds for federal civil servants following the enactment of the relevant legislation.

  • Develop a monitoring system to verify the quality of the accounting data provided to the Off-Site Banking Supervision Department of the Central Bank in terms of data consistency, and the accuracy of reported significant changes in key accounting data such as credit levels and composition, credit portfolio stress risks, and risk diversification.

By end-September 2002

  • Completion of a review of differences between Brazilian and internationally-accepted practices for the use of independent external bank auditors, in order to evaluate the appropriateness of implementing such international practices.

  • Develop a streamlined set of indicators from the financial data currently reported to the Off-Site Banking Supervision Department of the Central Bank to assess the economic and financial soundness of banks and non-banking financial institutions; and a registry of the largest borrowers in the financial system.

  • Completion of the updating of existing regulations regarding licensing of firms and individuals to operate as or serve as officers of financial institutions, including the adoption of a multistage approach to the licensing process; the introduction of a requirement that firms present detailed operating plans before licensing, including information on corporate organization and structure, internal controls, and corporate governance; and the requirement that the licensing process include consideration of the impact of the proposed new financial institution on market concentration and competition.

IV. Disclosure of Specific Information

20. Specific data to continue to be provided by the authorities to the Fund staff include the following (at the indicated frequencies, and lags):

  • Composition of gross international reserves under the cash concept (posição de caixa) and the liquidity concept (posição liquidez internacional) (weekly, the following week);

  • The levels of gross international reserves and of net international reserves as defined under the NIR concept (daily, the next business day);

  • The BCB's position in FX futures, including notional amounts of open-interest contracts, both bought and sold, in each contract for the next four months (daily, the next business day if this position should exceed zero);

  • Outstanding stocks of US$-indexed federal debt by instrument, showing auction values (preço de lastro) and updated nominal values (valor nominal atualizado), as well as information on rollovers of these instruments, showing the face value of the amounts falling due, and new placements of this debt (following each auction, with a one-day lag);

  • Quantitative results of the monitoring of the external credit lines of financial institutions (two business days after the deadline at which these institutions have to comply), and of external medium- and long-term bank claims on Brazilian nonbank debtors (once a week for the previous week).

V. Program Assumptions for Selected Variables

The following Tables 2 and 3 set out program assumptions for selected variables.

Table 2. Baseline Assumptions for Selected Variables
(In millions of R$)
    Mar.  Jun.  Sep.  Dec.  

Privatization receipts (cumulative/year)1   8,080   198 5,869 10,982 10,982
Recognition of previous liabilities and
   PROES (cumulative/year)
  26,796 2,528 5,066 8,345 10,892

1Excluding concession revenues.

Table 3. Assumption on Accounting Exchange Rates and Gold Prices1
  Program Assumptions
Third Quarter 2001

SDR (US$/SDR, end-period)
Gold price (US$/ounce, end-period)

1Currencies not shown here will first be converted using the official rate used by the Fund's Treasury Department as of August 31, 2001.

1Foreign currency debt denominated in currencies other than the US$ is first converted into US$ at actual average exchange rates for the period.
2The term "debt" has the meaning set forth in point No. 9 of the IMF's Guidelines on Performance Criteria with Respect to External Debt (Decision No. 12274-(00/85) of August 24, 2000).
3The term "debt" has the meaning set forth in point No. 9 of the IMF's Guidelines on Performance Criteria with Respect to External Debt (Decision No. 12274-(00/85) of August 24, 2000).