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Brazil and the IMF
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The IMF Executive Board on February 11, 1998 concluded the 1997 Article IV consultation1 with Brazil.
In 1997 Brazil continued to reduce its inflation rate to under 5 percent, reflecting a moderation in labor costs and import prices, as well as a good harvest. Real GDP grew by an estimated 3.0 percent, compared with 2.9 percent in 1996. Growth was led by domestic demand, especially investment. The trade deficit widened, albeit at a declining rate as the year progressed, reflecting a sharp increase in imports. Manufactured exports recovered significantly, however, in the second half of the year. The rise in the trade deficit, together with a deterioration in net service payments, contributed to an increase of the external current account deficit to US$33.4 billion in 1997 (4.2 percent of GDP) from US$24 billion in 1996 (3.2 percent of GDP). More than half of the current account deficit was financed by foreign direct investment, which increased strongly in 1997, partly as a result of the privatization program. In 1997 as a whole, international reserves declined by about US$8 billion (all of which occurred during the financial market turmoil in late October) to a level of about US$52 billion, equivalent to 8.2 months of imports of goods and nonfactor services. Reserves have subsequently recovered to about US$58 billion by end-February 1998.
Preliminary financing data indicate that the overall fiscal position, as measured by the public sector borrowing requirement, which remained at 5.9 percent of GDP, was essentially unchanged in 1997. The primary deficit, however, increased from 0.1 percent of GDP in 1996 to 0.7 percent of GDP in 1997. This result reflects mainly the outturn for the social security and increased spending by the states (partly to eliminate arrears or contingent liabilities) financed by large privatization receipts. Monetary policy remained cautious. In April 1997, the central bank departed from the policy of gradually reducing interest rates in line with the decline in inflation, leaving its basic intervention rate unchanged at 20.7 percent until the end of October. The authorities allowed the real to depreciate within the exchange rate band by about 0.6 percent a month against the U.S. dollar, more than the inflation differential between the two countries.
In late October 1997, Brazil’s currency came under pressure following the turmoil in financial markets in Asia. The authorities reacted swiftly by doubling the central bank intervention interest rate on October 30, 1997 to 43 percent, and on November 10, 1997 announced the adoption of a comprehensive fiscal package equivalent to about 2½ percent of GDP. These actions were instrumental in improving market expectations, and promoting a reflow of capital and the substantial recovery of international reserves to date in 1998. The reestablishment of calm in financial markets has allowed a sizable reduction (over 15 percentage points at an annual rate) of interest rates in the last couple of months.
Executive Board Assessment
Directors commended the authorities for their quick and decisive policy response to the strong pressures on the real in late October, noting that those actions—the doubling of interest rates and the quick passage of a strong fiscal package—had played an important role in limiting the contagion effects from the Asian turmoil in Brazil and the rest of Latin America. Directors stressed that the steady implementation of the fiscal adjustment measures, the early passage of the pending structural fiscal reforms, and prudent monetary policy would be essential to ensure a sustained reduction of the current account deficit, minimize Brazil’s vulnerability to the continuing volatility in international financial markets, and realize its full economic potential.
Directors noted that Brazil’s economy had continued to perform well in 1997, with per capita real GDP showing significant growth for the fifth consecutive year, and consumer price inflation falling to under 5 percent. They also noted the progress made in strengthening the financial system and in accelerating the privatization program. However, they noted that the external accounts had continued to deteriorate, albeit at a decelerating pace as the year had progressed.
While Directors were encouraged by the recovery of manufactured exports, strong growth of direct investment in 1997, and by the prospect of a further decline in the current account deficit in 1998, they noted that those projected improvements in the external accounts were predicated on a stable international environment and sustained export growth and, therefore, developments would need to be carefully monitored. In view of Brazil’s high level of external debt and debt service in relation to exports, Directors stressed the importance of securingfurther reductions of the current account deficit in subsequent years, through a sustained improvement in competitiveness and further growth and diversification of exports.
Directors generally supported the authorities’ policy of seeking a gradual depreciation of the real exchange rate within the current band system, taking into account productivity developments. Most Directors felt that, in the present unsettled market conditions, any significant modification of exchange rate policies could be misinterpreted and could lead to a loss of confidence.
Noting the recent reduction of maturities of new public debt and the increase in the share of domestic public debt with a foreign exchange guarantee, Directors urged the authorities to step up their efforts to revert soon to the earlier trends toward lengthening the average maturities of debt and reducing the share of foreign exchange indexed debt.
Directors noted that the implementation of the authorities’ fiscal policy package as envisaged, together with the use of most of the privatization receipts for debt reduction, would facilitate a decline in the overall public sector deficit and debt and, therefore, a further sustained reduction in interest rates during the course of the year. Directors stressed the importance of fiscal consolidation as a means of continuing to raise domestic savings. They also emphasized the importance of resisting spending pressures that might arise during a year of general elections, and welcomed the authorities’ readiness to adopt additional measures if needed.
Directors commended the progress made in setting the finances of the states on a more sustainable path, in particular through the restructuring of their debt at substantially reduced interest rates. To ensure long-term sustainability, it was essential that debt restructuring be accompanied by the negotiation and firm implementation of strong fiscal adjustment programs by the states, and by the use of a large share of their privatization proceeds to reduce debt. Directors stressed the importance of speedily concluding the negotiations of such programs, and emphasized that expenditure restraint will be key to the states’ fiscal adjustment in 1998. Moreover, the federal government will need to monitor closely and enforce firmly the implementation of those programs, and ensure that the states fully service their rescheduled debt.
Directors welcomed the authorities’ success in privatizing public enterprises, both at the federal and state levels. They noted that the privatization process would allow for much needed investments by the private sector, which, along with efficiency gains, would establish a better foundation for future economic growth.
Directors welcomed the authorities’ recent progress in obtaining Congressional approval of the proposed constitutional reforms concerning the social security and public administration system, and the prospect of final approval of that legislation in the near future. Some Directors noted, however, that it would be desirable to move forward as soon as possible with a further, more comprehensive reform of the social security system. Directors welcomed the steps taken in the context of the fiscal package to eliminate some important regional fiscal incentives and to streamline direct taxation, as well as the authorities’ intention to put forward soon proposals for a comprehensive fiscal reform and their efforts to improve efficiency in health andeducation spending. Directors believed that the efforts being undertaken to increase flexibility in the labor market were a key element of the modernization strategy. They also took note of the recent improvements in key social indicators, and encouraged the authorities to continue to strive for a reduction of poverty and income inequality.
Directors supported the authorities’ intention further to reduce interest rates at a pace that will prove consistent with the maintenance of stable conditions in financial and foreign exchange markets. They also noted that, as a result of the substantial progress made in the past couple of years in strengthening their balance sheets, the banks were in a better position than in 1995 to withstand the adverse effects of high real interest rates and a slowdown of economic activity on the quality of their portfolios. Nevertheless, Directors cautioned that the authorities would need to continue their close monitoring of the large banks and their ongoing program of thorough inspections of second-tier banks.
Directors also welcomed the authorities’ ongoing efforts to strengthen bank supervision, with the support of the World Bank, and the measures taken recently to tighten capital adequacy standards, and urged the authorities further to strengthen efforts to improve their information on the consolidated foreign currency exposure of financial institutions and of enterprises.
Directors welcomed the significant progress that had been made in restructuring state banks, with two large banks privatized in 1997, and two other major banks scheduled for privatization in 1998. With respect to the other smaller state-owned banks with problems, Directors urged the authorities to continue their efforts to privatize or, if necessary, close them. As far as the federal banks were concerned, Directors noted that their capital appeared adequate at the present time, and stressed the importance of allowing them to conduct their operations on a strictly commercial basis. Directors also felt that, over the medium term, it would be desirable to further reduce the public sector’s involvement in banking activities.
Directors encouraged the authorities to further liberalize trade, which would provide impetus to the modernization and development of the economy. Directors noted that import tariffs in Brazil remained high, and the dispersion of rates gave rise to high rates of effective protection in some sectors. Several Directors called for a reduction in the protection provided to the automobile sector. They also stated that the recently agreed increase in the common external tariff of Mercosur ran counter to the trade liberalization trend, and urged the authorities and their Mercosur partners to work toward an early reversal of this increase.
Directors urged the authorities to eliminate Brazil’s remaining exchange restrictions and move quickly to accept the obligations under Article VIII, Sections 2, 3, and 4 of the Articles of Agreement.
Directors commended the authorities for their efforts to provide comprehensive economic data regularly and on a timely basis to the staff. They encouraged the authorities to take steps to further improve the comprehensiveness of financial sector and external debt statistics. With a view to improving the transparency of Brazil’s economy to foreign financial markets, Directors agreed that it would be desirable that the authorities take the necessary steps to enable Brazil to subscribe to the Special Data Dissemination Standard.
|Brazil: Selected Economic Indicators|
|Change in Real GDP||6.0||4.2||2.9||3.0|
|Change in consumer prices (end of period)||929.3||22.0||9.1||4.3|
|Change in consumer prices (year average)||2,149.0||67.3||16.5||6.0|
|(In billions of U.S. dollars)2|
|Current account balance||-2||-18||-25||-33|
|Capital account balance||15||32||34||26|
|Gross official reserves||39||52||60||52|
|Current account balance (in percent of GDP)||-0.3||-2.5||-3.2||-4.2|
|(In percent of GDP)2|
|Public sector borrowing requirement||45.5||7.2||5.9||5.9|
|Change in broad money (in percent)||1,148.5||33.5||7.8||25.5|
|Monthly nominal interest rate (in percent)||25.2||3.6||2.0||1.9|
Source: Brazilian authorities and staff estimates.
2Unless otherwise noted.
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 directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.
IMF EXTERNAL RELATIONS DEPARTMENT