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Brazil and the IMF
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On March 21, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Brazil.1
Since the 2002 crisis, and in the context of a favorable external environment, strong macroeconomic policies and the pursuit of ambitious structural reforms have restored macroeconomic stability and fostered favorable conditions for growth. High primary surpluses—reaching 4.6 percent of GDP in 2004—have helped to improve debt sustainability. The ratio of net public debt to GDP fell from 65.5 percent at end-2002 to 54.5 at end-2004, while the structure of the debt has improved, with a marked reduction in the share of foreign-currency-linked debt. Cautious monetary policy kept inflation within the target band in 2004 despite supply shocks, and inflation is set to continue on a declining path this year. The passage of several important reforms—including tax and pension reforms and bankruptcy legislation—has strengthened confidence and improved the business climate.
The resulting decline in vulnerabilities and rising confidence have helped to fuel a strong economic recovery. GDP growth was 5.2 percent in 2004, and employment grew by 3.2 percent. The recovery has been aided by a very strong export performance, which has led to a record current account surplus of almost 2 percent of GDP. However, domestic demand also rebounded significantly during 2004, helped by declining real interest rates from mid-2003 and reforms facilitating access to credit. With capacity utilization close to peak levels and rising business confidence, investment rose by 11 percent in 2004.
Financial market conditions are currently the best in many years. Sovereign spreads have fallen to around 400 basis points, the real has been appreciating, and strong capital flows have allowed the central bank to rebuild international reserves. The government has already funded about three quarters of its US$6 billion external issuance requirements for 2005.
The health of the banking system has continued to improve over recent years and progress has been made in strengthening financial sector supervision. Overall, banks are well capitalized and profitable and capital adequacy ratios are high by international standards, although financial institutions remain significantly exposed to the public sector. The system withstood the pressures stemming from the intervention of Banco Santos in November well, partly aided by the prompt actions taken by the central bank.
Executive Board Assessment
Directors welcomed Brazil's impressive economic achievements over the last two years, and the remarkable track record of performance under the Stand-By Arrangement, which reflected the authorities' continued pursuit of strong macroeconomic policies and steady progress with structural reforms. Helped by a generally supportive external environment, these policies have led to a significant transformation of the economy, which has resulted in a strong economic recovery, income and employment gains, a declining public debt burden, and rising international reserves.
Directors pointed out that despite these successes, vulnerabilities and challenges remain. They noted that public debt was still high and sensitive to global financial conditions. Moreover, Directors stressed the need to persevere with structural reforms in order to boost long-term growth prospects, critical to addressing persistent poverty and inequality.
Directors observed that the inflation targeting and flexible exchange rate regimes had worked well in recent years and commended the authorities for their skillful conduct of monetary policy. They considered that, in light of the supply-side shocks faced by Brazil over the past year, the reduction of inflation to within the target band in 2004 was a substantial achievement. Directors supported the central bank's emphasis on keeping inflation on a downward path, and its cautious approach in the face of sticky inflation expectations and persistently high core inflation. They observed that the challenge for the central bank is to bring inflation down further while minimizing the impact on growth. In this regard, they noted that the recent appreciation of the real together with rising interest rates and the moderating pace of activity should contribute to slowing inflation in the coming months. Directors generally shared the view that the effectiveness of monetary policy would be enhanced by the passage of legislation to provide the central bank with full operational autonomy.
Directors supported the recent resumption of foreign exchange purchases by the central bank. They noted that continuing capital inflows could provide opportunities for further reserve accumulation, although a deterioration in external conditions could lead to some unwinding of the recent build up in real positions. They supported the authorities' continued commitment to a floating exchange rate regime, and stressed the importance of allowing the rate to move in the face of market forces, while continuing to take advantage of opportunities to build reserves. Directors welcomed the recent announcement of measures to streamline foreign exchange regulations, noting that carefully sequenced reforms in this area should help to strengthen integration with the global economy, promote trade openness, and enhance the efficiency of capital markets.
Directors congratulated the authorities for consistently achieving high primary fiscal surpluses. A number of Directors saw merit in a further moderate tightening, which would accelerate debt reduction while supporting monetary policy and helping to reduce pressures for appreciation of the real by lessening incentives for capital inflows. However, other Directors considered that the fiscal target for 2005 and beyond appeared prudent, while providing room for infrastructure and social spending. Directors commended the cautious approach taken in the first budget execution decree for 2005, given that determined efforts would be needed to contain nonpriority current spending so as to create room for additional spending on infrastructure. In this context, Directors welcomed the progress made under the pilot project to strengthen mechanisms for selecting, implementing and monitoring public investment, and the recent advances in establishing the framework for public-private partnerships. A key aspect of the pilot program will be maintaining full transparency in the context of the budget.
Directors stressed the importance over the medium term of fiscal reforms to increase budget flexibility, so as to provide more room for priority programs. Raising the flexibility of both revenue and expenditure and containing entitlement spending would allow for an expansion of targeted social spending, facilitate further tax reforms, and reduce vulnerabilities.
Directors welcomed improvements in the debt structure and agreed with the authorities' focus on lengthening maturities and reducing the share of exchange-rate and short-term interest rate linked debt. Directors also highlighted the need to develop the domestic debt markets further, including by continuing the dialogue with large institutional investors and reducing impediments to participation by foreign investors.
Directors pointed to the considerable strengthening of Brazil's banking system in recent years, observing that the system had coped well with the failure of a mid-sized bank in late 2004. They considered that further steps to strengthen the prudential framework would help the central bank to deal even more effectively with banking distress, thereby limiting the likelihood of contagion from problems in individual banks to the system as a whole. Directors encouraged the authorities to promote financial intermediation by gradually reducing directed lending requirements, and the distortionary taxation of financial intermediation. Directors also encouraged the authorities to implement the remaining recommendations of the FSSA, and welcomed their intention to explore an FSAP update.
Directors emphasized that the current environment provides a favorable opportunity to address structural weaknesses in the Brazilian economy and reduce poverty and inequality. Substantial progress has been made in recent years, although structural rigidities and bottlenecks continue to constrain Brazil's growth potential. Looking ahead, the authorities' reform agenda—including central bank autonomy, reform of the state-level VAT, and further measures to enhance the business environment—covers important areas. Other critical reforms would include measures to increase budget flexibility, address the large remaining imbalances in the pensions system, promote financial intermediation, and reduce labor market informality through reforms of the labor code, so as to substantially increase flexibility in labor contracts. In this regard, Directors emphasized the importance of careful sequencing of reforms and building consensus around them.
Brazil: Selected Economic Indicators
(annual percentage change)
Real GDP growth
Inflation (IPCA, end-of period)
(in billions of U.S. dollars)
Balance of payments
Current account balance
Capital and financial account
o/w Foreign direct investment
Current account balance (in percent of GDP)
Gross reserves to short-term external debt 1/
(in percent of nominal GDP)
Public sector net debt
Public sector primary balance
Public sector overall balance
Money and credit
Change in base money (in percent)
Change in broad money (M2) (in percent)
Average overnight interest rate (in percent)
Sources: Brazilian authorities and IMF Staff estimates.
1/ On a residual maturity basis, in percent.
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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