IMF Executive Board Concludes 2007 Article IV Consultation with Brazil

Public Information Notice (PIN) No. 07/114
September 18, 2007

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.

On July 30, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Brazil.1


The Brazilian economy is reaping the benefits of the continued implementation of strong stabilization and social policies, in the context of a favorable external environment. In recent years, economic growth has picked up and poverty has declined. To increase growth further over the medium term, the government has announced, within the current macroeconomic framework, the Growth Acceleration Program, which contains steps to increase public and private investment.

Growth has been strong in recent quarters, at 4¼-5 percent year-on-year, as domestic demand has picked up, supported by the ongoing monetary easing. Real GDP growth is projected to rise from 3¾ percent in 2006 to 4½ percent in 2007. In May 2007, twelve-month CPI inflation was 3.2 percent, well below the mid-range inflation target (4.5 percent). The inflation outlook remains benign, with 12-month inflation expected at around 3.5 percent by year-end.

Fast export growth has underpinned sustained external current account surpluses which, together with strong private capital inflows, have allowed the authorities to build a comfortable cushion of foreign exchange reserves. Brazil's trade surplus remained high in 2006, at 4⅓ percent of GDP, and export volumes picked up in the first part of 2007. With declining country risk premia, still relatively high interest-rate differentials, and reduced exchange rate volatility, capital inflows, including foreign direct investment, have risen. In that context, official international reserves have more than doubled over the past 12 months.

The fiscal accounts remain strong, despite some weakening in the primary surplus in 2006. After reaching a record-high of 4.4 percent of GDP in 2005, the primary fiscal surplus declined to 3.9 percent of GDP in 2006. However, strong revenue collections have raised the surplus in early 2007. For the year as a whole, the government plans to step up capital outlays under the Pilot Investment Program, to help address infrastructure needs. Owing to a falling interest bill, the overall deficit of the public sector is expected to decline in 2007.

Reflecting the effect of substantial primary surpluses, net public debt has declined significantly in recent years, from close to 60 percent at end-2002 to 46 percent at end-2006. Over that period, the government has repaid a large share of its external debt, thus contributing to a significant reduction in vulnerabilities. At the same time, debt management operations have eliminated exchange rate-linked domestic debt and raised the share of inflation-linked and fixed-rate debt. With improved debt composition and debt dynamics, and prospects for stronger growth, credit-rating agencies have raised Brazil's sovereign rating to one notch below investment grade.

The authorities have also taken advantage of favorable external conditions to deepen Brazil's domestic financial markets and enhance their integration with global markets. Banking system indicators are sound, and equity and domestic debt issuance by corporations has surged since 2004.

Executive Board Assessment

Executive Directors commended the authorities for the strong performance of Brazil's economy, which—against the backdrop of a favorable global environment—has been reaping the benefits of an impressive fiscal effort, sound monetary policy, and a reduction in vulnerabilities. Particularly notable have been the significant reductions in inflation and in public debt ratios, and the buildup of official reserves to comfortable levels. Directors also praised Brazil's enhanced social policies, which have contributed to a significant decline in poverty rates.

Directors considered that Brazil's near-term economic prospects are favorable. Notwithstanding the significant appreciation of the real and a sustained increase in imports, the external current account is expected to register another moderate surplus in 2007, reflecting the continued strength of exports. At the same time, Directors expected that Brazil's improved fundamentals and attractive asset prices will continue to encourage strong capital inflows.

Directors considered that the main challenge facing Brazil remains the creation of conditions for higher sustainable economic growth and further poverty reduction. This will require the continued implementation of sound macroeconomic policies and a deepening of structural reforms to make the economy more flexible and competitive. Directors welcomed the authorities' recognition of these challenges, which are reflected in the recent launching of the Growth Acceleration Program (PAC), with its focus on raising investment and growth.

Directors commended the central bank on its skillful management of the inflation targeting regime, and stressed that further entrenching the gains from a low rate of inflation remains a priority. While underscoring the need for continued vigilance, Directors saw room for further interest rate cuts. In this context, several Directors noted that resource pressures are expected to be contained. With inflation and inflation expectations below the authorities' mid-range target, a number of Directors also suggested lowering somewhat the inflation target, while narrowing the tolerance band. Many other Directors preferred to retain the present target range until low inflation is further entrenched, thus allowing greater flexibility for dealing with adverse shocks. A number of Directors favored granting de jure autonomy to the central bank to further solidify the inflation targeting framework and reduce inflation uncertainty.

Directors considered that the flexible exchange rate regime has served Brazil well, and noted that the level of the exchange rate is broadly in line with fundamentals. They noted the authorities' commitment to use intervention to minimize volatility and to strengthen international reserves. A number of Directors suggested that—while Brazil's foreign reserves buildup has helped create a welcome, strong buffer for the economy—large-scale intervention in the recent period may have reinforced capital inflows. In their view, reducing the magnitude of intervention would help attenuate one-way bets on the currency and minimize the fiscal costs of sterilization.

In the context of the strong private demand and buoyant tax collections, a number of Directors suggested that government revenue in excess of budgeted projections be saved. Raising public sector saving would alleviate appreciation pressures on the currency, introduce a welcome element of counter-cyclicality in fiscal policy, and strengthen public debt sustainability—thus widening the room for further interest rate cuts. Some other Directors—noting the strong track record of fiscal performance and declining debt ratios—were inclined to support the authorities' view that additional revenues may be used to reduce taxes and/or increase priority infrastructure spending. Several Directors considered that limiting the growth of primary fiscal current spending, which has been very rapid in recent years, would help strengthen the basis for high growth by creating space for much-needed infrastructure investment, reductions in the still-high gross public debt, and a lower tax burden.

Directors welcomed the reform plans in the fiscal and social security areas, aimed at further improving the quality of fiscal policy. Directors supported plans to merge all indirect taxes into two VATs, as this will help simplify the tax system, reduce tax evasion, and promote investment. To ensure its success and sustainability, several Directors noted that this complex reform will require a broad consensus and the introduction of mechanisms to minimize losses for some states. Some Directors considered that a meaningful social security reform is crucial to improving Brazil's fiscal position over the medium- and long-term. Directors also welcomed the authorities' plans to continue extending the average maturity of the public debt.

Directors noted that the Brazilian financial system is healthy and that the banking sector is adapting smoothly to lower interest rates. As long-term credit markets develop, it will be critical to ensure that lending growth remains guided by sound prudential principles. In the context of declining interest rates and to help deepen financial intermediation, Directors encouraged the authorities to reduce reserve requirements gradually and to lower the statutory rate of remuneration of savings accounts, and a number of Directors encouraged the authorities to also phase out financial transaction taxes. With new financing opportunities developing rapidly for the corporate sector, Directors saw room for phasing out directed lending by commercial banks. Directors noted that the welcome deepening of the Brazilian capital market should promote growth, but underscored the need for careful supervision and prudent management.

Directors considered that improvements in infrastructure, as envisioned in the PAC (Program to Accelerate Growth), will be critical to enhancing the climate for long-term investments and competitiveness. Given the sizable resource requirements for infrastructure and the benefits of private investment and expertise, Directors saw scope for the authorities to foster sound public-private partnerships and concessions. They also encouraged the creation of conditions to accelerate needed investments in electricity generation, and welcomed the authorities' plans to reform and strengthen the role of autonomous regulatory agencies.

Directors called for further labor market reforms and improvements in the business environment to help boost productivity and investment. Some Directors also encouraged the authorities to make further progress in trade liberalization. Directors encouraged the authorities to continue to play a constructive role in the Doha round negotiations.

It is expected that the next Article IV consultation with Brazil will be held on the standard twelve-month cycle.

Brazil: Selected Economic Indicators (as of July 30, 2007)
            Prel. Proj.
  2001 2002 2003 2004 2005 2006 2007
(Annual percentage changes, except otherwise indicated)

Real GDP

1.3 2.7 1.1 5.7 2.9 3.7 4.4

Domestic demand (contribution to growth, percent)

0.6 1.1 0.1 5.2 2.5 4.5 5.2

Private consumption (growth rate)

0.7 1.9 -0.8 3.8 4.7 4.3 4.2

Public consumption (growth rate)

2.7 4.7 1.2 4.1 1.9 3.6 5.2

Gross investment (growth rate)

-0.8 -3.3 1.5 9.7 -1.6 6.4 7.9

Gross fixed capital formation

0.4 -5.2 -4.6 9.1 3.6 8.7 12.1

Foreign balance (contribution to growth, percent)

0.7 1.6 1.0 0.6 0.4 -0.8 -0.7

Exports of GNFS (contribution to growth, percent)

0.8 0.6 0.9 1.5 1.1 0.5 0.7

Imports of GNFS (contribution to growth, percent)

0.1 -0.9 -0.1 0.9 0.7 1.4 1.5



Consumer price index (IPCA, period average)

6.8 8.4 14.8 6.6 6.9 4.2 3.4

Consumer price index (IPCA, end of period)

7.7 12.5 9.3 7.6 5.7 3.1 3.5

GDP deflator

9.0 10.6 13.7 8.0 7.5 4.3 5.6

Terms of trade

-2.0 1.8 -1.2 4.6 -0.5 6.9 3.8
(In percent of GDP)

Public finances


Federal government 1/


Total revenues

20.9 21.8 21.2 21.8 22.8 23.4 23.8

Total expenditures

22.9 22.7 24.8 23.4 26.3 26.7 26.2

Of which: interest

3.6 2.8 5.9 4.1 6.0 5.4 4.5

Primary balance

1.7 2.2 2.3 2.7 2.6 2.2 2.1

Consolidated public sector


Primary balance

3.4 3.5 3.9 4.2 4.4 3.9 3.6

Overall balance

-3.3 -4.2 -4.6 -2.4 -3.0 -3.0 -2.1

Public sector net debt

50.8 59.6 53.7 49.3 46.7 46.0 44.5
(12-month percentage changes, unless otherwise indicated)

Money and credit


Base money 2/

11.7 37.7 -0.1 21.2 14.1 19.6 ...

Broad money (M2) 3/

12.6 23.2 3.7 18.6 18.9 13.6 ...

Credit to the public sector (net)

21.8 22.3 20.5 10.2 9.3 13.5 ...

Credit to the private sector

6.1 13.7 12.4 14.9 27.9 30.6 ...
(In billions of U.S. dollars, unless otherwise indicated)

Balance of payments


Current account

-23.2 -7.6 4.2 11.7 14.2 13.3 12.6

Merchandise trade balance

2.7 13.1 24.8 33.6 44.7 46.1 42.9


58.2 60.4 73.1 96.5 118.3 137.5 151.5


-55.6 -47.2 -48.3 -62.8 -73.6 -91.4 -108.6

Services, income, and transfers (net)

-25.9 -20.8 -20.6 -22.0 -30.6 -32.8 -30.3

Capital and financial account

27.0 8.0 5.1 -7.5 16.3 80.2 22.7

Foreign direct investment

22.5 16.6 10.1 18.1 18.8 25.2 24.4

Portfolio investment

-0.5 -4.3 4.9 -5.2 4.8 28.0 10.1

Other capital (net)

5.1 -4.3 -9.9 -20.5 -7.3 27.1 -11.8

Errors and omissions

-0.5 -0.1 -0.8 -1.9 1.0 -0.4 0.0

Change in net international reserves

-3.7 -13.6 3.1 8.0 28.5 32.0 93.2

Current account (in percent of GDP)

-4.1 -1.5 0.7 1.8 1.6 1.2 1.0

Outstanding external debt (in percent of GDP)

37.7 40.8 38.6 30.3 19.1 16.1 16.0

Total debt service ratio (in percent of exports of goods & services)

120.4 107.5 91.1 66.6 68.9 58.3 60.0

Gross reserves/short-term external debt (residual maturity, in percent)

55.9 59.1 83.8 68.9 73.0 136.6 208.0

Sources: Central Bank of Brazil; Ministry of Finance; and IMF staff estimates.
1/ Includes the central government, central bank, and social security system.
2/ End of period. Currency issued plus required and free reserves on demand deposits held at the central bank.
3/ End of period. Currency in circulation plus demand, time and saving deposits.

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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