## cr17215

## Source details

**Canonical URL:** [cr17215](https://www.imf.org/-/media/files/publications/cr/2017/cr17215.pdf)

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---

### Outlook and risks
- Growth projections:
  - "0.3 percent in 2017 and 1.3 percent in 2018, moving towards 2 percent in the medium term."
- Inflation projections and conditionality:
  - "Inflation is projected to undershoot its central target of 4.5 percent in 2017 and 2018."
  - Forecast conditional on "a sufficiently strong set of measures—most notably social security reform—are put in place to ensure fiscal sustainability."
- Main domestic risks:
  - "Political instability and spillovers from the corruption investigation are major sources of risk that could threaten the reform agenda and the recovery."
  - "The main policy risk is that the social security reform is severely diluted or delayed to the next government, prompting adverse market reaction in the near term and necessitating additional fiscal measures over time."
- Main external risks:
  - "A faster than expected tightening of global financial conditions and, with a lower likelihood, a significant slowdown in China."

### Disinflation and monetary policy
- Recent trend and drivers:
  - "Disinflation has continued, providing more room for monetary easing."
  - Rapid decline in inflation over the past year due to: "the impact of large increases in regulated prices in 2015 has dissipated," "a widening output gap," "an appreciating exchange rate," "declining inflation expectations," and "a favorable shock to food prices."
- Policy actions:
  - "The central bank began an easing cycle in September 2016, bringing the monetary policy rate down by a cumulative 400 bps to 10.25 percent as of June 2017."
  - "The National Monetary Council has announced a gradual reduction in the inflation target to 4.25 percent in 2019 and 4.0 in 2020."
- Monetary guidance:
  - "Monetary policy easing can continue in 2017 given the large output gap and moderate inflation expectations, conditional on the outlook for inflation remaining benign."
  - Market expectations (Central Bank Focus Survey, June 2): "3.9 percent in 2017 and 4.4 percent in 2018."

### Fiscal outcomes and sustainability
- Recent fiscal performance:
  - "Non-financial public sector debt rose from 72.5 percent of GDP to 78.3 percent between 2015 and 2016, with primary balances of -1.9 and -2.5 percent of GDP, and overall balances of -10.3 and -9.1 percent of GDP in those two years."
  - Deficits driven by "trend increases in mandatory spending and a sharp cyclical revenue downturn," and adverse debt dynamics from "high borrowing costs and the contraction in output."
- Government plans and near-term measures:
  - Authorities aim "to restore fiscal sustainability by gradually bringing primary balances toward surplus territory, with the support of the constitutional expenditure ceiling and social security reform."
  - For 2017, authorities aim "to bring the primary deficit to -2.1 percent of GDP."
  - Introduced adjustment measures of "0.9 percent of GDP, including cuts in discretionary spending of 2/3 percent of GDP and a partial roll-back of payroll tax exemptions."
- Executive Directors’ assessment and guidance:
  - "Ensuring fiscal sustainability is a key priority."
  - Support for "controlling expenditure growth, including through the implementation of a cap on non interest federal expenditure."
  - Recommendation for "a rolling medium term fiscal framework" and that "the fiscal effort will need to be more intense as the recovery takes hold."
  - Emphasis on reforming social security schemes, including "those for civil servants at all levels of government."

### External sector and exchange rate
- Current account and external adjustment:
  - "The current account deficit narrowed to 1.3 percent of GDP in 2016 (from 3.3 percent of GDP in 2015)."
  - "On average in 2016, the external position was broadly consistent with medium-term fundamentals and desirable policies."
- Exchange rate and reserves:
  - "The flexible exchange rate has been an important shock absorber."
  - Central bank actions reduced net forward position to "1.4 percent of GDP from over 5 percent of GDP at end-2015."
  - "International reserves ... standing at US$365 billion at end-2016."
- Capital flows and nonresident holdings:
  - Net direct investment fully financed the current deficit in 2016.
  - Share of government debt held by nonresidents declined from "19 percent to 14 percent over 2016."

### Financial sector and banking
- Banking sector performance:
  - "Profits before taxes have surged due to high interest margins and lower funding costs."
  - Banks have been "renegotiating the terms of loans and writing off delinquent loans" to limit increases in non-performing loans.
  - "Capital ratios have increased on the back of a decline in private banks’ risk-weighted assets and higher unrealized gains on fixed income securities."
  - Liquidity improved as "withdrawals of saving deposits stopped and banks’ holdings of liquid assets increased."
  - Overall external funding exposure and net open positions "have remained low."
- Staff recommendations:
  - Encourage "actions to further strengthen financial safety nets through enhanced monitoring and an improved crisis management framework."
  - "Need for continued vigilance and close monitoring of the health of the corporate sector and its impact on the banking system."

### Subnational governments: stress and rescue measures
- Overview:
  - States’ fiscal positions deteriorated due to revenue shortfalls and steep wage bill and pension spending increases.
  - Federal government negotiated consolidation measures in exchange for debt rescheduling and loan guarantees with Rio de Janeiro and Rio Grande do Sul.
- Rio de Janeiro (RJ) specifics:
  - RJ accumulated an estimated financing gap of "R$26 billion in 2017 (3.7 percent of the state’s GDP and 0.4 percent of Brazil’s GDP)."
  - 3-year rescue package measures include increased revenues of "R$1.2 billion," "cuts in discretionary spending of R$9 billion," increased pension contributions worth "R$3.2 billion," suspension of servicing FG debt "R$6.2 billion" in 2017, and FG guarantee for a bank loan "R$3.4 billion."
  - Assessment: package helps 2017 cash pressures, but "additional measures will be needed" for 2018 and 2019 absent structural reforms.
- Rio Grande do Sul (RS) specifics:
  - Projected pension deficit "R$9 billion" for 2017; retirees-to-active ratio "1.3."
  - Measures: administrative spending cut "20 percent," closure of "9 out of 29 ministries," termination of "9 foundations," wage ceiling at "70 percent of revenue," employee pension contributions increased from "13.25 to 14 percent."
  - Short-term rescue includes extension of debt-service grace period generating about "R$4 billion" and loans with federal guarantees against asset sales.
  - Assessment: structural fiscal reforms necessary for medium-term sustainability.

### Policy recommendations (selected)
- Fiscal:
  - "Continued focus on fiscal reforms is crucial to underpin macroeconomic stability."
  - Authorities "should aim to overperform on their near-term fiscal consolidation objectives and to increase their fiscal effort as the recovery takes hold."
  - Recommendation: adopt "a rolling medium-term fiscal framework."
  - Quantified IMF recommendation: additional measures "of the order of 1−2 percent of GDP introduced over time" to ensure debt-GDP starts declining earlier.
- Monetary:
  - "Monetary policy easing can continue in 2017 given the large output gap and moderate inflation expectations, conditional on the outlook for inflation remaining benign."
  - Recommendation: continue to reassess stance "in view of the evolution of inflation and expectations and prospects for fiscal reforms."
- Structural and governance:
  - "Supply-side structural and regulatory reforms are needed to improve the business environment and boost medium-term growth."
  - "Improving governance, increasing transparency and strengthening institutional frameworks are key to secure strong, durable and inclusive growth."
- External adjustment and financial stability:
  - "The exchange rate should remain the main external adjustment variable."
  - "Financial safety nets should be strengthened through enhanced monitoring and an improved crisis management framework."

### Debt dynamics and Debt Sustainability Analysis (selected)
- Baseline trajectory:
  - "Debt keeps rising to about 92½ percent of GDP in 2022/2023, and only starts declining in 2024."
  - Gross debt projects to reach "92.4 percent of GDP by 2022."
  - Primary balance required to stabilize debt in baseline: "1.4 percent of GDP (excluding interest revenue)."
- Key baseline assumptions:
  - Real GDP growth: "0.3 percent in 2017, and a gradual return to potential growth of 2 percent by 2019."
  - Nominal interest rates on new borrowing: "around 10−10½ percent over 2017−22," effective interest rate "about 10 percent on average."
- Stress-test scenarios (selected outcomes):
  - Growth shock: gross debt increases to "112 percent of GDP by 2022" and gross financing needs peak at "31 percent of GDP."
  - Real interest rate shock: pushes debt-to-GDP up by "4 percentage points above the baseline in 2022."
  - Combined shocks: debt-to-GDP reaches "about 112−17 percent by 2022" in very severe scenarios.
  - No consolidation scenario: debt reaches "119 percent of GDP by 2022" and continues growing thereafter.
- Policy implication:
  - "If fully implemented, fiscal consolidation based on the government’s legislated and proposed reforms would restore the sustainability of debt in the baseline scenario."  
  - "A delay in implementing fiscal reforms would jeopardize debt sustainability."

### Key statistics and projections (selected figures preserved exactly as in source)
- Growth and prices (GDP at constant prices, Consumer prices IPCA end of period):
  - GDP at constant prices: "-3.8" (2015), "-3.6" (2016), "0.3" (2017), "1.3" (2018), "2.0" (2019–2022 each year shown).
  - Consumer prices (IPCA, end of period): "10.7" (2015), "6.3" (2016), "4.0" (2017), "4.0" (2018), "4.5" (2019–2022).
- Public finances:
  - NFPS primary balance: "-1.9" (2015), "-2.5" (2016), "-2.1" (2017), "-1.8" (2018), "-1.1" (2019), "-0.4" (2020), "0.2" (2021), "0.8" (2022).
  - NFPS gross debt: "72.5" (2015), "78.3" (2016), "81.5" (2017), "85.8" (2018), "88.6" (2019), "90.5" (2020), "91.7" (2021), "92.4" (2022).
  - Net public sector debt: "35.6" (2015), "46.2" (2016), "51.4" (2017), "55.9" (2018), "58.9" (2019), "61.0" (2020), "62.4" (2021), "63.3" (2022).
- External sector:
  - Current account (in percent of GDP): "-3.3" (2015), "-1.3" (2016), "-1.5" (2017), "-1.7" (2018), "-1.7" (2019), "-1.8" (2020), "-1.9" (2021), "-2.0" (2022).
  - Gross official reserves: "356.5" (2015), "365.0" (2016), projected "365.0" (2017–2022).
  - Total external debt (in percent of GDP): "36.9" (2015), "36.9" (2016), "32.2" (2017), "31.7" (2018), "30.7" (2019), "29.7" (2020), "28.6" (2021), "27.5" (2022).
- Monetary indicators and reserves:
  - Monetary policy rate: "10.25 percent as of June 2017" after "a cumulative 400 bps" reduction since September 2016.
  - International reserves: "US$365 billion at end-2016."
  - Central bank net forward position reduced to "1.4 percent of GDP from over 5 percent of GDP at end-2015."
- Selected socio-economic indicators:
  - Total population (million) (est., 2015): "204.5"
  - Unemployment rate (latest, 2017): "13.7"
  - GDP, dollars (2016): "US$1,799 billion"
  - GDP per capita (est., 2016): "US$8,795"

### Risk Assessment Matrix (high-level)
- Major risks (likelihood and expected impact):
  - Fiscal shock (Likelihood: H; Expected Impact on Economy: H)
  - Political/prolonged policy uncertainty (Likelihood: H; Expected Impact on Economy: H)
  - Capital flow reversal / global spillovers (Likelihood: H; Expected Impact on Economy: M)
  - Domestic financial stress / labor market weakness (Likelihood: L; Expected Impact on Economy: M)
  - Commodity price shock / external demand weakening (Likelihood: L/M; Expected Impact on Economy: M)
- Policy responses recommended:
  - Fiscal: "Deploy alternative measures on the fiscal side to shore up credibility" and may need to tighten fiscal policy.
  - Monetary/FX: "May need to stop or even reverse monetary policy easing" if inflation expectations change; "Exchange rate intervention only under disorderly market conditions."
  - Financial/macroprudential: Provide FX liquidity, support banks if dollar shortages appear, and consider temporary CFMs as part of a broad package.
  - Structural/labor: "Strengthen efforts to boost competitiveness and productivity" and "Enact structural reforms to combat corruption and money laundering."

*IMF staff summary of cr17215 (pdf chapter/section).*

### 1.3 percent in 2018, moving towards 2 percent in the medium term. Inflation is projected to

### cr17215 - 1.3 percent in 2018, moving towards 2 percent in the medium term. Inflation is projected to

### Outlook and risks
- Growth projections:
  - "0.3 percent in 2017 and 1.3 percent in 2018, moving towards 2 percent in the medium term."
- Inflation projections and assumptions:
  - "Inflation is projected to undershoot its central target of 4.5 percent in 2017 and 2018."
  - Forecast conditional on "a sufficiently strong set of measures—most notably social security reform—are put in place to ensure fiscal sustainability."
- Main domestic risks:
  - "Political instability and spillovers from the corruption investigation are major sources of risk that could threaten the reform agenda and the recovery."
  - "The main policy risk is that the social security reform is severely diluted or delayed to the next government, prompting adverse market reaction in the near term and necessitating additional fiscal measures over time."
- Main external risks:
  - "A faster than expected tightening of global financial conditions and, with a lower likelihood, a significant slowdown in China." (elsewhere phrased as "The main external risks are a significant slowdown in China and a faster than expected tightening of global financial conditions.")

### Disinflation and monetary policy
- Disinflation drivers and recent trend:
  - "Disinflation has continued, providing more room for monetary easing."
  - Rapid decline in inflation over the past year due to: "the impact of large increases in regulated prices in 2015 has dissipated," "a widening output gap," "an appreciating exchange rate," "declining inflation expectations," and "a favorable shock to food prices."
- Monetary policy actions:
  - "The central bank began an easing cycle in September 2016, bringing the monetary policy rate down by a cumulative 400 bps to 10.25 percent as of June 2017."
  - "The National Monetary Council has announced a gradual reduction in the inflation target to 4.25 percent in 2019 and 4.0 in 2020."

### Fiscal outcomes and sustainability
- Recent fiscal performance:
  - "Non-financial public sector debt rose from 72.5 percent of GDP to 78.3 percent between 2015 and 2016, with primary balances of -1.9 and -2.5 percent of GDP, and overall balances of -10.3 and -9.1 percent of GDP in those two years."
  - Deficits in the primary balance driven by "trend increases in mandatory spending and a sharp cyclical revenue downturn," and adverse debt dynamics from "high borrowing costs and the contraction in output."
- Government plans and near-term measures:
  - Government aims "to restore fiscal sustainability by gradually bringing primary balances toward surplus territory, with the support of the constitutional expenditure ceiling and social security reform."
  - For 2017, authorities aim "to bring the primary deficit to -2.1 percent of GDP."
  - Introduced adjustment measures of "0.9 percent of GDP, including cuts in discretionary spending of 2/3 percent of GDP and a partial roll-back of payroll tax exemptions."
- Executive Directors’ assessment and guidance:
  - "Ensuring fiscal sustainability is a key priority."
  - Support for "controlling expenditure growth, including through the implementation of a cap on non interest federal expenditure."
  - Recommendation for "a rolling medium term fiscal framework" and that "the fiscal effort will need to be more intense as the recovery takes hold."
  - Emphasis on reforming social security schemes, including "those for civil servants at all levels of government."

### External sector and exchange rate
- Current account and external adjustment:
  - "The current account deficit narrowed to 1.3 percent of GDP in 2016 (from 3.3 percent of GDP in 2015)."
  - "On average in 2016, the external position was broadly consistent with medium-term fundamentals and desirable policies."
- Exchange rate and reserves:
  - "The flexible exchange rate has been an important shock absorber."
  - Central bank actions reduced net forward position to "1.4 percent of GDP from over 5 percent of GDP at end-2015."
  - "International reserves ... standing at US$365 billion at end-2016."

### Financial sector and banking
- Banking sector performance and resilience:
  - "Profits before taxes have surged due to high interest margins and lower funding costs."
  - Banks have been "renegotiating the terms of loans and writing off delinquent loans" to limit increases in non-performing loans.
  - "Capital ratios have increased on the back of a decline in private banks’ risk-weighted assets and higher unrealized gains on fixed income securities."
  - Liquidity improvements as "withdrawals of saving deposits stopped and banks’ holdings of liquid assets increased."
  - Overall external funding exposure and net open positions "have remained low."
- Board recommendations:
  - Encourage "actions to further strengthen financial safety nets through enhanced monitoring and an improved crisis management framework."
  - "Need for continued vigilance and close monitoring of the health of the corporate sector and its impact on the banking system."

### Policy recommendations (selected)
- Fiscal:
  - "Continued focus on fiscal reforms is crucial to underpin macroeconomic stability."
  - Authorities "should aim to overperform on their near-term fiscal consolidation objectives and to increase their fiscal effort as the recovery takes hold."
- Monetary:
  - "Monetary policy easing can continue in 2017 given the large output gap and moderate inflation expectations, conditional on the outlook for inflation remaining benign."
  - "Encouraged continuous reassessment of the policy stance in view of the evolution of inflation and expectations and prospects for fiscal reforms."
- Structural and governance:
  - "Supply-side structural and regulatory reforms are needed to improve the business environment and boost medium-term growth."
  - "Corruption has proven costly for Brazil; improving governance, increasing transparency and strengthening institutional frameworks are key to secure strong, durable and inclusive growth."
- External adjustment and financial stability:
  - "The exchange rate should remain the main external adjustment variable."
  - "Financial safety nets should be strengthened through enhanced monitoring and an improved crisis management framework."

### Key statistics and projections (selected figures preserved exactly as in source)
- Growth and prices:
  - GDP at constant prices: "-3.8" (2015), "-3.6" (2016), "0.3" (2017), "1.3" (2018), "2.0" (2019–2022 each year shown).
  - Consumer prices (IPCA, end of period): "10.7" (2015), "6.3" (2016), "4.0" (2017), "4.0" (2018), "4.5" (2019–2022).
- Public finances:
  - NFPS primary balance: "-1.9" (2015), "-2.5" (2016), "-2.1" (2017), "-1.8" (2018), "-1.1" (2019), "-0.4" (2020), "0.2" (2021), "0.8" (2022).
  - NFPS gross debt: "72.5" (2015), "78.3" (2016), "81.5" (2017), "85.8" (2018), "88.6" (2019), "90.5" (2020), "91.7" (2021), "92.4" (2022).
  - Net public sector debt: "35.6" (2015), "46.2" (2016), "51.4" (2017), "55.9" (2018), "58.9" (2019), "61.0" (2020), "62.4" (2021), "63.3" (2022).
- External sector:
  - Current account (in percent of GDP) memorandum: "-3.3" (2015), "-1.3" (2016), "-1.5" (2017), "-1.7" (2018), "-1.7" (2019), "-1.8" (2020), "-1.9" (2021), "-2.0" (2022).
  - Gross official reserves: "356.5" (2015), "365.0" (2016), and projected "365.0" (2017–2022).
  - Total external debt (in percent of GDP): "36.9" (2015), "36.9" (2016), "32.2" (2017), "31.7" (2018), "30.7" (2019), "29.7" (2020), "28.6" (2021), "27.5" (2022).
- Monetary indicators:
  - Monetary policy rate: "10.25 percent as of June 2017" after "a cumulative 400 bps" reduction since September 2016.
- Reserves and FX positions:
  - International reserves: "US$365 billion at end-2016."
  - Central bank net forward position reduced to "1.4 percent of GDP from over 5 percent of GDP at end-2015."

*BRAZIL: STAFF REPORT FOR THE 2017 ARTICLE IV CONSULTATION, June 20, 2017.*

### 1. Real Sector Developments __________________________________________________________ 35

### 1. Real Sector Developments

### Depth and features of the recession
- Real output has contracted by around 7 percent since the end of 2014.
- Around 3 million formal jobs have been lost.
- The unemployment rate has more than doubled.
- Investment has fallen by around 30 percent since the beginning of 2014.
- Key contributors to the investment decline: sustained low competitiveness, rising costs (e.g. energy and unit labor costs), worsening terms of trade, declining profitability, tightening financial conditions, higher corporate leverage, and rising economic policy uncertainty.
- Consumption contracted substantially amid severe deterioration in labor market conditions, falling real income growth, and tightening financial conditions.
- Net exports broadly supported growth over 2015 due to a sharp demand-related fall in imports and strong export growth amid exchange rate depreciation and delayed effects of stronger investment and commodity export capacity.
- Exports contracted by almost 5 percent in the year to December 2016 (a pickup in export volumes was reported in 2017-Q1, but it does not alter the overall picture).
- Additional growth headwinds: continuing uncertainty about the political situation, the government’s reform agenda, and the ongoing corruption probe.

### Turning point signs
- After eight consecutive quarters of contraction, real GDP increased in 2017-Q1, driven by net exports largely reflecting a positive supply shock to agricultural output.
- Domestic demand contracted again in 2017-Q1, making the end of the recession uncertain.
- Several previously adverse factors have normalized or improved (e.g., falling terms of trade, high inflation, tightening financial conditions).
- Corporate leverage has started to decline, albeit from a high level.
- Consumption expected to get a modest boost from release of funds in inactive mandatory savings accounts (FGTS): between March and July 2017, about 30 million people are eligible to withdraw funds worth 2/3 percent of GDP.
- Staff view: economy seems poised to resume modest growth in the second half of the year.

### Corruption probe (Box 1) — spillovers and institutional effects
- Lava Jato (car wash) investigation began in 2014; uncovered decades-long corruption practices across Petrobras, major construction firms, public works, energy sector, meatpacking, defense, pension funds, and BNDES.
- Odebrecht pleaded guilty and agreed to pay a penalty of US$2½ billion; implicated high-ranking officials from 12 countries in about 100 projects over the past 15 years.
- Investigations have been authorized into one third of current cabinet members, one third of Senators, and one third of state Governors, as well as the President and leaders of Congress and main parties; several former presidents and 2018 presidential hopefuls are also being investigated.
- Economic fallout: increased uncertainty and dampened activity in oil and gas and construction sectors; some projects suspended or delayed domestically and regionally.
- Institutional gains: strengthened governance at firms (including SOEs), review of public procurement rules, new reforms and initiatives expected to reduce corruption and money laundering over time.
- Note on judicial outcomes: In Lava Jato 139 individuals have been sentenced in the first instance (as of May 2017); Supreme Court’s cases against over one hundred politicians with immunities have not resulted in sentences yet.

---

### 2. Inflation Developments and Monetary Policy

### Recent inflation trajectory
- After almost 2 years above the ceiling of the central bank’s tolerance range of 6.5 percent, inflation declined rapidly over the past year.
- Annual IPCA inflation peaked at 10.7 percent in December 2015 and ended 2016 at 6.3 percent.
- Large regulated-price increases in 2015 (notably in energy) had major impact but began to dissipate in early 2016.
- A widening output gap, an appreciating exchange rate, declining inflation expectations, and a favorable shock to food prices contributed to disinflation since late 2016.

### Monetary policy response
- The central bank began an easing cycle in September 2016.
- The monetary policy rate (SELIC) was cut by a cumulative 400 bps to 10.25 percent as of June 2017.
- Reference rate for BNDES’ subsidized loans (TJLP) was reduced by 50 basis points to 7.0 percent in late March.
- Most private forecasters see the SELIC below 9 percent by year’s end.

### Drivers of disinflation (Box 2)
- Key contributors to the decline in inflation: waning regulated-price inflation, weak demand, appreciation of the exchange rate, and dissipation of earlier food-price shocks.
- Disinflationary pressures expected to continue in the near term due to weak demand, subdued regulated-price inflation, and favorable agricultural conditions in late 2016.
- Empirical Phillips-curve specification used by staff (coefficients statistically significant at the 1 percent level; adjusted R-squared is 0.7):
  - Quarterly IPCA inflation (annualized) regression: π_t = 0.34 π_{t-1} + 0.34 y_t + 0.05 e_t + 0.37 π_{t}^{regulated} + ε_t (variables described in source).

---

### 3. External Sector Developments

### Current account and reserves
- Current account deficit narrowed to 1.3 percent of GDP in 2016 (from 3.3 percent of GDP in 2015).
- On average in 2016, external position broadly consistent with medium-term fundamentals and desirable policies per the External Balance Assessment (EBA).
- In 2017-Q1 the REER was 14 percent stronger than its average in 2016; part of this appreciation was reversed after political turmoil.
- The Central Bank reduced the rollover rate of maturing FX swaps and auctioned reverse FX swaps, reducing its net forward position to 1.4 percent of GDP from over 5 percent of GDP at end-2015.
- International reserves stood at US$365 billion, equivalent to 166 percent of the ARA metric.

### Capital flows and nonresident holdings
- Brazil continued to attract sizable capital flows but composition changed in 2016:
  - Net direct investment fully financed the current deficit in 2016, partly supported by intercompany loans.
  - Net portfolio debt liabilities, which had been more than 1 percent of GDP in previous years, turned to net outflows.
  - Share of government debt held by nonresidents declined from 19 percent to 14 percent over 2016.

---

### 4. Financial Sector and Credit Conditions

### Market reactions and policy interventions
- The real appreciated by around 8 percent against the U.S. dollar over the year to December 2016, and by around 7 percent in real effective terms.
- Domestic government 10-year yield declined by around 400 basis points to 10 percent in the year to early May 2017.
- On May 18 (one day), 5- and 10-year sovereign yields rose by around 150 basis points; stock market and exchange rate against the U.S. dollar lost almost 10 percent in value; automatic circuit breakers triggered.
- Authorities intervened: Central Bank provided exchange rate hedge through FX swaps; Treasury implemented extraordinary buy and sell auctions to provide liquidity and pricing information. Asset prices stabilized thereafter, albeit at lower levels than in early May; uncertainty remains high.

### Credit cycle and financial conditions
- Private sector credit continued to decelerate, reflecting low demand and tight underwriting standards.
- Investigation of construction companies linked to corruption affected both supply and demand for credit, given their traditional use of BNDES credit.
- Demand and supply indicators of credit and new loans picked up since late-2016, potentially signaling an end to negative credit dynamics.
- Staff’s financial conditions index, a leading indicator of the cycle, has been loosening for several quarters.

### Banking sector health and balance sheets
- Banking sector profits before taxes surged due to high interest margins and lower funding costs.
- Banks continued renegotiating loan terms and writing off delinquent loans to limit increases in non-performing loans.
- Capital ratios increased for private banks due to decline in risk-weighted assets and higher unrealized gains on fixed income securities.
- Capital ratios of public banks continued declining because of higher Basel III deductions.
- Liquidity improved as withdrawals of saving deposits stopped and banks’ holdings of liquid assets increased.
- Overall external funding exposure and net open positions remained low.

### Nonfinancial corporate and household balance sheets
- Households’ debt-to-disposable income ratio is edging down, mainly due to lower non-mortgage debt.
- Debt-service-to-income ratios have declined owing to accelerated principal repayments on outstanding loans.
- Corporate bankruptcy protection applications have begun to fall.
- Leverage remains high in corporate and household sectors and warrants continued monitoring.
- Petrobras: EBITDA margin at its highest level in several years; debt maturing over 2017 and 2018 remains nearly US$20 billion, though its debt amortization schedule has improved.

---

### 5. Public Finance and Debt Dynamics

### Fiscal balances and public debt
- NFPS debt rose from 72.5 percent of GDP to 78.3 percent of GDP between 2015 and 2016.
- Primary balances were -1.9 and -2.5 percent of GDP in 2015 and 2016, respectively.
- Overall balances were -10.3 and -9.1 percent of GDP in 2015 and 2016, respectively.
- Drivers of deficits: trend increases in mandatory spending, a sharp cyclical revenue downturn, high borrowing costs, and contraction in output.
- Composition of spending worsened, with rising current outlays and stagnant investment.

### Policy implication
- Improving fiscal balances remains essential to ensure fiscal sustainability (see the accompanying Debt Sustainability Analysis).

*Source: IMF staff chapter "1. Real Sector Developments" from cr17215.*

### 12.      Some subnational governments’ finances are highly stressed (Box 3). States’ fiscal

### Some subnational governments’ finances are highly stressed (Box 3)

### Overview
- States’ fiscal positions have deteriorated due to the combination of revenue shortfalls, especially marked in oil producing states such as Rio de Janeiro, and steep wage bill and pension spending increases in the last several years.
- The federal government has negotiated consolidation measures in exchange for debt rescheduling and loan guarantees with Rio de Janeiro and Rio Grande do Sul, and the overall framework has received congressional approval.

### Box 3 — Rio de Janeiro (RJ)
- The situation in RJ is described as dire, driven by fast expenditure increases for many years, a sudden reduction in revenues from the recession, and a sharp contraction in royalty revenue as world oil prices fell.
- By the end of 2016, RJ accumulated an estimated financing gap of R$26 billion in 2017 (3.7 percent of the state’s GDP and 0.4 percent of Brazil’s GDP).
- The 3-year rescue package agreed in January between RJ and the federal government (FG) includes:
  - Measures to cover a fiscal gap of R$26 billion in 2017, including:
    - Increase of R$1.2 billion in revenues.
    - Cuts in discretionary spending of R$9 billion.
    - Increase in pension contributions worth R$3.2 billion.
  - RJ will not have to service its debt to the FG (R$6.2 billion) in 2017.
  - The FG will guarantee a bank loan against future privatizations (R$3.4 billion).
- Assessment:
  - While the package will help RJ deal with its cash pressures in 2017, additional measures will be needed to finance large expected deficits in 2018 and 2019.
  - Absent reforms to curb the structural growth of salaries and pensions, a large fiscal gap will remain and a new package will be needed in 2020.

### Box 3 — Rio Grande do Sul (RS)
- High spending on pensions and personnel are structural problems in RS.
  - Ratio of retirees and other beneficiaries to active employees is 1.3.
  - Projected deficit of the pension system for 2017 is estimated at R$9 billion.
- Fiscal adjustments undertaken:
  - Facing a R$25 billion deficit projected for 2017−19, RS launched measures early in 2015 and additional measures in 2016:
    - Administrative spending was cut by 20 percent.
    - 9 out of 29 ministries were closed.
    - 9 foundations were terminated.
    - Ceiling on government spending on wages capped at 70 percent of revenue.
    - Ceiling on the value of benefits that can be cumulated introduced.
    - New complementary system for civil servants joining from 2015 onwards, implying full capitalization above a certain salary threshold (benefits felt only 20 years from now).
- Revenue and contribution measures:
  - Increase in the inheritance tax.
  - Hike of the state consumption tax (ICMS).
  - Increases in telecom, fuel, electricity and alcohol taxes.
  - Employee pension contributions increased from 13.25 to 14 percent.
  - Local authorities stepped up collection of one-off revenues, recalled fiscal incentives, and encouraged early repayment of tax debt.
- Short-term rescue package being negotiated between the FG and RS to close the R$9 billion financing gap in 2017 likely includes:
  - Extension of the grace period on debt-service to the FG for another 3 years, generating about R$4 billion in temporary savings.
  - Loans with federal guarantees against a future sale of assets, mainly SOEs in the energy sector (electricity, mining, water and gas).
- Assessment:
  - Structural fiscal reforms are necessary for medium-term sustainability.
  - The increase in the contribution rate is useful but not sufficient to guarantee pension system sustainability.
  - The minimum retirement age proposed for the FG level, if approved, should be extended to military and security personnel at state level.
  - Legislation to alter the structure of teachers’ careers and introduce longer contribution periods before retirement is necessary.

### Policy measures and fiscal framework
- Expenditure Cap:
  - December 2016 constitutional amendment imposes a ceiling on federal noninterest spending; indexed to the rate of consumer price inflation of the previous year (measured in June).
  - The rule triggers corrective measures in case of breach and will be in effect for 20 years, with an opportunity to modify the ceiling’s indexation mechanism after the first 9 years.
  - A few items are excluded from this ceiling, chief among them transfers to subnational entities arising from the revenue-sharing system.
  - The DRU was approved in 2016, releasing the earmarking on 30 percent of federal taxes through 2023.
- Fiscal Sustainability:
  - Authorities aim to restore fiscal sustainability by gradually bringing primary balances toward surplus, supported by the constitutional expenditure ceiling and social security reform.
  - For 2017, authorities aim to bring the primary deficit to -2.1 percent of GDP.
  - Introduced adjustment measures of 0.9 percent of GDP, including cuts in discretionary spending of 2/3 percent of GDP and a partial roll-back of payroll tax exemptions.
  - For 2018, the primary balance target is -1.8 percent of GDP.
  - Other measures under consideration include selected privatization operations, such as the sale of Caixa’s lottery and insurance businesses.
- Monetary Policy and Credit Markets:
  - Central bank communications have become more transparent, with a narrowed tolerance range for inflation for 2017 and 2018.
  - The role of subsidized credit is being reduced: gradual phase out of the TJLP and replacement with the TLP; BNDES role adjusted accordingly.
- Labor Market and Other Reforms:
  - Draft labor reform (6787/16) would give firm/union agreements precedence over legislation in selected areas, broaden part-time employment, regulate firm-level worker representation, and discourage excessive litigation.
  - A recently enacted law allows unrestricted outsourcing of labor, including core activities.
  - Petrobras is cutting expansion, pursuing selective divestment, and a new pricing policy for domestic products guided by import parity.
  - Reforms announced to improve regulation, business environment, lower red tape, standardize foreign trade procedures, simplify tax refunds and payments, improve the positive credit registry, and empower creditors via a new bankruptcy law.
  - Infrastructure concessions program expanded; four airport concessions were auctioned to foreign bidders.
  - Under the concessions changes: period between bidding and auction expanded to 100 days; regulatory agencies to supervise contracts rather than organize auctions.

### Outlook and Risks
- Growth and activity projections:
  - Staff project output growth of 0.3 percent in 2017 and 1.3 percent in 2018.
  - Credit expected to recover broadly in line with activity, with a lag; over the medium term credit to grow again as a ratio to GDP.
  - Inflation expected to undershoot the midpoint of the target band in 2017 and 2018.
  - Unemployment projected to peak in late 2017; youth unemployment about 25 percent.
  - Baseline assumes pension reform delayed some months but ultimately approved without major additional dilution, and the constitutional expenditure cap is observed.
  - Current account deficit expected to stabilize at around 2 percent of GDP as demand recovers.
- Debt and financing risks:
  - Debt sustainability analysis (DSA) baseline: debt keeps rising to about 92½ percent of GDP in 2022/2023, and only starts declining in 2024.
  - Table excerpted scenario projections (selected rows preserved exactly where present in source):
    - Growth: 0.0 -1.0 -1.0 0.0 0.8 0.8
    - Inflation (CPI), %: 5.0 6.0 5.6 5.4 5.2 5.1
    - Primary Balance, % GDP: -2.5 -2.1 -2.4 -2.3 -2.1 -2.0
    - Gross Debt, % GDP: 84.7 90.8 98.3 105.4 111.8 118.6
- Key risks:
  - Dominant risks are political, including uncertainty on the continuity of the government and its policies.
  - Failure to enact social security reform, or significant dilution in Congress, would put fiscal consolidation at risk and could prompt sovereign downgrades, reverse confidence gains, and tip the economy back into recession.
  - External risks include a significant slowdown in China, persistent slow growth in major advanced economies, and shifts in U.S. policies leading to U.S. dollar strength and/or higher dollar interest rates.
  - Upside risks include stronger-than-expected agricultural output in 2017, higher household withdrawals from FGTS accounts, and faster deleveraging if monetary easing spurs it; but elevated political uncertainty could prevent sustained upside.

### Policy implications and recommendations
- Fiscal policy:
  - Pace of fiscal adjustment should quicken when economic recovery strengthens and be anchored by clarity on adjustment measures.
  - Decision to address spending pressures is welcome; the government aims to control spending growth and gradually increase primary balances.
  - Staff projects the NFPS primary balance returning to surplus in 2021 (official fiscal targets see a primary surplus in 2020).
- Social security reform:
  - An ambitious social security reform bill is needed to ensure long-term viability of the social security system and support compliance with the expenditure ceiling.
  - Social security spending exceeds 40 percent of federal government primary spending.
  - Linchpin of proposed reform is a higher mandatory retirement age (with transition rules) and an effective reduction in replacement ratios.
  - Government’s initial proposal aimed to stabilize social security spending as a percent of GDP for the next decade, implying savings of some 2 percent of GDP a year by 2026 relative to a no-reform scenario.
  - The version negotiated in Congress is estimated by the government to generate 75 percent of the savings intended in the original proposal over its first 10 years; savings would gradually rise over time.
- State-level measures:
  - Extend minimum retirement age proposals to military and security personnel at state level.
  - Legislate changes to teachers’ careers and contribution periods to address state pension pressures.
  - Short-term rescue packages (debt-service grace periods, federal-guaranteed loans against asset sales) can stabilize states’ cash positions but structural reforms are necessary for medium-term sustainability.
- Structural reforms and governance:
  - Monetary policy can be accommodative given slack and ongoing disinflation.
  - Structural reforms needed to support strong and inclusive growth: improve regulation, lower red tape, strengthen governance, increase transparency, and improve institutional frameworks.

*Italicized source attribution: IMF staff summary of cr17215 (pdf chapter/section).*

### 0.7 percent of GDP relative to no-reform projections. However, the approval of the reform has been

### cr17215 - 0.7 percent of GDP relative to no-reform projections. However, the approval of the reform has been

### Near-term fiscal challenges and measures
- Finding: The approval of the reform has been delayed and remains at risk in the current political environment.  
- Finding: The government faces challenges meeting its fiscal targets in the near term.  
- Conditional action: Expenditure containment measures will likely be needed in 2018 if, as widely expected, CPI inflation comes in well below 4 percent in June 2017 (this parameter defines the 2018 expenditure ceiling; see Table 3).  
- Quick-yielding measures for 2018 could include:
  - a hiring freeze,
  - a reduction in financial and credit subsidies,
  - the start of pension reform.
- Revenue-side options to meet 2017 and 2018 primary balance targets, given continuing weakness in revenue (Box 5), include:
  - asset sales (already under consideration for 2017),
  - rolling back tax breaks.
- Finding: Current primary balance targets depend on deep cuts in discretionary spending and one-off revenues.

### Medium-term consolidation and recommended fiscal package
- Finding: Under current plans and policies, primary balances will improve relatively slowly and the public debt-to-GDP ratio would only begin to decline many years from now.  
- Recommendation: Speed up fiscal consolidation beyond current plans when growth strengthens on a sustainable basis.  
- Quantified recommendation: Predicated on a firm return to growth in 2018, additional measures of the order of 1−2 percent of GDP introduced over time would make sure the debt-GDP ratio starts declining already in 2020 and peaks 9 points of GDP below the peak in the baseline projection.  
- Recommendation: Moderate and well-chosen revenue measures would be useful to accelerate fiscal adjustment, including the rollback of the remaining payroll tax exemptions.  
- Other fiscal measures to consider:
  - Medium-term fiscal planning: adopt a rolling medium-term fiscal framework to clarify and update governments’ goals for debt stabilization.
  - Mandatory spending: social security reform alone will not be enough to meet the expenditure ceiling over the next several years (Table 3). Additional measures should include:
    - a change in the minimum wage indexation formula,
    - revision of allowances for civil servants,
    - avoid wage increases for civil servants above inflation,
    - adopt a medium-term budget framework to identify expenditure policies to keep the budget consistent with the ceiling without triggering automatic corrective spending cuts foreseen in the constitution.
  - Subnational finances: the new framework to provide temporary debt relief to states in crisis in exchange for fiscal measures is a step in the right direction but likely falls short in the worst-hit states; continued work toward pension reform, wage restraint, ambitious deficit reduction at the subnational level, and increased fiscal transparency (use of common accounting standards by all states) is needed, with close monitoring of municipal finances.
  - Other reforms: utilize the Independent Fiscal Institution (IFI) attached to the Senate to promote fiscal transparency; improve fiscal forecasts at all levels; address large budget rigidities, including revenue earmarking and high mandatory spending, urgently.

### Key macro-fiscal projections and required measures (selected series)
- Growth, % by year:
  - 2017: 0.3
  - 2018: 1.5
  - 2019: 2.2
  - 2020: 2.5
  - 2021: 2.2
  - 2022: 2.2
- Inflation (CPI), % by year:
  - 2017: 4.0
  - 2018: 4.0
  - 2019: 4.5
  - 2020: 4.5
  - 2021: 4.5
  - 2022: 4.5
- Primary balance, % GDP:
  - Authorities' target: -2.1 (2017), -1.8 (2018), -0.8 (2019), 0.3 (2020), ...... (subsequent years not shown)
  - IMF baseline: -2.1 (2017), -1.8 (2018), -1.1 (2019), -0.4 (2020), 0.2 (2021), 0.8 (2022)
  - IMF recommended path: -1.9 (2017), -0.6 (2018), 0.3 (2019), 1.3 (2020), 2.5 (2021), 2.7 (2022)
  - Required measures: 0.2 (2017), 1.2 (2018), 1.4 (2019), 1.7 (2020), 2.3 (2021), 1.9 (2022)
- Gross debt, % GDP:
  - 2017: 81.4
  - 2018: 84.4
  - 2019: 85.1
  - 2020: 84.1
  - 2021: 82.3
  - 2022: 80.4
- Gross financing needs, % GDP:
  - 2017: 14.0
  - 2018: 16.0
  - 2019: 15.6
  - 2020: 17.0
  - 2021: 20.4
  - 2022: 19.6
- Scenario presented: Recommended

### Tax revenues and the economic cycle (Box 5)
- Finding: Tax revenues contracted more than GDP during the recent economic recession.  
- Finding: Tax elasticities have fallen below 1 after the financial crisis according to some (Ribeiro, 2016).  
- Possible explanations for weak revenue recovery:
  - high dependence of tax revenues on wages and sales, which shrank disproportionately during the recession,
  - compliance issues contributing to tax revenue contraction beyond what can be explained by the decline in GDP.
- Cross-country evidence (panel of 78 countries, 1997−2014):
  - Identified 32 episodes of cumulative real GDP contractions of at least 2 percent over two consecutive years associated with declining revenue-to-GDP.
  - Average cumulative GDP contraction in the sample: 5.3 percent over the crisis period.
  - Average decline in the tax revenue ratio: about 1.6 percentage points of GDP.
  - In the first year of recovery, average revenue-to-GDP gap compared to pre-crisis level: 1.3 percentage points of GDP.
  - In the second year after the crisis, average gap: 0.7 percentage points of GDP.
- Recommendation: As Brazil enters the recovery phase, a cautious approach to revenue projections is warranted; incomplete and delayed recoveries in tax ratios can stem from lags in collections (tax credits), structural changes in the economy affecting the tax base, and changes in the external environment.

### Monetary policy: disinflation gains and credibility
- Finding: The current pace of monetary easing is broadly appropriate given significant uncertainty about the neutral interest rate, significant excess supply, and below-target inflation expectations.  
- Market expectations (Central Bank Focus Survey, June 2): 3.9 percent in 2017 and 4.4 percent in 2018.  
- Recommendation: The central bank should continue to reassess the pace and extent of the easing cycle considering inflation, expectations, market signals, external conditions, and prospects for fiscal reforms.  
- Recommendation: Improve the inflation-targeting framework by specifying a well-defined medium-term target, strengthening Central Bank independence, and publishing and discussing fully endogenous inflation and policy rate projections.  
- On exchange rate: The exchange rate should remain the main external adjustment variable; intervention (including foreign-exchange swaps) should be limited to addressing disorderly market conditions. Authorities should resist pressures to use reserves for ad-hoc purposes such as financing public investment or repaying public debt.

### Financial system resilience
- Finding: The banking sector has weathered the recession well; soundness indicators improved in 2016 as shocks to funding dissipated, interest margins rose, and non-performing loans moderated.  
- Recommendation: Continue efforts to bolster resilience by:
  - strengthening financial safety nets (enhance the central bank’s ability to provide emergency liquidity assistance),
  - implementing the new resolution regime for banks,
  - establishing a committee with an explicit mandate for systemic risk monitoring,
  - assigning a separate entity to set up a crisis management framework.
- Recommendation: Banks that consistently fail stress tests should be required to raise additional capital or, if state-owned, be recapitalized or allowed to retain profits to boost capital.
- Credit market reforms supported:
  - replace the TJLP with a market-determined rate linked to government bond yields as scheduled,
  - revise earmarking of saving deposits for mortgages and agriculture credit,
  - Central Bank measures to reduce banking spreads: simplify reserve requirements, implement a positive credit bureau, establish a centralized market for receivables,
  - conclude bankruptcy framework reform to expedite bankruptcy process and reduce default losses.

### Structural reforms to lift medium-term growth
- Finding: Convergence of per capita income between Brazil and advanced economies has stalled; annual labor productivity growth in Brazil over the last 10 years averaged about 1 percent (versus around 4.5 percent for all upper-middle-income countries over the same period).  
- Constraints on productivity and growth include: a relatively closed economy (average tariff rates above peers, high non-tariff barriers, onerous domestic content requirements), a highly complex tax system, and inadequate infrastructure (particularly transport).  
- Recommended structural reforms:
  - Opening the economy: reduce tariffs (especially on capital goods), eliminate non-tariff barriers (including frequent resort to anti-dumping), pursue free-trade negotiations.
  - Tax reform: simplify the federal tax system beginning with PIS/COFINS, harmonize federal and state tax regimes to reduce taxpayer compliance costs and improve resource allocation and productivity.
  - Labor market: continue reforms to increase flexibility and reduce excess litigation in labor courts; monitor potential impacts on formal labor market duality and consider tax-code adaptations to limit adverse fiscal side effects; accompany reforms with policies to support individuals through unemployment.
  - Infrastructure: pursue the infrastructure concessions program to alleviate supply-side constraints and boost competitiveness; make the program more attractive to investors while maintaining high standards of governance and program design.

*International Monetary Fund staff summary of the content unit cr17215.*

### 28.      Improving governance, increasing transparency and strengthening institutional

### 28.      Improving governance, increasing transparency and strengthening institutional frameworks

### Main recommendations and actions to strengthen governance and transparency
- Continue pursuing significant corruption and money laundering cases, and work with the legislature to adopt relevant pending reforms to further strengthen the anti-corruption and anti-money laundering framework. This includes strengthening whistleblower mechanisms, provisional measures and confiscation, and the prevention of abuse of appeal provisions and statutes of limitations in legal proceedings.
- Follow-up on existing ENCCLA (National Strategy Against Corruption and Money Laundering) action items to make it more difficult to hide illicit assets, including:
  - (i) interagency sharing of tax and banking information, including to prevent abuse of tax-repatriation provisions for money laundering,
  - (ii) the effective implementation of beneficial ownership requirements, and
  - (iii) the enactment of international cooperation tools to facilitate detection and repatriation of funds channeled abroad.
- Continue to populate the Transparency Portal, and similar publicly accessible websites such as Compras Governamentais (“Government Purchases”) and the Brazilian open data portal, with data that assist to prevent and disclose corruption (including data related to public procurement, budgets and expenditures).

### Authorities’ views
- The authorities see evidence that economic growth has resumed and indicated that growth has turned positive in the first quarter of 2017, helped by strong agricultural production.
- The authorities generally agreed with staff that the weak labor market is likely to slow the recovery in private consumption, although increased access to FGTS will provide a one-off boost to private spending.
- The Ministry of Finance projects growth of 0.5 percent in 2017 and 2.5 percent in 2018.
- In their view, passage of pension reform is likely and could provide significant upside risks to the recovery.
- The authorities emphasized that social security reform is a crucial step towards ensuring fiscal sustainability and noted that negotiations in Congress had preserved the bulk of the savings anticipated in the initial formulation of the reform, and had enshrined principles including a minimum retirement age.
- They stressed further mandatory spending cuts, including the reform of military pensions, would be needed to ensure the federal spending ceiling is observed over the medium term.
- A large part of work on additional measures would have to be carried out by the next government, which would have the duty of issuing a multi-year fiscal plan for the 2019−22 period.
- The authorities indicated they are working on the design of a new medium-term fiscal framework.
- The authorities noted limited fiscal space and that further measures may be necessary to observe primary balance objectives in the near term; they are identifying measures to ensure the 2017 primary balance target is attained, and for a revision of the 2018 target.
- They are cutting back on new hiring, reducing some mandatory spending (for example, by preventing abuses in the sickness support program), and reviewing spending programs to identify additional savings.
- Some savings in the interest bill would come from declining subsidies to BNDES as the TJLP is gradually phased out and replaced with the market-linked TLP.
- The Central Bank indicated room for the easing cycle to continue, noting disinflation is broad-based and reflects significant excess capacity and subdued inflation expectations; monetary policy could adopt an expansionary stance implying further cuts in the policy interest rate.
- The National Monetary Council will decide on the 2019 inflation target at the end of June.
- The authorities agreed that the flexible exchange rate is a key shock absorber; interventions through FX swaps and FX repos aim at smoothing excess volatility and have not affected the direction of market-determined movements.
- They noted high international reserves and a policy of reducing the stock of swaps during last year, and cited their ability to respond to turmoil in the exchange market in mid-May as evidence of preparedness.
- The authorities emphasized the resilience of the banking system during the recession and expect a new resolution framework, consistent with the FSB’s key attributes, will be enacted this year; additional improvements are being implemented under the BC+ agenda.
- The authorities acknowledged the need to improve the business environment and enhance competitiveness, citing reforms: revamped infrastructure concession framework, relaxation of domestic-content rules in the oil and gas sector, planned reforms for BNDES’ lending and government procurement, reductions in tariffs, pursuit of new free-trade negotiations, simplification of indirect federal taxes (PIS-COFINS), labor reforms (some still before Congress), and a new bankruptcy framework.
- The authorities agreed that transparency and anti-corruption measures are an important part of improving long-term prospects and noted efforts to pursue significant corruption and money laundering cases and the creation of the Transparency Portal.

### Staff appraisal and priorities
- Fiscal sustainability has not yet been secured; Brazil has limited fiscal space for an expansionist policy. The government’s policy efforts are appropriately focused on an ambitious strategy of consolidation and reform in the fiscal sector to secure sustainability of public finances and social security.
- The pace of fiscal adjustment under current plans is relatively moderate, allowing debt ratios to remain high for a prolonged period; staff underscores the importance of speeding up fiscal consolidation, beyond current plans, when growth strengthens on a sustainable basis.
- Social security reform is key for fiscal and social reasons: it is essential to ensure the core of Brazil’s social protection system can remain viable long term and to meet the constitutional ceiling on expenditure. It is vital that Congress approves this reform.
- Additional expenditure and revenue measures should be considered by the current and any future government; social security reform will not be enough to ensure the expenditure limit is met over the medium term.
- Authorities are encouraged to introduce a rolling medium-term fiscal framework and a medium-term budget framework to clarify goals for debt stabilization and identify expenditure measures to keep the budget consistent with the ceiling in coming years.
- Moderate and well-chosen revenue measures would be useful to accelerate fiscal adjustment.
- The current pace of monetary easing is broadly appropriate given significant excess supply and below-target inflation expectations; the pace and extent should be reassessed considering inflation, expectations, market signals, external conditions, and fiscal reform prospects.
- Staff welcomes the use of the exchange rate as the first line of defense against shocks; Brazil’s external position in 2016 was on average broadly consistent with medium-term fundamentals and desirable policies. Intervention in foreign exchange markets should remain limited to episodes of disorderly market conditions, and reserve buffers should be preserved.
- Efforts to bolster the resilience of the financial sector should continue: conclude actions to strengthen financial safety nets, enhance the central bank’s ability to provide emergency liquidity assistance, implement the new resolution regime for banks, set up a committee with an explicit mandate for systemic risk monitoring, and give a separate entity the mandate to set up a crisis management framework. Banks that consistently fail Central Bank stress tests should be required to raise additional capital or, if state-owned, be recapitalized.
- Structural reforms to enhance efficiency and foster investment are essential to raise potential growth. Staff encourages follow-through on plans to strengthen the supply side, reduce subsidized credit, and reform BNDES to improve allocation of financial resources.
- Ongoing efforts to combat corruption are of the highest importance; strengthening governance and further implementing transparency, anti-corruption and AML measures is vital because corruption has caused a protracted period of elevated uncertainty, affecting economic activity and planning by consumers and firms.

*IMF staff summary based on chapter content.*

### 45.      It is recommended that the next Article IV consultation takes place on the standard

### 45.      It is recommended that the next Article IV consultation takes place on the standard 12-month cycle.

### Recommendation
- It is recommended that the next Article IV consultation takes place on the standard 12-month cycle.

### Social and Demographic Indicators (selected)
- Area (thousands of sq. km): 8,512
- Agricultural land (percent of land area): 31.2
- Physician per 1000 people (2013): 1.9
- Hospital beds per 1000 people (2012): 2.3
- Access to safe water (2015): 98.1
- Total population (million) (est., 2015): 204.5
- Annual rate of population growth (percent, 2015): 0.8
- Density (per sq. km.) (2015): 24.0
- Adult illiteracy rate (2015): 7.4
- Unemployment rate (latest, 2017): 13.7
- Life expectancy at birth (years): 75
- Infant mortality (per thousand live births): 14
- Poverty rate (in percent, 2014): 13.3
- Net enrollment rates (percent): Primary education (2014): 99; Secondary education (2014): 84
- Income distribution (2016): By highest 10 percent of households: 40.9; By lowest 20 percent of households: 3.6
- Gini coefficient (2015): 49.1
- GDP, local currency (2016): R$6,267 billion
- GDP, dollars (2016): US$1,799 billion
- GDP per capita (est., 2016): US$8,795
- Main export products: airplanes, metallurgical products, soybeans, automobiles, electronic products, iron ore, coffee, and oil.

### National Accounts and Prices (selected series, 2015–22)
- GDP at current prices: 3.8, 4.4, 7.8, 6.1, 6.8, 7.1, 7.1, 7.1
- GDP at constant prices: -3.8, -3.6, 0.3, 1.3, 2.0, 2.0, 2.0, 2.0
- Consumption: -3.3, -4.7, -0.2, 0.4, 0.8, 1.5, 1.5, 1.1
- Investment: -23.8, -10.4, 0.8, 4.0, 7.2, 4.0, 4.4, 5.6
- Consumer prices (IPCA, end of period): 10.7, 6.3, 4.0, 4.0, 4.5, 4.5, 4.5, 4.5
- Gross domestic investment (percent of GDP): 19.1, 17.5, 17.6, 17.9, 18.5, 18.8, 19.1, 19.6
- Gross national savings (percent of GDP): 15.8, 16.2, 16.0, 16.2, 16.8, 17.0, 17.2, 17.6
- Base money: 8.4, 8.1, 7.8, 6.1, 6.8, 7.1, 7.1, 7.1
- Broad money: 9.7, 12.4, 11.6, 8.7, 10.0, 13.8, 14.4, 14.5
- Bank loans to the private sector: 3.6, -2.9, 5.7, 7.4, 11.0, 12.4, 12.9, 12.2

### Balance of Payments (selected series, 2015–22; US$ billions unless indicated)
- Trade balance: 17.7, 45.0, 49.0, 49.1, 51.8, 52.3, 53.9, 56.5
- Exports (fob): 190.1, 184.5, 200.1, 205.4, 214.3, 221.8, 231.3, 241.8
- Imports (fob): 172.4, 139.4, 151.0, 156.3, 162.5, 169.5, 177.4, 185.3
- Current account: -59.4, -23.5, -32.4, -37.4, -38.1, -42.9, -47.1, -50.4
- Capital account and financial account: 55.6, 16.7, 32.4, 37.4, 38.1, 42.9, 47.1, 50.4
- Foreign direct investment (net): 61.2, 71.1, 59.0, 53.6, 50.5, 49.7, 49.8, 50.5
- Gross official reserves (eop): 356.5, 365.0, 365.0, 365.0, 365.0, 365.0, 365.0, 365.0
- Current account (in percent of GDP): -3.3, -1.3, -1.5, -1.7, -1.7, -1.8, -1.9, -2.0
- GDP in billions of U.S. dollars: 1,801, 1,799, 2,091, 2,155, 2,254, 2,359, 2,466, 2,579
- Oil price (Brent blend; US$ per barrel): 50.8, 42.8, 51.9, 52.0, 51.5, 51.7, 52.5, 53.7

### Public Finances (selected fiscal indicators, 2015–22; percent of GDP unless noted)
- NFPS primary balance: -1.9, -2.5, -2.1, -1.8, -1.1, -0.4, 0.2, 0.8
- NFPS cyclically adjusted primary balance: -1.8, -1.4, -1.0, -1.1, -0.8, -0.3, 0.3, 0.8
- NFPS overall balance (including net policy lending): -10.3, -7.5, -8.8, -10.2, -9.8, -9.8, -9.7, -9.7
- Net public sector debt: 35.6, 46.2, 51.4, 55.9, 58.9, 61.0, 62.4, 63.3
- NFPS gross debt: 72.5, 78.3, 81.5, 85.8, 88.6, 90.5, 91.7, 92.4
- Central government primary balance (authorities’ series): 0.2, -2.0, -2.3, -2.0, -2.6, -2.5, -2.5, -2.6, -1.9 (note: series spanning tables)
- Federal government net nonfinancial revenue: 17.3, 17.3, 17.5, 17.1, 17.3, 17.5, 17.6, 17.6
- Total primary expenditure (federal government): 19.3, 19.6, 19.5, 18.9, 18.5, 18.0, 17.6, 17.2
- Nominal GDP (millions of reais): 6,000,572; 6,266,895; 6,753,154; 7,161,955; 7,649,005; 8,191,506; 8,773,507; 9,397,288
- NFPS net interest expenditure: 8.4, 6.6, 6.7, 8.4, 8.7, 9.4, 10.0, 10.5
- Spending ceiling (million Brazilian reais): 1,301,820; 1,352,814; 1,408,977; 1,468,561; 1,534,398; 1,603,273 (mem. items)

### Monetary and Financial Sector (selected)
- Base money (2011–16, end-of-period, R$ bn examples): 587.7 (2011), 508.0 (2012), 574.6 (2013), 548.5 (2014), 594.4 (2015), 642.5 (2016)
- Broad money (M2) (2011–16, R$ bn): 3,067.9; 3,555.8; 3,872.7; 4,396.7; 4,823.2; 5,420.6
- Credit to private sector (R$ bn): 1,895.7; 2,195.5; 2,530.7; 2,807.8; 2,909.0; 2,824.4
- Financial sector credit to the private sector (percent): 58.1, 62.5, 64.2, 66.0, 66.8, 62.2
- Capital adequacy, total banking system (Regulatory capital to risk-weighted assets): 16.3, 16.4, 16.1, 16.7, 16.4, 17.2
- Nonperforming loans to total gross loans (total banking system): 3.5, 3.4, 2.9, 2.9, 3.3, 3.9
- Return on assets (total banking system): 1.7, 1.4, 1.4, 1.3, 1.5, 1.1
- Liquidity assets to short-term liabilities (total banking system): 178.6, 191.8, 158.0, 202.2, 190.0, 236.3

### External Vulnerability and Debt Sustainability (selected, 2011–22)
- Total external debt (in percent of GDP): 29.0, 36.9, 36.9, 32.2, 31.7, 30.7, 29.7, 28.6, 27.5
- Total external debt (US$ bn): 516.0, 570.8, 621.4, 712.7, 665.1, 663.6, 672.7, 682.9, 693.1, 700.4, 705.9, 709.9 (table spans)
- Gross external financing need (US$ bn): 163.6, 167.2, 207.7, 214.3, 170.8, 168.4, 173.1, 175.6, 182.5, 188.7, 193.4
- Gross reserves (eop, US$ bn): 363.6, 356.5, 365.0, 365.0, 365.0, 365.0, 365.0, 365.0, 365.0
- Current account (US$ bn): -77.0, -74.2, -74.8, -104.2, -59.4, -23.5, -32.4
- Current account (percent of GDP): -2.9, -3.0, -3.0, -4.2, -3.3, -1.3, -1.5
- Exports of GNFS (12-month percent change, US$): 26.1, -3.9, -0.5, -5.6, -15.2, -2.7, 8.5
- Imports of GNFS (12-month percent change, US$): 24.0, 0.6, 7.1, -2.1, -23.7, -16.4, 9.7
- Terms of trade (12-month percent change): 7.8, -5.8, -2.0, -3.4, -11.0, 3.0, -2.4

### Key Chart Observations (textual summaries from figures)
- Activity expanded in 2017Q1 after 8 consecutive quarters of contraction; investment and consumption continued contracting while contribution from net exports waned.
- Inflation declined rapidly and is close to the mid point of the target band; medium-term inflation expectations are drifting upwards.
- Since October 2016 the policy rate has been lowered by 400 basis points.
- Gross debt increased to near 80 percent of GDP; primary deficit continued to widen and rely on exceptional revenue.
- Credit growth decelerated reflecting weak loan demand and conservative supply; downturn phase of credit cycle deepened in 2016.
- External current account improved in 2016 supported by a trade surplus reflecting weak domestic absorption; net capital inflows declined in 2016.

### Stress Tests and Scenarios (selected)
- External Debt DSA baseline and bound tests indicate vulnerability to interest-rate, growth, and current-account shocks; a one-time 30 percent real depreciation scenario is presented.
- Debt-stabilizing non-interest current account (long-run constant) shown as -2.4 (table: "debt-stabilizing non-interest current account 6/": -2.4).

*Sources: Central Bank of Brazil; Ministry of Finance; IPEA; Ministry of Planning and the Budget; and Fund staff estimates.*

### Appendix I. Risk Assessment Matrix

### Appendix I. Risk Assessment Matrix

### Major Risks and Expected Impacts
- Fiscal shock (Likelihood: H; Expected Impact on Economy: H)
  - Fiscal balances would continue to disappoint and fail to stabilize debt.
  - Further loss of confidence would lower investment and growth.
  - Market adverse reaction: currency depreciation, increased sovereign yields, and inflationary pressures would resume.
  - Corporates could be vulnerable to capital flow reversals, exchange rate depreciation and higher funding costs.
  - Strains would worsen if banking system soundness deteriorated owing to an increase in NPLs and funding costs and losses on government bonds' holdings.

- Political/uncertainty and prolonged policy uncertainty (Likelihood: H; Expected Impact on Economy: H)
  - Prolonged uncertainty would continue to hamper investment, confidence and growth.
  - A further rise in unemployment increases the threat of social unrest.
  - Higher funding costs and higher unrealized losses on fixed income securities cause larger bank losses and capital shortfalls, tightening of financial conditions and further decline in credit.

- Domestic financial stress / labor market weakness (Likelihood: L; Expected Impact on Economy: M)
  - Delayed pick up in employment leading to deterioration of households’ balance sheet and income, rising delinquencies on consumer loans, loan losses and contraction of credit.
  - Lower corporate profits may expose some highly leveraged corporates.
  - Increased financial vulnerabilities among banks with portfolios concentrated in households and corporate loans.
  - Potential knock-on effects on public finances.

- Capital flow reversal / global spillovers (Likelihood: H; Expected Impact on Economy: M)
  - Increasing Brazil’s risk premiums, pressures on the real and reversal of capital flows.
  - Increasing yields in domestic bond markets and higher funding costs for corporates and banks.
  - Corporates lacking FX hedging could be exposed.

- Commodity price shock / external demand weakening (Likelihood: L/M; Expected Impact on Economy: M)
  - Worsening current account deficit and weaker growth.
  - Highly indebted corporates could see profits decline.
  - A sharp decline in commodity prices would directly impact the exporting sector and investment.

### Policy Responses Recommended in the RAM
- Fiscal measures
  - Deploy alternative measures on the fiscal side to shore up credibility in the fiscal framework and to ensure debt stabilizes over time.
  - May need to tighten fiscal policy to further strengthen policy credibility and avoid sell-offs of Brazilian domestic bonds.

- Monetary and FX policy
  - May need to stop or even reverse monetary policy easing, depending on the change in inflation expectations.
  - Monetary policy should remain focused on keeping inflation expectations anchored.
  - Exchange rate intervention only under disorderly market conditions; provide FX liquidity and support individual banks if dollar shortages appear.
  - Use the exchange rate as first shock absorber for external shocks.

- Financial sector and macroprudential
  - Provide FX liquidity and support individual banks if dollar shortages appear.
  - Capital flow management measures (CFMs) on outflows may be appropriate on a temporary basis in crisis circumstances; CFMs should be part of a broad policy package and not substitute for policy adjustment.
  - Monitor for signs of emerging domestic financial and corporate vulnerabilities and strengthen safety nets.

- Structural and labor market reforms
  - Strengthen efforts to boost competitiveness and productivity.
  - Enact structural reforms to combat corruption and money laundering.
  - Step up active labor market policies and flexibilize contracts to facilitate employment.
  - Press on with structural reforms to boost growth.

- Crisis-specific guidance
  - Recourse to FX intervention only in disorderly market conditions.
  - If implemented, CFMs should be part of a broad policy package designed to address the fundamental causes of the crisis, and should not substitute for policy adjustment.
  - No room for fiscal policy stimulus to smooth external shocks; further monetary easing would be appropriate in such shocks.

*Italicized final line: Appendix I. Risk Assessment Matrix, as presented in the source document.*

### Appendix II. Brazil: External Sector Assessment 2016

### Overall Assessment and Background
- Overall Assessment
  - Brazil’s external position in 2016 was, on average, broadly consistent with medium-term fundamentals and desirable policies.
  - The appreciation of the REER during 2016 reflects both improved ToT and the positive market response to the new government’s reform agenda.
  - The current account deficit will likely gradually widen starting in 2017 as demand recovers after the end of a deep recession during 2015‒16.

- Foreign asset and liability position and trajectory
  - Brazil’s NIIP deteriorated to -39 percent of GDP at end-Q4 2016 reflecting in part valuation effects (on BRL denominated liabilities) related to the sharp appreciation of the BRL during 2016.
  - The NIIP hovered around -30 percent of GDP throughout 2011-15.
  - The NIIP is projected to gradually strengthen over the medium term to around -30 percent of GDP reflecting stable CA deficits (around 1−2 percent).
  - FDI accounts for about half of all liabilities.
  - Rise in external debt since the global financial crisis to about 37 percent of GDP and 300 percent of exports is a source of risk.
  - Short-term gross external financing needs are moderate at 8 percent of GDP annually over the medium-term.

### Current Account
- Background and recent evolution
  - The current account (CA) deficit narrowed further in 2016 owing in part to the continued drop in domestic demand, especially investment, and some improvement in ToT.
  - The CA deficit is down from 4.2 percent of GDP in 2014 to 1.3 percent in 2016 despite a stable cyclically-adjusted fiscal stance.
  - The CA deficit is expected to increase slightly in 2017, and gradually widen to about 2 percent of GDP in the medium term as demand recovers.
  - Declines in ToT and a sharp slowdown in trading partner growth remain a downside risk.

- Assessment
  - Staff assesses the CA norm consistent with fundamentals and desirable policies in 2016 to range from -0.5 to -2.5 percent of GDP.
  - With a cyclically-adjusted CA balance of -2.1 percent, the 2016 CA gap ranged between -1.5 and 0.5 percent of GDP.

### Real Exchange Rate (REER)
- Background and recent evolution
  - The REER (INS) on average appreciated by 7 percent during 2016, after weakening by 16 percent during 2015.
  - The annual average ULC-based REER also appreciated by some 5 percent during the first three quarters in 2016 relative to 2015.
  - As of May 2017, the REER has appreciated an additional 10 percent relative to the average for 2016, although the currency remains volatile due to lingering political uncertainties.

- Assessment
  - Staff’s assessment is that the real was on average broadly consistent with the level implied by fundamentals and desirable policy settings in 2016, with a REER gap in the [-5, 15] percent range.

### Capital and Financial Accounts: Flows and Policy Measures
- Background and assessment
  - Brazil continues to attract sizable capital flows, but their composition changed recently.
  - Equity liability flows remained strong while debt liabilities showed outflows.
  - Net DI fully financed the CA deficit (DI liabilities totaled 4 percent of GDP), partly supported by intercompany loans counted in DI liabilities.
  - Net portfolio debt liabilities, having exceeded 1 percent of GDP in previous years, turned to net outflows.
  - Interest differentials, still large despite recent monetary easing, should help to attract inflows.
  - The composition of flows has a favorable risk profile; outflows on the liability side may pose some concerns, tempered by a more stable outlook for credit risk.

### FX Intervention and Reserves Level
- Background and recent measures
  - Brazil has a floating exchange rate.
  - Since mid-2011, reserves have remained broadly stable.
  - The preannounced intervention program initiated in 2013 ended in March 2015.
  - Intervention in 2015 continued to rely on the use of FX swaps and repos, but was symmetric and generally more limited compared to previous years.
  - In 2016, as the currency strengthened, the BCB reduced the rollover rate of maturing FX swaps and started auctioning reverse FX swaps, significantly reducing its net forward position to 1.4 percent of GDP at end-2016 from over 5 percent of GDP at end-2015.
  - Brazil’s gross reserves remained broadly constant in 2016, at US$365 billion, some 20 percent of GDP and 260 percent of short term debt at remaining maturity.

- Assessment
  - The flexible exchange rate has been an important shock absorber.
  - Reserves are adequate relative to various criteria including the IMF’s composite reserve adequacy metric (about 166 percent).
  - While reserve holdings in principle provide some space to intervene, authorities should aim to retain strong buffers and a net creditor FX position, with intervention limited to alleviating disorderly market conditions.

### Technical Background Notes (selected numeric highlights)
- The real appreciated by about 20 percent vis-à-vis the U.S. dollar from end 2015 to end 2016.
- Import volumes fell by 8 percent in 2016 adding to a 14 percent decline in 2015.
- Export volumes rose by 4 percent in 2016, after increasing by 8 percent in 2015.
- China is Brazil’s most important export destination (19 percent).
- Estimates suggest a CA norm between -2.6 percent (EBA CA approach) and -1.2 percent (NIIP-stabilizing approach).
- Staff’s assessment of the CA norm ranges from -0.5 to -2.5 percent.
- Brazil’s net forward position was reduced to 1.4 percent of GDP at end-2016 from over 5 percent of GDP at end-2015.
- Brazil’s gross reserves in 2016: US$365 billion; reserves equivalent to some 20 percent of GDP and 260 percent of short term debt at remaining maturity.
- IMF composite reserve adequacy metric: about 166 percent.

*Italicized final line: Appendix II. Brazil: External Sector Assessment 2016, as presented in the source document.*

### Appendix III. Implementation of 2016 Article IV

### Appendix III. Implementation of 2016 Article IV

### Monetary and Financial Sector Policies
- Recommendation: Keep Selic on hold until expectations settle to the mid-point of the target band.
  - Rationale: Contribute to disinflation and BCB credibility.
  - Implementation/status: Inflation has declined rapidly and expectations have converged to the target. The central bank has cut its policy rate in the last five meetings by a cumulative 400 bps (to 10.25 percent) noting increasing evidence of disinflationary pressures and progress with fiscal reforms.
- Recommendation: Enhance the BCB autonomy and improve communication.
  - Rationale: Strengthen the IT framework.
  - Implementation/status: Improved communications and started publishing notes from meetings between Copom members and market participants to enhance transparency.
- Recommendation: Enhance stress testing techniques; Strengthen financial stability oversight.
  - Implementation/status: In progress.
- Recommendation: Strengthen procedures for use of the deposit insurance fund, enhance the central bank’s emergency liquidity assistance, and modernize the resolution regime; Bolster banking sector resilience.
  - Implementation/status: The new resolution law for the banking sector was sent to Congress.
- Recommendation: Give mandate for macro-prudential oversight to a committee comprising all financial regulators, the deposit Guarantee Fund, and the Ministry; Strengthen transparency and accountability and improve risk management.
  - Implementation/status: No progress.
- Recommendation: Given mandate to a separate entity to set up a coordination framework to support timely and effective decision-making in a crisis situation, and periodically test the capacity of the authorities to respond to crisis scenarios; Strengthen safety net.
  - Implementation/status: No progress.

### Fiscal Policy
- Recommendation: Review credit earmarking rules and other distortions.
  - Rationale: Ensure that national savings go to their most productive uses.
  - Implementation/status: Announced reform of TJLP, and re-orient the strategy of the BNDES.
- Recommendation: Strengthen private insolvency frameworks, with the aim of expediting the bankruptcy process and reducing default losses incurred by creditors.
  - Rationale: Minimize risks from private sector leverage.
  - Implementation/status: The new bankruptcy law for non-financial companies in under review.
- Recommendation: Frontload the fiscal adjustment as growth firms up.
  - Rationale: Faster fiscal consolidation.
  - Implementation/status: Too soon to evaluate.
- Recommendation: Reform social security.
  - Rationale: Ensure fiscal sustainability and fairness.
  - Implementation/status: Reform proposal in Congress.
- Recommendation: End revenue earmarking.
  - Rationale: Efficient use of resources and faster consolidation.
  - Implementation/status: Approved the revenue earmarking provision in October 2016 allowing the govt to use 30 percent of Federal revenues from taxes and contributions freely, up from 20 percent.
- Recommendation: Contain payroll growth.
  - Rationale: Ensure fiscal sustainability.
  - Implementation/status: No new measures but freeze on hiring implemented.
- Recommendation: Reform social security and control wage bill growth in states.
  - Rationale: Ensure subnational fiscal sustainability.
  - Implementation/status: Some states have increased social security contributions.
- Recommendation: Severe the automatic link between benefit payments and the minimum wage and/or limit minimum wage increases to cost of living adjustments.
  - Rationale: Ensure fiscal sustainability.
  - Implementation/status: No progress.
- Recommendation: Publish a full balance sheet for general government.
  - Rationale: Make fiscal statistics more comprehensive to improve analysis and formulation of fiscal policy.
  - Implementation/status: In progress. This is a medium-term reform.
- Recommendation: Adopt standard accounting practices for states and monitor and enforcement fiscal rules timely.
  - Rationale: Increase fiscal transparency in states.
  - Implementation/status: This is a medium-term reform. The team working on this was selected.

### External Sector Policy
- Recommendation: Use intervention for disorderly market conditions.
  - Rationale: Use exchange rate as a first buffer against shocks.
  - Implementation/status: Interventions were limited to episodes of market disorder.
- Recommendation: Preserve reserve buffers.
  - Rationale: Maintain resilience to external shocks.
  - Implementation/status: Reserve buffers were preserved.
- Recommendation: Continue gradually reducing the net notional value of FX swaps.
  - Rationale: Minimize fiscal costs of exchange rate policy.
  - Implementation/status: The stock of FX swaps was reduced to US$28 billion.

### Structural Policies and Other Reforms
- Recommendation: Simplify the federal PIS/COFINS and the State Tax on the Circulation of Goods and Services (ICMS).
  - Rationale: Tax efficiency and business burden.
  - Implementation/status: A tax reform proposal under discussion envisages changes to PIS.
- Recommendation: Reduce tariffs and nontariff-barriers, revise domestic content requirements, and pursue free-trade negotiations outside Mercosur.
  - Rationale: Open the economy, increase competition and efficiency.
  - Implementation/status: Reformed domestic content rules for the oil and gas sectors; trade facilitation underway.
- Recommendation: Pursue labor reforms.
  - Rationale: Facilitate productive employment and lower informality.
  - Implementation/status: Labor law submitted to congress but further reforms needed.
- Recommendation: Make data on public procurement open by default, implement the recent legislation on conflict of interest, and strengthen whistleblowing mechanisms; Eliminate regulations that provide opportunities for bribes; Improve access to and sharing of banking and fiscal information, and prevent the abuse of appeal provisions and statutes of limitations in legal proceedings; Strengthen provisional measures and confiscation; effectively pursue a larger number of significant corruption, money laundering and illicit enrichment cases; enhance the AML/CFT supervision of banks’ obligations regarding politically exposed persons.
  - Rationale: Strengthen the AML framework.
  - Implementation/status: The number of corruption and anti-money laundering cases has increased, work is underway to improve the definition of politically-exposed-persons, and the transparency portal is being populated with relevant information, including on public procurement. But, a number of anti-corruption measures are still pending approval in Parliament and measures to increase access to and sharing of banking and tax information by and with competent authorities have not yet materialized.

---

### Fund Relations (As of June 7, 2017)
- Membership Status: Joined January 14, 1946; Article VIII
- General Resources Account:
  - Quota: 11,042.00 SDR Million (100.00 percent)
  - Fund holdings of currency (Exchange Rate): 10,166.59 SDR Million (92.07 percent)
  - Reserve Tranche Position: 875.50 SDR Million (7.93 percent)
  - New Arrangement to Borrow: 756.63 SDR Million
- SDR Department:
  - Net cumulative allocation: 2,887.08 SDR Million (100.00 percent)
  - Holdings: 2,599.03 SDR Million (90.02 percent)
- Outstanding Purchases and Loans: None
- Financial Arrangements (selected historical):
  - Stand-by 09/06/2002–03/31/2005 Amount Approved 27,375.12 (SDR Million) Amount Drawn 17,199.64
    - Of which: SRF 09/06/2002–09/05/2003 Approved 7,609.69 Drawn 7,609.69
  - Stand-by 09/14/2001–09/05/2002 Amount Approved 12,144.40 Amount Drawn 11,385.37
    - Of which: SRF 09/14/2001–09/05/2002 Approved 9,950.87 Drawn 9,950.87
  - Stand-by 12/02/1998–09/14/2001 Amount Approved 13,024.80 Amount Drawn 9,470.75
    - Of which: SRF 12/02/1998–12/01/1999 Approved 9,117.36 Drawn 6,512.40
- Projected Payments to the Fund (SDR million; based on existing use of resources and present holdings of SDRs):
  - Principal (2017–2021): 0.00, 0.00, 0.00, 0.00, 0.00
  - Charges/interest (2017–2021): 0.79, 1.67, 1.67, 1.67, 1.67
  - Total (2017–2021): 0.79, 1.67, 1.67, 1.67, 1.67
- Safeguards Assessments: A safeguards assessment of the Banco Central do Brasil (BCB) was completed in June 2002 and updated in March 2005.
- Exchange Rate Arrangement: Since January 18, 1999, Brazil’s de facto and de jure foreign exchange regime has been classified as floating. Brazil accepted the obligations of Article VIII, Sections 2(a), 3, and 4, effective November 30, 1999.
- IOF on exchange transactions: The tax on financial transactions (IOF) of 6.38 percent on exchange transactions carried out by credit card, debit card, and traveler's checks gives rise to multiple currency practices. In January 2008, the IOF for these exchange transactions was raised to 2.38 percent and then further increased to 6.38 percent in March 2011. The scope of operations was expanded in December 2013.
- Last Article IV Consultation: The last Article IV consultation with Brazil was concluded by the Executive Board on October 31, 2016. Brazil is on the 12-month cycle.
- Technical Assistance: FAD supported the Ministry of Finance on medium term fiscal planning and transparency; March 2017 mission on “Public Financial Management Reforms to Support the Implementation of the Expenditure Rule”; Fiscal Transparency Evaluation published in May 2017; STA supported IBGE in February 2017.
- Resident Representative: The Resident Representative is Mr. Fabian Bornhorst, who assumed the post in April 2014.

### Relations with the World Bank
- New CPF 2018‒23 is under preparation and will be presented to the Board of Directors on the 4th quarter of FY 17.
- Systematic Country Diagnostics (SCD) identifies five main challenges:
  1. lack of fiscal space and a large transfer of resources to the non-poor (particularly pensions);
  2. weaknesses of public sector governance and institutional fragmentation;
  3. segmentation of financial markets, lack of long term credit and high interest rates;
  4. insufficient competition and poor business environment;
  5. weaknesses in the management of Brazil’s natural resources and insufficient resilience against climate risks.
- IBRD lending program:
  - FY 15: US$550 million
  - FY 16: US$758 million
  - FY 17 revised expected lending: US$73.5 million
  - Federal Government commitment: US$3.0 billion IBRD lending envelope for FY 18‒19 (as indicated in high-level dialogue)
- IFC:
  - Investment portfolio: US$4.07 billion, including US$1.46 billion from syndications.
  - FY 17 commitments to date: US$584 million, of which US$329 million is in mobilization.
- MIGA: First exposure transaction processed in FY 15 since FY 09. Example: São Paulo Sustainable Transport Project NHSFO guarantee approved April 2014 and by the Brazilian Senate on September 2, 2014.
- Brazil to gain about $100 million in additional IBRD lending headroom through an exchange of existing IBRD exposure to Brazil for MIGA exposure to Panama.

### Brazil: World Bank – IMF Country Level Work Program under JMAP (expected approval/delivery dates listed)
- Investment Project Financing:
  - Fortaleza Sustainable Urban Development Project 4/28/2017
- Advisory Services and Analytics (selected entries and dates):
  - Mobility in Cities Study 12/9/2016
  - Dissemination CE Teachers Feedback IE 1/31/2017
  - Rio de Janeiro Education Studies 3/15/2017
  - Infrastructure Regulatory Frameworks 3/31/2017
  - Analysis of INDC Land Use Targets 3/31/2017
  - Energy Efficiency Recommendations for CESAN 4/28/2017
  - Governance and Modernization in Paraiba 4/30/2017
  - Knowledge Products on Social Assistance 5/8/2017
  - Conferences, Workshops and Other Events 5/10/2017
  - Brazil WWP Learning Initiative (SoD Hub) 5/25/2017
  - Infrastructure Efficiency for Growth 5/26/2017
  - Brazil Financial Sector Credit Allocation 5/30/2017
  - Brazil Subnational Governance Monitoring 5/31/2017
  - Expenditure Review of Education 5/31/2017
  - Exploring Forest Bonds 5/31/2017
  - Typology of Cities 5/31/2017
  - Post-COP21 Environmental Research Agenda 5/31/2017
  - Agriculture Drought Preparedness ENSO 6/12/2017
  - Violence Prevention in Brazil 6/14/2017
  - Assessment of the Bank's Engagement 6/14/2017
  - Brazil Governance in Infrastructure 6/15/2017
  - Brazil Expenditure Review 6/30/2017
  - Participat. Governance Citizen Security 6/30/2017
  - Review of Costs of Violence 6/30/2017
  - Municipal Diagnostics of C&V 6/30/2017
  - Briefs to Inform City Strategies 6/30/2017

*Prepared by the Western Hemisphere Department (In consultation with other departments).*

### 27. Capacity Building Based on Interventions6/30/2017

### 27. Capacity Building Based on Interventions6/30/2017

### Relations with the Inter-American Development Bank (IDB)
- The current IDB Group Country Strategy with Brazil was approved on March 30, 2016.  
- Strategy period: 2016‒18; three main intervention areas:
  - (1) increasing productivity and competitiveness;
  - (2) reducing inequity and improving public services;
  - (3) strengthening institutions at the three levels of government.
- Crosscutting issues: gender, diversity, integration, and climate change.
- Loan portfolio approved within the Country Strategy 2012‒14: eighty-four operations equivalent to US$8.35 billion.
  - Sixty-eight sovereign guarantee (SG) operations: US$7.4 billion.
  - Sixteen non-sovereign guarantee (NSG) operations: US$950.7 million.
  - Sixty-two of the SG operations were with Brazilian states, state-owned enterprises, and municipal governments.
  - Regional focus: 45 percent of SG operations corresponded to projects in the North and Northeast regions.
- Technical cooperation: forty-five technical-cooperation operations approved for US$40.9 million during the strategy period, focusing on social and productive inclusion, environmental and rural management, and climate change.
- 2015 approvals:
  - Seven loans amounting to US$382.5 million.
  - One SG operation for US$56 million and eight NSG operations for US$377.7 million.
  - Technical cooperation grants: US$11.7 million.
- 2016 approvals:
  - Thirty-five loans amounting to US$1,369 million.
  - Seven SG operations for US$1,197 million.
  - Twenty-eight NSG operations for US$172 million.
  - Most SG resources directed towards sustainable energy projects as part of a larger credit line focused on fostering productivity in the medium and long term.
  - Technical cooperation grants: US$10.5 million.
- Projected approvals for 2017:
  - Total: US$2,184 million.
  - SG operations: US$1,194.3 million.
  - NSG operations: US$989.7 million.
  - Estimated technical cooperation grants: US$85 million.
- Brazil is one of the largest IDB Group borrowers.
  - Current active portfolio: 100 loans to the public sector (US$11,738 million) and 21 to the private sector (US$738.2 million).
  - As of March 2017, Brazil’s outstanding public debt with the IDB: US$13,789 million, with US$6,974.7 million yet to be disbursed.

### Brazil: Loans Approved by the Inter-American Development Bank in 2016 (key figures)
- Table summary (In millions of US$):
  - Increase productivity and competitiveness: Subnational Gov. 257 | Central Gov. 501 | Private Sector 729 | Total 1,487
  - Reduce inequity and improve public services: Subnational Gov. 369 | Central Gov. 0 | Private Sector 0 | Total 369
  - Strengthen institutions at the three levels of government: Subnational Gov. 53 | Central Gov. 0 | Private Sector 53 | Total 53
  - Total value of loans: 447 | 750 | 172 | 1,369
  - Total number of loans: 61 | 28 | 35

### Statistical Issues (As of June 7, 2017) — Assessment of Data Adequacy for Surveillance
- General: The quality of macroeconomic statistics has improved significantly, and data provision is adequate for surveillance.
- National Accounts:
  - Since 2015, national accounts estimates follow the guidelines of the 2008 System of National Accounts.
  - Availability of annual and quarterly supply and use tables contributes to consistent national accounts estimates.
  - Series (data and supporting methodological notes) are available on the internet (http://www.ibge.gov.br) and in International Financial Statistics (IFS).
  - Brazil is participating in the G-20 Data Gaps Initiative regarding recommendation 15 (balance sheet approach, flow of funds, and sectoral data on a quarterly and annual basis).
- Price Statistics:
  - Since July 1999, the price index reference for monetary policy: Broad Consumer Price Index (IPCA) compiled by IBGE.
  - IPCA coverage: households earning between one and forty times the minimum wage in 11 metropolitan areas and two municipalities.
  - FGV and IBGE compile producer price indices, IPA and IPP respectively, since 2010.
- Government Finance Statistics:
  - Ministry of Finance and the Brazilian Central Bank (BCB) compile and disseminate government finance statistics using GFSM 2001 presentation.
  - Reported statistics include statement of government operations and financial balance sheet for the consolidated central government and financing operations and financial balance sheet for the general government.
  - Reported data are compiled by converting nationally published data, which still broadly follow the GFSM 1986 framework.
  - Data reflect movements of the single treasury account and are on a cash basis except for interest.
  - Gross debt indicator excludes government securities under the central bank’s outright ownership, making international comparisons difficult.
  - In 2009, authorities developed a migration plan for full implementation of GFSM 2001, including introduction of IPSAS-based accounting framework.
- Monetary and Financial Statistics:
  - BCB compiles and publishes monetary and financial statistics broadly in line with MFSM 2000.
  - Standardized report forms based on accounting data introduced in March 2013.
  - Institutional coverage of other financial corporations needs expansion to include insurance corporations, open pension funds, capitalization funds, and exchange houses.
  - BCB regularly reports quarterly FSIs to the IMF; currently reports all core and 18 encouraged FSIs with data beginning in Q1 2005; plans underway to compile the rest.
- External Sector Statistics:
  - Brazil disseminates monthly balance of payments and quarterly international investment position data on a BPM6 basis.
  - BCB supplementing foreign exchange registry with surveys on transportation, insurance, and other services.
  - BCB collects position data on foreign assets held by Brazilian residents and direct investment liabilities of Brazil.
  - BCB monthly disseminates data on International Reserves and Foreign Currency Liquidity.
  - Brazil participates in CDIS and CPIS, and reports quarterly external debt data to World Bank’s QEDS database.
- Data Standards and Quality:
  - Subscriber to the Fund’s SDDS since 2001; uses SDDS flexibility options on timeliness of general government operations and depository corporations survey.
  - Implementing G-20 DGI recommendations; further progress would focus on monetary and financial statistics, external position and flow statistics, real estate price indexes, general government statistics, and sectoral accounts.
  - No data ROSC is publicly available.

### Table of Common Indicators Required for Surveillance (As of June 7, 2017) — Selected observation and receipt dates, frequency
- Exchange Rates: Date of Latest Observation 5/07/17 | Date Received 6/07/17 | Frequency of Data D | Frequency of Reporting D | Frequency of Publication D
- International Reserve Assets and Reserve Liabilities: Date of Latest Observation 5/07/17 | Date Received 6/07/17 | Frequency of Data D | Frequency of Reporting D | Frequency of Publication D
- Reserve/Base Money: Apr. 17 | Date Received 5/31/17 | Frequency M | Frequency of Reporting M | Frequency of Publication M
- Broad Money: Apr. 17 | Date Received 5/31/17 | Frequency M | Frequency of Reporting M | Frequency of Publication M
- Central Bank Balance Sheet: Apr. 17 | Date Received 5/31/17 | Frequency M | Frequency of Reporting M | Frequency of Publication M
- Consolidated Balance Sheet of the Banking System: Q4 2016 | Date Received 3/31/17 | Frequency Q | Frequency of Reporting Q | Frequency of Publication Q
- Interest Rates: 6/07/17 | Date Received 6/07/17 | Frequency D | Frequency of Reporting D | Frequency of Publication D
- Consumer Price Index: Apr. 17 | Date Received 5/10/17 | Frequency M | Frequency of Reporting M | Frequency of Publication M
- Revenue, Expenditure, Balance and Composition of Financing – General Government: Apr. 17 | Date Received 5/30/17 | Frequency M | Frequency of Reporting M | Frequency of Publication M
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Apr. 17 | Date Received 5/30/17 | Frequency M | Frequency of Reporting M | Frequency of Publication M
- Stocks of Central Government and Central Government-Guaranteed Debt: Apr. 17 | Date Received 5/30/17 | Frequency M | Frequency of Reporting M | Frequency of Publication M
- External Current Account Balance: Apr. 17 | Date Received 5/22/17 | Frequency M | Frequency of Reporting M | Frequency of Publication M
- Exports and Imports of Goods and Services: Apr. 17 | Date Received 5/22/17 | Frequency M | Frequency of Reporting M | Frequency of Publication M
- GDP/GNP: Q1 2017 | Date Received 6/1/17 | Frequency Q | Frequency of Reporting Q | Frequency of Publication Q
- Gross External Debt: Apr. 17 | Date Received 5/22/17 | Frequency M | Frequency of Reporting M | Frequency of Publication M
- International Investment Position: Q4 2016 | Date Received 5/22/17 | Frequency Q | Frequency of Reporting Q | Frequency of Publication Q

### Debt Sustainability Analysis — Key findings (Staff Report for the 2017 Article IV Consultation)
- Debt sustainability risks remain large.
- Gross debt of the nonfinancial public sector (NFPS) increased by 5.8 percentage points of GDP in 2016, reaching 78.3 percent of GDP.
- Net debt of the public sector rose by 11 percentage points of GDP.
- Debt maturity profile and composition changed at the margin since the last DSA; foreign holdings of government securities have declined.
- If fully implemented, fiscal consolidation based on the government’s legislated and proposed reforms would restore the sustainability of debt in the baseline scenario.
- However, debt ratios would stabilize after the end of the 5-year projection period, with gross debt reaching 92.4 percent of GDP in 2022.
- Primary surpluses of about 1½ percent of GDP (excluding interest revenue) would be needed to keep gross debt from growing as a ratio to GDP beyond the projection horizon.
- The trajectory of gross debt is highly sensitive to fiscal performance, due to modest GDP growth and high borrowing costs.
- A delay in implementing fiscal reforms would jeopardize debt sustainability.

### Background and definitions (selected)
- Definitions and coverage:
  - Brazil’s gross debt statistics cover the NFPS, defined to exclude Petrobras and Eletrobras, and consolidate the Sovereign Wealth Fund.
  - In line with GFSM 2014, NFPS debt includes all Treasury securities on the Central Bank's (BCB) balance sheet, including those not used under repurchase agreements.
  - At end-2016, gross debt amounted to 78.3 percent of GDP.
  - As reported by the government, net debt statistics correspond to the public sector, defined to include the BCB.
  - The consolidated public sector assets: 35.1 percent of GDP in 2016, which include 19.2 percent of GDP in international reserves.
  - Non-financial public sector assets: 29.6 percent of GDP.
  - Brazil’s debt is reported at nominal value.

### Debt profile and recent developments
- Debt profile:
  - Federal government (FG) domestic tradable securities account for 91 percent of total NFPS gross debt.
  - Less than 2/3 of FG domestic tradable securities are held by the public; the rest is held by the BCB.
  - Nearly 17 percent of domestic tradable securities will mature in 2017.
  - Zero-coupon bonds with original maturities over one year constitute slightly more than half of FG domestic tradable securities held by the public.
  - Foreign currency denominated tradable securities accounted for 5 percent of the total in 2016, representing 4 percent of GDP.
  - Gross financing needs have tended to be high, above 15 percent of GDP; about 33 percent of federal government debt is held by the BCB, which follows a policy of automatic rollover of its holdings of government securities.
- Developments:
  - At end-2016, NFPS gross debt: 78.3 percent of GDP (5.8 percentage points higher than a year before).
  - Public sector net debt: 46.2 percent of GDP.
  - Large primary deficit of 2.5 percent of GDP and net interest payments of 6.5 percent of GDP contributed to much of the increase in gross debt.
  - Net interest payments were lower than in 2015 (8.4 percent of GDP), when the BCB recorded large losses on FX swaps.
  - In December 2016, BNDES repaid R$100 billion in outstanding government securities to the Treasury, resulting in a decline in NFPS assets of 1.6 percent of GDP and a corresponding fall in NFPS gross debt of the same amount.
  - The Treasury reconstituted the BCB’s stock of securities used for monetary policy by issuing bonds amounting to 2.7 percent of GDP.
  - At end-2016, the BCB held 24.3 percent of GDP of FG securities, of which 16.7 percent of GDP were in use as collateral in OMOs.
  - Contingent liability risk from Petrobras reduced as the company made progress on asset sales and improved management practices; EBITDA margin is at its highest level in several years because of the pricing policy targeting a premium over import parity.
  - Debt maturing in 2017 and 2018 remains high at over US$20 billion, but the debt amortization schedule has improved.

### Box 1 — Changes in the Profile of FG Securities (selected)
- Debt profile and yields:
  - Yield curve on government bonds shifted downward, remained below 2015 values during 2016, and was below the Selic for most of the year.
  - Decline in the marginal cost of borrowing reduced implicit interest on total debt, which fell from nearly 14 percent at end-2015 to below 13 percent at end-2016.
  - Non-residents’ holdings of domestic federal government securities shrank in nominal terms by R$70 billion over the year, falling to 14 percent of total debt held by the public.
  - Institutional investors’ (investment and pension funds) share of holdings increased to fill the gap.
  - The average maturity of new placements remained at its 2015 level, somewhat lower than in previous years.
  - The share of SELIC-linked debt in the total increased, with a decline in inflation-linked and fixed-rate securities.
- Note: Interest charged on new issuances declined further in early 2017 and is currently about 600 bps below the end-2015 level.

### Baseline scenario (projections and assumptions)
- Macroeconomic assumptions:
  - Real GDP growth: 0.3 percent in 2017, and a gradual return to potential growth of 2 percent by 2019.
  - Fiscal adjustment brings the primary balance to 0.8 percent of GDP by 2022, implying an improvement of about 3 percentage points of GDP during 2017−22.
  - Nominal interest rates on new borrowing: around 10−10½ percent over 2017−22, bringing the effective interest rate to about 10 percent on average.
  - Baseline assumes limited structural reforms and a modest world output recovery.
- Debt trajectory:
  - Gross debt remains on an upward path, reaching 92.4 percent of GDP in 2022 under the baseline scenario.
  - Primary surpluses of about 1½ percent of GDP (excluding interest revenue) would be needed to prevent gross debt from growing as a ratio to GDP beyond the projection horizon.

*Prepared by the staff of the International Monetary Fund; June 20, 2017.*

### 92.4 percent of GDP by 2022. Under the assumption that the primary balance path remains consistent with

### 92.4 percent of GDP by 2022. Under the assumption that the primary balance path remains consistent with

### Baseline debt dynamics and fiscal position
- Gross nominal public debt projects to reach 92.4 percent of GDP by 2022.
- Under an unchanged expenditure cap until 2027 (when a revision first becomes possible), debt:
  - peaks in 2023 and starts falling in 2024.
  - is sensitive to assumptions on the real interest rate and the rate of potential growth in the medium term.
- The primary balance required to stabilize debt in the baseline scenario is 1.4 percent of GDP (excluding interest revenue).
- Up to 2022, the primary balance is a non-interest balance, with interest income showing in the residual. From 2023 onwards interest income counts toward the required primary balance.
- Key baseline projections (selected):
  - Nominal gross public debt: 62.3 (2014), 62.3 (2015), 72.5 (2016), 78.3 (2017), 81.5 (2018), 85.8 (2019), 88.6 (2020), 90.5 (2021), 91.7 (2022), 92.4 (2022) — values as reported in the table.
  - Public gross financing needs: 14.9 (2014), 15.9 (2015), 19.0 (2016), 20.6 (2017), 14.3 (2018), 17.2 (2019), 18.0 (2020), 20.7 (2021), 25.3 (2022), 25.1 (2022) — values as reported.
  - Real GDP growth (in percent): 2.8 (2014), 0.5 (2015), -3.8 (2016), -3.6 (2017), 0.3 (2018), 1.3 (2019), 2.0 (2020), 2.0 (2021), 2.0 (2022).
  - Inflation (GDP deflator, in percent): 7.9 (2014), 7.9 (2015), 8.0 (2016), 8.3 (2017), 7.4 (2018), 4.7 (2019), 4.7 (2020), 5.0 (2021), 5.0 (2022).
  - Effective interest rate (in percent): 11.3 (2014), 11.0 (2015), 13.7 (2016), 12.6 (2017), 10.8 (2018), 10.5 (2019), 10.1 (2020), 9.8 (2021), 9.7 (2022).
- Cumulative identified debt-creating flows over the projection horizon reported as 19.7 percent of GDP.

### Debt vulnerabilities and gross financing needs (heat map)
- Gross financing needs remain above the high-risk threshold of 15 percent of GDP on average.
- Two reasons the gross financing needs indicator overstates fresh market financing:
  - Continuous rollover policy maintained by the BCB, which holds a significant amount of FG bonds; excluding rollover of BCB held bonds, gross financing needs would amount to about 13 percent of GDP on average over the medium-term.
  - Interest on existing FG securities is reported on an accrued basis in the authorities’ overall fiscal balance; this overstates the actual impact of government borrowing on markets by between 1 and 3 percent of GDP in the next few years relative to a cash-basis interest measure.
- Market/perception indicators reported include an EMBIG (bp) of 284 and 5Y CDS (bp) of 217 as of the table.

### Realism of projections and forecast errors
- No evidence of systematic projection bias in the baseline assumptions that would undermine the assessment of sustainability.
- Brazil’s projected fiscal adjustment equals an improvement of about 1½ percentage points in the cyclically-adjusted primary balance/GDP over the medium term, with a 3-year adjustment in cyclically-adjusted primary balance at the 46 percentile among all surveillance countries.
- Recent forecast errors for GDP growth are larger than those of other surveillance countries, reflecting Brazil’s largest recession in a century starting in late 2014.
- Fiscal multipliers and persistence were estimated at 0.3‒0.5 percent in the 2015 Article IV Selected Issues Paper.

### Shocks and stress-test scenarios (selected outcomes and assumptions)
- Growth shock (1 standard deviation = 3.8 percent):
  - Over 2018–19, real GDP contracts by a cumulative 4 percent while inflation declines by 230 bps in each year.
  - Primary balance worsens before recovering in 2020; interest rates increase by 55 bps for each percentage point decline in output growth.
  - Gross debt increases to 112 percent of GDP by 2022 while gross financing needs peak at 31 percent of GDP.
- Primary balance shock:
  - Consolidation is delayed by one year.
  - Pushes debt-to-GDP up by 3 percentage points above the baseline in 2022.
- Real interest rate shock:
  - Borrowing costs increase by 200 bps in the first projection year and remain the same over the medium term.
  - Pushes debt-to-GDP up by 4 percentage points above the baseline in 2022.
- Combined macro-fiscal shock and contingent liabilities shock:
  - Combined shock includes growth shock, interest rate shock, primary balance shock, and real exchange rate shock consistent with the maximum movement over the past 10 years.
  - Contingent liability shock simulates a loss of 10 percent of banking system assets, resulting in a primary deficit of 7 percent of GDP in 2018 and a 1 standard deviation shock to GDP growth in 2018 and 2019.
  - Debt-to-GDP reaches about 112−17 percent by 2022 in the most acute of these shock scenarios.
- No consolidation scenario (custom-made):
  - Government abandons the expenditure cap after 2019; currency depreciates by 5 percent in 2017, 2018, and 2019 and remains at this level.
  - Spreads on domestic securities pick up by 300 bps by 2019 and remain elevated.
  - Growth recovery delayed and considerably weaker.
  - Debt reaches 119 percent of GDP by 2022 and continues growing thereafter.

### Alternative scenarios and composition of public debt (high-level)
- Alternative scenario examples reported:
  - Historical Scenario: higher primary balances and slightly different growth path.
  - Constant Primary Balance Scenario: primary balance held at -2.1 percent of GDP throughout projections.
- Composition trends shown (figures reported):
  - By original maturity: increasing share of medium and long-term vs short-term over projection period.
  - By currency: predominately local currency-denominated with a foreign currency-denominated share shown in historical series.

### Additional developments reported in staff statement (June/July 2017)
- National Monetary Council set the 2019 inflation target at 4.25 percent, and that for 2020 at 4.0 percent, with a tolerance range of 1.5 percentage points on each side of the target.
- Central bank survey inflation expectations: 4.25 percent for both 2019 and 2020 as of June 23, 2017.
- High-frequency indicators:
  - June mid-month annual inflation declined from 3.8 (May) to 3.5 percent (June).
  - Agricultural strength contributed to 34 thousand new jobs in May; market expectation had been 15.5 thousand.
- Current account remained in surplus in May; financial account showed net outflows reflecting weaker FDI inflows and net fixed income portfolio outflows.

*Source: IMF staff report and statements (as contained in the provided content).*

### 3.      With inflation expectations well-anchored and an ample output gap, the

### 3.      With inflation expectations well-anchored and an ample output gap, the

### Recent macro developments and monetary policy
- Inflation dropped from 10.7 percent in January 2016 to 3.6 percent last May.
- The Central Bank has lowered its policy rate by 400 basis points since October 2016.
- Market participants project further monetary easing over the remainder of the year given falling inflation and expectations slightly below the target for next year.
- Monetary policy is expected to provide the economy with an important cyclical impulse over this year and the next, contributing meaningfully to the recovery.
- Various indicators strongly suggest that the economy has reached the trough of the cycle and that stabilization of activity will give way to a measured recovery.

### Fiscal stance and public debt dynamics
- Fiscal revenues have fallen significantly more than in previous recessions.
- Budget rigidities reduce the scope for cutting public spending in the near term.
- The Ministry of Finance’s primary fiscal target for 2017 was set at approximately -2.1 percent of GDP.
- The primary balance is expected to shift into positive territory in 2020.
- The authorities recognize that long-term sustainability of public debt requires structural reforms to contain expenditures and foster GDP growth.
- The social security deficit is projected at about 4 percent of GDP in 2017 and weighs on the public sector primary deficit.
- The pension reform sent to Congress was modified but preserved about 75 percent of the originally proposed savings.
- The approval of social security reform requires a 60 percent qualified majority in each house of Congress.
- The fiscal situation in a few states is challenging; Congress approved a bill in May that allows the suspension of debt payments to the federal government (for a period of 3 years) conditional on approval of fiscal consolidation laws.
- Rio de Janeiro state has preliminarily agreed with the Ministry of Finance on the terms of a fiscal adjustment program under the new Law; Rio Grande do Sul is negotiating a similar program.

### Structural and microeconomic reforms
- Continuity of the ongoing reform agenda is fundamental to supporting the gradual recovery.
- The spending cap, now embedded in the Constitution, establishes a strict ceiling with corrective mechanisms and has elevated debate on public expenditure composition.
- Needed actions to meet the ceiling include social security reform and tackling budget rigidity.
- A broad microeconomic reform agenda is being pursued to improve the business climate, facilitate job creation and raise productivity growth.
- The labor market reform is in its final congressional stages and is expected to be approved by Congress in the near future.
- A new model for concessions, reduced local content requirements and enhanced autonomy of regulatory agencies have improved the attractiveness of privatization programs, yielding positive results in oil and gas, airport and energy sectors.
- The subsidized funding rate for the national development bank (BNDES) is being gradually replaced by a new market-based rate to rein in fiscal expenditures and enhance monetary policy transmission.
- The Central Bank is implementing a program to streamline procedures and regulation, increase transparency, reduce costs of compliance and improve competitiveness.
- Additional reforms underway include new customs processes, simplified procedures to start a business, standardization of municipal tax payments, strengthened governance in state-owned companies, reductions in the time needed to pay taxes and comply with legal requirements, and improvements in the bankruptcy law.

### Risks to the outlook
- The main risk to the baseline scenario is uncertainty regarding the speed and approval of the reform agenda, in particular the pension reform, due to deterioration of the political climate.
- Developments in the ongoing overarching corruption probe may be a source of short-term political instability, although economic authorities and the reform agenda continue to enjoy support in Congress.
- External risks include:
  - A faster pace of monetary policy normalization in the US,
  - A rise of trade protectionism in advanced economies,
  - An abrupt deceleration in China.
- While these external outcomes would negatively affect Brazil as in most EMEs, Brazil has strong balance of payments numbers, proven buffers and tested instruments to mitigate the effects.

### External and financial sector resilience
- Brazilian external and financial sectors have been exposed to real-life stress tests and have performed well.
- Resilience sources identified:
  - Flexible exchange rate regime,
  - High level of international reserves,
  - Strong financial regulatory framework and supervision.
- These pillars have ensured stability of the financial sector and the balance of payments despite recent large shocks.

*https://www.imf.org/-/media/files/publications/cr/2017/cr17215.pdf*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17215.pdf_