## cr18253

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### Fiscal developments and public debt
- Primary fiscal deficit declined to 1.7 percent of GDP in 2017, below the authorities’ target, reflecting under-execution of discretionary expenditures.
- Cyclically adjusted stance was contractionary and net interest payments declined owing to lower policy rates and bond spreads.
- Public debt and projections:
  - Public debt: 84 percent of GDP in 2017.
  - Even if federal expenditure remains constant in real terms at its 2016 level, public debt is expected to rise further and peak in 2023 at above 90 percent of GDP.
- Key fiscal projections and indicators (selected):
  - Central government primary balance: -2.6 (2016), -1.8 (2017), -2.3 (2018), -1.8 (2019), -1.3 (2020), -0.6 (2021), 0.0 (2022), 0.5 (2023)
  - NFPS primary balance: -2.5 (2016), -1.7 (2017), -2.4 (2018), -1.8 (2019), -1.1 (2020), -0.4 (2021), 0.2 (2022), 0.7 (2023)
  - NFPS overall balance (including net policy lending): -9.0 (2016), -7.9 (2017), -8.5 (2018), -7.8 (2019), -7.5 (2020), -7.1 (2021), -6.8 (2022), -6.5 (2023)
  - Net public sector debt: 46.2 (2016), 51.6 (2017), 56.2 (2018), 59.9 (2019), 62.9 (2020), 65.7 (2021), 67.7 (2022), 68.9 (2023)
  - NFPS gross debt: 78.4 (2016), 84.0 (2017), 88.2 (2018), 90.4 (2019), 92.4 (2020), 94.2 (2021), 95.1 (2022), 95.6 (2023)

### Inflation and monetary policy
- Inflation dynamics:
  - Inflation decreased from 6.3 to 2.9 percent during 2017, just below the target range, owing largely to slack in the economy and a notable fall in food prices due to an exceptional harvest.
  - Inflation projected to increase towards the 4.25 midpoint of the inflation target in 2019 as the food price shock dissipates and the output gap narrows.
- Policy rate and stance:
  - Since September 2016 easing cycle, Central Bank lowered policy rate by 775 bps to 6.5 percent (record low).
  - Ex-ante real rate: 2.3 percent, below estimated natural rate range of 4−6 percent.
  - Directors and staff view stance as appropriate; recommendation: remain accommodative while vigilant to domestic and external inflationary pressures.
- Policy guidance:
  - Monetary policy should remain accommodative to offset contractionary effects of fiscal consolidation, provided inflation expectations remain anchored.
  - Preserve floating exchange rate and large reserve buffers; limit foreign exchange intervention to disorderly conditions.
  - Monetary policy should respond to exchange rate movements only insofar as there are risks for inflation expectations; underscore importance of central bank independence.

### External sector and balance of payments
- Current account:
  - Current account deficit shrank from 4.2 percent of GDP in 2014 to 0.5 in 2017 as imports contracted with collapse of private investment.
  - As recovery strengthens, rebound in investment will offset fiscal consolidation and lead to deterioration of the current account to about -2 percent of GDP over the medium term.
- External indicators and finances:
  - Net foreign liabilities: slightly less than 35 percent of GDP.
  - Foreign reserves: US$374 billion (noted elsewhere US$382 billion in another excerpt).
  - External rollover needs (private and public debt): about 8 percent of GDP per year.
  - FDI (net, billions of U.S. dollars): 65.4 (2016), 64.1 (2017), 60.0 (2018), 55.1 (2019), 50.7 (2020), 48.8 (2021), 48.1 (2022), 48.7 (2023)
  - Current account (billions of U.S. dollars): -23.5 (2016), -9.8 (2017), -24.4 (2018), -30.5 (2019), -35.1 (2020), -39.3 (2021), -43.8 (2022), -46.9 (2023)
  - Current account (percent of GDP): -1.3 (2016), -0.5 (2017), -1.2 (2018), -1.4 (2019), -1.5 (2020), -1.6 (2021), -1.7 (2022), -1.8 (2023)
- Assessment: On average in 2017, external position broadly consistent with medium-term fundamentals and desirable policies.

### Banking sector and financial resilience
- Banking system performance:
  - Banks broadly resilient; despite large losses during 2015−16 recession, FSAP found banks well capitalized, profitable, and liquid, reflecting high interest margins and fees.
  - Loan losses declined with recovery, boosting profits; capital ratios above regulatory minima.
- FSAP findings and recommendations:
  - Systemic risk analysis suggests bank solvency and liquidity broadly resilient to further severe macro-financial shocks.
  - Stress tests: four banks (public and private) would fail solvency stress test with a small capital shortfall.
  - Recommendations include strengthening microprudential, macroprudential, and safety net frameworks; upgrade supervision of related party exposures, large exposures, country and transfer risk, and restructured loans; introduce a new resolution regime; tighten ELA processes; bring deposit guarantee fund into public sector; create multi-agency committees for macroprudential policy and crisis management.
- Financial intermediation inefficiencies:
  - Net interest margins among highest in peer EMs; top five banks account for 82 percent of credit.
  - Intermediation costs driven by operating costs and credit losses; earmarked credit and state intervention contribute to inefficiencies.
  - Policy actions proposed: improve collateral enforcement and judicial system, enact corporate bankruptcy and electronic collateral laws, positive credit registry, new Fintech regulation, leverage BCB-CADE cooperation, improve transparency of financial products, phase out BNDES subsidized interest rate (TLP reform), and limit state intervention in credit markets.

### Growth, labor market, and social outcomes
- Growth and potential:
  - After cumulative real GDP contraction of 8.2 percent in 2015−16, growth resumed in 2017 with GDP growing at 1 percent.
  - Outlook: GDP projected to grow at 1.8 percent in 2018 and 2.5 percent in 2019.
  - Projections assume 2015−16 recession had a permanent effect on potential GDP, involving a 9 percent drop relative to long-run trend.
  - Output gap estimated at about -3.5 percent and projected to close in 2022.
- Labor market and social indicators:
  - Unemployment rose from 7 to 13 percent during the recession; unemployment rate (latest, Apr 2018): 13.1
  - Poverty rate (2017): 25.4 percent
  - GDP (dollars, 2017): US$2,055 billion
  - GDP per capita (est., 2017): US$9,896
  - Informality: most employment growth since 2017 has been in informal sector; informality rose from 45 percent to 60 percent of total employment between 2004 and 2014 (noting historical decline from 60 to 45 percent during 2004–2014).
- Labor market reform: labor market reform effective November 2017 reduced litigation and increased contractual flexibility; effects on employment weak so far.

### Risks and outlook
- Major risks:
  - Failure to pursue fiscal consolidation could undermine debt sustainability, raise government bond yields, and cause sharp exchange rate depreciation.
  - Tightening global financial conditions and possible trade disruptions.
  - Domestic political uncertainty, including election outcomes and potential policy reversals.
- Debt dynamics and scenarios:
  - Baseline: NFPS gross debt projected to peak at 95.6 percent of GDP in 2023 under limited structural reforms.
  - Downside (no consolidation): public debt could increase to almost 120 percent of GDP by 2023.
  - Stress test scenarios (selected outcomes):
    - Primary balance shock (expenditure cap abandoned): gross debt-to-GDP 104.2 percent in 2023; gross financing needs 31.7 percent of GDP.
    - Growth shock: gross debt-to-GDP 102.4 percent in 2023; gross financing needs 29.6 percent of GDP.
    - Real interest rate shock (+400bps): pushes debt-to-GDP about 5 percentage points above baseline in 2023.
    - Combined macro-fiscal shock: gross debt-to-GDP 117.5 percent by 2023; gross financing needs peak at 34.9 percent of GDP.
  - Debt-stabilizing primary balance (DSPB): DSPB is 1.1 percent of GDP under baseline assumptions (2.2 percent growth and 8.6 percent nominal effective interest rate in 2023); if growth falls and rates rise, DSPB exceeds 2.0 percent of GDP.

### Policy recommendations and priorities
- Fiscal policy:
  - Continue efforts to ensure fiscal sustainability and remove structural impediments to growth.
  - Strengthen primary balance faster than planned; consider additional expenditure measures including decisive efforts to contain public wage bill while protecting public investment and social programs.
  - Pension reform imperative: increase retirement ages; delink minimum pension from minimum wage; moderate generosity of pensions, notably for government employees.
  - Consider reforms to simplify taxes; remove distortionary tax exemptions costing about 4 percent of GDP annually; move toward a single broad-based VAT with full refund for VAT on intermediate goods; harmonize federal and state tax regimes.
  - Authorities committed to saving any revenue overperformance.
- Expenditure containment (specific targets and measures):
  - Reduce personnel spending by about 1 percent of GDP (contain wages and hiring, better align compensation with private sector).
  - Identify additional expenditure measures and efficiency gains of about 0.5−1 percent of GDP (including better targeting of social benefits such as abono salarial).
  - Protect effective social programs, including Bolsa Família, and public investment.
- Revenue-side and fiscal framework:
  - Strengthen revenue administration; revamp administrative and judicial tax appeal system; grant powers to recover arrears; allow installment payments.
  - Review fiscal rules while maintaining an ambitious consolidation path; introduce medium-term budget framework and publish medium-term fiscal policy statement.
- Monetary and exchange rate policy:
  - Monetary policy should remain accommodative with inflation below target and large output gap; enhance central bank independence.
  - Preserve flexible exchange rate; intervene only under disorderly conditions.
- Financial sector and structural reforms:
  - Undertake ambitious structural reforms to raise productivity and potential growth: reduce state intervention in credit markets, reduce role of public banks, improve efficiency of financial intermediation, lower intermediation costs.
  - Strengthen microprudential, macroprudential, and safety net frameworks.
  - Improve trade integration and public infrastructure.
- Governance:
  - Continue efforts to combat corruption and money laundering; strengthen AML supervision, whistleblower mechanisms, provisional measures and confiscation; expand transparency and beneficial ownership data usage.

### Subnational finances
- Three states (Minas Gerais, Rio de Janeiro, and Rio Grande do Sul) have debt above 200 percent of current revenues, the limit established by the Fiscal Responsibility Law.
- Rio de Janeiro is following a fiscal recovery program with the federal government.
- Priority for subnational governments: reduce personnel costs and reform pensions (which together account for about 57 percent of current state expenditure).
- FRL subnational limits:
  - Ratio of net public debt-to-net revenues cannot exceed: Federal government 3.5; States 2; Municipalities 1.2.
  - Wage bill limits (personnel and pensions as share of net current revenue): Federal: 50 percent; States and Municipalities: 60 percent.

### Financial intermediation efficiency and structural priorities
- Determinants of inefficiency:
  - High NIMs driven by operating costs, loan loss provisions, market structure, bank size, and earmarked credit.
  - Earmarked credit (about half of credit controlled by state) correlates with higher free-market interest rates and provides room for corruption and inefficient allocation.
- Policy actions to lower costs and boost competition:
  - Improve collateral enforcement and judicial system.
  - Enact corporate bankruptcy law, electronic collateral registration, positive credit registry.
  - New Fintech regulation to ease market entry.
  - Phase out subsidized BNDES interest rate and limit state intervention.
  - Improve transparency and comparability of financial products.
- Structural reform priorities:
  - Banking sector reforms prioritized for high economic impact and public support.
  - Other priorities: trade openness, labor market, legal system, and product market reforms.
  - Specific institutional recommendations: refocus Caixa Economica Federal on mortgage credit and invite strategic investor; scale down BNDES lending portfolio to mobilize private finance.

### Infrastructure investment and PPPs
- Brazil’s infrastructure gap versus peers remains large and binding as recovery gains momentum.
- Under new PPP framework (end-2016), several projects auctioned in oil and gas exploration, power generation and airport concessions.
- Investment in transport infrastructure would alleviate bottlenecks, lower transaction costs, and facilitate growth.
- PPPs must be mindful of fiscal risks.

### Governance, anti-corruption, and AML
- Ongoing efforts to combat corruption are of highest importance; strengthen AML supervision and governance and implement pending transparency, anti-corruption and AML measures.
- Selected factual findings on Lava Jato (state of Paraná) as of May 14, 2018:
  - 1,765 court proceedings instigated.
  - 240 arrest warrants issued.
  - 309 defendants charged in 74 separate prosecutions with money laundering, corruption, and forms of organized crime.
- Authorities should continue pursuing cases, adopt pending reforms, strengthen whistleblower protections, and finalize national AML risk assessment.

### Risk Assessment Matrix (RAM) — selected scenarios and policy responses
- RAM framing:
  - “Low” probability <10 percent; “Medium” 10–30 percent; “High” 30–50 percent. “Short term” within 1 year; “Medium term” within 3 years.
- High-likelihood / High-impact scenario (H / H):
  - Expected impact: fiscal balances disappoint; confidence falls; currency depreciation; higher sovereign yields; inflationary pressures resume; banks and corporates stressed.
  - Policy responses: deploy alternative fiscal measures; tighten monetary policy if needed; strengthen competitiveness and productivity.
- High / Medium scenarios (H / M):
  - Expected impact: market volatility; hamper investment recovery; higher funding costs and capital shortfalls.
  - Policy responses: strengthen fiscal consolidation; keep inflation expectations anchored; restrict exchange rate intervention to disorderly conditions; enact structural reforms.
- Medium / Medium and external shock scenarios:
  - Expected impact: worsening current account deficit and weaker growth.
  - Policy responses: exchange rate as shock absorber; monetary easing if broad-based; pursue structural reforms and negotiate trade agreements.

### Debt definitions, coverage, and sustainability
- Gross debt statistics cover NFPS excluding SOEs Petrobras and Eletrobras; consolidate the Sovereign Wealth Fund; follows GFSM 2014.
- At end-2017:
  - NFPS gross debt: 84 percent of GDP.
  - Consolidated public sector assets: 34.3 percent of GDP (including international reserves 18.9 percent of GDP).
  - Public sector net debt: 51.6 percent of GDP.
- Debt profile:
  - FG domestic tradable securities account for 92 percent of total NFPS gross debt.
  - About 17 percent of FG domestic tradable securities will mature in 2018.
  - Foreign currency denominated NFPS debt: 4.3 percent of GDP.
  - Gross financing needs (GFN) consistently above 15 percent of GDP; adjusted GFN lower when excluding BCB rollover.
- Baseline projections and assumptions (2018–23):
  - Real GDP growth: 1.8 percent in 2018; gradual return to potential growth of 2.2 percent by 2020.
  - Primary balance moves into positive territory in 2022 (0.1 percent of GDP).
  - Cumulative adjustment: about 3 percentage points of GDP during 2018−23.
  - Nominal interest rates on new borrowing between 6.6 and 10.7 percent; effective interest rate about 8.9 percent on average.
  - Baseline gross debt remains on upward trajectory, reaching 95.6 percent of GDP by 2023.
- Key projection table highlights (selected exact figures):
  - Nominal gross public debt: 84.0 in 2017; 95.6 in 2023 (percent of GDP).
  - Public gross financing needs: 15.9 in 2017; 26.7 in 2023 (percent of GDP).
  - Real GDP growth (percent): 1.8 in 2018; 2.2 in 2023.
  - Inflation (GDP deflator, percent): 3.1 in 2018; 4.8 in 2023.
  - Primary Balance (percent of GDP, baseline): -2.4 in 2018; 0.7 in 2023.
  - Effective interest rate (percent): 9.6 in 2018; 8.6 in 2023.
  - Identified debt-creating flows cumulative (2018−23): 14.4 (percent of GDP).
  - Primary deficit contribution (cumulative identified flows): 4.8 (percent of GDP).
  - Automatic debt dynamics (cumulative identified flows): 10.9 (percent of GDP).

### Staff appraisal and overall assessment
- Placing Brazil on a path of strong, balanced, and durable growth requires fiscal consolidation, ambitious structural reforms, and strengthening banking sector underpinnings; this will require strong leadership and resolve.
- Fiscal consolidation should accelerate to secure sustainability and rebuild buffers; primary balance should be strengthened faster than planned to achieve a decline in public debt by 2023.
- Pension reform is imperative and should increase retirement age, delink minimum pension from minimum wage, and moderate undue generosity of pensions for some segments.
- Monetary stance appropriate: remain accommodative with inflation below target and large output gap; enhance central bank independence.
- Strengthen independence of BCB, upgrade regulatory and supervisory approach, operationalize multi-agency committees for macroprudential policy and crisis management, and promptly adopt a new financial resolution regime.

*Source: STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION (International Monetary Fund), cr18253.*

### 2017. The primary fiscal deficit declined to 1.7 percent of GDP in 2017, below the authorities’

### BRAZIL — STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION

### Fiscal developments and public debt
- The primary fiscal deficit declined to 1.7 percent of GDP in 2017, below the authorities’ target, reflecting under-execution of discretionary expenditures.
- The cyclically adjusted stance was contractionary and net interest payments declined, owing to lower policy rates and bond spreads.
- Public debt reached 84 percent of GDP in 2017.
- Even if federal expenditure remains constant in real terms at its 2016 level, public debt is expected to rise further and peak in 2023 at above 90 percent of GDP.
- Key fiscal projections and indicators (selected):
  - Central government primary balance: -2.6 (2016), -1.8 (2017), -2.3 (2018), -1.8 (2019), -1.3 (2020), -0.6 (2021), 0.0 (2022), 0.5 (2023)
  - NFPS primary balance: -2.5 (2016), -1.7 (2017), -2.4 (2018), -1.8 (2019), -1.1 (2020), -0.4 (2021), 0.2 (2022), 0.7 (2023)
  - NFPS overall balance (including net policy lending): -9.0 (2016), -7.9 (2017), -8.5 (2018), -7.8 (2019), -7.5 (2020), -7.1 (2021), -6.8 (2022), -6.5 (2023)
  - Net public sector debt: 46.2 (2016), 51.6 (2017), 56.2 (2018), 59.9 (2019), 62.9 (2020), 65.7 (2021), 67.7 (2022), 68.9 (2023)
  - NFPS gross debt: 78.4 (2016), 84.0 (2017), 88.2 (2018), 90.4 (2019), 92.4 (2020), 94.2 (2021), 95.1 (2022), 95.6 (2023)

### Inflation and monetary policy
- Inflation decreased from 6.3 to 2.9 percent during 2017, just below the target range, owing largely to slack in the economy, a notable fall in food prices due to an exceptional harvest, and well-anchored expectations.
- Inflation is projected to increase towards the 4.25 midpoint of the inflation target in 2019, as the food price shock dissipates and the output gap narrows.
- Since the beginning of the easing cycle in September 2016, the Central Bank has lowered the policy rate by 775 bps to the record low level of 6.5 percent.
- Directors and staff view the current monetary policy stance as appropriate and recommend it remain accommodative to help close the output gap, while remaining vigilant to domestic and external inflationary pressures.

### External sector and balance of payments
- The current account deficit shrank from 4.2 percent of GDP in 2014 to 0.5 in 2017 as imports contracted with the collapse of private investment.
- As the recovery gains strength, a rebound in investment will offset the effects of fiscal consolidation and lead to a deterioration of the current account to about -2 percent of GDP over the medium term.
- On average in 2017, the external position was broadly consistent with medium-term fundamentals and desirable policies.
- Brazil has continued to attract sizeable capital inflows, especially foreign direct investment (net FDI: 65.4 (2016), 64.1 (2017), 60.0 (2018), 55.1 (2019)).

### Banking sector and financial resilience
- Banks have been broadly resilient. Despite large losses during the 2015−16 recession, the recent FSAP found the banks to be well capitalized, profitable, and liquid, in large part reflecting high interest margins and fees.
- The economic recovery led to a decline in loan losses, which boosted profits. Capital ratios are above regulatory minima.
- The FSAP systemic risk analysis suggests that bank solvency and liquidity are broadly resilient to further severe macro-financial shocks.
- Directors agreed with the FSAP recommendation that further action is needed to strengthen the microprudential, macroprudential, and safety net frameworks and to improve the efficiency of the financial system by reducing high intermediation costs.

### Growth, labor market, and social outcomes
- Following a cumulative real GDP contraction of 8.2 percent in 2015−16, growth resumed in 2017 with GDP growing at 1 percent.
- Outlook:
  - GDP is projected to grow at 1.8 percent in 2018 and 2.5 percent in 2019, driven by a recovery in domestic consumption and investment.
- In line with empirical evidence on severe crises, projections assume the 2015−16 recession had a permanent effect on potential GDP, involving a 9 percent drop relative to the long-run trend.
- The output gap is estimated to be about -3.5 percent and projected to close in 2022.
- Social indicators and labor market:
  - Unemployment rose from 7 to 13 percent during the recession; the unemployment rate has begun to decline but mainly in the informal sector.
  - Unemployment rate (latest, Apr 2018): 13.1
  - Poverty rate (in percent, 2017): 25.4
  - GDP, dollars (2017): US$2,055 billion
  - GDP per capita (est., 2017): US$9,896
- The labor market reform effective November 2017 has reduced litigation and increased contractual flexibility, but effects on employment have been weak so far.

### Risks and outlook
- Major risks include:
  - Failure to pursue fiscal consolidation, which could undermine confidence in debt sustainability, leading to higher government bond yields and a sharp depreciation of the exchange rate.
  - Tightening of global financial conditions and possible trade disruptions.
  - Domestic political uncertainty that could compound the above risks.
- Even with the expenditure ceiling as a basis for consolidation, measures to comply with it are yet to be identified; given adverse debt dynamics, the primary balance should be strengthened at a faster pace than planned to achieve a decline in public debt by 2023.

### Policy recommendations and priorities
- Fiscal policy:
  - Continue efforts to ensure fiscal sustainability and remove structural impediments to growth.
  - Strengthen the primary balance faster than planned; consider additional expenditure measures including decisive efforts to contain the public wage bill while protecting public investment and social programs.
  - Pension reform is deemed imperative to ensure sustainability of the system and improve equity.
  - Reforms to simplify taxes should be considered and the fiscal framework should continue to be strengthened.
  - Authorities committed to saving any revenue overperformance.
- Monetary and exchange rate policy:
  - Monetary policy should remain accommodative to offset contractionary effects of fiscal consolidation, provided inflation expectations remain anchored.
  - Preserve the floating exchange rate regime and large reserve buffers; limit foreign exchange intervention to addressing disorderly conditions.
  - Monetary policy should respond to exchange rate movements only insofar as there are risks for inflation expectations; underscore the importance of central bank independence.
- Financial sector and structural reforms:
  - Undertake ambitious structural reforms to raise productivity and potential growth, including reducing state intervention in credit markets and reducing the role of public banks.
  - Improve efficiency of financial intermediation and reduce high intermediation costs.
  - Strengthen microprudential, macroprudential, and safety net frameworks.
  - Enhance trade integration and improve public infrastructure.
- Governance:
  - Continue efforts to combat corruption and money laundering to secure strong and inclusive growth.

*Source: STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION (International Monetary Fund), June 20, 2018.*

### 4.      Inflation has declined to record lows prompting a large reduction in the policy rate.

### 4.      Inflation has declined to record lows prompting a large reduction in the policy rate.

### Inflation and Monetary Policy
- Inflation decreased from 6.3 to 2.9 percent in 2017, just below the target range, owing largely to slack in the economy and a notable fall in food prices due to an exceptional harvest.
- Since the beginning of the easing cycle in September 2016, the Central Bank has lowered the policy rate by 775 bps to the record low level of 6.5 percent.
- Inflation is projected to increase towards the 4.25 midpoint of the inflation target in 2019, as the food price shock dissipates and the output gap narrows.
- Policy implication: Since inflation is below target and expectations are anchored, monetary policy should remain accommodative to facilitate a durable recovery; the exchange rate should remain flexible to absorb external shocks.

### Nonfinancial Sector Balance Sheets and Labor Markets
- Households:
  - Household debt as a share of disposable income and the debt service-to-income ratio have declined slightly, supported by lower lending rates and higher income.
- Corporates:
  - Corporate leverage ratio has declined but remains high.
  - Nonfinancial corporates’ liquidity and profitability have improved but remain below pre-recession levels.
  - Corporate bankruptcy applications have edged down.
- Labor markets and informality (Box 1):
  - Since 2017, most employment growth has been in the informal sector.
  - Historically, the business cycle was tightly connected to formal job creation; the current recovery’s concentration in the informal sector suggests persistent uncertainty and reluctance to hire in the formal sector following the deep recession.
  - Informality rose from 45 percent to 60 percent of total employment between 2004 and 2014 (noting the historical decline was from 60 to 45 percent during 2004–2014).
  - Consequences of increased informality: jeopardizes reductions in income inequality, weakens the tax base, associates with lower productivity growth, lacks adequate social protection, and disproportionately affects women, the young, and poorly-educated workers in northern and northeastern regions.

### Banking, Credit, and External Accounts
- Banks:
  - Despite considerable losses on loan portfolios during the recession, banks remained resilient.
  - High interest margins and fees preserved profitability and bank capital; liquidity remained adequate.
  - Capital ratios are well above regulatory minima.
- Credit:
  - Credit growth turned slightly positive in recent months, supported by looser financial conditions.
  - Intermediation spreads have declined slightly and a recent large reduction in reserve requirements has lowered bank funding costs.
  - Non-earmarked credit to households is growing at a moderate pace.
  - Public banks are reducing lending after a big expansion following the financial crisis; private banks and capital markets are taking up the slack.
- Current account:
  - The current account deficit shrank from 4.2 percent of GDP in 2014 to 0.5 in 2017 as imports contracted with the collapse of private investment.
  - As the recovery gains strength, the rebound in investment will offset the effects of fiscal consolidation and lead to a deterioration of the current account to about -2 percent of GDP over the medium term.

### Risks to the Outlook
- Domestic risks:
  - Key domestic risk is delayed fiscal reforms, notably pension reform.
  - The outcome of the October elections is uncertain and may undermine political will to pursue fiscal consolidation; investor loss of confidence could trigger exchange rate depreciation, higher sovereign yields, tighter financial conditions, and possibly a recession.
  - Political developments ahead of elections could manifest risks earlier.
  - The nation-wide trucker strike at the end of May poses a risk to the 2018 growth outlook.
- External risks:
  - Tighter global financial conditions and negative trade shocks (e.g., U.S. trade policy or slowdown in China) could put pressure on the exchange rate and raise sovereign spreads.
  - China accounts for almost 20 percent of Brazil’s exports; effects could be partly attenuated by positive trade diversion.
  - Brazil maintains a capital flow management measure (CFM) — a tax on short-term external loans — which was relaxed in 2014 and should be periodically reviewed.

### Policy Discussions — Fiscal Consolidation and Structural Reforms
- Overall policy focus: secure a strong and durable recovery, ensure fiscal sustainability, improve resilience and efficiency of the financial sector, and remove structural impediments to growth.
- Fiscal policy stance:
  - Given debt dynamics, fiscal consolidation should be strengthened while protecting spending aimed at addressing social consequences of the crisis.
  - Staff baseline: even if federal government expenditure is reduced by about 0.5 percent of GDP per year starting in 2019 (as mandated by the constitutional expenditure ceiling), gross public debt will increase to peak above 90 percent of GDP in 2023.
  - A widening of the primary deficit, as implied by the 2018 budget, should be avoided.
- Staff recommendations on fiscal consolidation (paras 13–14):
  - The authorities should reduce the primary deficit faster than in the baseline scenario; continue fiscal consolidation in 2018, including by advancing measures originally contemplated in the draft budget but rejected by congress.
  - Objective: start reducing public debt as share of GDP by 2023.
  - Federal government primary surplus targets:
    - Reach 1 percent of GDP in 2023 (0.5 percent of GDP higher than in the baseline).
    - Reach at least 2.5 percent of GDP in 2026.
  - Achieving the 2023 surplus requires a cumulative fiscal adjustment of about 4.5 percent of GDP (the primary deficit was 1.8 percent of GDP in 2017), but only half of the adjustment is structural.
  - Consolidation mix: contain expenditure in line with the constitutional ceiling together with some revenue measures.
- Expenditure containment recommendations:
  - Comprehensive pension reform to stabilize pension spending in percent of GDP; should aim at increasing retirement ages, delinking the minimum pension from the minimum wage, and moderating the generosity of pensions, particularly for government employees.
  - Reduce personnel spending by about 1 percent of GDP (containing wages and hiring, and better aligning compensation with the private sector) (Box 3).
  - Identify additional expenditure measures and efficiency gains of about 0.5−1 percent of GDP (including better targeting of social benefits such as abono salarial).
  - Protect effective social programs, including Bolsa Familia, and public investment.
- Revenue-side measures to consider:
  - Remove distortionary tax exemptions which cost about 4 percent of GDP annually.
  - Simplify the tax system (moving toward a single broad-based VAT with full refund for VAT on intermediate goods).
  - Harmonize the fragmented federal and state tax regimes.
  - In the medium-term, review the personal and corporate income tax system toward simplification, including by reducing incentives for individuals to incorporate as businesses for tax purposes.
- Fiscal framework and governance:
  - Address major budget rigidities, including revenue earmarking, high mandatory expenditure (over 80 percent of federal spending cannot be modified without legal changes), and the indexation of key spending items.
  - Limit minimum wage increases to cost of living adjustments; the minimum wage formula is up for review in 2019.
  - Strengthen revenue administration (revamp administrative and judicial tax appeal system, grant powers to recover arrears, allow installment payments).
  - Review fiscal rules while maintaining an ambitious consolidation path; revamp fiscal framework to introduce simple, flexible, and enforceable rules consistent with debt sustainability.
  - Introduce a medium-term budget framework, including publishing a medium-term fiscal policy statement, and improve reporting standards for all levels of government.

### Boxed Measures and Rightsizing the Wage Bill
- Box 2 — Fiscal measures proposed in 2018 draft budget:
  - Eletrobras privatization: 12.2 billion in extraordinary revenue (included in budget but at risk).
  - Discretionary cuts included in budget: Minha Casa Minha Vida (1.2 billion), emergencias de defesa civil (1.2 billion).
  - Tax increase for closed-end funds: fiscal savings 6 billion (included in budget, but diluted).
  - Delay wage increases for the civil service: fiscal savings of 4.4 billion (not included in budget).
  - Increase pension contributions for civil servants: fiscal savings of 2.5 billion (not included in budget).
  - End of payroll tax exemptions: fiscal savings of 5.8 billion (not included in budget).
  - Pension reform: fiscal savings of 1.9 billion (not included in budget).
- Box 3 — Rightsizing the government wage bill:
  - Wage bill at 13 percent of GDP, substantially above advanced economies (10 percent of GDP), emerging economies (9 percent of GDP), and Latin America (8 percent of GDP).
  - Government employment is in line with peers (below 9 percent of working-age population) but pay is the main factor driving the high wage bill.
  - Public wage markup up to 50 percent, especially for individuals with low levels of education.
  - Nearly 75 percent of the wage bill corresponds to state and municipal governments; about 55 percent of employees in state and local governments are in health, education, and security compared to 35 percent in the federal government.
  - To achieve near-term fiscal savings of 0.5 percentage points of GDP would require freezing remuneration in nominal terms and halting new hiring for the next five years.
  - Federal wage bill increased by about 4 percent per year in real terms in 2000-16.
  - Personnel expenditure in subnational governments increased by 1 percentage point of GDP in the past six years.
  - Recommendation: enhance subnational remuneration transparency and expand federal Transparency Portal practices to all subnational governments.

*Source: IMF country report text.*

### 15.      Subnational finances need to be bolstered. Three states (Minas Gerais, Rio de Janeiro, and

### 15.      Subnational finances need to be bolstered. Three states (Minas Gerais, Rio de Janeiro, and

### Subnational finances
- Three states (Minas Gerais, Rio de Janeiro, and Rio Grande do Sul) have debt above 200 percent of current revenues, the limit established by the Fiscal Responsibility Law.
- Rio de Janeiro is following a fiscal recovery program with the federal government.
- Priority for subnational governments: reduce personnel costs and reform pensions (which together account for about 57 percent of current state expenditure).

### Maintaining an accommodative monetary stance
- Current stance: accommodative given low inflation and anchored expectations.
- Selic rate: 6.5 percent (historically low level).
- Ex-ante real rate: 2.3 percent, below the estimated range of the natural rate (4−6 percent).
- Rationale: inflation is hovering slightly below the target range and the output gap is large; inflation expectations are anchored around the 4.25 percent target for 2019.
- Policy guidance:
  - Monetary policy should stand ready to offset contractionary effects of fiscal consolidation, especially if fiscal tightening is accelerated in line with staff’s advice.
  - If the fiscal stance turns expansionary in 2019, monetary policy should tighten to offset possible inflationary effects.

### Flexible exchange rate and reserves
- Flexible exchange rate regime: important cornerstone; depreciation in 2015–16 supported swift reduction of the current account deficit.
- Monetary policy response to exchange rate fluctuations: only to offset possible second-round effects on inflation.
- Foreign exchange intervention: should be limited to episodes of excessive market volatility.
- International reserves: current level provides an important buffer against large external shocks.

### Preserving external balance and external position
- Net foreign liabilities: slightly less than 35 percent of GDP.
- Foreign reserves: US$374 billion or about 160 percent of the ARA metric.
- External rollover needs (private and public debt): about 8 percent of GDP per year.
- FDI: large and steady flow; more than finances the current account deficit.
- Public debt: predominantly denominated in local currency; FX debt in the private sector is mostly hedged.
- 2017 assessment: external position broadly consistent with medium-term fundamentals and desirable policies according to the External Balance Assessment (EBA) and REER methodologies.

### FDI inflows to Brazil (findings)
- Over the past decade, Brazil has attracted substantially larger net FDI inflows than other EMs.
- Net inflows driven by strong inward FDI and are large even if excluding debt instruments, mainly intercompany loans.
- FDI inflows mostly directed to the service sector, suggesting investors are primarily interested in Brazil’s large domestic market rather than its export industry.
- Presence of China in FDI to Brazil increased considerably: a BCB (2018) report shows the share of China increased from around one to 10 percent of equity FDI inflows during 2015-17.

### Competitiveness and labor costs
- Since 2005 real wages have grown faster than labor productivity, increasing unit labor costs (ULC) and weakening external competitiveness.
- ULC-based REER: significantly more appreciated than in the early 2000s; currently about 30 percent above the values prevailing in the early 2000s and in line with the historical average since 1995.
- Policy implications:
  - Important to limit future wage growth to preserve external balance.
  - 2017 labor market reform: by allowing more flexible contracts and wage negotiations, should improve efficiency and limit pressure in the private sector.
  - Authorities should contain public wages, which have grown relatively faster than private sector wages and potentially affect reservation wages for the formal sector.

### Financial system resilience and reforms
- Banks: broadly resilient; despite large losses during the 2015−16 recession, banks are well capitalized, profitable, and liquid owing to high interest margins and fees.
- FSAP systemic risk analysis: bank solvency and liquidity are broadly resilient to further severe macro-financial shocks.
- Stress test: four banks (public and private) would fail the solvency stress test, but with a small capital shortfall.
- Identified bank risks: concentration, exchange rate, and market risk.
- Recommendation: Pillar 2 capital requirements could help mitigate identified risks; build additional capital buffers for banks that failed the stress test.
- Corporates: remain vulnerable to shocks; macro-financial shocks could increase debt-at-risk—profitability and interest rate shocks could double debt at risk, especially in manufacturing and energy sectors.

### FSAP recommendations for prudential and safety-net frameworks
- Strengthen BCB as bank supervisor: BCB’s independence and legal protection of staff should be ingrained in law.
- Upgrade regulatory and supervisory approach to better deal with related party exposures and transactions, large exposures, country and transfer risk, and restructured loans.
- Introduce a new resolution regime in line with FSAP recommendations promptly.
- Tighten processes for dealing with weak banks and emergency liquidity assistance (ELA) to ensure assistance is not provided to insolvent banks.
- Bring the deposit guarantee fund into the public sector to help prevent conflict of interest, retain mandate for financial stability in the public sector, and improve exchange of confidential information.
- Create high-level multi-agency committees with mandates for macroprudential policy and crisis management to improve coordination among supervisory agencies.

### Raising financial intermediation efficiency
- Intermediation costs in Brazil exceed peer countries; operating costs and credit losses are main determinants.
- Contributing factors: concentration at the credit-product level, vertical integration, and the share of earmarked credit.
- Policy actions to lower costs:
  - Improve collateral enforcement and the judicial system.
  - Enact proposed laws on corporate bankruptcy, electronic collateral registration and positive credit registry.
  - New regulation on Fintech to ease market entry and foster bank competition.
  - Leverage a memorandum of understanding between the BCB and CADE to collaborate on improving financial market efficiency and competition.
  - Improve transparency and comparability of financial products to facilitate client mobility.
- State intervention in credit markets:
  - Phase out the subsidized interest rate of BNDES in line with the recent TLP reform.
  - Further limit state intervention: about half of credit is controlled by the state through earmarked loans directed to preferred borrowers at subsidized rates.
  - Effects of state intervention: uneven playing field between private and public banks, increased cost of free-market intermediation, high fiscal or parafiscal costs, weakened monetary transmission, and hampered capital market development.

### Determinants of financial intermediation (in)efficiency
- Net interest margins (NIM): one of the highest among 15 peer emerging market economies; credit card market has the highest spreads.
- Top five banks: account for 82 percent of credit.
- Factors behind high NIMs:
  - Operating costs (main factor).
  - Loan loss provisions.
  - Market structure—concentration at the product level.
  - Bank size: larger banks typically have wider spreads.
  - Volume of earmarked-credit provision: among private banks, higher share of earmarked credit correlates with higher interest rates in free-market loans, suggesting cross-subsidization.
- Earmarked credit consequences:
  - Little or no evidence for positive effects on investment and productivity.
  - Hampered capital market development and monetary policy transmission.
  - Provided room for corruption and inefficient allocation of resources.
  - BCB analysis: for firms receiving non-earmarked credit, a one percent increase in policy rate reduces loan growth by three percent; for firms with access to earmarked credit the reduction is by 2 percent (Bonomo and Martins, 2016).

### Boosting potential growth and productivity
- Growth history: since the early 1980s, GDP has grown on average by about 2.6 percent per year.
- Weak growth drivers: lack of productivity growth compounded by low investment; current level of TFP close to the one prevailing in the early 1980s.
- Importance: raising productivity is especially important to offset ageing demographic trend that will weigh down potential growth.
- Recent steps: labor market reform and reduction in credit subsidies (TLP) are important steps, but more is needed.
- Priority reforms:
  - Accelerate reform agenda, starting with banking sector reforms that limit state intervention in credit markets—these would have large positive effects on productivity and broad public support.
  - Caixa Economica Federal: refocus on core mandate of providing mortgage credit, improve risk management and efficiency to boost its capital; inviting a strategic investor could provide stronger corporate governance and know-how.
  - BNDES: scale down its lending portfolio by selectively assuming risks to mobilize private finance.
  - Continue trade liberalization: trade openness can raise productivity significantly over the medium term; prospect of OECD accession can foster trade integration and avoid further backpaddling on structural reforms.

### Structural reform priorities (summary)
- Banking sector reforms: highest economic impact and highest level of public support; aim to foster a stronger and more efficient private credit market.
- Trade openness, labor market, legal system, and product market reforms: also important but banking reforms are prioritized due to impact, public support, and relative ease of legislation (many measures can be undertaken by the government without congressional approval).

_International Monetary Fund — Chapter content from the Brazil country report excerpt provided._

### 27.      Investment in infrastructure should be revived. Brazil’s infrastructure gap against peers

### 27.      Investment in infrastructure should be revived. Brazil’s infrastructure gap against peers

### Infrastructure investment and PPPs
- Brazil’s infrastructure gap against peers and competitors, and relative to the country’s development level, remains large and will become more binding as the recovery gains momentum.
- Under the new PPP framework launched at end-2016, several projects have been auctioned, mainly in the areas of oil and gas exploration, power generation and airport concessions.
- Investment in transport infrastructure would help alleviate bottlenecks, lower transaction costs, and facilitate growth.
- Public-private partnerships (PPPs) must be mindful of fiscal risks.

### Responding to shocks
- High public debt exposes Brazil to confidence shocks; pronouncements against fiscal consolidation during the political campaign may spook investors.
- Downside scenario without fiscal consolidation:
  - Exchange rate depreciation.
  - Increase in interest rates.
  - Possibly a recession.
  - Public debt would increase to almost 120 percent of GDP by 2023.
- Policy responses to confidence shocks:
  - Adopt additional fiscal measures to show resolute commitment to debt sustainability.
  - Allow the exchange rate to absorb shocks; intervene in foreign exchange only in case of disorderly market conditions.
  - Monetary authorities may need to increase policy rates to offset second-round inflation effects from exchange rate depreciation.
  - Avoid resumption of counter-cyclical lending through public banks due to distortive credit-market effects and possible contingent liabilities.
- Negative trade shocks (e.g., U.S. trade restrictions or a sharp slowdown in China) may require:
  - Monetary accommodation: reduce policy rates provided inflation expectations remain anchored around the target.
  - Fiscal policy should instead stay on the path of consolidation since the high level of debt does not provide room for fiscal stimulus.
  - Support export sector via fostering trade integration by negotiating new agreements at regional and global levels.

### Strengthening governance and anti-corruption / AML measures
- Effective implementation of anti-money laundering and anti-corruption measures remains critically important to secure strong and inclusive growth.
- Past legal and policy changes (including introduction of plea bargains and leniency agreements) supported by some strong and independent law enforcement and judicial authorities have led to an increasing number of AML and corruption cases.
- Authorities should:
  - Continue pursuing significant corruption and money laundering cases.
  - Work with the legislature to adopt relevant pending reforms to further strengthen the AML and anti-corruption framework.
  - Strengthen whistleblower mechanisms, provisional measures and confiscation.
  - Continue to prevent the abuse of appeal provisions and statutes of limitations in legal proceedings.
- Preventive actions and data improvements:
  - Update and expand the Transparency Portal with additional data to increase usefulness.
  - Tax authorities have started to collect beneficial ownership data; these data should be made available to other government entities for AML and anti-corruption purposes.
  - Undertake and finalize the national anti-money laundering risk assessment expeditiously.
  - Financial supervisors are at various stages of introducing risk-based supervision specific for AML; supervision can be further refined by applying risk matrixes independent of prudential classifications.
- Additional measures considered:
  - Implement departmental integrity programs.
  - Move from a rule-based to a risk-based approach for preventing corruption, including procurement.
  - Consider legal protection for government employees acting in good faith (against criminal and civil liability).
  - Work with the legislature to address existing shortcomings related to terrorist financing to avoid increasingly negative FATF statements.

Box 8 — Selected factual findings on corruption prosecutions
- Lava jato (state of Paraná) as of May 14, 2018:
  - 1,765 court proceedings instigated.
  - 240 arrest warrants issued.
  - 309 defendants charged in 74 separate prosecutions with money laundering, corruption, and forms of organized crime.
- Other notable cases include Odebrecht and JBS spin-offs, Greenfield, Panatenaico, Zelotes, and Câmbio, desliga.
- The relative high number of investigations and prosecutions may indicate competence, independence and impartiality of authorities rather than necessarily higher prevalence of corruption relative to the region.
- Long-term reduction of corruption risks requires both continued strong enforcement and preventive reforms; repression alone is insufficient.

### Authorities’ views (selected)
- Authorities envisage a sustained economic recovery but expect moderate growth in 2018 given weak early-2018 data.
- They believe the 2015−16 crisis did not have as large permanent effects on potential output as staff assumes and expect structural reforms (labor market, education, immigration, competition in oil and gas) to boost productivity and potential growth.
- Authorities see faster fiscal consolidation than implied by the expenditure ceiling depending on revenue performance.
  - Discretionary expenditure under the control of the treasury—about 10 percent of federal expenditure—has been greatly contained.
  - Wage increases reflect previous binding agreements.
  - Any revenue in addition to what is currently budgeted will not be used for new spending because of the expenditure ceiling.
  - Debt service is expected to remain contained reflecting structurally lower interest rates.
- Authorities see scope for revenue-neutral tax reform, starting with PIS/COFINS reforms.
- Central Bank stance:
  - Maintains prudent monetary and exchange rate policy consistent with its inflation targeting regime.
  - Currency will continue to float freely; central bank has no exchange rate target.
  - In case of disorderly market conditions, stand ready to intervene using large foreign reserves in the spot market or through swaps.
- Financial sector legislation under way:
  - Granting central bank independence and legal protection to its staff.
  - Strengthening bank resolution framework.
  - Creating a committee for macroprudential policy and crisis management.
  - Central bank notes it already has an indemnity with respect to general losses, including those which could stem from ELA.
  - No plan to transform the FGC (Fundo Garantidor de Credito) into a public institution.
  - Work is ongoing on supervision of related party and large exposures, account portability, and improving Pillar 2 capital requirements.
- Structural reform priorities highlighted by authorities: refocusing BNDES toward co-financing and long-term financing access, Caixa moving away from non-core activities and improving governance, BC+ agenda measures to enhance efficiency and reduce cost of credit, and commitment to foster trade integration and reduce tax distortions.
- Authorities stressed commitment to transparency and anti-corruption measures, including expeditious undertaking of the national risk assessment and progress on beneficial ownership requirements since 2009.

### Staff appraisal — key recommendations and findings
- Placing Brazil on a path of strong, balanced, and durable growth requires fiscal consolidation, ambitious structural reforms, and strengthening banking sector underpinnings; this will require strong leadership and resolve.
- Fiscal consolidation:
  - Fiscal consolidation should accelerate to secure sustainability and rebuild buffers.
  - Primary balance should be strengthened at a faster pace than planned to achieve a decline in public debt by 2023.
  - A widening of the primary deficit in the 2018 budget relative to the 2017 outturn is unwarranted given adverse debt dynamics and tightening global financial conditions.
- Pension reform is imperative; comprehensive reform should:
  - Increase the retirement age.
  - Delink the minimum pension from the minimum wage.
  - Moderate undue generosity of pensions for some segments, notably public employees.
  - Such reform will improve equity and subnational government finances.
- Additional measures to reduce the deficit while protecting effective public investment and social expenditures:
  - 2019 revision of the minimum wage adjustment formula provides an opportunity to contain mandatory spending.
  - Reform public sector employment and compensation to make the wage bill sustainable and reduce labor market distortions.
  - Increase spending efficiency to create fiscal space while protecting social programs such as Bolsa Familia and public investment.
  - Prioritize tax measures aimed at improving efficiency and bolstering revenues.
- Monetary and exchange rate policy:
  - Monetary stance is appropriate: with inflation below target, large output gap, and inflation expectations well-anchored, monetary policy should remain accommodative.
  - Enhancing central bank independence would further improve the inflation-targeting framework.
  - Flexible exchange rate regime is an important cornerstone; intervention should be limited to acute market volatility. International reserves at current level provide an important buffer.
- Banking sector underpinnings:
  - Strengthen independence of BCB and legal protection of its staff.
  - Upgrade regulatory and supervisory approach to address FSAP-identified gaps.
  - Create multi-agency committees for macroprudential policy and crisis management and operationalize them.
  - Put in place promptly a new financial resolution regime in line with FSAP recommendations.
  - Tighten the process for providing emergency liquidity assistance and bring the deposit guarantee fund into the public sector.
- Structural reform priorities:
  - Improve financial intermediation.
  - Enhance trade integration.
  - Tackle corruption.
  - Prioritization of reforms is key given the long list of potential measures.

*Source: IMF staff report material contained in the supplied content unit.*

### 48.      Ongoing efforts to combat corruption are of the highest importance. It is vital for Brazil

### 48.      Ongoing efforts to combat corruption are of the highest importance. It is vital for Brazil

### Anti-corruption, transparency, and AML measures
- "Ongoing efforts to combat corruption are of the highest importance. It is vital for Brazil to strengthen AML supervision and governance, and further implement pending transparency, anti-corruption and AML measures."

### Surveillance and consultation timing
- "It is recommended that the next Article IV consultation takes place on the standard 12-month cycle."

### Recent economic developments (summary points and chart text excerpts)
- "After a sharp recession in 2015-2016, the recovery is strenghtening"
- "Private consumption and investment are  driving the recovery"
- "The recovery is broad-based across sectors"
- "Retail sales are  growing and  consumers' confidence is gradually strenghtening"
- "Industrial production is recovering, but capacity utilization remains well below historical averages"
- "Business confidence has improved and investment is growing"
- Chart labels and metrics presented:
  - Demand Contribution to GDP Growth (Seasonally adjusted, annualized quarter-on-quarter percentage change) with series: Private consumption; Government consumption; Investment; Net Exports; Inventories; GDP
  - Industrial Production and Capacity Utilization (3-month moving average annualized percentage change) with series: Capacity utilization, rhs 1/; Industrial production; Manufacturing
  - Retail Sales Volumes (3-month moving average annualized percentage change) with series: Consumer confidence (deviation from historical average); Retail sales incl. autos and construction materials; Retail sales excl. autos and construction materials
  - Business Confidence and Investment (Index and yearly percentage change, respectively) with series: Business Confidence Index (50+=Growth); Total real investment growth, year-on-year (right scale)
  - Supply Contribution to GDP Growth (Seasonally adjusted, annualized quarter-on-quarter percentage change) with series: Agriculture; Industry; Services; Tax on Products; GDP
  - Real GDP Growth and Output Gap (Percent change and percent of potential output) with series: Real GDP growth; Output gap
- Sources listed: "Haver analytics; IBGE; and Fund staff estimates."
- Footnote text: "1/ Difference between the current rate and the 10-year average in percentage points."

### Monetary sector (summary points and chart text excerpts)
- "Inflation has declined slightly below the target range, while inflation expectations are well anchored"
- "...  and medium-term inflation expectations are drifting upwards."
- "The  inflation diffusion index has increased rapidly."
- "Regulated-price inflation has resumed,  while free-price inflation remains subdued"
- "Inflation has declined mostly in the tradable sector because of a sharp drop in food prices"
- "Real wages are growing again"
- "The central bank has cut the policy rate to historic lows"
- "As demand for dollar hedge declined, the central bank has significantly reduced the stock of FX swaps"
- Chart labels and metrics presented:
  - Regulated and Free Prices (Sesonally adjusted, year-on-year percentage change) with series: Regulated prices; Free prices
  - Tradables and Non-tradables (Seasonally adjusted, year-on-year percentage change) with series: Tradables; Nontradables
  - Headline and Core (Sesonally adjusted, year-on-year percentage change) with series: Headline; Core 1/; Expected inflation 2/; Target band; Target mid-point
  - Wage and Earnings Growth (Year-on-year percent change) with series: Real average earnings; Min. wage real
  - Monetary Policy Target Interest Rate (SELIC) (Monthly average, percent) with series: Nominal; Real (ex-ante)
  - Central Bank Foreign Exchange Swaps (Notional value of non‐deliverable forwards settled in local currency in billion U.S. dollars; positive means Central Bank is shorting dollars)
- Sources listed: "Haver Analytics, IBGE, and Fund Staff calculations."
- Footnotes:
  - "1/ Extended Consumer Price Index, Exclusion Core (IPCA-EX1)."
  - "2/ 12 month ahead IPCA (Central Bank of Brazil)"

### Fiscal policy (excerpted statements and chart note)
- "Gross debt has  increased to  84 percent of  GDP."
- "The  overall fiscal balance remains  negative due  to primary deficit and interest bill."
- "Excluding exceptional revenue, the primary deficit remains  around"
- Sources listed: "Central Bank of Brazil, IBGE, Haver Analytics, and Fund staff calculations."

*International Monetary Fund — cr18253*

### 2.5 percent of GDP

### 2.5 percent of GDP

### Fiscal stance and public finances
- Capital expenditure has been reduced substantially.
- After two years of consolidation, the fiscal stance (excluding policy lending) is projected to loosen in 2018.
- Change in Structural Primary Balance (percent of GDP) charted around range: -2, -1, 0, 1, 2 (visual series shown).
- Primary expenditure remains contained and revenue shows signs of recovery.
- NFPS primary balance:
  - 2016: -2.5
  - 2017: -1.7
  - 2018: -2.4
  - 2019: -1.8
  - 2020: -1.1
  - 2021: -0.4
  - 2022: 0.2
  - 2023: 0.7
- NFPS overall balance (including net policy lending):
  - 2016: -9.0
  - 2017: -7.9
  - 2018: -8.5 (table shows -8.5 and elsewhere -8.3/-9.1 variants in different tables)
  - 2019: -7.8 / -8.1 (table differences)
  - 2020: -7.5 / -7.8
  - 2021: -7.1 / -7.6
  - 2022: -6.8 / -7.1
  - 2023: -6.5 / -6.8
- Federal Government (selected lines, percent of GDP):
  - Net nonfinancial revenue: 2016: 17.4; 2017: 17.6; 2018: 17.3; 2019: 17.0; 2020: 17.2; 2021: 17.7; 2022: 17.8; 2023: 17.8
  - Total primary expenditure: 2016: 20.0; 2017: 19.5; 2018: 19.7; 2019: 18.9; 2020: 18.5; 2021: 18.3; 2022: 17.8; 2023: 17.4
  - Primary balance: 2016: -2.6; 2017: -1.8; 2018: -2.4; 2019: -1.9; 2020: -1.3; 2021: -0.6; 2022: 0.0; 2023: 0.4
- Structural primary balance (NFPS):
  - 2016: -1.2
  - 2017: -0.5
  - 2018: -1.5
  - 2019: -1.2
  - 2020: -0.8
  - 2021: -0.7
  - 2022: -0.2
  - 2023: 0.3
- Net public sector debt:
  - 2016: 46.2 percent of GDP
  - 2017: 51.6
  - 2018: 56.2
  - 2019: 59.9
  - 2020: 62.9
  - 2021: 65.7
  - 2022: 67.7
  - 2023: 68.9
- NFPS gross debt:
  - 2016: 78.4 percent of GDP
  - 2017: 84.0
  - 2018: 88.2
  - 2019: 90.4
  - 2020: 92.4
  - 2021: 94.2
  - 2022: 95.1
  - 2023: 95.6

### External sector and current account
- Despite an improvement in the terms of trade, the net international investment position is gradually deteriorating.
- After a significant improvement during the 2015–16 crisis, the current account is expected to gradually deteriorate.
- Current account (billions of U.S. dollars):
  - 2016: -23.5
  - 2017: -9.8
  - 2018: -24.4
  - 2019: -30.5
  - 2020: -35.1
  - 2021: -39.3
  - 2022: -43.8
  - 2023: -46.9
- Current account (percent of GDP):
  - 2016: -1.3
  - 2017: -0.5
  - 2018: -1.2
  - 2019: -1.4
  - 2020: -1.5
  - 2021: -1.6
  - 2022: -1.7
  - 2023: -1.8
- Trade balance (billions of U.S. dollars):
  - 2016: 45.0
  - 2017: 64.0
  - 2018: 59.4
  - 2019: 55.4
  - 2020: 55.6
  - 2021: 57.8
  - 2022: 60.3
  - 2023: 62.6
- Exports (fob, billions of U.S. dollars): 2016: 184.5; 2017: 217.2; 2018: 234.1; 2019: 242.8; 2020: 253.5; 2021: 265.7; 2022: 277.8; 2023: 289.5
- Imports (fob, billions of U.S. dollars): 2016: 139.4; 2017: 153.2; 2018: 174.7; 2019: 187.4; 2020: 197.9; 2021: 207.9; 2022: 217.4; 2023: 226.9
- Foreign direct investment (net, billions of U.S. dollars):
  - 2016: 65.4
  - 2017: 64.1
  - 2018: 60.0
  - 2019: 55.1
  - 2020: 50.7
  - 2021: 48.8
  - 2022: 48.1
  - 2023: 48.7
- Total external debt (percent of GDP):
  - 2016: 37.2
  - 2017: 32.5
  - 2018: 32.0
  - 2019: 30.4
  - 2020: 28.9
  - 2021: 27.3
  - 2022: 25.7
  - 2023: 24.2
- Gross reserves (end of period, billions of U.S. dollars): 2016: 365.0; 2017: 374.0; 2018–2023: 374.0 (constant projection)
- Terms of trade (percentage change): 2016: 3.0; 2017: -0.8; 2018: -1.3; 2019: -0.8; 2020: -0.8; 2021: -0.4; 2022: -0.1; 2023: 0.0

### Financial sector and banking system
- Credit growth decelerated, reflecting both weak loan demand and conservative supply.
- Non-performing loans have been stable in 2017 reflecting high write-offs and renegotiation of loans.
- Profit drivers:
  - Profits before taxes increased due to lower funding costs and lower allowances for credit losses.
  - Credit losses would be partly driven by higher losses to the corporate sector.
- Banks would be broadly resilient to the stress scenario.
- Capital and liquidity remain above regulatory minima but capital ratio of public banks are below those of private banks.
- CET1 ratio, baseline and stress (selected points):
  - 2017Q4 baseline and stress projections shown across 2017Q4, 2018Q4, 2019Q4, 2020Q4 with regulatory threshold line (figure).
- Sensitivity analysis (2017Q3) — Impact on Corporate Debt Servicing Capacity (Share of Debt at Risk, ICR<1) under shocks shown: Interest Rate Shock (8%), FX shock (43%) operational and financial hedge, FX shock (43%) financial hedge only, Profit shock (10%), Combined Shock, Combined Shock (only financial hedge) (figure).
- Income statement of banking sector (Trillions of R$) components shown: Net interest income, Net other income, Net income before taxes (RHS), Provisions, Noninterest income, Noninterest expense with small numeric axis ticks shown (-1.3 to 1.3 etc.).

### Debt sustainability and stress tests
- External Debt Sustainability Bound Test highlights:
  - Baseline and scenario projections charted for interest rate shocks, growth shock, current account shocks, combined shocks, and a one-time real depreciation of 30 percent occurring in 2018.
  - Growth shock figures (in percent per year) shown with baseline and scenario and historical: Baseline: 2.6, 3.2, 3.7 (contextual placement in figure).
  - Baseline/Scenario/ Historical averages are presented in figures and boxes.
- External Debt Sustainability Framework (selected lines, percent of GDP unless otherwise indicated):
  - Baseline external debt (percent of GDP): 2013: 25.1; 2014: 29.0; 2015: 36.9; 2016: 37.2; 2017: 32.5; 2018: 32.0; 2019: 30.4; 2020: 28.9; 2021: 27.3; 2022: 25.7; 2023: 24.2
  - Change in external debt (percent of GDP): 2013: 2.0; 2014: 3.9; 2015: 7.9; 2016: 0.2; 2017: -4.6; 2018: -0.5; 2019: -1.6; 2020: -1.6; 2021: -1.6; 2022: -1.6; 2023: -1.5
  - Gross external financing need (in billions of US dollars): 2013: 167.2; 2014: 207.7; 2015: 214.3; 2016: 170.8; 2017: 147.2; 2018: 162.1; 2019: 168.6; 2020: 173.4; 2021: 177.6; 2022: 181.1; 2023: 182.8
  - Gross external financing need (in percent of GDP): 2013: 6.8; 2014: 8.5; 2015: 11.9; 2016: 9.5; 2017: 7.2; 2018: 8.2; 2019: 8.3; 2020: 8.2; 2021: 8.0; 2022: 7.7; 2023: 7.4
- Bound tests (B1–B5) shown with debt paths; B5 one-time 30 percent real depreciation in 2018 yields higher debt paths (figure numeric pointers such as 41.5, 39.1, 37.0, etc. mapped to years in chart).

### Macroeconomic outlook and key indicators
- GDP and macro framework:
  - GDP at current prices (indices in table): 2016: 4.4; 2017: 4.8; 2018: 4.9; 2019: 7.5; 2020: 7.2; 2021: 7.1; 2022: 7.1; 2023: 7.1 (table header unclear—these are values as presented).
  - GDP at constant prices (percent): 2016: -3.5; 2017: 1.0; 2018: 1.8; 2019: 2.5; 2020: 2.3; 2021: 2.2; 2022: 2.2; 2023: 2.2
  - Consumer prices (IPCA, end of period): 2016: 6.3; 2017: 2.9; 2018: 3.5; 2019: 4.1; 2020: 4.0; 2021: 4.0; 2022: 4.0; 2023: 4.0
- Investment and savings (percent of GDP):
  - Gross domestic investment: 2016: 15.4; 2017: 15.5; 2018: 16.2; 2019: 16.9; 2020: 17.8; 2021: 18.7; 2022: 19.3; 2023: 19.5
  - Gross national savings: 2016: 14.1; 2017: 15.0; 2018: 14.9; 2019: 15.4; 2020: 16.2; 2021: 16.9; 2022: 17.4; 2023: 17.6
- Labor market and social indicators:
  - Unemployment rate (latest, Apr 2018): 13.1 (population characteristics section)
  - Unemployment rate series: 2016: 11.3; 2017: 12.8; 2018: 11.6; 2019: 10.5; 2020: 10.1; 2021: 9.8; 2022: 9.5; 2023: 9.5
  - Population total (est., 2018): 208.8 million
  - GDP per capita (est., 2017): US$9,896
  - GDP (dollars, 2017): US$2,055 billion
- Balance of payments (selected items, billions of U.S. dollars):
  - Exports (fob) 2017: 217.2; 2018: 234.1
  - Imports (fob) 2017: 153.2; 2018: 174.7
  - Capital and Financial Account: 2016: 16.7; 2017: 6.5; 2018: 24.4; 2019: 30.5; 2020: 35.1; 2021: 39.3; 2022: 43.8; 2023: 46.9
- Money and credit (selected):
  - Base money 2016: 8.1; 2017: 0.5; projection 2018–2023: 4.9, 7.5, 7.2, 7.1, 7.1, 7.1 (values as presented)
  - Broad money (12-month cumulative, real y/y growth as shown in figure): numbers plotted with axes -50 to 50; specific series: Revenue, Primary expenditure, Primary expenditure excl. transfers to S&M (figure).
- Financial soundness indicators (selected, percent):
  - Total banking system regulatory capital to risk-weighted assets: ranges shown 2012–2017 with values such as 16.4, 16.1, 16.7, 16.4, 17.1, 18.1
  - Nonperforming loans to total gross loans (total banking system): 2012: 3.4; 2013: 2.9; 2014: 2.9; 2015: 3.3; 2016: 3.9; 2017: 3.6
  - Liquidity assets to short-term liabilities (total banking system): 2012: 191.8; 2013: 158.0; 2014: 202.2; 2015: 190.0; 2016: 236.3; 2017: 237.5

*Source: IMF staff estimates and projections, as presented in the document.*

### Appendix I. Risk Assessment Matrix

### Appendix I. Risk Assessment Matrix

### Overview
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff).
- The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent).
- The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities.
- Non-mutually exclusive risks may interact and materialize jointly.
- “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

### Key Risk Scenarios, Expected Impact, and Policy Responses
- H / H.
  - Expected Impact on Economy:
    - Fiscal balances would continue to disappoint and fail to stabilize debt.
    - Further loss of confidence would lower investment and growth.
    - Market adverse reaction would include currency depreciation and increased sovereign yields, and inflationary pressures would resume.
    - Corporates could suffer from capital flow reversals, exchange rate depreciation, and higher funding costs.
    - The strains would worsen if banks' soundness deteriorated owing to an increase in NPLs and funding costs and losses on government bonds' holdings.
  - Policy Responses:
    - Deploy alternative fiscal measures to shore up credibility and ensure that debt stabilizes.
    - The monetary policy stance may have to be tightened depending on the effect on inflation expectations.
    - Strengthen efforts to boost competitiveness and productivity.

- H / M.
  - Expected Impact on Economy:
    - Uncertainty would cause market volatility and hamper the incipient investment recovery, confidence, and growth.
    - Higher funding costs and losses on the portfolio would trigger capital shortfalls, tightening of financial conditions, and contraction of credit.
  - Policy Responses:
    - Ensure macroeconomic policy resilience. This involves:
      1. Strengthening fiscal consolidation efforts to achieve medium-term debt sustainability;
      2. Monetary policy should remain focused on keeping inflation expectations anchored;
      3. Exchange rate intervention only under disorderly market conditions; and
      4. Enact structural reforms to combat corruption and boost competitiveness and growth.

- H / M. (Brazil-specific)
  - Expected Impact on Economy:
    - Increasing Brazil’s risk premia, 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.
    - Exchange rate depreciation could pass through to inflation threatening to de-anchor inflation expectations.
  - Policy Responses:
    - Monetary policy may have to be tighthened to counter the second round effects from exchange rate appreciation.
    - Recourse to FX intervention only in disorderly market conditions.
    - Provide FX liquidity and support individual banks if dollar shortages appear.
    - May also need to tighten fiscal policy to further strengthen policy credibility and avoid sell-offs of Brazilian domestic bonds.
    - Capital flow management measures (CFMs) on outflows may be appropriate in crisis circumstances. 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.

- M / M.
  - Expected Impact on Economy:
    - Worsening current account deficit and weaker growth.
    - Some corporates could see their profits decline and unemployment in some sectors could increase.
  - Policy Responses:
    - No room for fiscal policy stimulus to smooth the shock, but further monetary easing could be appropriate if the shock is broad-based.
    - Press on with structural reforms to open up the economy and boost potential growth.
    - Negotiate trade agreements both at regional and global level.

- L/M / M.
  - Expected Impact on Economy:
    - The spillover impact would reverberate through the trade and commodity channels, but also through financial markets contagion.
    - Worsening current account deficit and weaker growth.
    - Profits of highly indebted corporates could decline.
  - Policy Responses:
    - Use the exchange rate as first shock absorbers.
    - No room for fiscal policy stimulus to smooth the shock, but further monetary easing may be appropriate.
    - Press on with structural reforms to boost potential growth.

### Nature / Source of Threat (Selected Entries)
- Tighter global financial conditions.
  - Context:
    - Against the backdrop of continued monetary policy normalization and increasingly stretched valuations across asset classes, an abrupt change in global risk appetite (e.g., due to higher-than-expected inflation in the U.S) could lead to sudden, sharp increases in interest rates and associated tightening of financial conditions.
    - Higher debt service and refinancing risks could stress leveraged firms, households, and vulnerable sovereigns, including through capital account pressures in some cases.

- Significant China slowdown and its spillovers.
  - Context:
    - While ongoing efforts by the Chinese authorities to “de-risk” the financial system are welcome, too fast an adjustment and improper sequencing of actions may adversely affect near-term growth (low likelihood).
    - Over the medium term, overly ambitious growth targets, including by over reliance on credit stimulus and investment, lead to unsustainable policies, reducing fiscal space, further increasing financial imbalances.
    - A sharp adjustment would weaken domestic demand, with adverse international spillovers, including a pullback in capital flows to EMs (medium likelihood).

- External Risks (examples noted)
  - Retreat from cross-border integration: Fraying consensus about the benefits of globalization leads to protectionism and economic isolationism, resulting in reduced global and regional policy and regulatory collaboration with negative consequences for trade, capital and labor flows, sentiment, and growth.

- Domestic Risks (examples noted)
  - Failing to pass reforms necessary to maintain the constitutional expenditure ceiling.
  - Political uncertainty surrounding the upcoming elections or broadening of the corruption scandal.

### Risk Assessment Definitions and Interpretations
- “Low” is meant to indicate a probability below 10 percent.
- “Medium” is meant to indicate a probability between 10 and 30 percent.
- “High” is meant to indicate a probability between 30 and 50 percent.
- “Short term” indicates the risk could materialize within 1 year.
- “Medium term” indicates the risk could materialize within 3 years.

*Source: Appendix I. Risk Assessment Matrix, cr18253 - Appendix I. Risk Assessment Matrix*

### 1.      The Constitutional Amendment No. 95, adopted on December 15, 2016 establishes an

### cr18253 - 1.      The Constitutional Amendment No. 95, adopted on December 15, 2016 establishes an

### Expenditure rule (Constitutional Amendment No. 95)
- The rule is to remain in place for the following twenty years.
- Sets ceilings on federal government real primary expenditure as of 2016; nominal expenditure can grow thereafter in line with inflation calculated as the 12-month inflation rate observed in the period ending in June of the year prior to the budget year.
- The ceiling is applied to actual payments (execution) including restos a pagar (RAP).
- Coverage: applies to all branches of federal government—the Executive branch, the Legislature, and the Judicial branch—but each branch has its own ceiling within the overall expenditure ceiling.
- Exclusions:
  - The ceiling excludes extraordinary credits used for urgent and unforeseen events, such as natural disasters, war or civil unrest.
  - Some specific spending categories, namely constitutional transfers (mainly to states and municipalities) as well as bailouts of non-financial state-owned enterprises are exempt from the cap.
  - Spending on education and health is protected: previously earmarked as minimum percentages of revenue (respectively 18 percent of net tax revenue and 15 percent of net current revenue) and from 2018 the rule defines spending floors for education and health; expenditure for each sector should be superior to their respective shares in the 2017 total primary expenditure ceiling and additional funds can be allocated if they are within the overall expenditure ceiling.
- Transitional provision: during the first three years of the application of the rule, the legislative and judiciary branches can surpass their respective expenditure ceilings for a maximum cumulative amount of 0.25 percent of the Executive branch’s ceiling with the excess being offset through a corresponding decrease in the Executive branch’s budget.
- Safeguards and adjustment:
  - Ex ante: any legislative proposal for new mandatory expenditure or new tax expenditure must be accompanied by an assessment of its fiscal impact; Congress can block and review proposals suspected to be incompatible with the rule.
  - Ex post: automatic adjustments in case of non-compliance include prohibiting mandatory spending above inflation (including the readjustment of the minimum wage), preventing the creation of new mandatory spending items, stopping salary increases and new hiring, and prohibiting measures that expand credit lines, programs or tax incentives.
- Amendment mechanics:
  - At the initiative of the President of the Republic, the expenditure ceiling can be changed at the earliest after 10 years (in 2027) by complementary law, which requires an absolute majority in both the House and the Senate.
  - The ceiling can be altered only once in each presidential term, and the scope of the modification is limited to the calculation of the spending growth component.
  - The cap can be modified or abolished otherwise through a constitutional amendment which would require a three-fifths majority and two votes each in the House and the Senate.

### The Golden Rule (Article 167 Art. III of the Constitution)
- Principle: “Credit operations cannot exceed capital spending”.
- Exemptions include supplementary or special credits (for natural disasters, for example); these exceptions require approval of Congress with absolute majority.
- Compliance: checked annually and the rule has always been met. Details included in Annex 9 of the Budget Execution Summary Report (Relatório Resumido de Execução Orçamentária – RREO) issued at the end of each fiscal year.
- Interaction with fiscal aggregates:
  - Golden rule aligned with the cash concept of federal government receipts and expenses as recorded in the budget; broadly, new debt issuances cannot exceed public investment spending.
  - Credit operations comprise receipts from debt refinancing operations and from new debt issuances.
  - Capital spending includes expenses for investment (including financial investments) and debt refinancing operations.
  - Financial receipts can include Central Bank profits, remuneration of the Treasury Single Account (TSA), debt repayments to Treasury by the BNDES, states and municipalities, and can substitute for new debt issuances—thus financial receipts can help compliance by providing financing beyond new debt issuances.
- Coverage/interpretation dispute:
  - Treasury and Planning/SOF diverge over whether investments by state-owned companies should be included as capital spending; the Court of Accounts (TCU) ruled in 2016 that both institutions should harmonize their criterion and a decision is pending. At the moment, Treasury’s interpretation prevails.
- Complementarity with expenditure ceiling: while fiscal aggregates differ across rules, complying with the spending cap in a growth-friendly way—by cutting current spending instead of investments—boosts compliance with the golden rule.

### Wage bill rules (Fiscal Responsibility Law - FRL)
- FRL limits personnel expenditure (expenditures on personnel and pensions) as a share of net current revenue:
  - Federal government: 50 percent.
  - States and municipalities: 60 percent.
- The law specifies further limits within each level of government for the executive, legislative, judiciary and other offices. Table 1 entries (Spending on Personnel as a Share of Net Current Revenues (Percent)):
  - Legislative: 2.50 2.38 2.25
  - Judiciary: 6.00 5.70 5.40
  - Executive: 40.90 38.36 36.81
  - Federal Prosecution Service: 0.60 0.57 0.54
  - Legislative: 3.00 2.85 2.71
  - Judiciary: 6.00 5.70 5.42
  - Executive: 49.00 46.55 44.22
  - State-level Prosecution Service: 2.00 1.90 1.81
  - Legislative: 6.00 5.70 5.42
  - Executive: 54.00 51.30 48.74
  - Government level Power Limit:
    - Federal - 50%
    - State - 60%
    - Municipal - 60%

### Subnational borrowing limits
- The FRL introduced debt ceilings for each level of government which must be approved by the Senate and are defined as a percentage of the net current revenue of each government level.
- According to the FRL, the ratio of net public debt-to-net revenues cannot exceed:
  - Federal government: 3.5
  - States: 2
  - Municipalities: 1.2
- Implementation note: since an agreement was not reached on the limits for the Federal government the only the limits on indebtedness of States and Municipalities are currently in place.
- Additional controls: National Monetary Council Resolutions authorize the central bank to control the supply of domestic bank credit to subnational governments.
- Banking-sector restriction (Resolution 2,827): outstanding loans to the public sector (the three levels, including public enterprises) may not exceed 45 percent of any bank’s (private and public) net worth.
- There are also Senate-set limits for annual borrowing of States and Municipalities.

### Primary balance target and monitoring
- The government sets multiyear numerical targets for the budget balance defined in terms of the primary balance.
- Targets are expressed in levels in the annual Law on Budget Directives and are binding for the first year; targets for the following two years are indicative.
- The target must include projections for the overall balance, expenditure and debt for the two following years and a description of fiscal risks with an assessment of contingent fiscal liabilities.
- Escape clauses exist for exceptional economic conditions and natural disasters and can be invoked with Congressional approval.
- Non-compliance: corrective measures need to be taken and can result in sanctions under the Fiscal Crimes Law, ranging from fines to loss of job.

### Compliance monitoring and institutional arrangements
- Independent Fiscal Institution (IFI):
  - Created in 2016 and attached to the Senate.
  - Produces its own macroeconomic forecasts as a basis for its fiscal scenario; assesses compliance with fiscal targets; evaluates the fiscal impact of government policies, including monetary, credit and foreign exchange policies; and projects the evolution of fiscal indicators relevant for long-term fiscal sustainability.
  - The IFI does not provide normative analysis or recommendations.
- Federal Court of Accounts (TCU):
  - Provides ex post analysis of compliance with primary balance targets and has the mandate to assess compliance with the expenditure rule.

### Debt sustainability (summary finding)
- Debt sustainability risks remain large.
- Gross debt of the non-financial public sector (NFPS) is rapidly increasing.
- Under the baseline scenario, public debt is projected to peak at 95.6 percent of GDP in 2023, reflecting a slow fiscal consolidation.
- The debt-to-GDP ratio is highly sensitive to real GDP growth, fiscal performance, and borrowing costs; a delay in implementing fiscal reforms would jeopardize sustainability.

*Source: cr18253 - 1.      The Constitutional Amendment No. 95, adopted on December 15, 2016 establishes an (Staff Report for the 2018 Article IV Consultation — Informational Annex).*

### 1.      Definitions and coverage. The gross debt statistics of Brazil cover the non-financial public sector

### 1.      Definitions and coverage. The gross debt statistics of Brazil cover the non-financial public sector

### Definitions and coverage
- Gross debt statistics cover the non-financial public sector (NFPS), excluding the state-owned enterprises (SOEs) Petrobras and Eletrobras, and consolidate the Sovereign Wealth Fund.
- Following the GFSM 2014 manual, the NFPS debt includes all Treasury securities on the Central Bank’s (BCB) balance sheet.
- At end-2017, gross debt amounted to 84 percent of GDP.
- The consolidated public sector has a stock of assets equal to 34.3 of GDP in 2017, which include international reserves amounting to 18.9 of GDP.
- Brazil’s debt is reported at nominal value.

### Debt profile
- Federal government (FG) domestic tradable securities account for 92 percent of total NFPS gross debt.
- Of FG domestic tradable securities, close to 2/3 is held by the public and the rest is held by the BCB.
- Nearly 1/3 of FG domestic tradable securities are fixed income securities, 1/3 are linked to inflation, and 1/3 are linked to the SELIC rate.
- Zero coupon bonds with original maturities over one year constitute slightly more than half of FG domestic tradable securities held by the public.
- About 17 percent of FG domestic tradable securities will mature in 2018.
- Foreign currency denominated NFPS debt accounted for only 4.3 percent of GDP.
- Gross financing needs have been consistently above 15 percent of GDP.
- A large fraction of the federal government debt (about 33 percent of total) is held by BCB, following a policy of automatic rollover.

### Debt developments (historical 2017 and drivers)
- At end-2017, NFPS gross debt amounted to 84 percent of GDP, 5.5 percentage points higher than a year before.
- Public sector net debt amounted to 51.6 percent of GDP.
- Primary deficit of 1.7 percent of GDP and net interest payments of 6.1 percent of GDP contributed to the increase in gross debt.
- Net interest payments were slightly lower than 2016 (6.5 percent of GDP).
- Average maturity of FG securities edged down slightly to 4.3 from 4.5 years in 2016.
- In September and October 2017, BNDES repaid R$50 billion in outstanding government securities to the Treasury, resulting in a proportional decline in NFPS assets of 0.7 percent of GDP.
- An additional repayment of 130bn reais in 2018 is mandated and will contribute to lowering the stock of gross debt of up to 2 percent of GDP.
- National definition note: authorities’ national definition of gross debt (which includes Treasury securities used for monetary policy purposes by the BCB but excludes the rest of government securities held by the BCB) yields gross debt of the general government of 74 percent of GDP at end-2017.
- Nominal value definition note: The nominal value is calculated as the PDV of future interest and principal payments at the security’s contractual interest rate(s), and generally differs from face value.

### Baseline and realism of projections (2018–23)
- Macroeconomic assumptions:
  - Real GDP growth of 1.8 percent in 2018, and a gradual return to potential growth of 2.2 percent by 2020.
  - Primary balance moves into positive territory in 2022 (0.1 percent of GDP).
  - Cumulative adjustment of about 3 percentage points of GDP during 2018−23.
  - Nominal interest rates on new borrowing are between 6.6 and 10.7 percent over the projection horizon, bringing the effective interest rate to about 8.9 percent on average.
- Baseline scenario:
  - Assumes limited structural reforms and favorable external conditions.
  - Gross debt remains on an upward trajectory, reaching 95.6 percent of GDP by 2023.
  - If the expenditure cap remains in place until 2027 and the primary balance follows the same consolidation path, debt peaks in 2023 and starts falling in 2024.
  - The debt stabilizing primary balance in the baseline scenario is 1.1 percent of GDP (excluding interest revenue).
- Box: Debt-stabilizing primary balance (DSPB):
  - Under baseline of 2.2 percent growth and 8.6 percent nominal effective interest rate in 2023, the DSPB is 1.1 percent of GDP to stabilize gross debt-to-GDP at 95.6 percent in 2023.
  - If real growth falls (below 2 percent) and interest rates increase (above 8 percent), the DSPB becomes above 2.0 percent of GDP and above.

### Debt profile risks and financing needs
- Stock of debt and gross financing needs (GFN) are high and volatile, mainly because of the repayment schedule of existing zero-coupon bonds.
- GFN breach the high-risk threshold of 15 percent of GDP through most of the projection period.
- Two factors overstate GFN:
  - Actual rollover risk is overstated because of the BCB’s automatic debt roll over policy; GFN would be about 30 percent lower on average excluding rollover of BCB held bonds.
  - Interest on existing FG securities used in the DSA includes accrued interest (reporting debt at nominal value), overstating market borrowing need by about 2 percent of GDP relative to cash interest in early projection years.
- Despite adjustments, debt sustainability risks are large.

### Forecast errors and realism
- Forecast errors for GDP growth are larger than those in surveillance countries reflecting Brazil’s deep recession in 2015−16.
- Projected fiscal adjustment (an improvement of about 1.4 percentage points in the cyclically-adjusted primary balance/GDP over the medium term) is in line with other surveillance countries’ experience.
- Projected path of fiscal adjustment is based on the expenditure rule, which is a constitutional norm.

### Shocks and stress tests (selected scenarios and outcomes)
- Primary balance shock:
  - Expenditure cap abandoned starting in 2019; primary balance deteriorates cumulatively by 8 percentage points of GDP over 2019−23 compared to baseline.
  - Gross debt-to-GDP increases to 104.2 percent in 2023 (8.6 percentage points above baseline).
  - Gross financing needs reach 31.7 percent of GDP.
- Growth shock:
  - Real output growth reduced by one standard deviation (3.5 percent) for two consecutive periods starting in 2019; over 2019−20 real GDP contracts by a cumulative 2.3 percent.
  - Gross debt-to-GDP reaches 102.4 percent, with gross financing needs at 29.6 percent.
- Real interest rate shock:
  - Real interest rate increased by 400bps over 2019−23.
  - Impact modest: pushes debt-to-GDP by 5 percentage points above baseline in 2023.
- Real exchange rate shock:
  - Real exchange rate depreciates by 26 percent in 2019 and remains at this level; impact modest: pushes debt-to-GDP by 0.7 percentage points above baseline in 2023.
- Combined macro-fiscal shock:
  - Combines real growth, interest rate, exchange rate, and primary balance shocks.
  - Gross debt-to-GDP reaches 117.5 percent by 2023, 21.9 percent above baseline.
  - Gross financing needs peak at 34.9 percent of GDP.
- Stronger growth scenario:
  - Output gap closes faster; growth is on average 1.5 percentage point higher in each projection year compared to baseline.
  - Stronger primary surpluses from higher revenues; gross debt-to-GDP declines by about 20 percentage points of GDP by 2023, assuming compliance with expenditure ceiling using high-quality measures and adoption of a strong fiscal framework.

### Key projection table highlights (selected exact figures)
- Nominal gross public debt: 84.0 in 2017; 95.6 in 2023 (percent of GDP).
- Public gross financing needs: 15.9 in 2017; 26.7 in 2023 (percent of GDP).
- Real GDP growth (percent): 1.8 in 2018; 2.2 in 2023.
- Inflation (GDP deflator, percent): 3.1 in 2018; 4.8 in 2023.
- Primary Balance (percent of GDP, baseline): -2.4 in 2018; 0.7 in 2023.
- Effective interest rate (percent): 9.6 in 2018; 8.6 in 2023.
- Identified debt-creating flows cumulative (2018−23): 14.4 (percent of GDP).
- Primary deficit contribution (cumulative identified flows): 4.8 (percent of GDP).
- Automatic debt dynamics (cumulative identified flows): 10.9 (percent of GDP).
- "Interest revenue" (part of residual): values exhibit negative entries in historical years and small negatives in projections (series shown in table).

*https://www.imf.org/-/media/files/publications/cr/2018/cr18253.pdf*

### 1.      I would like to thank staff for the report and for the productive engagement with the

### 1.      I would like to thank staff for the report and for the productive engagement with the

### Acknowledgement
- Thanks to staff for the report and for the productive engagement with the Brazilian authorities.
- Thanks to staff for the laborious FSAP exercise and for the comprehensive FSSA report.

### The ongoing gradual recovery
- Brazil has taken important steps to restore confidence, bring inflation down, and create better conditions for a sustainable economic recovery.
- Congressional actions:
  - Approved a constitutional ceiling for federal expenditures.
  - Increased budget flexibility.
  - Enacted a comprehensive labor reform.
- Central bank initiatives aim to trim the margins of credit to policy rates and increase the traction of monetary policy.
- Policy mix underpinning recovery: gradual fiscal consolidation combined with a supportive monetary policy stance.
- Monetary policy: accommodative, with the policy rate set at a record low level as confidence improved and inflation declined to historical lows.
- Fiscal developments:
  - Discretionary spending has been slashed and reached levels last seen in 2010.
  - Excluding the social security balance, the central government posted in the first five months of this year a primary surplus of R$57 billion, more than R$20 billion above the result in the same period last year in real terms.
  - Authorities acknowledge need to contain mandatory expenditures and create room for needed public investment within the spending ceiling.
  - Parametric changes in social security raised awareness, but there was no sufficient political momentum to approve the constitutional reform before the elections this year.

### Recent developments and outlook
- External environment and domestic shocks:
  - A more challenging and volatile external scenario with declining risk appetite for emerging markets.
  - A slowdown in the recovery in the first quarter and a 10-day strike in truck freight transportation led to downward revisions in growth projections for this year.
- Growth and sectoral performance:
  - Growth of 0.4 percent (qoq) in the first quarter of 2018 marked the fifth consecutive positive quarter after two straight years of contraction.
  - Investment grew 5.3 percent (1Q18/1Q17).
  - Private consumption grew 2.9 percent (1Q18/1Q17).
  - Agricultural sector remained buoyant; industrial sector showed more tepid developments.
  - Economy continues to operate with significant slack, reflected in low levels of capacity utilization and a high, albeit declining, unemployment rate.
- Central Bank of Brazil (BCB) forecast:
  - BCB now forecasts a 1.6 percent growth for 2018, in line with market expectations and one percentage point below what was projected at the end of March.
- Inflation and monetary policy:
  - Monetary policy remains accommodative while vigilant to inflation expectations and second-round effects.
  - Inflation reached 2.9 percent last May, running below the tolerance range.
  - Impacts from the transport sector strike and the weakening of the domestic currency are unfolding and expected to be considerable, but temporary.
  - Most recent market survey indicates inflation expectations for this year and the next remain well-anchored around 4 percent, still below the target, which has been set on a downward path to 3.75 percent in 2021.
  - Risks to the baseline scenario include external shocks and internal shocks, including unfavorable perceptions about the pace of reforms.
- Fiscal stance:
  - Fiscal stance will continue consistent with a gradual consolidation path, mindful of risks and taking opportunities from unexpected revenues to strengthen the primary balance.
  - Authorities committed to a sustainable fiscal path anchored by the spending ceiling, which ensures a contraction of roughly half a percentage point per year in the public expenditure ratio to GDP.
  - Approval of a comprehensive pension reform will be instrumental for proper application of the spending ceiling.
  - Staff notes the 2018 budget loosens the fiscal stance relative to the government's original bill, but fiscal assessment must consider execution of revenue collection and primary spending.
  - For the first five months of this year:
    - Primary deficit of the central government at R$ 16.4 billion is less than half the deficit for the same period in 2017 (R$ 36.6 billion).
    - If adjusted for timing of payment of court ordered credits (precatórios), the 2018 Jan-May primary deficit would be R$ 5.7 billion, less than 16 percent of last year’s figure.
- External sector and reserves:
  - Current account deficit (CAD) has shrunk to 0.6 percent of GDP in May and should remain at this level by the end of the year.
  - Floating exchange rate functions as first line of defense and shock absorber; since 1999 the BRL is one of the G20 currencies that has floated most extensively.
  - Central bank interventions via swaps and repos have been used transparently to meet market demand for hedge and liquidity while allowing adjustment.
  - FDI continues to post robust figures, covering the CAD by several times.
  - International reserves at US$ 382 billion represent 28 months of imports and three and a half times all external debt related payments due within twelve months.
- Credit and household/corporate finance:
  - Credit has evolved in line with the measured recovery and monetary stimulus.
  - Average interest rate for new credit concessions declining in the non-earmarked segment for both households and businesses.
  - Corporate deleveraging remains incomplete; corporate finance composition shifting toward capital markets and external credit.
  - Household indebtedness declined to a level close to 2011, allowing credit expansion consistent with improvements in disposable income and lower costs.

### Financial stability assessment
- Conclusion: Brazilian financial system has remained resilient after the deep contraction of 2015-2016.
- Banks:
  - Banks remain largely able to withstand another round of severe macroeconomic and financial shocks.
  - Bank concentration in Brazil, albeit high, is similar to those of other mature economies.
- Regulation and supervision:
  - Supervisory and regulatory frameworks and practices have evolved continuously.
  - Authorities’ efforts to improve financial regulation and supervision align with FSAP recommendations.
  - New regulation on Fintech aims to favor competition and enhance reach and efficiency without hampering stability.
  - Increasing competition in the financial sector and tackling hindrances that contribute to high cost of credit are permanent objectives at the BCB and permeate the BC+ agenda.
- Divergent views:
  - Some specific recommendations did not resonate with authorities, e.g., turning the deposit insurance fund into a public sector entity, given its effective operation and collective ownership by the system.

### Overall assessment
- Policy stance adjusted to cope with weaker growth momentum and more challenging international environment.
- More reforms needed to ensure sustainability of the fiscal framework over time and to further productivity and efficiency in the economy.

*IMF staff report excerpts as provided in source content.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18253.pdf_