## BRAZIL: STAFF REPORT FOR THE 2023 ARTICLE IV CONSULTATION ## Source details **Canonical URL:** [BRAZIL: STAFF REPORT FOR THE 2023 ARTICLE IV CONSULTATION](https://www.imf.org/-/media/files/publications/cr/2023/english/1braea2023001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1braea2023001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1braea2023001.pdf.json) --- ### Executive Board Assessment - After a rapid recovery from the pandemic, Brazil’s economic activity is converging towards potential levels. - Directors noted downside risks related to the uncertain external environment, while many emphasized that the balance of risks has shifted, with domestic risks now tilted to the upside. - Directors encouraged the authorities to continue fiscal consolidation and price stabilization efforts, while sustaining structural reforms to promote a sustainable, inclusive, and green economy. - Progress welcomed on the legislative agenda: tax reform, new fiscal framework, and strengthening administrative review of tax disputes. - Resilience supported by: - a sound financial system, - adequate FX reserves, - large public sector cash buffers, - a flexible exchange rate regime. ### Outlook and Risks - Growth and inflation outlook: - GDP growth is moderating but expected to gradually improve towards staff’s estimate of potential over the medium term. - With the monetary policy stance remaining in restrictive territory, inflation would converge to target by mid-2025. - Fiscal outlook (staff baseline): - An improvement in the non-financial public sector (NFPS) primary balance of around 3 percent of GDP is projected over the medium term, contingent on implementation of measures. - NFPS gross debt stabilizes at 97 percent of GDP in staff’s baseline scenario. - Balance of risks: - Tilted to the downside overall: - External downside risks: abrupt global slowdown; sharp tightening of global financial conditions; commodity price volatility. - Domestic downside risks: renewed fiscal uncertainty; more persistent inflation. - Downside risks mitigated by strong buffers listed under Executive Board Assessment. - Upside channels: - More ambitious fiscal consolidation, - Approval and implementation of the indirect tax reform, - Green growth opportunities. ### Key Policy Recommendations — Overview - Fiscal Policy: - Authorities’ commitment to improve the fiscal position guided by the new proposed fiscal rule is welcomed. - To put debt on a firmly declining path, staff recommends a more ambitious fiscal effort anchored in an enhanced fiscal framework that builds on the new rule. - Expenditure reforms needed to tackle rigidities, including on pensions and public administration. - Indirect tax reform under discussion would significantly simplify the tax regime and boost potential output. - Planned direct tax reform is key to: - generate additional revenues, - eliminate inefficient tax expenditures, - increase progressivity. - Monetary and Exchange Rate Policy: - Monetary policy stance is appropriate and consistent with inflation converging to target. - Adoption of a continuous 3 percent inflation target from 2025 onwards should help reduce uncertainty and improve monetary policy effectiveness. - Build on improvements to BCB autonomy; future efforts could focus on flexibility in budgetary decisions and in setting risk buffers. - Flexible exchange rate regime and adequate FX reserves remain important shock buffers. - Develop guidance on the use of FX swaps, aiming to reduce the outstanding high stock when conditions allow. - Financial Sector Policies: - Financial sector remains resilient; systemic risks contained with adequately capitalized, profitable, and liquid banks. - Address household debt vulnerabilities; consider a tailored limit on households’ debt service-to-income ratio (DSTI). - Carefully manage any bigger role for public banks to mitigate fiscal sustainability and monetary transmission risks. - Leverage financial innovation: Pix success and plans to launch a wholesale Central Bank Digital Currency (CBDC). - Structural Reforms: - Priorities to lift low potential growth: - increase investment in physical and human capital, - boost skills and improve education, - focus on early childhood and expand childcare centers to support female labor force participation, - further labor market reforms and trade integration to support productivity and competitiveness. - Climate Policy: - Climate risks affect agriculture and power generation; land-use patterns amplify water-cycle risks. - Policy options: - boost Amazon resilience via fiscal incentives for forest protection, - invest in climate-smart agriculture and insurance, - continue diversification of power supply to renewables, - develop a green and social taxonomy, - leverage the BCB Sustainability Agenda. - To meet emissions reduction ambitions: - plans to create a mandatory Emissions Trading System (ETS) are welcome, - launching the first sovereign green bond would be first step to develop a yield curve for green bonds to catalyze private financing. ### Selected Macro and Financial Indicators (highlights) - Social and demographic: - Area (thousands of sq. km.): 8,510 - Population total (million) (2022): 203.1 - GDP, local currency (2022): R$9,915 billion - GDP, dollars (2022): US$1,920 billion - GDP per capita (2022): US$9,455 - Poverty rate (in percent, 2021) 1/: 29.4 - Gini coefficient (2020): 48.9 - National accounts and prices (percentage change): - GDP at current prices: 16.9 (2021), 11.4 (2022), 5.9 (2023), 7.0 (2024), 5.5 (2025), 5.4 (2026), 5.6 (2027), 5.6 (2028) - GDP at constant prices: 5.0 (2021), 2.9 (2022), 2.1 (2023), 1.2 (2024), 1.7 (2025), 1.9 (2026), 2.0 (2027), 2.0 (2028) - Consumer prices (IPCA, average): 8.3 (2021), 9.3 (2022), 5.1 (2023), 4.6 (2024), 3.0 (2025), 3.0 (2026), 3.0 (2027), 3.0 (2028) - Consumer prices (IPCA, end of period): 10.1 (2021), 5.8 (2022), 5.4 (2023), 3.9 (2024), 3.0 (2025), 3.0 (2026), 3.0 (2027), 3.0 (2028) - Public sector finances (percent of GDP): - Central government primary balance 2/: -0.4 (2021), 0.5 (2022), -1.3 (2023), -0.8 (2024), -0.3 (2025), 0.3 (2026), 0.9 (2027), 1.3 (2028) - NFPS primary balance: 0.7 (2021), 1.3 (2022), -1.3 (2023), -0.8 (2024), -0.3 (2025), 0.3 (2026), 0.9 (2027), 1.3 (2028) - NFPS overall balance: -4.3 (2021), -4.6 (2022), -7.9 (2023), -7.4 (2024), -6.2 (2025), -5.4 (2026), -4.8 (2027), -4.2 (2028) - Net public sector debt: 55.8 (2021), 57.1 (2022), 60.1 (2023), 63.5 (2024), 66.2 (2025), 68.3 (2026), 69.3 (2027), 70.1 (2028) - NFPS gross debt: 90.7 (2021), 85.9 (2022), 89.2 (2023), 91.2 (2024), 93.3 (2025), 94.8 (2026), 95.6 (2027), 95.9 (2028) - Balance of payments (Billions of U.S. dollars): - Trade balance: 36.4 (2021), 44.2 (2022), 50.1 (2023), 47.0 (2024), 47.8 (2025), 49.0 (2026), 50.1 (2027), 50.2 (2028) - Exports: 284.0 (2021), 340.3 (2022), 338.5 (2023), 343.3 (2024), 349.4 (2025), 357.4 (2026), 366.5 (2027), 379.0 (2028) - Imports: 247.6 (2021), 296.2 (2022), 288.4 (2023), 296.3 (2024), 301.6 (2025), 308.4 (2026), 316.4 (2027), 328.8 (2028) - Current account: -46.4 (2021), -56.9 (2022), -48.0 (2023), -56.1 (2024), -58.6 (2025), -60.0 (2026), -61.4 (2027), -64.2 (2028) - Foreign direct investment (net inflows): 30.2 (2021), 60.8 (2022), 54.2 (2023), 53.2 (2024), 52.4 (2025), 53.3 (2026), 54.3 (2027), 55.3 (2028) - Memorandum items: - Output Gap: -0.2 (2021), 0.9 (2022), 1.0 (2023), 0.2 (2024), 0.0 (2025), 0.0 (2026), 0.0 (2027), 0.0 (2028) - Current account (in percent of GDP): -2.8 (2021), -3.0 (2022), -2.3 (2023), -2.5 (2024), -2.5 (2025), -2.4 (2026), -2.4 (2027), -2.3 (2028) - Unemployment rate 5/: 13.2 (2021), 9.3 (2022), 9.5 (2023), 9.4 (2024), 9.4 (2025), 9.4 (2026), 9.4 (2027), 9.4 (2028) - Gross official reserves: 362 (2021), 325 (2022), 346 (2023), 346 (2024), 346 (2025), 346 (2026), 346 (2027), 346 (2028) ### Implementation Priorities and Institutional Recommendations - Fiscal: - Adopt and operationalize the enhanced fiscal framework built on the new fiscal rule. - Pursue expenditure reforms (pensions, public administration). - Implement indirect and direct tax reforms to broaden the base and increase progressivity. - Monetary: - Maintain a forward-looking, data-dependent monetary stance. - Operationalize continuous 3 percent inflation target from 2025. - Consider guidance on FX swaps to reduce the outstanding stock when feasible. - Financial stability: - Monitor and address household debt vulnerabilities; consider DSTI limits. - Manage role of public banks to limit fiscal and monetary transmission risks. - Continue oversight of digital innovations (Pix, Open Finance, Digital Real/CBDC). - Structural and social policies: - Invest in education and skills, early childhood, and childcare to raise potential growth and female labor force participation. - Enhance anti-corruption and AML/CFT frameworks. - Climate: - Implement fiscal incentives for forest protection. - Invest in climate-smart agriculture and insurance. - Diversify power supply to renewables. - Pursue a mandatory ETS. - Issue the first sovereign green bond to catalyze private green financing. ### Fiscal targets, debt outlook, and recommended fiscal effort - Authorities’ fiscal targets and strategy: - Authorities aim to improve the federal primary balance: - from a projected deficit of 2.2 percent of GDP in the 2023 budget - to a deficit of 0.5 percent of GDP in 2023 - and to a surplus of 1 percent of GDP by 2026, within a narrow tolerance band. - Authorities estimate consolidation of about 3 percent of GDP would stabilize public debt by 2026 (authorities’ definition). - Staff estimates authorities’ strategy would require increasing revenues by about 2.5 percent of GDP over the near to medium term from the 2023 budget. - Staff baseline and medium-term assessment: - Staff’s baseline projects a NFPS primary deficit of 1.3 percent of GDP in 2023. - Staff projects an improvement to a NFPS primary surplus of 1.3 percent of GDP over the medium term under gradual implementation of tax revenue measures and moderated spending growth. - Staff finds risks of debt distress to be moderate under the baseline, but debt trajectory highly sensitive to shocks to borrowing costs and real GDP growth, and to fiscal risks. - Recommended fiscal effort: - Staff estimates a total fiscal effort of around 4-4½ percent of GDP over the medium term (about 2-3 percent of GDP in spending measures and 1-2 percent of GDP in revenue measures) would put debt on a firmly downward path while preserving space for inclusive and growth-friendly spending. ### Enhancements to the proposed new fiscal rule (selected staff recommendations) - Strong fiscal anchor that puts debt on a firmly downward path; under staff assumptions, a primary surplus of around 1½ percent of GDP would be needed to stabilize debt over the longer term. - Adequate longer-term anchor: net general government debt-to-GDP ratio of around 55 percent (NFPS gross debt of 80-85 percent). - Alternatively, a binding multi-year primary balance path with a correction mechanism to offset deviations. - Strengthen spending rule elements to: - ensure consistency with primary balance targets, - link spending growth to sustained increases in the structural revenue-to-GDP ratio, - reduce embedded pro-cyclical bias, - harmonize rules on current versus capital spending to mitigate misclassification risks, - allow spending cuts in budget preparation if needed. - Define a well-specified economic escape clause. - Introduce a mechanism to promote additional government savings when commodity prices are high. - Implement rules for subnational governments to harden budget constraints and strengthen monitoring. - Develop a more comprehensive medium-term fiscal framework (MTFF) and strengthen institutions; suggested roles for the Independent Fiscal Council (IFI) include monitoring escape clauses, running debt sustainability analysis with independent assumptions, and publishing goalposts and milestones. ### Tackling spending rigidities while protecting social and investment spending - Mandatory spending (mainly pensions and wages) has reached more than 90 percent of general government spending. - Reform options that could generate savings of about 2-3 percent of GDP over time include: - Pensions: - Federal and subnational RPPS regimes generate a deficit of about 2.5 percent of GDP. - Options: align all RPPS to RGPS parameters; reduce replacement rates; increase effective retirement age; higher contribution rates; full income taxation of pensions; coordination of non-contributory regimes. - Implement an automatic adjustment mechanism for pension parameters. - Public administration: - Employee compensation accounts for about 30 percent of general government spending and 12 percent of GDP. - Adjust wage growth below nominal GDP (e.g., by IPCA) and implement targeted attrition policies to save up to 1 percent of GDP. - Budget rigidities: - Review spending indexation and revenue earmarking rules combined with sectoral spending reviews. ### Indirect and direct tax reform priorities - Indirect tax reform: - Revenue-neutral plan merging consumption taxes into an integrated VAT would foster efficiency and productivity gains, reduce tax competition among subnational governments, mitigate judiciary dispute risks, and boost potential growth. - Support for the poor via targeted VAT refunds and/or cash transfers is welcome. - Direct tax reform: - Expected in second half of 2023 to generate additional revenues, eliminate inefficient tax expenditures, and increase progressivity. - Staff estimates measures could yield about 1-2 percent of GDP in additional revenues from: - Personal Income Tax: broaden base, limit deductions, improve progressivity. - Corporate Income Tax: broaden base, limit exemptions, reintroduce dividend taxation. - SIMPLES: lower eligibility threshold options and improve graduation. - Property Taxes: broaden base and strengthen collection. - Commodity Revenues: refrain from ad hoc temporary taxes; tailor taxes to capture rents. ### Monetary policy, FX swaps, and reserves - Monetary policy context: - Policy rate at 13.75 percent; ex-ante real rate around 9 percent (using 12-month ahead inflation expectations). - Neutral rate estimates of at least 4 percent. - BCB on hold since August 2022. - CMN decision to adopt a continuous target of 3 percent from 2025 onwards. - Exchange rate and FX swaps: - Flexible exchange rate regime and adequate FX reserves are important shock buffers. - Reserve adequacy: 136 percent of the IMF ARA metric as of end-2022. - Since 2020, stock of non-deliverable futures denominated in local currency (FX swaps) increased by close to US$70 billion. - Stock of FX swaps has risen to over 30 percent of reserves. - Recommendation: develop a plan to reduce the outstanding FX swap stock when market conditions are conducive; improve currency convertibility and deepen FX spot markets. - Reserves and external buffers: - International reserves: US$362 billion at end-2021; US$325 billion at end-2022; recovered to US$345 billion in May (some tables show gross reserves eop = 362.2 (2021), 324.7 (2022), 345.7 (2023–2028)). ### Financial sector, household debt, and macroprudential options - Banking sector resilience: - Average Tier1 ratio of 14.2 percent at end-2022. - Liquidity coverage ratios well above regulatory minimum. - NPL ratios picked up but remain close to long-term average of about 3 percent. - Unrealized losses from held-to-maturity portfolios small: 2-3 percent of equity for the two largest private banks and less than 1 percent for other major banks. - Household debt vulnerabilities: - Households’ DSTI ratio reached an all-time high of 27.7 percent in April. - Government estimates nearly 70 million individuals (one-third of the population) are in default on some form of debt. - Desenrola program to restructure existing household debt; government guarantee for consolidated and restructured debt of low-income households using a BRL 10 billion fund (0.1 percent of GDP). - IMF policy option: prudential limit appropriate when DSTI exceeds 20-25 percent and rising above a 15-year trend; BCB could set targeted prudential limits focused on riskier credit modalities. - Public banks: - Public banks make up about 35 percent of the banking system (system ~140 percent of GDP). - Caixa funding: slightly over 20 percent from FGTS which totals about BRL 600 billion; Caixa on-lends some BRL 354 billion for mortgages. - BNDES funding from FAT about BRL 400 billion. - Public banks profitable with ROEs averaging 15 percent for two largest public banks; T1 capital ratios around 15 percent as of Q3 2022; liquidity ratios above 200 percent for two largest public banks. - Risks: expanding earmarked credit at subsidized rates can distort allocation and complicate monetary transmission; past recapitalizations occurred and cost of earmarking estimated at 1.5-2 percent of GDP per year on average historically. - Recommendation: maintain market-rate benchmarks for government funding, use co-financing and loan guarantees, maintain underwriting standards. ### Financial innovation and Digital Real - Open Finance uptake: - "5 million users in less than one year" - "22 million after two years" - Pix outcomes: - Tens of millions of new users of payment accounts; increased inclusion and efficiency. - Digital Real (RD) objectives and design: - Wholesale CBDC planned (end-2024 or early 2025 in some notes; CMN decision operationalizes target from 2025), intended for bank reserves and settlement accounts. - Design to use tokenized deposits/accounts issued by regulated institutions to minimize disintermediation risks. - Legal, operational, and privacy challenges identified; gradual approach may be required. ### Macro frameworks, potential growth, and Annex findings - Potential output: - Long-run pattern: 2003–2008 averaged about 4.1 percent; 2009–2013 averaged about 3.3 percent; 2014–2019 averaged 0.1 percent; recent years up to 2022 averaged 1.3 percent. - Cross-methodology 2022 range: 1.3-2.2 percent. - Annex IV — Debt Sustainability Analysis: - Overall risk of sovereign stress: Moderate. - NFPS gross debt: 85.9 percent of GDP (end-2022) declining from previous highs then projected under baseline to stabilize around 97 percent of GDP over extended horizon. - Public sector assets stock = 26 percent of GDP, including international reserves = 16 percent of GDP. - Stock of judicial claims reached 38 percent of GDP in 2022 (Annex V). - Staff projects gross financing needs and real interest rates across 2023–2032 with specific annual figures (see tables in source). ### Risks, scenarios, and credibility effects - IMF GIMF simulations: - Scenario of tackling spending rigidities through entitlement reform and other spending restraint of about 2½ percent of GDP, complemented by tax measures of around 1 percent of GDP, with savings over a 5-year horizon and a decline in the sovereign risk premium of 25 bps per year. - Two expectations modes: - Limited credibility: agents update yearly; consolidation weighs on GDP; real GDP declines relative to baseline. - Credibility with stepwise updating: agents consider fiscal path credible; investment increases; negative output effects broadly offset. - Results reinforce benefits of consolidation supported by reforms tackling spending rigidities and bolstering credibility. ### Social, labor market, and distributional notes - Poverty and inequality: - Poverty rate (in percent, 2021) 1/: 29.4 - Minimum wage around 70 percent of median wage. - Labor market: - Real GDP growth: 5.0 (2021), 2.9 (2022), 2.1 (2023), 1.2 (2024), 1.7 (2025), 1.9 (2026), 2.0 (2027), 2.0 (2028) (percent, constant prices). - Employment growth cooled to 0.9 percent year-over-year in May 2023, from 9.8 percent at end-2021. - Female labor participation: participation rate for women with young kids fell about 3.9 percentage points relative to pre-pandemic trend; about 25 percent of women reported care work as reason for not searching for jobs in Q1 2023 survey. - Policy implication: expanding early childhood care and daycare centers, reducing gender pay gaps, increasing pay transparency, expanding parental leave. *Source: IMF staff report for the 2023 Article IV consultation with Brazil (June 29, 2023).* ### 2.3 percent of GDP this year and remain broadly stable over the medium term. ### BRAZIL: STAFF REPORT FOR THE 2023 ARTICLE IV CONSULTATION ### Executive Board Assessment - Directors noted that after a rapid recovery from the pandemic, supported by ample buffers and proactive policies, Brazil’s economic activity is converging towards potential levels. - Directors noted downside risks related to the uncertain external environment, but many emphasized that the balance of risks has shifted, with domestic risks now tilted to the upside. - Directors encouraged the authorities to continue fiscal consolidation and price stabilization efforts, while sustaining structural reforms to promote a sustainable, inclusive, and green economy. - Directors welcomed progress on the legislative agenda: tax reform, new fiscal framework, and strengthening administrative review of tax disputes. - Resilience is supported by: - a sound financial system, - adequate FX reserves, - large public sector cash buffers, - a flexible exchange rate regime. ### Key Issues and Recent Context - Economic context: - After a rapid recovery from the pandemic, economic activity is converging towards potential levels. - Headline inflation has rapidly declined from last year’s peak, but core inflation remains elevated and inflation expectations are above target. - The new government expanded the 2023 budget envelope while identifying measures to recover tax revenues. - Authorities are pursuing an ambitious agenda to steer a sustainable, inclusive, and green economy. - Strong buffers mitigate downside risks from: - an abrupt global slowdown, - a sharp tightening of global financial conditions, - commodity price volatility, - renewed fiscal uncertainty, - more persistent inflation. - Upside factors include: - more ambitious fiscal consolidation, - approval and implementation of the indirect tax reform, - green growth opportunities. ### Outlook and Risks - Growth and inflation outlook: - GDP growth is moderating but expected to gradually improve towards staff’s estimate of potential over the medium term. - With the monetary policy stance remaining in restrictive territory, inflation would converge to target by mid-2025. - Fiscal outlook (staff baseline): - An improvement in the non-financial public sector (NFPS) primary balance of around 3 percent of GDP is projected over the medium term, contingent on implementation of measures. - NFPS gross debt stabilizes at 97 percent of GDP in staff’s baseline scenario. - Balance of risks: - Tilted to the downside overall, with external and domestic downside risks noted above. - Downside risks are mitigated by strong buffers listed under Executive Board Assessment. ### Key Policy Recommendations — Overview - Fiscal Policy - Authorities’ commitment to improve the fiscal position guided by the new proposed fiscal rule is welcomed. - To put debt on a firmly declining path, staff recommends a more ambitious fiscal effort anchored in an enhanced fiscal framework that builds on the new rule. - Expenditure reforms are needed to tackle rigidities, including on pensions and public administration. - The indirect tax reform under discussion would significantly simplify the tax regime and boost potential output. - The planned direct tax reform is key to: - generate additional revenues, - eliminate inefficient tax expenditures, - increase progressivity. - Monetary and Exchange Rate Policy - The monetary policy stance is appropriate and consistent with inflation converging to target, in line with the inflation targeting framework. - The recent decision to adopt a continuous 3 percent inflation target from 2025 onwards should help reduce uncertainty and improve monetary policy effectiveness. - Building on improvements to BCB autonomy, future efforts could focus on flexibility in budgetary decisions and in setting risk buffers. - The flexible exchange rate regime and adequate FX reserves remain important shock buffers. - Developing additional guidance on the use of FX swaps, aiming to reduce the outstanding high stock when conditions allow, would be advisable. - Financial Sector Policies - Financial sector remains resilient; systemic risks are contained with adequately capitalized, profitable, and liquid banks. - Authorities are taking steps to address household debt vulnerabilities. - Consideration could be given to a tailored limit on households’ debt service-to-income ratio (DSTI) to protect consumers on future borrowing. - Carefully managing any bigger role for public banks is important to mitigate risks for fiscal sustainability and monetary policy transmission. - Benefits of financial innovation: - successful instant payment system Pix, - plans to launch a wholesale Central Bank Digital Currency (CBDC). - Structural Reforms - Priorities to lift low potential growth: - increase investment in physical and human capital, - boost skills and improve education, - focus on early childhood and expand childcare centers to support female labor force participation, - further labor market reforms and trade integration to support productivity and competitiveness. - Climate Policy - Climate risks already affect agriculture and power generation; land-use patterns amplify climate risks by affecting water cycles. - Policy options under consideration: - boost Amazon resilience to climate shocks via fiscal incentives for forest protection, - invest in climate smart agriculture and insurance, - continue diversification of power supply to renewables, - develop a green and social taxonomy, - leverage the BCB Sustainability Agenda. - To meet emissions reduction ambitions: - plans to create a mandatory Emissions Trading System (ETS) are welcome. - launching the first sovereign green bond would be the first step in developing a yield curve for green bonds to catalyze private financing. ### Selected Macro and Financial Indicators (highlights from Table 1) - Social and demographic - Area (thousands of sq. km.): 8,510 - Population total (million) (2022): 203.1 - GDP, local currency (2022): R$9,915 billion - GDP, dollars (2022): US$1,920 billion - GDP per capita (2022): US$9,455 - Poverty rate (in percent, 2021) 1/: 29.4 - Gini coefficient (2020): 48.9 - National accounts and prices (percentage change) - GDP at current prices: 16.9 (2021), 11.4 (2022), 5.9 (2023), 7.0 (2024), 5.5 (2025), 5.4 (2026), 5.6 (2027), 5.6 (2028) - GDP at constant prices: 5.0 (2021), 2.9 (2022), 2.1 (2023), 1.2 (2024), 1.7 (2025), 1.9 (2026), 2.0 (2027), 2.0 (2028) - Consumer prices (IPCA, average): 8.3 (2021), 9.3 (2022), 5.1 (2023), 4.6 (2024), 3.0 (2025), 3.0 (2026), 3.0 (2027), 3.0 (2028) - Consumer prices (IPCA, end of period): 10.1 (2021), 5.8 (2022), 5.4 (2023), 3.9 (2024), 3.0 (2025), 3.0 (2026), 3.0 (2027), 3.0 (2028) - Public sector finances (percent of GDP) - Central government primary balance 2/: -0.4 (2021), 0.5 (2022), -1.3 (2023), -0.8 (2024), -0.3 (2025), 0.3 (2026), 0.9 (2027), 1.3 (2028) - NFPS primary balance: 0.7 (2021), 1.3 (2022), -1.3 (2023), -0.8 (2024), -0.3 (2025), 0.3 (2026), 0.9 (2027), 1.3 (2028) - NFPS overall balance: -4.3 (2021), -4.6 (2022), -7.9 (2023), -7.4 (2024), -6.2 (2025), -5.4 (2026), -4.8 (2027), -4.2 (2028) - Net public sector debt: 55.8 (2021), 57.1 (2022), 60.1 (2023), 63.5 (2024), 66.2 (2025), 68.3 (2026), 69.3 (2027), 70.1 (2028) - NFPS gross debt: 90.7 (2021), 85.9 (2022), 89.2 (2023), 91.2 (2024), 93.3 (2025), 94.8 (2026), 95.6 (2027), 95.9 (2028) - Balance of payments (Billions of U.S. dollars) - Trade balance: 36.4 (2021), 44.2 (2022), 50.1 (2023), 47.0 (2024), 47.8 (2025), 49.0 (2026), 50.1 (2027), 50.2 (2028) - Exports: 284.0 (2021), 340.3 (2022), 338.5 (2023), 343.3 (2024), 349.4 (2025), 357.4 (2026), 366.5 (2027), 379.0 (2028) - Imports: 247.6 (2021), 296.2 (2022), 288.4 (2023), 296.3 (2024), 301.6 (2025), 308.4 (2026), 316.4 (2027), 328.8 (2028) - Current account: -46.4 (2021), -56.9 (2022), -48.0 (2023), -56.1 (2024), -58.6 (2025), -60.0 (2026), -61.4 (2027), -64.2 (2028) - Foreign direct investment (net inflows): 30.2 (2021), 60.8 (2022), 54.2 (2023), 53.2 (2024), 52.4 (2025), 53.3 (2026), 54.3 (2027), 55.3 (2028) - Memorandum items - Output Gap: -0.2 (2021), 0.9 (2022), 1.0 (2023), 0.2 (2024), 0.0 (2025), 0.0 (2026), 0.0 (2027), 0.0 (2028) - Current account (in percent of GDP): -2.8 (2021), -3.0 (2022), -2.3 (2023), -2.5 (2024), -2.5 (2025), -2.4 (2026), -2.4 (2027), -2.3 (2028) - Unemployment rate 5/: 13.2 (2021), 9.3 (2022), 9.5 (2023), 9.4 (2024), 9.4 (2025), 9.4 (2026), 9.4 (2027), 9.4 (2028) - Gross official reserves: 362 (2021), 325 (2022), 346 (2023), 346 (2024), 346 (2025), 346 (2026), 346 (2027), 346 (2028) ### Implementation Priorities and Institutional Recommendations - Fiscal: adopt and operationalize the enhanced fiscal framework built on the new fiscal rule; pursue expenditure reforms (pensions, public administration); implement indirect and direct tax reforms to broaden the base and increase progressivity. - Monetary: maintain a forward-looking, data-dependent monetary stance; operationalize continuous 3 percent inflation target from 2025; consider guidance on FX swaps to reduce the outstanding stock when feasible. - Financial stability: monitor and address household debt vulnerabilities; consider DSTI limits; manage the role of public banks to limit fiscal and monetary transmission risks; continue oversight of digital innovations (Pix, Open Finance, Digital Real/CBDC). - Structural and social policies: invest in education and skills, early childhood, and childcare to raise potential growth and female labor force participation; enhance anti-corruption and AML/CFT frameworks. - Climate: implement fiscal incentives for forest protection; invest in climate-smart agriculture and insurance; diversify power supply to renewables; pursue a mandatory ETS; issue the first sovereign green bond to catalyze private green financing. *Source: IMF staff report for the 2023 Article IV consultation with Brazil (June 29, 2023).* ### 4. Depository Corporations and Monetary Aggregates, 2018-22 ________________________________ 47 ### 1braea2023001 - 4. Depository Corporations and Monetary Aggregates, 2018-22 ________________________________ 47 ### Context - New administration (January 2023) priorities: addressing hunger and inequality, turning Brazil into an environmental leader, ensuring fiscal credibility and robust public policies. - Early steps: renewed Bolsa Familia program replacing Auxilio Brasil; measures to halt illegal deforestation and re-establish the Amazon Fund; proposing a new fiscal rule and measures to restore fiscal revenues; advancing indirect tax reform. - Structural constraints: low potential growth, entrenched budget rigidities limiting priority spending (including public investment), and climate risks absent investment in resilient infrastructure and energy production. ### Recent developments — macro and labor markets - Growth and activity - Real GDP grew by 5 percent in 2021. - Growth slowed to 2.9 percent in 2022 (above staff’s estimate of potential). - In early 2023: very strong agricultural output; subdued manufacturing and services. - Employment growth cooled to 0.9 percent year-over-year in May 2023, from 9.8 percent at end-2021. - Labor market and gender gaps (Box 1) - Unemployment rose sharply during the pandemic and declined across the board since mid-2021. - Real wages bounced back to pre-pandemic levels. - Rapid growth in gig/new economy employment poses social security and job protection challenges. - Female labor participation: progress stalled post-pandemic; participation rate for women with young kids fell about 3.9 percentage points relative to pre-pandemic trend, compared to a 0.14 percentage point decline for equivalent male counterparts. - About 25 percent of women reported care work as the reason for not searching for jobs in the Q1 2023 survey. - Policy implication: expanding early childhood care and day-care centers, reducing gender pay gaps, increasing pay transparency, and expanding parental leave would help narrow participation gaps and boost potential growth. ### Recent developments — inflation, monetary policy, and credit - Inflation - Headline inflation peaked at 12 percent year-over-year in April 2022. - Headline inflation declined to 3.9 percent in May (within the tolerance band). - Core inflation: peaked at 9.7 percent in June 2022 and declined to 7.2 percent in May. - Core inflation has been more persistent due to a positive output gap, tighter labor markets, and more persistent inflation expectations. - Monetary policy - Policy rate at 13.75 percent; ex-ante real rate around 9 percent (using 12-month ahead inflation expectations). - Neutral rate estimates of at least 4 percent. - BCB has been on hold since August 2022. - National Monetary Council (CMN) decision in June to adopt a continuous target of 3 percent from 2025 onwards. - Credit and financial stability - Bank credit growth declined to 10 percent year-over-year in May (from 18 percent in mid-2022). - Credit gap remains positive. - Households’ DSTI ratio reached an all-time high of 27.7 percent in April. - Banks’ NPL ratios have picked up but remain close to long-term average of about 3 percent. - Financial innovation and digital underwriting broadened credit access; two largest payment institutions now each represent about 1 percent of banking system assets. - External sector and reserves - Current account deficit reached 3 percent of GDP in 2022 (despite a sizable goods trade surplus). - Current account financed by net FDI inflows of 3.1 percent of GDP and limited net portfolio outflows of 0.3 percent of GDP. - International reserves: US$362 billion at end-2021, declined to US$325 billion at end-2022 (mostly valuation effects), recovered to US$345 billion in May. - 2022 external position assessed broadly in line with fundamentals (Annex II). ### Recent developments — fiscal - 2022 fiscal outcomes - NFPS primary surplus increased from 0.7 in 2021 to 1.3 percent of GDP in 2022. - Commodity revenues about 3½ percent of GDP (record, double the decade-long average). - NFPS gross debt declined to 86 percent of GDP at end-2022 (below pre-pandemic levels). - Nonetheless, fiscal stance was expansionary in 2022 as structural balance deteriorated due to broad tax cuts (ICMS, PIS/COFINS) and higher social spending. - 2023 fiscal actions and measures - ‘Transition constitutional amendment’ expanded projected federal primary deficit in the 2023 budget to 2.2 percent of GDP to accommodate continuation of social benefits, public investment programs (including social housing), and increases in public wages and pensions; amendment ended the federal spending cap and called for a new fiscal rule (unveiled in March). - Authorities reversed pandemic-related tax cuts on fuels and financial revenues and implemented tax changes on transfer pricing and offshore financial revenues. - Recent court decisions on double taxation across levels of government expected to be implemented in coming months. - Authorities estimate these measures would yield about 2.3 percent of GDP in the near term, of which 1.6 percent of GDP would be permanent. ### Outlook and projections - Growth and inflation - Growth projected to moderate from 2.9 percent in 2022 to 2.1 percent in 2023, then converge to staff’s estimated potential over the medium term. - Headline inflation expected to reach 5.4 percent by end-2023 and converge to the target of 3 percent by mid-2025. - Core inflation projected to decline more gradually. - Fiscal and external projections (baseline) - Baseline scenario: NFPS primary deficit of 1.3 percent of GDP in 2023, consistent with a fiscal impulse of about ¾ percent of GDP. - Contingent on implementation of 2 percent of GDP in revenue measures, NFPS primary balance projected to improve to a surplus of around 1¼ percent of GDP over the medium term. - NFPS gross debt stabilizing at around 97 percent of GDP over the longer term. - Current account expected to narrow to about 2.3 percent of GDP in 2023 and remain broadly stable over the medium term. - Monetary stance - Monetary policy stance expected to remain restrictive, with the real policy rate approaching its neutral level by 2025. ### Risks and scenarios - Balance of risks tilted to the downside. - External downside risks: abrupt global slowdown; commodity price volatility; sharp tightening of global financial conditions (Annex III). - Domestic downside risks: renewed fiscal uncertainty; more persistent inflation (including due to tight labor markets); intensification of adverse climate events; social discontent from global supply shocks increasing cost of living. - Upside scenarios - Successful fiscal consolidation supported by an enhanced fiscal framework, broadening of the tax base, and reforms tackling budget rigidities could enable earlier monetary easing, lower risk premia, and protection of priority spending. - Approval and implementation of indirect tax (VAT) reform could simplify the tax regime and boost potential output. - Leveraging green growth opportunities could further lift potential. ### Authorities’ views - Authorities agreed growth would moderate in 2023 but were more optimistic than staff, projecting convergence to a potential rate around 2.5 percent over the medium term. - Authorities emphasize policies supporting growth: social assistance, inequality reduction, minimum wage policies, increased public and private investment (guided by ecological transformation), and new fiscal and tax regimes reducing uncertainty. - Authorities concurred on the importance of leveraging green growth and implementing VAT reform to boost potential. - BCB highlighted persistent inflationary pressures and components sensitive to the cycle remaining above ranges compatible with meeting the inflation target, slowing convergence. - Authorities cited reduced fiscal uncertainty after unveiling the new proposed fiscal rule, reflected in lower long-term yields, and reiterated buffers supporting resilience: adequate FX reserves, flexible exchange rate, external position in line with fundamentals, sound financial system, and large public sector cash buffers. *International Monetary Fund — BRAZIL, excerpts from chapter text.* ### 15. The authorities' commitment to improve the fiscal position is very welcome. ### 15. The authorities' commitment to improve the fiscal position is very welcome. ### Fiscal targets and authorities' strategy - Authorities aim to improve the federal primary balance: - from a projected deficit of 2.2 percent of GDP in the 2023 budget - to a deficit of 0.5 percent of GDP in 2023 - and to a surplus of 1 percent of GDP by 2026, within a narrow tolerance band. - Authorities estimate consolidation of about 3 percent of GDP would stabilize public debt (authorities’ definition) by 2026 (based on more favorable assumptions than staff). - Staff estimates the authorities’ strategy would require increasing revenues by about 2.5 percent of GDP over the near to medium term from the 2023 budget. - Near-term revenue measures announced by authorities focus on: - reversing pandemic-related tax cuts, - mitigating tax litigation losses, - closing loopholes. - Forthcoming plans would pursue a direct tax reform and reduce inefficient tax expenditures. - Authorities are advancing an indirect tax reform that would be revenue neutral. ### Staff baseline projections and near-term fiscal stance - Staff’s baseline scenario projects a NFPS primary deficit of 1.3 percent of GDP in 2023, relative to a projected deficit in the 2023 budget of 2.2 percent of GDP. - Staff’s projection includes: - gradual reversal of PIS/COFINS taxes on fuels and financial revenues, - tax changes on transfer pricing and off-shore financial revenues, - unwinding of pandemic-related unused funds (PIS/PASEP), - some spending restraint. - Staff’s baseline only partially reflects the impact of other near-term tax measures, including double taxation on goods and services, given uncertainty around yields and lagged full impact. - Staff welcomes the authorities’ intention to reach a 2023 federal primary deficit of 0.5 percent of GDP and notes this would be consistent with an adequately neutral fiscal stance if any revenue overperformance is saved. - Over the medium term, staff projects an improvement to a NFPS primary surplus of 1.3 percent of GDP under a more gradual implementation of tax revenue measures coupled with some moderation in spending growth guided by the new fiscal rule. ### Debt outlook and recommended fiscal effort - Brazil’s debt is high and projected to rise further, with debt stabilizing around 97 percent of GDP in 2032. - Staff’s debt sustainability assessment finds risks of debt distress to be moderate under the baseline, but the debt trajectory is highly sensitive to shocks to borrowing costs and real GDP growth, and to materialization of fiscal risks (Annex IV). - Large fiscal risks include: - sizable stock of judicial claims, - postponement of settling court-ordered payments, - delays in tax litigation (Annex V). - Mitigating factors: overwhelmingly domestic investor base, low external debt, and large public sector cash buffers at 10 percent of GDP. - Staff estimates that a total fiscal effort of around 4-4½ percent of GDP over the medium term, supported by an enhanced fiscal framework, a further broadening of the tax base, and reforms tackling budget rigidities, would put debt on a firmly downward path while preserving space for inclusive and growth-friendly spending. - Staff notes this effort could comprise about 2-3 percent of GDP in spending measures and 1-2 percent of GDP in revenue measures. ### Enhancements to the proposed new fiscal rule (Box 3 highlights and staff recommendations) - Key elements of the authorities’ proposed new fiscal rule (indicative primary balance path; spending corridor; floor on investment; revenue growth definition; within-year correction mechanism) are summarized in Box 3. - Possible enhancements recommended by staff include: - A strong fiscal anchor that puts debt on a firmly downward path within a medium-term perspective. Under staff assumptions, a primary surplus of around 1½ percent of GDP would be needed to stabilize debt over the longer term. - Staff estimates an adequate longer-term anchor would be a net general government debt-to-GDP ratio of around 55 percent (NFPS gross debt of 80-85 percent), consistent with the recommended fiscal effort of 4-4½ percent of GDP. - Alternatively, anchor the framework in a binding multi-year primary balance path with a correction mechanism to offset deviations. - Continue transparent reporting on fiscal developments and projections to ensure consistency with fiscal targets. - Strengthen spending rule elements to address Brazil’s large public spending ratio and reduce the risk of consolidation through revenues only: - ensure consistency with primary balance targets; - link spending growth to sustained increases in the structural revenue-to-GDP ratio; - reduce embedded pro-cyclical bias; - harmonize rules on current versus capital spending to mitigate misclassification risks; - allow spending cuts in budget preparation if needed. - Define a well-specified economic escape clause to guide responses to shocks while remaining consistent with debt sustainability. - Introduce a mechanism to promote additional government savings when commodity prices are high to shield public finances from commodity cycle fluctuations. - Implement rules for subnational governments that harden budget constraints and strengthen monitoring; ideally set expenditure rules for each government level concertedly. - Develop a more comprehensive medium-term fiscal framework (MTFF) and strengthen institutions to bolster transparency and accountability. Suggested roles for the Independent Fiscal Council (IFI) include monitoring escape clauses, running debt sustainability analysis with independent assumptions, reality checks on feasibility of budget plans, and publishing goalposts and milestones. ### Tackling spending rigidities while protecting social and investment spending - Mandatory spending (mainly pensions and wages) has reached more than 90 percent of general government spending and generally benefits higher-income households. - Reforms are needed to put spending growth on a sustainable path and create space for priority programs; revisiting indexation and revenue earmarking would provide flexibility. - Reform options that could generate savings of about 2-3 percent of GDP over time include: - Pensions: - 2019 pension reform introduced good practices and stabilized deficits but federal and subnational RPPS regimes generate a deficit of about 2.5 percent of GDP. - Align all RPPS to RGPS parameters; gradually eliminate deficits via a mix of: reduced replacement rates (including lower accrual rates and a cap on pension indexation); increases in the effective retirement age; higher contribution rates while avoiding unintended effects on formalization; full income taxation of pensions; coordination of non-contributory regimes with other social programs. - Implement an automatic adjustment mechanism for pension parameters to allow automatic adaptation to demographic changes. - Public administration: - Employee compensation accounts for about 30 percent of general government spending and 12 percent of GDP, above the 8-9 percent average for emerging and Latin American economies. - Adjust wage growth below nominal GDP (e.g., by IPCA) and implement targeted attrition policies to save up to 1 percent of GDP. - Additional savings from revamping career progression, service structure, and changing salary structures. - Public administration reform supports RPPS reforms by limiting the mechanical link between wage bill growth and pensions. - Budget rigidities: - Reviewing spending indexation and revenue earmarking rules combined with sectoral spending reviews is key to create space for priority spending and could bring efficiency gains. ### Indirect tax reform and potential growth effects - Authorities’ revenue-neutral indirect tax reform plan is described as well-designed; merging all consumption taxes and introducing an integrated VAT would: - foster substantial efficiency and productivity gains, - reduce tax competition among subnational governments, - mitigate risks from judiciary disputes, - boost potential growth. - Plans to support the poor through targeted VAT refunds and/or cash transfers, rather than generalized exemptions, are welcome. ### Alternative fiscal scenarios and the role of credibility (Box 4 summary) - IMF GIMF model simulations assess benefits of policy credibility during fiscal consolidation. - Simulation considers tackling spending rigidities through entitlement reform and other spending restraint of about 2½ percent of GDP, preserving inclusive and growth-friendly spending, complemented by tax measures of around 1 percent of GDP; savings span over a 5-year horizon with a decline in the sovereign risk premium of 25 bps per year. - Two expectations modes: - Limited credibility: agents consider fiscal plans for one year only and update yearly; consolidation weighs on GDP, driven by decline in government consumption and transfers and higher labor and corporate taxes; real GDP declines relative to baseline; investment effects small. - Credibility with stepwise updating: agents consider fiscal path credible and update as next year’s plan is released; investment increases, boosted by decline in sovereign risk premia, broadly offsetting negative impact on real GDP with limited overall output losses. - Results reinforce benefits of consolidation supported by reforms tackling spending rigidities and bolstering credibility of an enhanced fiscal framework. ### Revenue mobilization and direct tax reform priorities - Even with spending reforms, additional revenue mobilization is necessary to secure consolidation. - The direct tax reform expected in the second half of 2023 is key to generate additional revenues, eliminate inefficient tax expenditures, and increase progressivity. - Staff cautions against short-term revenue gains that introduce undesirable distortions. - Staff estimates the following measures could yield about 1-2 percent of GDP in additional revenues: - Personal Income Tax: broaden base by eliminating regressive exemptions; strictly limit income tax deductions (e.g., health and education); improve progressivity by keeping exemption threshold constant and increasing marginal PIT rates for higher incomes. - Corporate Income Tax: broaden base by strictly limiting exemptions (e.g., allowances for corporate equity, presumptive regime); reintroduce dividend taxation. - SIMPLES: explore options to lower eligibility threshold; improve ‘graduation’ out of SIMPLES to avoid Small and Medium-size Enterprise trap. - Property Taxes: broaden base and strengthen collection capacity. - Commodity Revenues: refrain from ad hoc temporary taxes (e.g., export levies) and tailor taxes to better capture rents (e.g., excess profit taxes in short term and a lower share of price-independent royalties in upcoming oil and gas extraction contracts). ### Authorities’ views - Authorities reaffirm commitment to improve Brazil’s fiscal position and are confident tax measures in train will rebuild the tax base, meet fiscal targets, and stabilize public debt over the medium term. - They stress closing loopholes will reduce compliance costs and mitigate judiciary dispute risks. - They expect indirect tax reform could be approved in coming months and streamline the tax regime, reducing inefficiencies and boosting potential output; direct tax reform could follow in the second half of the year to increase progressivity and mobilize revenues. - Authorities view the proposed new fiscal rule as sufficient to guide consolidation while providing flexibility for new spending priorities; under the new framework, public debt would stabilize by 2026 and gradually decline thereafter. - They note that following the 2019 pension reform and a federal public wage freeze lasting several years, further reforms of pension systems or public administration are not a priority at this point. - Authorities underscore shortcomings of the IMF concept of General Government Gross Debt in capturing Brazil’s debt dynamics and fiscal/rollover risks and argue a net debt concept would better portray the situation. ### Monetary policy context - The monetary policy stance is appropriate and consistent with inflation converging to target. - Bringing inflation down remains critical to protect the real income of vulnerable households. - The BCB reacted early to price pressures; current monetary policy stance is appropriately tight. - Despite recent large decline in headline inflation, cycle-sensitive components (e.g., core services) remain elevated and highly inertial. - Inflation expectations are above target but have come down more recently. - The start of the monetary policy easing cycle expected later this year should proceed with caution to ensure inflation converges to target, guided by incoming data on price pressures and inflation expectations. *Source: 1braea2023001 - 15. The authorities' commitment to improve the fiscal position is very welcome.* ### 24. The recent decision to adopt a continuous inflation target better aligns Brazil’s ### 24. The recent decision to adopt a continuous inflation target better aligns Brazil’s ### Inflation-targeting framework and monetary policy - CMN Resolution set a 3 percent inflation target for 2026, the same level as 2024 and 2025. - The CMN decided to change the inflation-targeting framework, with the adoption of a continuous 3 percent target (instead of calendar year targets) from 2025 onwards, to be established by Presidential decree. - Expected benefits of a continuous target: - Reduce uncertainty around the determination of targets and facilitate the re-anchoring of medium-term expectations. - Increase monetary policy flexibility by acknowledging the inflation-output trade-off in the short run and lags in transmission that extend beyond the calendar year. - Policy recommendation: Monetary policy action and communication should aim to strengthen credibility around the continuous target. ### Central bank autonomy and institutional reforms - Recent legislative reforms improved BCB autonomy and the financial relationship with the treasury, strengthening the inflation-targeting framework. - Future reform options: - Provide the BCB with flexibility in budgetary decisions to hire and retain personnel to fulfil its mandate. - Bolster financial autonomy by allowing the BCB to set up risk buffers based on its own assessment of risk exposures. - Reduce the stock of federal securities held by the BCB. - Operational constraint noted: The BCB’s operating expenditures, such as staff salaries and staff numbers, are determined by the federal budget. ### Exchange rate regime, FX reserves, and FX swaps - Flexible exchange rate regime and adequate FX reserves are important shock buffers given risks from abrupt global financial tightening. - Reserve adequacy: 136 percent of the IMF ARA metric as of end-2022 (noted as “well within adequate ranges”). - Brazil retains a comfortable net creditor status on external debt. - Since 2020, the authorities increased the stock of non-deliverable futures denominated in local currency (FX swaps) by close to US$70 billion, primarily to deal with market dysfunctionality. - The stock of FX swaps has risen to over 30 percent of reserves, in line with highs seen during the 2015-16 exchange rate pressures. - Risks and considerations: - No well-established limit on FX swap interventions; the outstanding stock can represent contingent demand on hard currency reserves. - Realized losses/gains on swaps are directly reflected on the public sector interest rate bill; FX swap losses could contribute to central bank losses in some scenarios. - Policy recommendation: When market conditions are conducive, develop a plan to reduce the outstanding FX swap stock; over the medium term, improve currency convertibility and deepen FX spot markets to reduce reliance on the non-deliverable market. ### Financial system resilience and banking sector - System-wide assessments: - Banking system: adequately capitalized, highly profitable, and highly liquid. - Average Tier1 ratio of 14.2 percent at end-2022. - Liquidity coverage ratios well above the regulatory minimum. - Asset quality deteriorated and credit losses picked up on banks’ loans for households and corporates since mid-2022, but provisioning remains adequate. - Authorities’ stress tests (May) confirm banks’ resilience to significant hypothetical credit, market, liquidity, and climate shocks. - Interest rate exposure: - Unrealized losses from held-to-maturity portfolios are small, representing 2-3 percent of equity for the two largest private banks and less than 1 percent for other major banks. - Banks’ security holdings are mostly short maturity or variable coupons; remaining interest rate exposure is actively hedged. - A major increase in sovereign risk premia could adversely affect bank balance sheets and lending appetite. ### Household debt, consumer protection, and macroprudential options - Household debt vulnerability: - DSTI ratio has risen well-above previous episodes, largely due to credit cards and non-payroll loans. - Government estimates nearly 70 million individuals (one-third of the population) are in default on some form of debt, including bank loans and utility bills. - Government program: - Desenrola program aims to restructure existing household debt via a digital application. - Government will provide a guarantee for consolidated and restructured debt of low-income households, using a BRL 10 billion fund (0.1 percent of GDP) already allocated. - IMF analysis and policy options: - A prudential limit would be appropriate in situations where the DSTI ratio exceeds 20-25 percent and is rising above a 15-year trend. - Recommendation: BCB could set a targeted prudential limit focused on riskier credit modalities, based on industry consultation. - Interest rate caps could help curb excessive costs for some households but require careful assessment due to possible negative implications for credit quantity and quality. - Authorities’ view: BCB noted operational difficulties and possible incentives to borrow from unregulated entities if a targeted macroprudential DSTI limit were introduced. ### Public banks and fiscal/monetary transmission risks - Historical context: Prior to the 2017 TLP reform, subsidized funding to public banks for mortgages and developmental loans negatively affected fiscal accounts and monetary policy transmission. - Current status: - Public banks are well-capitalized, profitable, and liquid; paying dividends and pre-paying liabilities (mainly BNDES). - Government intends to expand earmarked credit in strategic developmental areas without reintroducing interest rate subsidies and maintaining rigorous practices. - Risk management recommendation: Maintain appropriate credit underwriting standards; expand use of loan guarantees and co-financing with public and private banks to limit distortions and fiscal costs. ### Financial innovation, Pix, Open Finance, and the Digital Real (RD) - Ongoing innovations: - Pix (instant payment system) launched late 2020 has increased inclusion and efficiency. - Open Finance introduced in 2021 for data and service sharing between regulated entities. - Digital Real (RD) initiative: - BCB flagship: introduce a wholesale CBDC (Digital Real-RD) by early 2025; elsewhere the text notes BCB aims to launch the Digital Real at end-2024 or early 2025. - RD aims to underpin a public blockchain infrastructure in a regulated environment, interoperable with existing payment infrastructures and facilitating new business models. - Design choice: pilots utilize tokenized deposits/accounts issued by regulated institutions to minimize disintermediation risks; RD intended for wholesale purposes (bank reserves and settlement accounts). - Expected phased tokenization: - Initial tokenization of deposits/accounts and financial assets (e.g., federal securities); later stages to include more complex assets (vehicles, real estate titles, rural financing examples cited). - Legal, operational, and safety challenges: - Need changes in legal and regulatory frameworks to ensure a reliable ‘bridge to reality’ (holder rights, recovery of assets, insolvency treatment, enforcement). - Funding risks: aggregator models could amplify funding risks; mitigation could include limits on transfer speeds and adjusted liquidity stress testing. - Scaling-up challenges: participation costs could burden smaller players; minimum hardware/software tools could facilitate their entry. - Privacy compliance: composability and traceability of some services may conflict with the Brazilian General Personal Data Protection Law. - Authorities’ view: BCB recognizes privacy and other challenges and noted a more gradual approach may be required; BCB’s LIFT Challenge tests use cases like DvP, PvP, IoT, and DeFi. *Source: IMF staff summary of Brazil chapter content provided.* ### introduction of such services would require ensuring prior compliance with domestic legislation. ### 1braea2023001 - introduction of such services would require ensuring prior compliance with domestic legislation. ### D. Boosting Potential Growth - Key diagnosis - Brazil’s real GDP growth per capita has been low in recent decades, driven by low capital and labor growth and stagnant productivity growth. - In the last decades, agriculture was the only sector with high productivity growth, while productivity growth in the industry and services sectors has been stagnant. - Potential growth is also projected to be lower in Brazil than in regional and emerging market peers over the medium term. - Policy priorities identified by authorities and staff - Public Investment - Tackling spending rigidities remains key to make room for much-needed public investment. - Well-prioritized multi-year investment plans, commensurate with multi-year investment budgets and coordinated across levels of government, would improve investment spending efficiency, including from public-private partnerships (PPPs), state-owned enterprises (SOEs), and public banks. - The upcoming regulatory framework for PPPs is expected to support the expansion of public investment. Clear provisions to mitigate and manage fiscal risks from PPPs will be key. - Skills - Brazil needs skilled labor to lift labor productivity, innovate further, reduce informality, and embrace new green technologies. - Priorities include improving education quality, increasing secondary school enrolment, and upgrading curricula. - Recalibrating the mix of salaries and personnel in line with ratios of high performing countries would help improve PISA scores. - Minimum Wage Policies - Brazil’s minimum wage has hovered around the 30th percentile of the income distribution and around 70 percent of median wage over the last decade, including all jobs and sources. - Minimum wages have generally grown faster than labor productivity (and faster than regional peers particularly in the first part of the 2000s). - Future minimum wage increases should reflect productivity growth, with due consideration to tradeoffs between inequality, job creation, and competitiveness. - Labor Markets - Easing job protection could increase employment and investment, if enacted during economic normal or good times (IMF World Economic Outlook, October 2019). - The policy focus on early childhood and planned expansion of day-care centers is welcome and would help narrow the gender labor force participation gap. - Trade and domestic complementarities - Further trade integration would support productivity and competitiveness; Brazil has lowered import tax rates and reduced non-tariff barriers. - Regional integration plans and the ongoing OECD accession process offer opportunities to further open Brazil to international trade and support productivity and competitiveness. - Labor market and other domestic policies can help share gains from trade and technological adoption, including updating skills, facilitating labor reallocation, and strengthening social safety nets. - AML/CFT and anti-corruption - There is scope to strengthen the effectiveness of the AML/CFT regime against the ongoing FATF/GAFILAT assessment to mitigate threats from money laundering, tax evasion, and organized crime. - An enhanced anti-corruption strategy should bolster the independence of related institutions and address corruption risks in macro-relevant areas. - Authorities’ views (summary) - Authorities were confident their economic reform agenda would foster competitiveness, productivity, and efficiency, and help lift living standards. - They agreed the pandemic had set back progress in female labor market participation and emphasized the forthcoming National Policy for Care to promote formalization, increase access to child- and elderly-care, and implement full day schooling. - Authorities reiterated that the policy of real increase in the minimum wage, which is being resumed, was important for reducing poverty and inequality, while risks of fostering labor informality were low. ### E. Changing Climate in Brazil - Observed and projected climate impacts - Rising temperatures in Brazil (between +1°C and +5°C by the end of the century) and temperature variability have increased occurrences and the likelihood of extreme weather events. - Most common extreme events: (w(i) floods, which have more than doubled relative to the 1980s-90s; and (ii) droughts and extreme heat waves that directly impact agricultural output and decrease labor productivity. - The 2021 drought increased inflation by 0.7 percentage points and led to agriculture output losses of BRL 45.3 billion (0.5 percent of GDP) in four states, of which 40 percent was not insured, while private insurers experienced loss ratios on rural plans peaking at 90 percent in 2022. - World Bank estimate: natural disasters can push an additional 0.6-1.3 percent of the population into extreme poverty by 2030. - Sectoral vulnerabilities and financial sector exposure - Agriculture - Estimated to lose 1 percent of its sectoral GDP per year due to extreme weather events (World Bank CCDR, 2023). - About 20 percent of farming activity is covered by insurance, with Southern farmers significantly more insured than peers in the North; drought risks affect both Northern and Southern regions. - Hydropower - Past deviations from mean temperatures by +0.1C have led to a lower capacity utilization of 2-3 percent, increasing likelihood of energy supply disruptions and higher energy costs. - Hydropower generation could decline by 5 percent in 2050 under moderate climate assumptions and by 20 percent in a more severe scenario. - Financial sector exposure - About 20 percent of the financial sector’s credit portfolio is exposed to sectors vulnerable to climate change. - The share of agriculture (businesses and rural households) increased to around 12 percent of total bank loans over the past decade. - The BCB estimates around 8 percent of the financial sector’s credit portfolio is sensitive to transition risks, concentrated on smaller financial institutions, notably lending to the cattle and soybean industry, as well as cargo and transportation. - Focusing on physical risks and drought scenarios, about 20 percent of the credit stock is with water-intensive borrowers. - Operations at risk from heavy rainfall events are currently contained but estimated to increase to 16 percent in 2030 and 30 percent in 2050. - Environmental dynamics and tipping points - Increasing dry-season length and drought frequency have diminished the Amazon’s resilience and may have pushed the Amazon close to a critical threshold of rainforest dieback. - Some estimates quantify the output loss of reaching the Amazon tipping point for Brazil alone at 10 percent of 2022 GDP through 2050 (World Bank CCDR, 2023). - Policy measures and recommendations - Boost Amazon resilience via fiscal incentives for forest protection - To meet pledges to eliminate illegal deforestation by 2030 and restore 12mn hectares of forests, a revenue-neutral feebate scheme covering larger landowners at the forestry/agriculture border could provide incentives for forest protection. - Invest in climate-smart agriculture and strengthen insurance mechanisms - Improvements in irrigation infrastructure and soil management, new technologies, and more resilient crops can offset reduced yields and productivity. - Policies could de-risk farmer investment in the short term by redirecting public funds from credit to insurance. - Promote climate-indexed insurance schemes and link agricultural loans to sustainability criteria. - Diversify power supply while leveraging hydropower - Continue diversification to solar, wind, and biomass; solar and wind capacities have rapidly expanded and Brazil’s energy share from biomass is among the largest worldwide. - Planned private investments in renewables would more than offset expected declines in production due to temperature and precipitation changes and create opportunities for energy export, including green hydrogen. - Address bottlenecks: strengthen grid infrastructure, cross-border connections, and energy storage to handle weather volatility and avoid short-term higher fossil fuel consumption. - Green the financial sector via BCB Sustainability Agenda - Since 2017, the BCB has integrated social and environmental risk into the risk framework for financial institutions, inducing larger lenders to reallocate portfolios to less environmentally exposed sectors. - From end-2023 onwards, disclosure will be expanded to quantitative metrics and targets. - BCB is considering a liquidity facility that would offer preferential conditions to bonds based on ESG criteria. - The BCB’s green credit bureau for agribusiness is helping enforce social and environmental regulations and stop farming credit operations in protected lands. - Consider linking agricultural credit (Proagro) to sustainability criteria. - Green growth and financing - Opportunities: fostering sustainable farming, a greener industry, the bioeconomy, socio-biodiversity businesses, and green financing. - Brazil can leverage its green and relatively low-cost energy mix to expand export-oriented manufacturing and green production sites; competitive advantages include biofuels, hydropower, and wind energy equipment. - Plans to double annual investment in deep-water oil production by 2026 should consider synergies with green growth objectives and exposure to decarbonization risk. - Carbon market and ESG instruments - Authorities plan a mandatory carbon market; first stage would focus on companies and industries responsible for 90 percent of Brazil’s emissions, then gradually include other sectors; a limited share of nature offsets (~10 percent) might be considered. - Design of the ETS should aim to cover all sectors, incorporate price stabilizing mechanisms, and use possible receipts from auctioning emission allowances to compensate vulnerable households. - Authorities aim to develop an economy-wide green and social taxonomy and a yield curve for green bonds; first sovereign green and social bond planned in H2 2023 with regular issuances to catalyze private ESG financing. - Regional coordination on standards would help avoid fragmentation and support green capital flows. - Authorities’ views (summary) - Authorities broadly agreed with macroeconomic challenges posed by climate change and are defining a new sustainability strategy, including progress to establish a domestic carbon market, develop a green and social taxonomy, build climate resilient infrastructure, and restore climate justice for poorer households. - Emphasized aim to shape a ’bio economy’ by integrating agricultural production with forest protection through ecotourism, biotechnologies, and payment for environmental services. - Saw opportunities to accelerate the energy transition and export green hydrogen; expressed skepticism on cross-border adjustments and doubts on compatibility with international trade rules. ### Box 6 — Carbon Footprint and Commitments (highlights) - Brazil’s carbon emissions account for about 3.5 percent of global emissions. - Emissions composition (average 2017–2020): carbon dioxide 60 percent; methane 32 percent. - Emissions by source (average 2017–2020): agriculture 34 percent; land-use change (LULUCF) 29 percent; industry 12 percent (about half are process emissions); transportation 12 percent; waste, power generation, and buildings 11 percent combined. - Power generation low emissions reflect renewables: about 90 percent of electricity was generated by renewables in 2022. - Brazil’s updated NDC (2022) commits to reducing emissions by 50 percent below 2005 levels by 2030 and reaching net zero emissions by 2050. - To achieve the NDC, Brazil will need to reduce 2020 emissions by 28 percent by 2030. *Source: BRAZIL, INTERNATIONAL MONETARY FUND.* ### 50. Growth is moderating but is expected to gradually improve towards staff’s estimate of ### Growth is moderating but is expected to gradually improve towards staff’s estimate of potential over the medium term ### Growth, inflation, and external position - Growth projections and trajectory: - Growth is projected to slow to 2.1 percent in 2023, from 2.9 percent in 2022. - Growth is expected to gradually improve to staff’s estimate of potential over the medium term. - Inflation dynamics: - Headline inflation has rapidly declined from last year’s peak, but core inflation remains elevated, and inflation expectations are above target. - Headline inflation is expected to converge to target by mid-2025, in line with the inflation targeting framework. - External sector: - The external position was broadly in line with fundamentals and desirable policy settings in 2022. - The current account deficit is expected to narrow this year and remain broadly stable over the medium term. ### Risks and resilience - Downside external risks: - An abrupt global slowdown. - A sharp tightening of global financial conditions. - Commodity price volatility. - Downside domestic risks: - Renewed fiscal uncertainty. - More persistent inflation. - Upside channels: - More ambitious fiscal consolidation could facilitate earlier monetary policy easing and lower risk premia. - Approval and implementation of the indirect tax reform could simplify the tax regime and boost potential output. - Leveraging green growth opportunities. - Resilience factors: - A sound financial system, low reliance on FX debt, a flexible exchange rate regime, adequate FX reserves, and large cash buffers by the public sector. ### Fiscal outlook, authorities’ objectives, and staff recommendations - Authorities’ fiscal objectives: - Authorities aim to improve the federal primary balance to a deficit of 0.5 percent of GDP in 2023, which would be broadly consistent with an adequately neutral fiscal stance. - Authorities further aim to improve the fiscal position to a surplus of 1 percent of GDP by 2026. - Authorities intend to boost revenues by closing loopholes, streamlining inefficient tax expenditures, broadening the tax base, and reforming direct taxes. - Staff baseline projections and assessment: - Staff’s baseline scenario projects a NFPS primary deficit of 1.3 percent of GDP in 2023 (relative to a projected deficit of 2.2 percent of GDP in the 2023 budget), consistent with an expansionary fiscal stance. - Staff recommendations: - Staff recommends a more ambitious fiscal effort that continues beyond 2026 to put debt on a firmly declining path. - Staff estimates that a fiscal effort of 4-4 ½ percent of GDP is needed to put debt on a firmly downward path, supported by both spending and revenue measures. - Suggested fiscal framework enhancements: a strong medium-term fiscal anchor, stricter provisions to ensure consistency between the spending corridor and fiscal targets, and mechanisms to limit procyclicality. - Operational reforms to support consolidation: a more comprehensive MTFF, plans for a spending review and performance-based budgeting, pension and public administration reform, revisiting indexation and revenue earmarking. - Assessment of the proposed indirect tax reform: - The proposed revenue-neutral VAT reform is well-designed, would significantly streamline the tax regime, and could boost potential output. - The planned direct tax reform will be key to generate revenues, eliminate inefficient tax expenditures, and increase progressivity. - Measures that bring short-term gains but introduce unnecessary distortions are not advisable. ### Monetary policy - Current stance and recommendations: - The monetary policy stance is appropriate and consistent with inflation converging to target. - The BCB reacted to price pressures in a pro-active manner and the monetary policy stance is appropriately tight. - Given upside risks from more persistent inflation, the start of the monetary policy easing cycle should proceed with caution and be guided by incoming data and inflation expectations. - The recent decision to adopt a continuous inflation target has aligned Brazil’s inflation targeting framework with peers and should improve monetary policy effectiveness. - Institutional and operational suggestions: - Building on improvements to BCB autonomy, future efforts could focus on flexibility in budgetary decisions and in setting risk buffers. - Adequate FX reserves and the flexible exchange rate regime remain important to absorb shocks. - Developing further guidance on the use of FX swaps would be advisable. ### Financial sector, consumer protection, and innovation - Financial sector soundness: - Banks are profitable, adequately capitalized, and liquid; the financial system weathered domestic and external stress events. - The system is resilient and systemic risks are contained. - Household vulnerabilities and policy responses: - Targeted policy measures and financial literacy initiatives to address pockets of household debt vulnerabilities and protect consumers are welcome. - Authorities could consider a prudential limit targeted to riskier credit modalities to protect consumers on future borrowing. - Careful management of a bigger role for public banks will be important to mitigate risks for fiscal sustainability and monetary policy transmission. - Financial innovation: - The BCB-led initiatives such as Pix and the Open Finance environment have increased financial inclusion, efficiency, and competition. - Plans for a wholesale CBDC are expected to underpin a public blockchain infrastructure that fosters financial innovation within a regulated environment. ### Structural and green agenda - Authorities’ priorities: - Fostering innovation, trade integration, and competitiveness. - Upgrading investment and skills. - Tackling poverty and inequality. - Promoting green growth opportunities. - Climate and sustainability measures: - Plans to strengthen climate resilience, halt illegal deforestation, and decarbonize the economy, including by creating a mandatory ETS and leveraging the BCB Sustainability Agenda, are welcome. - Launching the first sovereign green bond will help green the financial system. - Governance and integrity: - Continuing efforts to strengthen the effectiveness of the anti-corruption and AML/CFT frameworks remains important. *BRAZIL — INTERNATIONAL MONETARY FUND.* ### 59. Staff recommends that the next Article IV consultation take place on the standard 12- ### 1braea2023001 - 59. Staff recommends that the next Article IV consultation take place on the standard 12- ### Poverty, Inequality, and Social Conditions - Poverty and extreme poverty increased in 2021, in particular among children. - Inequality increased across all regions, with the largest increases in the Northern states. - Inflation has hit vulnerable households. - Emergency assistance and Auxilio Brasil/Bolsa Familia have helped boost household incomes. - Household indebtedness has increased to record levels. - The minimum wage is around 70 percent of the median wage, including all jobs and sources. - 1/ Includes income from all jobs and all sources. - Sources cited: BCB, IBGE, Ipea, Haver Analytics, and Fund staff calculations. ### Real Sector Developments - Real GDP growth: - Real GDP grew by 2.9 percent in 2022. - Real GDP is expected to moderate to 2.1 percent in 2023. - Growth in Q1 2023 was supported by strong agricultural output. - Real investment growth declined from 32 percent y/y in Q2 2021 to 1 percent in Q1 2023. - Industrial production growth remains lukewarm. - Extended retail sales posted 6.8 percent y/y growth in March 2023. - Confidence indicators point towards moderation in activity in 2023. - Sources cited: IBGE, CNI, Haver Analytics, and Fund staff estimates. ### Inflation Developments and Monetary Policy - Headline inflation has declined, while core inflation has been stickier, and inflation expectations are above target. - The marked decline in inflation was largely due to lower transport prices. - Both tradable and non-tradable inflation have declined but remain elevated. - Real wage growth accelerated in late 2021 but is showing signs of cooling down. - The BCB has kept the policy rate on hold since August 2022 at 13.75 percent. - The BCB increased the stock of FX swaps after the pandemic to deal with market dysfunctionality issues. - Sources cited: IBGE, BCB, Haver Analytics, and Fund Staff calculations. ### External Sector Developments - 2022 current account deficit remained broadly unchanged, driven by higher deficits in services and primary income despite a sizeable trade surplus benefitting from favorable terms of trade. - FDI inflows substantially increased in 2022 amid limited portfolio outflows. - The NIIP deteriorated mostly due to negative valuation effects on international reserves. - Financial flows have been volatile. - The exchange rate was broadly stable since July 2022, while reserves started to recover this year. - Sources cited: BCB, Haver Analytics, Bloomberg, and Fund staff calculations. ### Financial Sector Developments - Credit growth is moderating. - NPL ratios have picked up. - Banks remain profitable. - Capital and liquidity ratios remain above the regulatory minima, with private banks having ample buffers. - Credit supply to corporations has become more reliant on market issuance. - Credit spreads have remained relatively low compared to other emerging market economies (EMs). - Sources cited: BCB, Capital IQ, CEIC, Bloomberg, and Fund staff calculations. ### Fiscal Sector Developments - After strong growth since early 2021, fiscal revenues started to decelerate mid-2022 and contracted recently, driven by a decline in indirect taxes following the 2022 tax cuts. - Corporate income taxes and other revenues reached record levels in 2022 helped by high commodity prices. - The overall NFPS overall balance is expected to deteriorate in 2023 as interest expenditures increase. - After the unwinding of pandemic stimulus in 2021, the fiscal stance turned expansionary in 2022 and is expected to remain so in 2023, followed by gradual consolidation. - A large increase in the deflator and primary surpluses helped lower NFPS gross debt in 2021-22. Unfavorable interest rate-growth differentials are expected to push up debt in coming years. - Gross NFPS and net public debt ratios are expected to stabilize over the longer term. - Sources cited: Treasury, BCB, Haver Analytics, and Fund Staff calculations. ### Labor Market Developments - The unemployment rate declined following the pandemic. - Informal workers lost more jobs during the pandemic but rebounded stronger. - There has been a broad-based decline in the labor force participation rate across age, education, and gender. - Sectoral recovery: agriculture and construction have recovered; accommodation has yet to recover. - Self-employed and informal private sector jobs posted strong growth since the pandemic. - Sources cited: PNADc Survey, IBGE, Haver Analytics, and Fund staff calculations. ### Key Numerical Indicators and Projections (selected highlights from tables) - GDP growth (constant prices): 2021 = 5.0; 2022 = 2.9; 2023 = 2.1; 2024 = 1.2; 2025 = 1.7; 2026 = 1.9; 2027 = 2.0; 2028 = 2.0 (percent). - Consumer prices (IPCA, average): 2021 = 8.3; 2022 = 9.3; 2023 = 5.1; 2024 = 4.6; 2025 = 3.0; 2026 = 3.0; 2027 = 3.0; 2028 = 3.0 (percent). - NFPS overall balance: 2021 = -4.3; 2022 = -4.6; 2023 = -7.9; 2024 = -7.4; 2025 = -6.2; 2026 = -5.4; 2027 = -4.8; 2028 = -4.2 (percent of GDP). - Net public sector debt: 2021 = 55.8; 2022 = 57.1; 2023 = 60.1; 2024 = 63.5; 2025 = 66.2; 2026 = 68.3; 2027 = 69.3; 2028 = 70.1 (percent of GDP). - Current account (US$ billions): 2021 = -46.4; 2022 = -56.9; 2023 = -48.0; 2024 = -56.1; 2025 = -58.6; 2026 = -60.0; 2027 = -61.4; 2028 = -64.2. - Trade balance (US$ billions): 2021 = 36.4; 2022 = 44.2; 2023 = 50.1; 2024 = 47.0; 2025 = 47.8; 2026 = 49.0; 2027 = 50.1; 2028 = 50.2. - Exports (fob, US$ billions): 2021 = 284.0; 2022 = 340.3; 2023 = 338.5; 2024 = 343.3; 2025 = 349.4; 2026 = 357.4; 2027 = 366.5; 2028 = 379.0. - Imports (fob, US$ billions): 2021 = 247.6; 2022 = 296.2; 2023 = 288.4; 2024 = 296.3; 2025 = 301.6; 2026 = 308.4; 2027 = 316.4; 2028 = 328.8. - Gross reserves (eop, US$ billions): 2021 = 362.2; 2022 = 324.7; 2023–2028 = 345.7 (each year). - Policy rate: BCB policy rate on hold since August 2022 at 13.75 percent. - Labor: Unemployment rate (average of March, June, September, and December) 2021 = 13.2; 2022 = 9.3; 2023 = 9.5; 2024 = 9.4; 2025 = 9.4; 2026 = 9.4; 2027 = 9.4; 2028 = 9.4 (percent). - External debt (total, US$ billions): 2021 = 670.3; 2022 = 681.1; 2023 = 706.2; 2024 = 737.6; 2025 = 770.4; 2026 = 801.8; 2027 = 831.1; 2028 = 859.8. - NFPS gross debt: 2021 = 90.7; 2022 = 85.9; 2023 = 89.2; 2024 = 91.2; 2025 = 93.3; 2026 = 94.8; 2027 = 95.6; 2028 = 95.9 (percent of GDP). - Selected fiscal projections (central government primary balance): 2021 = 0.7; 2022 = 1.3; 2023 = -1.3; 2024 = -0.8; 2025 = -0.3; 2026 = 0.3; 2027 = 0.9; 2028 = 1.3 (percent of GDP). - Main export products listed: airplanes, metallurgical products, soybeans, automobiles, electronic products, iron ore, coffee, and oil. - GDP (US$ billions): 2021 = 1,650; 2022 = 1,920; 2023 = 2,069; 2024 = 2,228; 2025 = 2,339; 2026 = 2,461; 2027 = 2,598; 2028 = 2,768. - Oil price (Brent blend; US$ per barrel): 2021 = 69.2; 2022 = 96.4; 2023 = 76.4; 2024 = 71.7; 2025 = 68.9; 2026 = 66.7; 2027 = 64.9; 2028 = 63.4. *Sources: Central Bank of Brazil; Ministry of Finance; IBGE; IPEA; Treasury; BCB; Haver Analytics; Bloomberg; Capital IQ; CEIC; Fund staff estimates and projections.* ### Annex I. Potential Output Growth ### Annex I. Potential Output Growth ### Methodologies to estimate potential output - Three broad approaches were employed: - Univariate Filters: - Hodrick-Prescott (HP) filter: smoothing parameter λ set to a standard value of 100 for annual data; alternative λ of 1600 (typically used for quarterly data) produces an almost linear decline in potential growth; Ravn–Uhlig frequency rule produces a sharper increase and then decrease over time. - Band Pass filters: Baxter and King (1999); Christiano–Fitzgerald (2003). - Multivariate Filter: - Follows Alichi, and others (2015); includes economic identification restrictions linking the output gap to labor market conditions and inflationary pressures. - Estimated via Bayesian methods using annual nominal GDP, CPI inflation, and unemployment for 2003–2022. - Model structure (as specified): - Output Gap Y_t = φ_Y Y_{t−1} + ε_Y - Phillips Curve π_t = λ_π π_{t+1} + (1−λ_π) π_{t−1} + β Y_t + ε_π - Okun’s Law u_gap,t = τ_1 u_gap,t−1 + τ_2 Y_t + ε_u - Production Function Approach: - Growth-accounting decomposition using Y_t = A_t K_t^α L_t^{1−α} - Assumes constant returns to scale. - Parameter α calibrated to 0.45 (in line with the SAMBA model). ### Historical evolution of potential output growth (findings) - Long-run pattern: - 2003–2008: potential output growth averaged about 4.1 percent across methodologies; supported by high investment and a declining unemployment rate. - 2009–2013: averaged about 3.3 percent; decline driven by lower investment growth and lower employment rate despite a declining unemployment rate. - 2014–2019: averaged 0.1 percent; determinants included negative investment growth and significant deterioration in labor markets, notably an increase in the unemployment rate. - Recent years (up to 2022): potential output growth averaged 1.3 percent, attributed to improvements in the labor market and an increase in investment. - Cross-methodology 2022 range: - Potential growth rate in 2022: 1.3-2.2 percent across methodologies. ### Pandemic impact and scarring - 2020–2022: - Average loss in potential output growth (using HP filter): about 0.4 percentage points. - NAIRU estimates (multivariate filters): - NAIRU increased from 8.1 percent in 2012 to 11.1 percent before the pandemic. - In 2022, NAIRU estimated at 9.8 percent. - Actual end-of-year unemployment rate in 2022: 7.9 percent. - Interpretation: 2022 unemployment below estimated NAIRU, suggesting the economy was operating above potential. ### Uncertainties and methodological caveats - Sensitivity to filter parameters and identification: - HP filter results depend on smoothing parameter λ: λ = 100 (annual standard) versus λ = 1600 (quarterly standard) produce materially different trend dynamics. - Ravn–Uhlig frequency rule for λ yields different temporal patterns (sharper rise and fall). - Multivariate filters considered more accurate than univariate filters due to semi-structural identification linking output gap, inflation, and labor market indicators, but results still depend on model priors and shock variance assumptions. - Production-function estimates rely on the calibrated factor share α = 0.45. ### Policy relevance and implications - Role of potential output: - The growth rate of potential output is a critical determinant of policy settings: assessing the fiscal stance, calibrating central bank responses to inflationary shocks, and guiding structural reforms for convergence to advanced-economy living standards. - Implications from findings: - The observed decline in potential growth over recent decades, the partial recovery to 1.3–2.2 percent in 2022, and pandemic-related scarring underscore the importance of policies that raise productive capacity. - Structural reforms to boost investment, improve labor market outcomes, and raise total factor productivity are central to increasing potential growth. *Prepared by Matteo Ghilardi, in collaboration with Swarnali Hannan (WHD).* ### Annex IV. Debt Sustainability Analysis ### Annex IV. Debt Sustainability Analysis ### Overview and main assessment - Overall risk of sovereign stress: Moderate. - Debt sustainability risks assessed as moderate using a wide range of analyses including the Sovereign Risk and Debt Sustainability Framework (SRDSF). - Key mitigating factors: overwhelmingly domestic investor base, low FX debt, large public sector cash buffers, and substantial Central Bank holdings of federal securities that mitigate refinancing risks. - Key vulnerabilities: high share of short-term and variable coupon debt makes debt projections highly sensitive to changes in interest rates; sizable fiscal risks from judiciary claims. ### Debt developments and stock (2022) - NFPS gross debt declined to 86 percent of GDP in 2022. - NFPS net debt declined to 57 percent of GDP in 2022. - More precise figures at end-2022: NFPS gross debt = 85.9 percent of GDP; consolidated public sector net debt = 57.1 percent of GDP. - Public sector assets stock = 26 percent of GDP, including international reserves = 16 percent of GDP. - Contributors to 2022 debt decline: primary surplus of 1.3 percent of GDP; favorable interest–growth differential of 1.1 percentage points (driven by an 8.3 percent increase in the GDP deflator); faster than expected repayment of BNDES loans; use of cash buffers. ### SRDSF methodology and accounting nuances - The SRDSF template accounts for large cash vs. accrual adjustments in financing needs: nominal interest is recorded on an accrual basis, but actual debt servicing for most Brazilian federal securities occurs at maturity. - The SRDSF emulates this by using zero coupon and inflation-linked instruments as financing instruments. - Stock of debt reported in nominal value terms (includes accrued interest at year-end); financing needs shown in cash terms. ### Baseline projections and fiscal dynamics - Under staff’s baseline, NFPS debt is projected to continue increasing in the medium-term, before stabilizing around 97 percent of GDP in the extended projection horizon (contingent on gradual fiscal adjustment). - Staff commentary: consolidation of around 3 1/2 percent of GDP is expected to stabilize debt at high levels. - Selected baseline figures (public debt, percent of GDP): 2022 = 85.9; 2023 = 89.2; 2024 = 91.2; 2025 = 93.3; 2026 = 94.8; 2027 = 95.6; 2028 = 95.9; 2029 = 96.2; 2030 = 96.5; 2031 = 96.6; 2032 = 96.6. - Change in public debt (percent of GDP): 2022 = -4.8; 2023 = 3.2; 2024 = 2.0; 2025 = 2.1; 2026 = 1.6; 2027 = 0.8; 2028 = 0.3; 2029 = 0.3; 2030 = 0.3; 2031 = 0.1; 2032 = 0.0. - Primary deficit (percent of GDP): 2022 actual = -1.3; projections (2023–2032) = 1.3, 0.8, 0.3, -0.3, -0.9, -1.3, -1.3, -1.3, -1.3, -1.3. - Automatic debt dynamics and real rates: Automatic debt dynamics contribution = -1.1 in 2022; 3.5 in 2023; 2.1 in 2024; 2.7 in 2025; 2.7 in 2026; 2.4 in subsequent years. Real interest rate and relative inflation (percent) = 1.7 in 2022; 5.2 in 2023; 3.2 in 2024; 4.2 in 2025; 4.4 in 2026; 4.3 in 2027–2029; 4.1 in 2031; 4.0 in 2032. - Gross financing needs (percent of GDP): 2022 actual = 17.3; projected range 2023–2032 = 16.7, 15.9, 12.6, 17.1, 17.2, 16.0, 17.1, 18.8, 19.0, 17.6. - Memo: Real GDP growth (percent) = 2022 actual 2.9; projected 2023–2032 = 2.1, 1.2, 1.7, 1.9, 2.0, 2.0, 2.0, 2.0, 2.0, 2.0. Inflation (GDP deflator; percent) = 8.3 in 2022; 3.8 in 2023; 5.7 in 2024; 3.7 in 2025–2032 (3.5 in some years shown). Effective interest rate (percent) = 10.3 in 2022; 10.3 in 2023; 9.4 in 2024; 8.5 in 2025; 8.4 in 2026; 8.2 in 2027–2029; 8.0 in 2030; 7.8 in 2031. ### Debt composition and refinanceability - Debt composition features: small amounts of FX and foreign law debt; limited reliance on foreigners for local currency debt; large stock of securities held by the BCB that pose negligible refinancing risks. - High share of short-term and variable coupon debt increases sensitivity to interest rate changes. - The SRDSF and other modules treat central bank holdings and government cash buffers as material mitigants to refinancing and liquidity risk. ### Medium-term risk analysis and stress indicators - Debt Fanchart Module signal: points to a high level of risk. - GFN Financeability Module: suggests a lower, but still moderate, level of risk. - Selected indicator values: - Fanchart width = 61.2 - Probability of debt not stabilizing (pct) = 75.1 - Terminal debt level x institutions index = 63.1 - Debt fanchart index = 2.9 - Average GFN in baseline = 15.9 - Bank claims on government (pct bank assets) = 25.2 - Change in claims on government in stress (pct bank assets) = 0.6 - GFN financeability index = 13.8 - Probabilities related to medium-term index (2023–2028): Prob. of missed crisis, if stress not predicted = 54.5 pct; Prob. of false alarm, if stress predicted = 5.7 pct. - Commentary: Debt Fanchart and GFN give differing signals; large liquid assets and negligible refinancing risk for central bank held securities further mitigate GFN risks. ### Annex V — Fiscal risks from judiciary claims - Stock of judicial claims reached a record high of 38 percent of GDP in 2022. - Drivers: free-of-charge access to judicial remedies, complexity and overlaps in tax system (federal and state taxes), classification procedure for fiscal risks introduced in 2015, creation of the Independent Fiscal Council in 2016, and three recently classified claims in 2022 regarding pensions and mandatory saving accounts. - Share of claims “likely to come due” surged to around 10 percent of GDP in recent years; note: a 2017 Supreme Court ruling on double taxation (PIS/COFINS and ICMS) was recognized as a 'likely' fiscal risk in 2019 and reconsidered in 2023. - Materialized judicial claims (precatorios): - Moderately trending upward to reach 0.6 percent of GDP at the onset of the pandemic. - In 2022, judicial claims coming due amounted to BRL 91.4 billion, or about 1 percent of GDP. - Constitutional amendment (No. 23/2021 – split into PEC 113 and PEC 114) response: - Set a limit for precatorios to be paid within a given year in line with the level of materialized claims in 2016 adjusted for inflation (around 0.4 percent of GDP). - Yearly remainder to be rescheduled until 2026, remunerated at SELIC rates as before. - Allowed some precatorios to be paid outside the expenditure ceiling under specified cases. - Fiscal risk implications and projection scenarios for precatorios: - In 2022 and 2023, around 0.6 percent of GDP of precatorios payments were rescheduled. - Under assumption that judicial claims grow with inflation and rescheduled precatorios grow with SELIC: accrued precatorios (cumulated rescheduled claims) would reach 1.6 percent of GDP in 2026 and 2.2 percent of GDP in 2028. - If precatorios grow at the same rate as in previous years: accrued precatorios would reach 2.1 percent of GDP in 2026 and 3.1 percent of GDP in 2028. - As a consequence, around 2–3 percent of GDP would be added to public debt in the medium term under conservative assumptions. - Authorities’ view: the three recent disputes related to pension reform, food stamps inclusion in reference salary for pensions, and inflation index for FGTS individual accounts are viewed by the authorities as unlikely to be decided against the government. *Source: IMF staff (Annex IV. Debt Sustainability Analysis; Annex V. Fiscal Risks from Judiciary Claims).* ### 5. Efforts to clear the stock of judicial fiscal risks should be accelerated. In particular, ### 5. Efforts to clear the stock of judicial fiscal risks should be accelerated. In particular, ### Judicial fiscal risks and settlement options - Recommendation: Consider a settlement/arrears’ clearance plan (possibly including asset/bond settlements), notably for disputes across levels of government. - Recommendation: Adopt more efficient approaches to litigation to limit future exposure. - Recommendation: Approve the planned VAT reform, which "would greatly simplify consumption taxes across levels of government and help mitigate an important source of judicial disputes." ### Administrative tax disputes and expected recovery - Finding: The stock of ongoing tax disputes at the tax court (CARF), mostly related to the corporate income tax, amounts to 10 percent of GDP. - Cause: Backlog owes to a pandemic-related slow-down in settlements and a 2020 change in procedural rules to favor taxpayers (assigning the tie-braker vote to taxpayers). - Change in rules: With the reversal of the rule by the new government and further improvements in litigation, including through Artificial Intelligence, the government expects to collect about 60 percent of this tax owed to the government over the coming years. ### Public debt accounting note - Accounting implication: Accounting for public debt under GFSM 2014 would consider precatorios under other accounts payable and thus included in the broader definition of debt. ### Implementation of FSAP recommendations (selected institutional and financial sector measures) - Institutional coordination: - Action: The BCB, CVM, Previc, and SUSEP finalized the Financial Stability Coordination Law, a draft bill which is now being discussed with the MoF. (Short Term) - Action: The Financial Stability Coordination Law draft bill proposes creation of a Financial Stability National Committee with authority over macroprudential policy and crisis management. (Medium Term) - Central bank independence and governance: - Action: Complementary Law 179 of 2021 enacted objectives and autonomy of the BCB, defines price stability as primary objective, sets four-year terms (with one possible renewal) for Board members, and establishes removal cases requiring Senate approval. The law does not establish legal protection for BCB staff. (Short Term) - Action: Bank Resolution Bill submitted to lower house includes provision for legal protection of public agents and legal defense by the General Counsel to be covered by the BCB. (Short Term) - Financial stability tools and crisis arrangements: - Action: Structured and by Reference Add-ons are implemented in the BCB’s supervisory methodology for Pillar 2; Structured Add-on implemented (segments S1 to S4). (Short Term) - Action: The BCB deployed Temporary Liquidity Facilities (ELA for the COVID-19 crisis) in April 2020; new permanent liquidity facilities implemented in November 2021; broadening of collateral framework to accept CCB (securitized individual bank loans) expected to be effective by 2024Q1. (Short Term) - Position: The BCB does not agree to make solvency on a point-in-time the main determinant of ELA approval and prefers discretionary flexibility; indemnity of the MoF for ELA in systemic circumstance will not be implemented. - Deposit insurance fund and FGC: - Action: FGC amended by-laws to establish communication to the BCB prior to each assistance operation; BCB signed a MoU with FGC to grant access to detailed information on financial institutions that are FGC members. Recommendation to transform FGC into a fully public-owned institution will not be implemented. (Short Term; Medium Term) - Financial integrity and AML/CFT: - Action: Decree to establish Strategic Committee for the National AML/CFT Risk Assessment issued March 2020; the risk assessment was completed and published in 2021. (Short Term) - Financial intermediation efficiency and competition: - Actions and regulations enhancing client mobility and cost transparency include Resolution 4,639/2018 (consolidated by Resolution CMN 5,058/2022), Complementary Law 166/2019 and Resolution 4,737/2019 (opt-out Credit Registry), Resolution 4,734/2019 and Circular 3,952/2019 on pledging receivables, Resolution CMN 4,762/2019 expanding portability eligibility, and Joint Resolution CMN-BCB No. 1/2020 implementing Open Finance under General Data Protection Law (No. 13,709/2018). - Effect: Open Finance's open data phase requires disclosure of service channels and products, improving cost transparency and comparability; sharing of clients’ data and services fosters competition and client-centric financial services. ### Public banks: roles and key magnitudes - System share: Banks comprise about 140 percent of GDP, and public banks make up about 35 percent of the system. - Three largest public banks and roles: - Banco do Brasil (BB): Focused on lending for agriculture, SME, and consumer loans; retains majority government ownership. - Caixa Econômica Federal (Caixa): Most important mortgage lender; receives a significant portion of its funding "slightly over 20 percent" from FGTS, which totals about BRL 600 billion; Caixa manages the FGTS and on-lends a portion, "some BRL 354 billion" for mortgages; government fully owns Caixa’s equity. - BNDES: Development bank supporting corporates and owning significant shares in national champions; receives most funding from FAT, "about BRL 400 billion"; also receives government funding and is fully government-owned. - Recent strategic shifts: - BNDES: New administration in January 2023 focused on revitalizing industry, promoting an inclusive, green, digital, innovative, and creative economy; efforts to enlarge market-based instruments, foster domestic credit and capital markets, and improve access to international funds (green, social e sustainable bonds); pipeline to reduce risks on infrastructure investment to catalyze private sector finance. - Caixa: Repositioning credit operations to prioritize loans to micro companies, payroll-deducted loans, and housing; governance improvements, gender diversity priority; strategic partnerships in insurance and card segments; Caixa Seguridade Participações S/A IPO April 2021; CAIXAPAR sold Banco Pan shares to BTG Pactual in 2021. *Source: 1braea2023001 - 5. Efforts to clear the stock of judicial fiscal risks should be accelerated.* ### 3. These public banks support the government’s strategic objectives. The government can ### 3. These public banks support the government’s strategic objectives. The government can ### Role and channels of support - The government can direct low-cost government funding to provide credit (earmarked loans) via public and private banks in specific strategic areas such as for mortgages, SMEs, and agriculture. - Since 2017, funding provided to BNDES from government and public sources, including FAT, is at a market benchmark rate (TLP) in 2017. - The earlier benchmark (TJLP) was at a subsidized rate. - When BNDES provides banks with earmarked loans, they must lend them out to the strategic areas as swiftly as possible; otherwise, they have to hold them as unremunerated reserve requirements determined by the CMN. - There are fines if loans do not go to the designated sectors. - Reserve requirements and fines vary by bank and are not disclosed. ### Governance and public control - Overall public control of the banks makes it possible to fulfil strategic government objectives. - BB: half of its board of directors, including its chairman, is appointed by the government, and the same is the case with its supervisory board. - Caixa: the government appoints the bulk of the board of directors, including the full supervisory board. - BNDES: most of the board of directors and the supervisory board are appointed by the government. - During 2023, the President appointed new management for the three large public banks. ### Funding patterns and historical context - Past funding and earmarked lending patterns of public banks have varied with government priorities. - The senior unsecured debt of public banks rose sharply through 2016, as did subordinated debt funding of public banks, especially BNDES, benefiting from funding provided by the government and the FAT. - Government support for lending picked up after the global financial crisis. - The cost benefit of such lending relative to non-earmarked loans is significant, even if the type of loans is not exactly the same in earmarked versus non-earmarked credit, as the former includes mortgages and the latter consumer loans. ### Profitability, solvency, liquidity, and asset quality - Brazilian public banks are profitable, with ROEs averaging 15 percent for the two largest public banks and much higher for BNDES, in comparison with private banks and versus public banks in some other large emerging markets. - Brazilian public banks are also solvent and liquid, the latter being mainly due to high holdings of government securities. - There is wide variation in capital ratios between the public banks. - The two largest have T1 capital ratios averaging around 15 percent as of Q3 2022, BNDES has a much higher capital ratio. - Liquidity ratios are above 200 percent for the two largest public banks, though much smaller for BNDES given the unique nature of its lending. - The earmarking of credit may come at the cost of more lenient underwriting assessments and correspondingly weaker asset quality; however, this is not the case at present and the NPL ratios of major Brazilian public banks are better than those of private banks, and roughly comparable if not better than in some key emerging markets. ### Fiscal implications and past impacts - Public banks have had an important impact on fiscal accounts in the past. - Thanks to advanced repayments over the past years, public banks’ liabilities vis-à-vis the government built up to finance policy lending during 2008-2014, have been almost fully cleared. - An expansion in the role of public banks through below-the line transfers, however, could lead to a renewed increase in fiscal risks. - There has been a strong positive contribution in terms of dividend distributions from the profitable public banks, but this benefit has to be weighed against the past cost of recapitalizations of public banks and the subsidized funding provided to them. - During the past three decades, BB and Caixa have had to be recapitalized by the government several times. - Some estimates suggest that the cost of earmarking has amounted to 1.5-2 percent of GDP per year on average in the past. ### Pros and cons of earmarking of credit in Brazil - Pros: - Credit is available to certain corporates and households (on mortgages) at rates that are below the market rates. - Since the reform of the benchmark rate, this has not prevented public banks from staying profitable or being able to return dividends to the public. - Cons: - Earmarking at subsidized rates leads to inefficient credit allocation; some sectors may get cheaper funding compared with others without the cost of such funding being commensurate with risk. - The lowering of costs for certain targeted borrowers may also raise borrowing costs for other non-targeted borrowers, as banks seek to make up net interest margins. - Earmarking at subsidized rates also makes monetary policy transmission more difficult, as rates do not adjust or do not adjust as swiftly on the earmarked portion of credit, which accounts for nearly 40 percent of the total stock of credit. - Need for improved governance and transparency: there may be scope to improve transparency in subsidies granted to banks and provide these more directly; despite various controls, loans could end up being earmarked for special interest groups. - Greater clarity on earmarked credit requirements being applied to individual banks and whether they are being treated comparably to others would be helpful. ### IMF (Fund) recommendations and policy approaches - The Fund continues to recommend policy approaches that do not distort the allocation of credit. - The authorities are appropriately planning to maintain government funding benchmarks at market rates and considering greater reliance on co-financing (including PPPs) and loan guarantees to expand government support for credit in strategic areas. *Source: IMF staff report excerpt (Brazil).* ### 4. The lower house approved the indirect tax reform (PEC 45), paving the ### 4. The lower house approved the indirect tax reform (PEC 45), paving the ### Indirect tax reform (PEC 45) - Introduces a destination-based dual value added tax (VAT), merging all existing federal consumption taxes into a unified federal VAT (CBS) and all state and local consumption taxes into a subnational VAT (IBS). - An excise tax (IS) would replace the tax on industrial goods (IPI). - Includes a compensation mechanism to subnational governments for foregone revenues and a preferential rate for selected priority sectors. - Creates the broad legal framework for the new VAT; implementation details, including VAT rates, would only be defined in 2024 through supplementary laws. - The Lower House approved the tax reform’s constitutional amendment by an overwhelming majority; the Senate is expected to consider it in the next few months. - Expected objectives: - Make the system simpler and fairer, tax goods and services at destination instead of origin, enhance efficiency, avoid tax wars among subnational entities, and increase transparency and fairness. - Improve quality of revenue mobilization rather than increase revenue. - Include a comprehensive review of tax expenditures to address perverse and regressive features and tackle state capture. ### Economic growth, productivity, and reform impacts - Recent headline growth history and projections: - Real GDP growth: 5 percent in 2021; decelerated to 2.9 percent in 2022. - Median GDP growth projection for 2023 (January): 0.8 percent. - Most recent survey shows projected growth of 2.2 percent for 2023. - Short-run dynamics: - Some deceleration expected for the remainder of the year as better-than-expected first quarter results were driven by agriculture, whose contribution peaks in the first quarter. - IBC-Br posted a seasonally adjusted monthly growth in April that was twice the market’s median expectation. - Potential growth and supply-side reforms: - Recent initiatives to reduce the cost of finance and boost investment through strengthening credit collaterals, deepening capital markets, and modernizing financial legislation. - Tax reform approved by the Lower House expected to have a meaningful impact on productivity over the next few years. - Labor market recovery strong since the pandemic; gender gap remains a drag. Administration focusing on expanding early childhood education and daycare to boost female participation. - Infrastructure bottlenecks and basic services supply to be addressed with mobilization of private capital. - Estimated efficiency/productivity gains from tax reform: - Preliminary estimates for the long-term increase in the level of GDP from reliable sources range from 5 to 20 percent. - Some studies suggest an impact of 0.5 to 1 percentage point on the annual rate of growth over a decade. - Reduction of tax compliance costs and elimination of distortions that penalize investment expected to boost the stock of capital. ### Fiscal measures, new fiscal framework, and revenue actions - Fiscal position and measures: - 2023 federal budget initially projected a primary deficit of 2.2 percent of GDP. - Authorities presented a plan to raise revenues by at least 1 percent of GDP; several measures already adopted. - Elimination of major tax loopholes and new legislation aligning transfer pricing with international best practices. - A law to strengthen review of tax disputes in CARF was approved in the Lower House with a potential impact of 0.3 percent of GDP in revenue collection in 2023 and 0.1 percent of GDP thereafter. - Primary fiscal balance is on track to post a deficit of 1 percent of GDP in 2023, significantly lower than projected in the 2023 budget. - Authorities reaffirm commitment to a zero primary fiscal balance target for 2024, and primary fiscal surpluses of 0.5 percent of GDP in 2025 and 1.0 percent of GDP in 2026 (as envisaged in the Budget Guidelines Law submitted to Congress). - New fiscal framework (pending final congressional approval): - Proposed fiscal rule aims to stabilize public debt by 2026 and thereafter put it on a clear downward path. - Expenditures constrained to grow below revenues — with a real growth floor of 0.6 percent if revenues grow by less than 0.86 percent in real terms. - Primary fiscal balance targets set consistent with debt sustainability objective; incentives to further constrain real growth of expenditures if needed. - Approval of the fiscal framework in both houses is at a final stage, having already dissipated uncertainty regarding the fiscal path and improving market sentiment. - Direct tax reform (expected in second semester): - Administration will present a reform of direct taxes to increase revenues and progressivity. - Overall intention: close loopholes and fix cumbersome features in personal and corporate income taxation; increase progressivity in personal income tax and property taxation. - To be proposed to Congress for consideration before the 2024 budget law. ### Debt dynamics and assessments - Debt performance: - Even with the pandemic, public debt in Brazil declined between 2019 and 2022. - Example: the 2019 DSA projected public debt to reach 95.9 percent of GDP in 2022; gross general government debt (GGGD) in 2022 was 85.9 percent of GDP. - Errors in past DSA projections cited: 15 and 5 percentage points on the upside in 2020 and 2021, respectively. - Authorities argue the Fund’s debt sustainability analysis (DSA) has been too pessimistic and that the Brazilian National Treasury had more accurate projections. ### Monetary policy, inflation, and external buffers - Inflation and monetary stance: - Brazil began tightening monetary policy early in 2021. - Headline inflation: peaked at above 12 percent (y-o-y) in early 2022; fell to 3.2 percent (y-o-y) in June. - Core inflation has fallen significantly but remains stickier and still above the range consistent with the inflation target. - Credit growth has slowed; labor market showing signs of moderation. - Inflation expectations and framework: - Market analysts expect inflation to be below 4 percent in 2024 and then converge to 3.5 percent in the long run. - National Monetary Council reaffirmed the 3 percent inflation target and made it permanent and continuous. - Increased confidence in the new fiscal framework has lightened the burden on monetary policy and reduced risk premia. - Exchange rate and reserves: - Floating exchange rate regime retained; BCB intervenes only when FX market conditions are dysfunctional. - Brazil has an appropriate level of international reserves and guidance on use of FX swaps is assessed as adequate. - Any eventual reduction in stock of FX swaps will be conditional on market developments and communicated by the BCB. ### Confidence, market signals, and risk assessment - Since May (Article IV mission), upside risks materialized and confidence improved: - Brazil’s CDS declined by 50 bps (to 175 bps). - The exchange rate appreciated; inflation expectations converged further toward the target; growth projections have been systematically revised up. - Authorities’ view on risks: - Domestic risks are viewed as tilted to the upside. - Fiscal path uncertainty has largely dissipated; risk of policy reversal viewed as quite small. - While extreme climate events and social discontent are acknowledged risks, authorities consider their likelihood of having sizable, longer-lasting national impacts to be low relative to scenarios suggested by staff risk assessments. ### Financial system - System soundness and resilience: - The banking system is well capitalized and highly liquid. - Banks increased provisions concurrently with a moderate rise in problem assets; coverage remains strong. - Ratio of provisions to expected losses was 1.29 at end- *Statement by Afonso Bevilaqua, Executive Director for Brazil; July 13, 2023 and July 19, 2023.* ### 2022. Credit standards in household lending have become stricter, which is already having an ### 1braea2023001 - 2022. Credit standards in household lending have become stricter, which is already having an ### Financial sector resilience and asset quality - Credit standards in household lending have become stricter, which is already having an effect, with more recent credit vintages performing better than the ones from the height of the pandemic. - In business lending, despite the recent increase, measures of delinquency and problem assets are below their pre-pandemic levels. - The banking system has low exposure to interest rate risk and unrealized losses from held-to-maturity bond portfolios are insignificant. ### Financial innovation: Open Finance, Pix, and the Digital Real - Open Finance, Pix instant payment system, and the Digital Real (in development) are expected to mutually reinforce an environment conducive to innovation and contestable markets. - Brazil’s Open Finance uptake: - "5 million users in less than one year" - "22 million after two years" - Pix outcomes: - Helped level the playing field between new digital entrants and incumbent banks with large networks and physical infrastructure. - Led to greater financial inclusion, with "tens of millions of new users of payment accounts" building transaction histories that can facilitate access to additional financial services, including credit. - The BCB continues to add new features to Pix to allow financial institutions to offer new and innovative products. - Digital Real (wholesale CBDC) objectives: - Provide a secure platform for the private sector to create innovative solutions using new technologies. - End-users will have indirect access only through regulated financial and payment institutions, mitigating the risk of financial disintermediation. ### Household debt, policy responses, and consumer protection - The government is rolling out the Desenrola program to help millions of low-income households with overdue loans and other past-due obligations, including to utility companies, to restructure their debts. - Program mechanics and safeguards: - The government will offer incentives to creditors in exchange for reductions in the principal and interest on the restructured debts. - For the lowest-income borrowers, there will be a government guarantee on the restructured debt, underpinned by funds previously allocated for this purpose. - Complementary measures: - The BCB, together with other regulators and government bodies, has a long-standing comprehensive financial literacy agenda, which has recently been boosted. - Legislation to help prevent and treat overindebtedness was passed in 2021 and is currently being implemented. - Policy intent: - These measures and other regulatory initiatives aim to prevent households, including those benefiting from Desenrola, from over-extending themselves again in the future. ### Climate policy, deforestation, and green economy transition - Authorities are developing a strategic plan to promote the ecological transition of the Brazilian economy and aim to enhance private sector participation to meet a significant share of needed investments. - Actions already taken: - The Administration has taken action to combat deforestation in the Amazon in a way consistent with enabling the livelihood of the people in the region. - Emphasis on reconciling economic development and improved living conditions with environmental responsibility. - Agriculture and energy context: - Productivity in Brazilian agriculture has increased substantially in past decades and production can continue to expand without further deforestation. - Embrapa’s decades-long effort focuses on improving productivity and restoring degraded areas. - The recently launched agricultural credit program (Proagro) is cited as an example of providing incentives to green production even with limited fiscal space. - Assessment of vulnerability claims in the staff report: - The report’s characterization of agriculture and energy as "sectors at risk" is questioned as overstated. - Examples cited by the staff report are viewed as not corroborative of "high economic vulnerability": - World Bank’s estimate that agriculture loses "1 percent of its yearly output due to extreme climate events" is labeled a stretched argument. - Hydropower generation losing "5 percent of its capacity by 2050 in a moderate climate change scenario" is considered not sufficient to corroborate the report’s characterization. - In an extreme scenario (Amazon tipping point), the IDB estimates a cumulative output loss of "10 percent of 2022 GDP spread out over 30 years," which equates to "less than a quarter of a percentage point of GDP per annum" using the staff’s assumption of "2 percent GDP growth." - Authorities remain fully committed to halting deforestation, incentivizing smart-agriculture, and expanding other renewable energy sources as part of their climate change agenda. ### Debt measures and the BCB–Treasury financial relationship - Public debt statistics in Brazil are described as widely available and transparent. - The GGGD (government gross general debt) used by the authorities: - Is "well accepted and understood by private sector analysts and credit rating agencies." - "Immediately reflects changes in the primary fiscal balance" and is deemed suitable given Brazil’s substantial buffers. - Availability of alternative metrics: - All data required for computing other debt concepts are publicly available. - Fiscal risks and performance may be better depicted by net debt concepts; public sector net debt provides important information for fiscal analysis. - BCB–STN relationship: - The staff report acknowledges that, "Despite differing from international practices, the current setup has its own advantages and has allowed Brazil to conduct sterilization, public financing, and exchange rate operations in an efficient manner even under challenging market conditions." - The authorities do not consider changing the framework for the BCB–STN financial relation an agenda item following the comprehensive "2019 reform." - Given the authorities’ assessment of the adequacy of the current framework and their priorities, the staff chapter’s analysis is unlikely to be taken up in the foreseeable future. *Source: 1braea2023001 - 2022.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1braea2023001.pdf_