## 1. The New Proposed Rule Under Alternative Growth and Revenue Scenarios ## Source details **Canonical URL:** [1. The New Proposed Rule Under Alternative Growth and Revenue Scenarios](https://www.imf.org/-/media/files/publications/cr/2023/english/1braea2023002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1braea2023002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1braea2023002.pdf.json) --- ### A. Introduction and context - Brazil’s fiscal framework has guided policy for two decades but effectiveness has waned due to design problems, weakening legal provisions, entrenched budget rigidities, and shock responses. - The new proposed fiscal rule aims at achieving fiscal consolidation by limiting expenditures to grow less than revenues over time and requires sustained ambitious revenue increases. - Current plans envisage reversing pandemic-related tax cuts, mitigating tax litigation losses, and increasing direct tax collection through closing loopholes and reducing tax expenditures. - Authorities’ objective: improve the federal primary balance from a deficit of 0.5 percent in 2023 to a surplus of 1 percent of GDP in 2026; primary balance targets set yearly in the Budget Guidelines Law with a tolerance band of +/- 0.25 percent of GDP in the draft complementary law. - Real federal spending corridor: floor of 0.6 percent and ceiling of 2.5 percent (growth corridor). - Spending growth contingent on prior-year revenue collection and fiscal performance: - If federal primary balance in year t is within the target band, real federal spending growth in t+2 = real revenue growth in t+1 (mid-year) × 0.7. - If federal primary balance in year t is outside the target band, real federal spending growth in t+2 = real revenue growth in t+1 (mid-year) × 0.5. - New rule introduces a floor on public investment of 0.6 percent of GDP and a mechanism to channel up to 70 percent of overperformance on the primary balance to investment, limited to 0.25 percent of the previous year’s GDP; the remainder saved. - Draft complementary law specifies sanction mechanisms and a limit of 25 percent of total discretionary spending that can be cut to meet the primary balance target. FRL provisions largely remain in place; debt limits for subnational governments and requirement that new permanent spending mandates be matched by compensatory revenue increases would remain. ### B. International evidence and design principles - Common international practice: - Many countries combine a debt anchor with an operational rule (budget balance or expenditure rule); debt ceiling/anchor supported by an operational rule is most common. - Expenditure rules more prevalent in emerging markets and Latin America, often capping real or nominal spending growth with exemptions for interest payments, cyclically sensitive items, capital and security spending. - Empirical findings: - Debt rules: more effective at reverting debt after shocks. - Budget balance rules: better at limiting forecast errors. - Expenditure rules: reduce pro-cyclicality, but event studies show investment spending often falls after implementation. - A well-designed MTBF can help mitigate crowding out of capital spending. - Institutional requirements and principles: - Strong institutions needed for forecasting, monitoring MTFF implementation, and enforcing compliance. - Rules should be simple, transparent, flexible to respond to shocks, provide operational guidance and accountability, ensure long-term sustainability and stabilization, and facilitate coordination across levels of government. ### C. Brazil’s fiscal framework — past lessons - Key milestones: - 1988 Golden Rule (broadly defined capital spending); resulted in sizable current spending sustainable under de jure compliance but failed to contain public debt growth or foster public investment. - 2000 Fiscal Responsibility Law (FRL): spending limits, annual primary balance targets, personnel spending caps (50 (60) percent of net current revenue for federal (subnational)), debt limits for states and municipalities (200 percent and 120 percent of net current revenues). - 2016 Federal Spending Ceiling: constitutional limit on federal primary spending growth to inflation for 20 years; helped curb spending growth and improved primary balances but retrenchment and frequent amendments weakened effectiveness; compliance often required restraining public investment. - December 2022: federal spending ceiling revoked; transition constitutional amendment and new rule proposed to Congress in March 2023. - Recurrent weaknesses: procyclicality (nominal primary targets), lack of a medium-term anchor, budget rigidities, reliance on legislative amendments, non‑recurrent revenues, and off‑budget operations; subnational compliance uneven. ### D. Implications and limitations of the new proposed rule - Focus and implementation risks: - The rule is revenue-centric: spending growth linked to prior-year revenue growth introduces a procyclical bias and places heavy emphasis on sustained revenue measures. - Implementation risks given slowing cyclical conditions and a high revenue ratio on a structural basis. - Floors on real spending growth and investment add to budget rigidities and complexity; potentially conflicting provisions (spending floors, within-year correction mechanisms, 25 percent cap on discretionary cuts) complicate compliance and communication. - Debt sustainability and required consolidation: - No built-in debt reduction anchor in the proposed rule. Under staff macro assumptions, a primary surplus over 1 percent of GDP over the medium term is needed to stabilize gross NFPS debt; unfavorable interest rate-growth differentials expected to push debt upward in near term. - Staff estimates a total fiscal effort of around 4-4½ percent of GDP would be required over the medium to longer term to put debt on a firmly declining path. - Feasibility if: real federal spending growth remains at the floor of the corridor (see “Inflation+0.6” scenario) and a sustained increase in the revenue-to-GDP ratio of 2 percent of GDP is achieved (in line with staff’s baseline on revenues). - With real spending growth at the ceiling of the corridor (2.5 percent), NFPS gross debt would reach around 110 percent of GDP by 2028. - Compliance with the primary balance target band until 2026 requires revenue increases of around 2½ percent of GDP from the 2023 budget. ### E. Box 1 — Illustrative macro scenarios under the new rule - Modeled scenarios: - ‘recession’ (decline in real GDP growth similar to the 2015-16 crisis), - ‘slowdown’ (around ½ percent in three consecutive years), - ‘boom’ (akin to pre-global financial crisis growth spurt). - Assumptions: - Revenue measures of 1 percent of GDP implemented in 2024 prior to cyclical swings; no further measures thereafter. - Revenue elasticity around 1.1 percent. - Findings: - Real spending paths: similar during slowdowns and recessions (guided by the 0.6 percent real spending floor); increase strongly in a boom (guided by the 2.5 percent ceiling). - During slowdown/recession the rule offers some spending envelope increases thanks to the floor, but the stance is somewhat contractionary and pro-cyclical; missing the primary balance target lowers spending growth in years following the trough and accelerates in recovery without rebuilding buffers. - In booms, spending growth hits the corridor ceiling making the fiscal stance expansionary and pro-cyclical. - Debt dynamics: debt increases in recessions mainly due to declining GDP; in booms debt ratios decline initially but may rise again absent sustained revenue increases. ### F. Avenues to enhance the fiscal framework — key options and policy recommendations - Refining the spending rule: - Calibrate the spending corridor to ensure consistency with primary balance targets, including for 2027 and beyond. - Incentivize exercising discretion to remain below the 2.5 percent real federal spending growth ceiling, particularly during good times. - Ensure spending cuts remain possible to address shocks; harmonize rules on current and capital spending within the corridor to mitigate misclassification risks and safeguard public investment. - Continue transparent intra-year reporting; introduce binding multi-year targets and transparent medium-term expenditure paths with five-year projections of expenditure components. - Addressing procyclicality: - Link federal spending growth to sustained increases in the structural revenue-to-GDP ratio rather than headline revenue growth. - Exclude volatile non-recurring revenues (dividends, concessions, royalties) from the revenue base — the rule already excludes these, but tax revenues remain cyclical. - Compute and publish cyclical and structural components of revenues or non-commodity fiscal balances; establish guidelines to smooth consumption of surprise proceeds over several years. - Introduce an economic escape clause with clearly defined triggers, designated activating authority, and predefined correction mechanism and timeline. - Securing debt sustainability via a fiscal anchor: - Adopt a public debt anchor as foreseen by the FRL to guide primary balance calibration. - Anchor options: (i) derived from a DSA with risk buffers; (ii) a fixed medium-term target; (iii) a multi-year primary balance path with pre-announced binding targets. - Rule-of-thumb: dividing the highest historical primary balance (4 percent of GDP) by an interest-rate growth differential under stress of 4.5 percent indicates a maximum debt level around 90 percent of GDP for gross NFPS debt during crisis times. - IMF (SRDSF) threshold for Brazil around 90 percent of GDP in 2022 (holding everything else constant); factor in buffers calibrated to avoid crossing the debt limit with 90 percent probability (e.g., ~15-25 percent of GDP depending on horizon). - Desirable longer-term anchors: around 50-55 percent of GDP for net general government debt, or around 80 percent of GDP for NFPS gross debt, taking into account liquid cash buffers broadly 10 percent of GDP. - Subnational constraints and institutional strengthening: - Harden subnational expenditure ceilings, address legal uncertainty over FRL application (injunctions preventing sanctions), improve municipal data quality and harmonize accounting standards. - Strengthen fiscal institutions (MTFF, fiscal council, IFI) and checks and balances, empower the Independent Fiscal Institution to monitor escape clause activation, run DSAs with independent macro assumptions, and present opinions on fiscal paths. - Publish a credible medium-term fiscal strategy to anchor expectations. ### G. Revenue mobilization and tax reform options - Revenue requirement implied by the new rule: increase revenues by about 2.5 percent of GDP in the near to medium term compared to the 2023 budget. - Context and constraints: - Tax revenue ratio about 25 percent of GDP in 2022. - Stock of unsettled tax disputes at CARF amounted to 10 percent of GDP in 2022. - Heavy reliance on indirect taxes limits progressivity; direct taxes (CIT, PIT) are underperforming relative to peers. - Indirect tax reform: - Integrate five existing federal and subnational consumption taxes into a national or dual VAT; destination-based domestic taxation; eliminate origin‑based cumulative taxation and differentiated subnational exemptions. - Reform intended to be revenue neutral; estimates point to a positive potential GDP impact of 12 to 20 percent in 15 years via TFP and private investment improvements. - Current consumption tax revenues equivalent to a VAT rate of 26.9 percent (estimate). - Direct tax reform: - Move toward a dual income tax model to neutralize treatment across income sources, increase progressivity, and align with comparable countries. - PIT measures: higher marginal PIT rates for higher incomes, phase out or cap deductions for health and education, extend capital income taxation (closed-end funds), align capital income rates with labor income. - CIT measures: introduce dividend taxation, replace Juros sobre Capital Próprio (JCP) with a proper equity allowance, consider reducing statutory CIT rates (current CIT rate: 34 percent) to offset dividend taxation and discourage SIMPLES avoidance. - Current CIT rate: 34 percent (50 percent higher than the OECD average of 21 percent). - Tax expenditure rationalization: - Tax expenditures estimated to over 5 percent of GDP; federal estimate of foregone revenue 4.2 percent of GDP (latest budget documents), excluding subnational tax expenditures. - Notable items: - SIMPLES: annual federal cost estimated at about 1.1 percent of GDP in 2023; high turnover ceiling about US$1 million per year vs. recommendable ~US$200,000 per year; nearly 65 percent of formal firms registered in SIMPLES as of 2020. - PIT deductions/exemptions: foregone revenues about 1 percent of GDP; current PIT exemption threshold exempts about 80 percent of the population. - Presumptive CIT regime cost at least 0.2 percent of GDP. - Deductibility of 15 percent interest on net equity (JCP) foregone revenue estimated at 0.2 percent of GDP. - Institutional constraints: since 2019 new tax expenditures must have a 5-year expiration, compensatory measures, and monitoring; 2020 constitutional amendment aims to reduce federal tax expenditures by 2 percent of GDP by 2029 (exclusions apply). ### H. Spending-side measures, rigidities, and efficiency - Size and composition: - Total general government spending reached 46 percent of GDP in 2022. - Primary general government spending ~38 percent of GDP. - Wage bill: 12 percent of GDP. - Gross pension spending: 12 percent of GDP. - Gross public investment: 1.5 percent of GDP (vs. about 3 percent average in OECD). - About 60 percent of general government primary current spending (net of pension contributions) goes to public sector salaries and public and private pensions; 13 percent allocated to social assistance/targeted transfers. - Potential savings: - Spending reforms could yield about 2-3 percent of GDP over time (pensions, public administration, budget rigidities, efficiency gains). - Pension system: - 2019 reform stabilized RGPS deficits at around 2.5 percent of GDP until 2030; combined RGPS and RPPS deficits 5.7 percent of GDP in 2022. - RGPS NPV of pension deficits estimated at 70 percent of 2023 GDP (discounted at current interest rates); 118 percent when discounted at staff’s neutral interest rate. - Replacement rates over 90 percent on aggregate; contribution rates average 9.5 percent of wages. - Staff-recommended measures include reduced replacement rates for newcomers and existing pensioners, increases in effective retirement age, higher contribution rates, elimination of partial PIT exemption for pensioners above 65, coordination of non-contributory regimes, and automatic adjustment mechanisms tied to life expectancy. - Subnational RPPS reforms: converge RPPS to federal RGPS with transition periods; federal government can require reforms as part of fiscal recovery programs. - Public administration and wage bill: - Public pay about 30 percent higher than formal private sector on average. - Near-term actions: review compensation structure, align entry salaries with private sector, increase intervals for progressions, reduce automatic seniority increases, merge allowances into base wage, transition to merit-based remuneration. - Estimated savings: public administration reforms could save up to 1 percent of GDP; freezing average remuneration and halting new hiring for five years could reduce federal wage bill by about 0.5 percent of GDP and subnational by another 0.5 percent. - Budget rigidities: - Automatic indexation (minimum wage link), revenue earmarking (over 400 rules; almost 80 percent of total federal revenue earmarked), mandatory spending exceeding 90 percent of total primary spending. - Reducing rigidities would raise discretionary budget share, aid compliance with the new rule, reduce procyclicality, and free resources for shocks and priorities. - Efficiency and PFM: - Authorities plan MTBF introduction in the 2025 budget law; MTBF to include reliable granular multi-year expenditure projections and prioritization. - Recommend central agency-led comprehensive spending reviews and rolling reviews for large programs with efficiency dividends. Country examples: UK comprehensive spending reviews (every 2-3 years) achieved a reduction of 5 percent of GDP in spending over 5 years. - Public procurement improvements could yield up to 0.2 percent of GDP in savings. ### I. Public debt measures, BCB–NT financial relationship, and transparency - Debt measures and Brazilian peculiarities: - Multiple debt measures in use: Federal Public Debt (FPD), General Government Gross Debt (GGGD-authorities), General Government Gross Debt (GGGD-IMF), Non-Financial Public Sector Debt (NFPS–IMF), General Government Net Debt (GGND), Public Sector Net Debt (PSND). - Treatment of Federal Securities (FS) held by the BCB and repos drives material differences across measures and affects stock-flow adjustments. Inclusion/exclusion rules changed post-2008 and after 2019 reforms. - Repos and FS dynamics are jointly driven by fiscal, monetary, and exchange rate policies; historical repo stock movements illustrated (e.g., repo stock rose by 9 percent of GDP since end-2005; declined by 7 percent of GDP since end-2017). - Key operational considerations and transparency recommendations: - Publish actual debt servicing needs of FS held by the BCB since FS rolled over by the BCB do not create financing needs for the NT. - Include GGND projections in main fiscal planning instruments to complement GGGD-authorities and PSND. - Provide monthly information on BCB operations’ impact on the repo stock and GGGD (authorities) and decompose BCB operations included in the interest bill as memo items. - Preserve operational neutrality and not undermine effective liquidity and debt management practices. - Pros and cons of indicators: - GGGD-authorities: immediately reflects primary balance via repos; influenced by non-fiscal factors (FX swaps, reserve sales, voluntary deposits); well-known to market participants. - GGGD-IMF: reflects primary balance only when surpluses used to redeem debt; less affected by BCB operations post-2019. - GGND/Net measures: useful if financial assets are liquid and usable to cover liabilities; can conceal fiscal risks if assets earmarked or illiquid (FAT, earmarked TSA subaccounts). - PSND: includes BCB assets/liabilities; historically sensitive to exchange rate valuations. - Debt dynamics examples and conditioning factors: - FS stock dynamics affected by negative BCB financial results, automatic issuance rules when non-earmarked portfolio falls below thresholds, snowball effects (price index accrual), and sterilization operations linked to reserve accumulation or FX operations. - Repo stock can increase due to net redemptions to the public, TSA declines, international reserve purchases, FX swap losses, compulsory/voluntary deposit changes, and a repo interest rate above nominal GDP growth. - Key statistics and fiscal operations: - FX repos increased by 0.5 percent of GDP in December 2022 (year‑end FX liquidity support), reversed by early 2023. - TSA assets as of end 2022: 18 percent (of TSA assets); around one third of TSA assets linked to bodies/programs or earmarked by law; remaining two thirds labelled as “liquidity reserve.” - Exceptional transfer from BCB reserve: R$325 billion (August 2020), representing almost 70 percent reduction of the reserve buffer. - Equity-to-assets ratio: around 8 percent in 2020-21 vs 4 percent in 2014-19. - 2022 exchange equalization income: -R327bn; other operations: R28 bn; reserve used in 2022: R179bn; reduction of equity: R83bn; credit from NT: R37bn. - Legal minimum net worth: 1.5 percent of assets. - Sensitivity thresholds: currency appreciation of 4 percent; foreign interest rates increase of 100 basis points. - Annualized VaR: R324 billion in 2021; R404 billion in 2022 (VaR confidence level: 95 percent; probability of losses above this level: 5 percent). - Policy considerations for BCB financial autonomy: - Provide BCB discretion to set risk buffers considering current and future income and balance sheet exposures; allow profit distributions accounting for accumulated past losses. - Prioritize repayment of BCB-held federal securities from BCB profits before allocations to reserves or distributions to reduce NT recapitalization needs. - Facilitate reduction of FS held by the BCB while ensuring BCB retains adequate monetary policy tools. ### J. Fiscal institutions, IFI role, and MTBF implementation - Strengthen and resource the Independent Fiscal Institution (IFI) to perform tasks including: - Monitoring escape clause activation and implementation. - Running DSA inputs with independent macro assumptions. - Performing reality checks on budget feasibility and stability. - Presenting opinions on federal and subnational fiscal paths and rules. - MTBF and spending control: - Authorities aim to complement MTFF with MTBF in the 2025 budget law that delivers granular multi-year expenditure projections and prioritization. - Recommend central agency-led comprehensive spending reviews, rolling reviews for fast‑growing programs, and efficiency dividends on ministries’ operational expenses. ### K. Other relevant policy domains (payments, climate) — selected findings - Pix (instant payments) success factors and risks: - Rapid adoption due to speed, cost, flexibility, ease of access, interface standardization, and mandatory participation by major banks; coverage: more than 140 million individuals and 13 million firms; more than 3 billion transactions each month (BCB stats as of May 2023). - Ongoing risks: indirect credit risks from fintechs, account creation and fraud, operational resilience; recommendations include financial literacy initiatives, strengthening monitoring of account creation, potential alias reduction, and crisis simulation drills. - Climate and green economy priorities: - Projected temperature changes between +1°C and +5°C by century end; floods have more than doubled relative to the 1980s-90s; agriculture and power generation are most vulnerable. - Estimated output loss of reaching the Amazon tipping point: 10 percent of 2022 GDP through 2050 (World Bank CCDR, 2023). - Power sector risks: slow-moving temperature increases and precipitation changes could lower dispatchable hydro capacities by approximately 9 to 28 percent from 2030 to 2050 under a high emission scenario; absent expansion, power deficiency up to 82 TWH in 2030 (14 percent of 2021 supply) possible. - Policy options: incentives and feebates for forest protection; Payment for Environmental Services; scale up climate-smart agriculture, irrigation, R&D, and insurance; invest in renewables, grid strengthening, storage, and climate-aware project selection; consider mandatory ETS with price stability mechanisms and careful rules on forestry offsets. - Climate-related fiscal needs: yearly infrastructure investment for climate action estimated at 1.2 percent of GDP beyond current investments. *Source: 1braea2023002 - IMF staff chapter excerpts on Brazil fiscal framework, revenue and spending measures, public debt and BCB operations, Pix system, and climate policy options.* ### 1. The New Proposed Rule Under Alternative Growth and Revenue Scenarios _______ 13 ### 1. The New Proposed Rule Under Alternative Growth and Revenue Scenarios _______ 13 ### A. Introduction - Brazil adopted fiscal rules early; the fiscal framework guided fiscal policies for two decades and helped modernize public financial management and contributed to fiscal sustainability and macroeconomic stability. - Effectiveness has waned in recent periods due to design problems, weakening of legal provisions, entrenched budget rigidities, and the need to respond to shocks. - The new proposed fiscal rule aims at achieving fiscal consolidation by limiting expenditures to grow less than revenues over time. - Delivering on consolidation under the new rule requires ambitious efforts to increase fiscal revenues over an extended period of time. - Current plans envisage a combination of reversing pandemic-related tax cuts, mitigating tax litigation losses, and increasing direct tax collection, including through closing loopholes and reducing tax expenditures. - Purpose of the paper: discuss options to build on the new fiscal rule and enhance the fiscal framework; assess risks from the rule’s revenue focus; propose options based on Brazil’s and cross-country experience. ### B. International Experience with Fiscal Rules - Global trends and common structures: - Many countries use a combination of a debt anchor and an operational rule (e.g., budget balance or expenditure rule). - The most common combination is a debt ceiling or anchor supported by an operational rule (IMF, 2021). - The new European approach focuses on debt stabilization rather than returning to a fixed numerical threshold once debt exceeds 60 percent of GDP. - Regional notes: - Debt rules are less common in Latin America; Peru was the only LA6 country with a debt rule up to 2022, with Chile and Colombia introducing debt rules in 2022. - LA6 countries include Argentina, Brazil, Chile, Colombia, Peru, and Mexico. - Prevalence of expenditure rules: - Expenditure rules are more prevalent in emerging markets and in Latin America; caps on real expenditure growth and caps on nominal spending growth are most common. - Exemptions often include items not under government control (e.g., interest payments) and cyclically sensitive items; some countries exclude capital and security spending. - Empirical evidence on rule effectiveness: - Debt rules: more effective in reverting to previous (or lower) debt levels after shocks (IMF, 2021). - Budget balance rules: better at limiting forecast errors (IMF, 2021); minimize deviations between rule limits and IMF forecasts (Davoodi and others, 2022). - Expenditure rules: useful in reducing pro-cyclicality, notably in emerging markets; event studies show investment spending often falls after implementation of expenditure rules. - A well-designed medium-term budgetary framework (MTBF) can help mitigate risks that capital spending will be crowded out to comply with expenditure ceilings (Cordes and others, 2015). - Institutional requirements: - Strong institutions are needed to forecast fiscal paths and risks, monitor MTFF implementation, and enforce compliance. - Nearly 80 percent of countries suspended or modified rules after the pandemic (Davoodi and others, 2022), with many governments planning a return to fiscal rules. - Principles for rule design: - Rules should be simple, transparent, flexible to respond to shocks, provide operational guidance and accountability, ensure long-term sustainability and stabilization, and facilitate coordination across levels of government. ### C. Brazil’s Fiscal Framework: Past and Present - Historical adoption and key milestones: - 1988: Golden Rule introduced in the constitution to restrict new borrowing to finance capital expenditures and safeguard fiscal responsibility and public investment. - 2000: Fiscal Responsibility Law (FRL) established spending limits and institutionalized annual primary balance targets; personnel spending capped at 50 (60) percent of net current revenue for the federal (subnational) government(s). - 2016: Federal spending ceiling enshrined in the constitution, limiting federal primary spending growth to inflation for 20 years, with a possible revision after 10 years. - December 2022: The ceiling was revoked by a constitutional amendment; a new fiscal rule is under consideration by Congress. - 1988 Golden Rule — design and outcomes: - Definition of capital spending is very broad, including investment in non-financial and financial assets, debt amortization, government lending, equity purchases, and debt valuation changes due to exchange rate fluctuations. - Financial revenues (e.g., transfer of central bank profits, returns to government assets, large Treasury Single Account) have been sizable. - Result: the level of current spending sustainable under the golden rule is much higher than under a strict application; current deficits have been positive in most years despite de jure compliance. - The golden rule has not been effective in containing public debt growth or fostering public investment. - 2000 Fiscal Responsibility Law — features and limitations: - FRL improved fiscal transparency, limited deficit biases, and defined control mechanisms at all levels of government. - Established spending limits, annual primary balance targets, caps on personnel spending (50 (60) percent of net current revenue), pre-election spending constraints, and prohibition of permanent spending mandates without compensation. - Debt limits legislated for states and municipalities at 200 percent and 120 percent of net current revenues, respectively. - FRL remains the backbone of the fiscal framework, enabling transparent reporting and periods of debt decline. - Challenges: procyclicality (primary balance target defined in nominal terms), lack of a medium-term anchor, extensive budget rigidities, and reliance on legislative amendments, non-recurrent revenues, and off-budget operations when conditions worsened. - Over time, structural primary balances turned negative and nonfinancial public sector gross debt trended upward (IMF, 2017). - Subnational compliance was uneven due to accounting differences, weak controls, legal uncertainty, and loosened borrowing controls (IMF, 2020). - 2016 Federal Spending Ceiling — design and effects: - Objective: address procyclicality and reverse the secular rise in the federal spending ratio by limiting federal primary spending growth to inflation for 20 years. - The ceiling had broad coverage with few exceptions (exceptions included constitutional transfers to subnational governments, capitalization of SOEs, and extraordinary credits). - Accompanied by institutional reforms and the creation of the Independent Fiscal Institution to provide independent projections and assess compliance. - The ceiling helped curb spending growth, improve primary balances, and contributed to credibility and lower sovereign risk premia. - The 2019 pension reform stabilized pension spending of the general pension regime (RGPS). - Limitations and practical outcomes: - Much of the adjustment came from retrenchment of discretionary spending and frequent amendments that weakened effectiveness. - Compliance required restraining public investment, often below capital depreciation. - Pandemic response in 2020 increased spending which was largely reversed by early 2021. - In 2021-22, four constitutional amendments accommodated new spending mandates (expanded social assistance, court-ordered payments, health, and public investment), expanding the spending envelope and introducing uncertainty. - Frequent amendments and retrenchment of discretionary spending weakened the effectiveness of the 2016 federal ceiling. ### D. Implications of the New Proposed Fiscal Rule - Focus and risks: - The new rule focuses on limiting expenditure growth relative to revenues, placing emphasis on revenue increases to achieve consolidation. - Revenue-centric design carries implementation risks and will require sustained, ambitious revenue measures. - Policy measures envisaged to meet revenue objectives: - Reverse pandemic-related tax cuts. - Mitigate tax litigation losses. - Increase direct tax collection by closing loopholes and reducing tax expenditures. - Overall assessment: - The new rule addresses political priorities and can reduce fiscal uncertainty while creating an opportunity to prepare reforms for gradual improvement in the primary fiscal balance. - More ambitious consolidation will be needed to achieve a firmly downward public debt path. - Building on Brazil’s experience and cross-country lessons, the paper proposes options to enhance the fiscal framework (detailed options are discussed in subsequent sections of the source). *Source: 1braea2023002 - 1. The New Proposed Rule Under Alternative Growth and Revenue Scenarios* ### 22. The transition constitutional amendment was passed in late 2022 to replace the ### 22. The transition constitutional amendment was passed in late 2022 to replace the ### New proposed spending rule and immediate context - The transition constitutional amendment lifted the federal spending ceiling in December 2022 and the new rule was proposed to Congress as a complementary law in March and informed the preparation of the 2024 Budget Guidelines Law. - With a few exceptions, FRL provisions would remain in place. - The authorities’ objective: improve the federal primary balance from a deficit of 0.5 percent in 2023 to a surplus of 1 percent of GDP in 2026. - Primary balance targets are determined yearly in the Budget Guidelines Law; a tolerance band around targets of +/- 0.25 percent of GDP is included in the draft complementary law. - Real federal spending corridor: floor of 0.6 percent and ceiling of 2.5 percent (growth corridor). - Spending growth is contingent on prior-year (i) revenue collection and (ii) fiscal performance relative to the primary balance target: - If the federal primary balance in year t is within the target band, real federal spending growth in t+2 equals real revenue growth in t+1 (mid-year) multiplied by a factor of 0.7. - If the federal primary balance in year t is outside the target band, real federal spending growth in t+2 equals real revenue growth in t+1 (mid-year) multiplied by a factor of 0.5. - The rule introduces a floor on public investment of 0.6 percent of GDP. - In case of overperformance relative to the primary balance target, investment spending can be increased up to 70 percent of the overperformance per year, limited to 0.25 percent of the previous year’s GDP; the remainder would be saved. - The draft complementary law specifies new sanction mechanisms and a limit of 25 percent of total discretionary spending allowed for cuts to meet the primary balance target. - Debt limits for subnational governments and the requirement for new permanent spending mandates to be matched by compensatory (permanent) revenue increases would remain in place. ### Main assessment and challenges - The fiscal framework has supported responsible fiscal management but has become relatively complex, with potentially internally inconsistent rules and weakened monitoring and accountability due to past exceptions. - Limits to effectiveness: - Challenges to advance structural spending reforms, short-term planning, and reduced flexibility. - Frequent amendments to rules when addressing shocks or new priorities; approving structural reforms has been more difficult. - Lack of a medium-term horizon facilitating a short-term bias and postponement of reforms. - Key weaknesses of the new proposed rule: - No built-in debt reduction. Under staff’s macroeconomic assumptions, a primary surplus of over 1 percent of GDP over the medium term is needed to stabilize gross NFPS debt; unfavorable interest rate-growth differentials are expected to lead to a rising debt path in the near future. - To put debt on a firmly declining path, staff estimates a total fiscal effort of around 4-4½ percent of GDP would be required over the medium to longer term. - Feasibility conditions: such consolidation would be feasible under the new rule if real federal spending growth remains at the floor of the corridor (see “Inflation+0.6” scenario), and a sustained increase in the revenue-to-GDP ratio of 2 percent of GDP is achieved (in line with staff’s baseline scenario on revenues). - With real spending growth at the upper limit of the corridor of 2.5 percent, NFPS gross debt would reach around 110 percent of GDP by 2028. - Consolidation through higher revenues: compliance with the primary balance target band until 2026 requires increases in revenue collection of around 2½ percent of GDP from the 2023 budget; implementation risks given slowing cyclical conditions and a high revenue ratio on a structural basis. - Procyclical bias: linking spending growth to prior-year revenue growth entails a procyclical bias, stronger during economic booms (real spending growth is higher in good times, even if capped at 2.5 percent). - Increased budget rigidities and complexity: floors on both real spending growth and investment add to entrenched rigidities; potentially conflicting provisions (e.g., spending floors, within-year correction mechanisms when the primary balance target is at risk, and limitation of expenditure cuts to 25 percent of discretionary spending) could pose communication and compliance challenges. ### Box 1 — Illustrative scenarios under the new proposed rule - Scenarios modeled: (i) ‘recession’ (decline in real GDP growth similar to the 2015-16 crisis); (ii) ‘slowdown’ (around ½ percent in three consecutive years); (iii) ‘boom’ (akin to pre-global financial crisis growth spurt). - Assumptions: revenue measures of 1 percent of GDP implemented in 2024 prior to cyclical swings; no further measures thereafter in the scenarios; revenue elasticity around 1.1 percent. - Findings: - Real spending path: similar during slowdowns and recessions (guided by the spending floor); trends strongly upwards in a boom (guided by the spending ceiling). - In slowdown and recession, the new rule offers some increase in the spending envelope thanks to the 0.6 percent real spending floor, but the resulting stance is somewhat contractionary and pro-cyclical. - Missing the primary balance target during downturns implies spending growth is lowest in years following the trough and accelerates in the recovery, without recovering fiscal buffers. - In booms, real spending follows a strong upward path with spending growth at the maximum of the corridor, turning the fiscal stance expansionary and pro-cyclical. - Debt dynamics: debt increases in recessions mainly due to declining GDP, and also in slowdowns, stabilizing over a long horizon; during booms debt ratios decline initially but may rise again in outer years absent sustained revenue increases. ### Avenues to enhance the fiscal framework — key options and policy recommendations - Refining the New Fiscal Rule: - Calibrate the spending corridor to ensure consistency between spending paths and primary balance targets, including for 2027 and beyond. - Incentivize exercising discretion to remain below the ceiling of 2.5 percent real federal spending growth, particularly during good times. - Ensure spending cuts remain possible to deal with shocks. - Harmonize differentiated rules on current and capital spending within the corridor to mitigate misclassification risks and safeguard public investment. - Continue transparent reporting on fiscal developments and projections within the fiscal year. - Introduce binding multi-year targets and transparent medium-term expenditure paths; make multi-year target paths more binding and include five-year projections of expenditure components. - Addressing Procyclicality: - Link federal spending growth to sustained increases in the structural revenue-to-GDP ratio rather than headline revenue growth. - Exclude volatile non-recurring revenues (dividends, concessions, royalties) from the revenue base — the rule already excludes these, but tax revenues remain exposed to cycles. - Compute and publish cyclical and structural components of revenues, or non-commodity fiscal balances, to raise awareness. - Establish guidelines to smooth consumption of surprise proceeds over several years. - Introduce an economic escape clause with a limited, clearly defined set of triggering events (quantitatively defined where possible), a designated activating authority, and a pre-defined correction mechanism with timeline and procedures to return to normal times. - Securing Debt Sustainability Through a Fiscal Anchor: - Adopt a public debt anchor as foreseen by the FRL to guide calibration of primary balance targets. - Options for anchors: (i) derived from a Debt Sustainability Analysis (DSA) with risk buffers; (ii) a fixed target over the medium term; (iii) anchor on a multi-year primary balance path with pre-announced, binding targets synchronized with consolidation needs. - Considerations for setting limits and buffers: - A rule-of-thumb calculation: dividing the highest historical primary balance (4 percent of GDP) by an interest-rate growth differential under stress of 4.5 percent indicates a maximum debt level around 90 percent of GDP for gross NFPS debt during crisis times. - IMF (SRDSF) threshold for debt at risk of distress, computed for Brazil, would be around 90 percent of GDP in 2022 (holding everything else constant). - Factor in a buffer calibrated to avoid crossing the debt limit with a 90 percent probability in the medium term, e.g., around 15-25 percent of GDP depending on horizon. - A desirable longer term debt anchor could be around 50-55 percent of GDP for net general government debt, or around 80 percent of GDP for NFPS gross debt, taking into account liquid cash buffers broadly 10 percent of GDP. - Hardening Subnational Budget Constraints: - Strengthen expenditure ceilings for states and municipalities to more fairly distribute fiscal effort and reduce overall debt burden. - Address legal uncertainty over FRL application, notably injunctions that prevent enforcement of sanctions. - Improve data quality for municipalities and harmonize accounting standards to facilitate monitoring. - Empowering Fiscal Institutions and Strengthening Medium-term Fiscal Planning: - Strengthen institutions (e.g., MTFF, fiscal council) and checks and balances if anchors rely on models and DSA inputs. - Enhance medium-term fiscal planning to reduce short-term biases and support structural reforms. *Source: IMF staff analysis as presented in the provided chapter text.* ### 36. Strong fiscal institutions are needed to provide an effective control mechanism. The ### 36. Strong fiscal institutions are needed to provide an effective control mechanism. ### Fiscal institutions and governance - Leverage the existing IFI to perform tasks akin to an independent fiscal watchdog with adequate resources and bolstered independence. - Potential IFI tasks: - Monitoring the activation and implementation of escape clauses. - Running the DSA as an input to fiscal management when applicable (with independent macro assumptions). - Performing reality checks on the feasibility and stability of budget plans. - Presenting opinions on federal and subnational fiscal paths and rules. - Communication and anchoring: - Publish a credible medium-term fiscal strategy to anchor expectations. ### Conclusion (key findings and risks) - Brazil pioneered fiscal rules; the fiscal framework has adapted to new challenges and priorities over time but has become increasingly complex. - The framework supported responsible fiscal management but: - Complexity, challenges to advance spending structural reforms, a short-term policy horizon, and reduced flexibility have undermined effectiveness. - These factors increase the need to amend the framework. - The new proposed rule: - Addresses important political priorities and offers opportunities for gradual consolidation over an extended horizon. - Faces several challenges and implementation risks. - Scope to shape a more comprehensive and integrated fiscal framework includes: - Ensuring consistency of the spending rule and the primary balance targets, while making the latter more binding. - Establishing a strong fiscal anchor to put debt on a firmly declining path, rebuild buffers, and embed a medium-term perspective. - Addressing procyclical bias, institutionalizing the escape clause, considering a mechanism to smooth commodity revenues, and hardening budget constraints for subnational governments. - Strengthening the MTFF and fiscal institutions to support greater flexibility. *Source: Excerpts from the IMF chapter on Brazil fiscal framework and policy (provided content).* ### REVENUE AND SPENDING MEASURES FOR INCLUSION AND FISCAL SUSTAINABILITY ### Introduction — objectives and targets - Authorities’ fiscal objective: - Improve the federal primary balance from a projected deficit of 2.1 percent of GDP in the 2023 budget to a deficit of 0.5 percent of GDP in 2023 and a surplus of 1 percent of GDP by 2026, within a narrow tolerance band as guided by the new proposed fiscal rule. - New proposed fiscal rule: spending increases must be preceded by revenue increases. - Government revenue priorities include: - Recovering the pre-pandemic tax base. - Approving the indirect tax reform (to boost potential output). - Direct tax reform to foster redistribution and increase revenues. - Streamlining inefficient tax expenditures. - Revenue requirement implied by the new rule: - Increase revenues by about 2.5 percent of GDP in the near to medium term compared to the 2023 budget. - Measures announced so far: - Reversal of selected tax cuts and tax credits. - Elimination of selected tax expenditures (e.g., exemptions for close-end funds). - Measures to limit tax disputes. ### Medium-term budgeting and spending efficiency - Plans to roll out spending reviews to improve efficiency of high-spending programs. - Strengthen the top-down MTFF by introducing an MTBF with bottom-up multi-year expenditure forecasts and support for strategic spending allocation. - Staff recommendation: - A more ambitious fiscal effort supported by both revenue mobilization and spending reforms to put debt on a firmly downward path. - Relying on a sizable and rapid increase in revenues alone carries implementation risks; spending reforms are necessary to make spending growth sustainable and create space for priority programs. ### Revenue measures — overview and context - Tax revenue ratio: - About 25 percent of GDP in 2022, one of the highest among peers. - System characteristics and issues: - Several layers of cumulative indirect taxes and large tax expenditures increase compliance costs and reduce potential GDP growth. - Tax disputes are sizable and create large fiscal risks: the stock of unsettled tax disputes at CARF amounted to 10 percent of GDP in 2022. - Distributional profile: - Heavy reliance on indirect taxes makes the system only moderately redistributive despite high overall tax collection. - Redistribution has decreased since the mid-1990s due to low effective income tax rates for the rich and the low share of direct taxes. - Social transfers partially offset regressivity. ### Indirect tax reform — goals and impacts - Reform design: - Integrate five existing federal and subnational consumption taxes into a national or dual VAT in line with international good practices. - Destination-based domestic taxation; no taxation of intermediate goods and exports; eliminate differentiated subnational exemptions on ICMS and municipal ISS. - Eliminate origin-based cumulative taxation to improve resource allocation. - Potential macro impact: - Estimates point to a positive impact on potential GDP of 12 to 20 percent in 15 years, driven mainly by an increase in TFP and private investment. - Revenue neutrality and current equivalents: - Reform intended to be revenue neutral. - Some estimates: current consumption tax revenues equivalent to a VAT rate of 26.9 percent. - State/municipal compensation: - Discussions ongoing on a compensation mechanism for subnational governments that would temporarily lose revenue. - Design considerations to secure benefits: - Limit differentiated rates and exemptions to lock in productivity and simplification gains. - Target consumption support to lower-income households using direct cash transfers or VAT credits leveraging the poverty cadaster; streamline exemptions for basic food. - Favor federal investment compensation to subnational governments rather than tax-policy flexibility; fund pre-identified, carefully planned projects aligned with national priorities. ### Direct tax reform — priorities and design - Current shortfall: - Share of direct tax revenues from CIT and PIT is 22 percent lower than in the region and 37 percent lower than in the OECD. - Drivers: - PIT: high personal exemption threshold, low statutory rates compared to peers, significant deductions and exemptions. - CIT: low revenue partly due to reliance of many companies on SIMPLES. - Reform directions: - Move toward a dual income tax model to neutralize tax treatment across income sources, increase progressivity, and align with comparable countries. - PIT measures: - Compensate recent increase in the personal exemption threshold with higher marginal PIT rates for higher incomes and phase out or cap deductions for health and education. - Extend capital income taxation to unrealized gains (e.g., in closed-end funds) and align capital income rates with labor income. - Reform SIMPLES to discourage PIT avoidance through incorporation. - Alternative: replace the threshold with a scheme comparable to the US Earned Income Tax Credit to target the poor and encourage formalization. - CIT measures: - Introduce dividend taxation and replace the interest on net equity (Juros sobre Capital Próprio, JCP) with a proper allowance on corporate equity to reduce debt bias and foster investment. - Consider reducing high statutory CIT rates closer to the top PIT rate to partly offset dividend taxation and encourage graduation away from SIMPLES. - Ensure corporate-level capital income taxation follows the same principles as personal capital gains. - Contextual numbers: - Current CIT rate: 34 percent (50 percent higher than the OECD average of 21 percent). ### Property taxation - Strengthening property taxes as a promising avenue for revenue and redistribution. - Existing taxes that could be strengthened/harmonized: IPTU, ITBI, ITCMD, IPVA, ITR. - Options: improve valuations and streamline exemptions to increase property tax revenues. ### Tax expenditure rationalization — scale and major items - Estimated magnitude: - Tax expenditures amount to over 5 percent of GDP; federal estimate of foregone revenue at 4.2 percent of GDP (latest budget documents), excluding subnational tax expenditures and other measures. - Over 200 categories of tax expenditures reported. - Noteworthy tax expenditures and estimated costs: - SIMPLES: - High maximum turnover ceiling of about US$1 million per year vs. recommendable level ~US$200,000 per year. - Nearly 65 percent of formal firms registered in SIMPLES as of 2020. - Annual cost estimated at about 1.1 percent of GDP at federal level in 2023 (excluding subnational exemptions). - Payroll tax exemptions (desoneração da folha): - Peaked at about 0.4 percent of GDP in foregone revenue in 2015; currently about 0.1 percent of GDP. - Presumptive CIT profit regime (regime de lucro presumido): - Cost estimated at 0.2 percent of GDP at least. - PIT deductions and exemptions: - Foregone revenues sum to about 1 percent of GDP; deductions include education and uncapped health expenditures. - PIT exemption threshold represents 52 percent of GDP per capita; was recently raised from 1.8 times the minimum wage to 2 times the minimum wage; current threshold exempts about 80 percent of the population from PIT. - CIT exemptions: - Deductibility of a 15 percent interest on net equity (JCP) results in foregone revenue estimated at 0.2 percent of GDP; combined with no dividend taxation, this effectively allowed companies to distribute dividends with limited taxation. - Recent institutional changes and targets: - Since 2019, Budget Guidelines Law requires new tax expenditures to have a 5-year expiration date, be associated with compensatory measures, and include proper monitoring. - A constitutional amendment adopted in 2020 aims to reduce federal tax expenditures by 2 percent of GDP by 2029, excluding SIMPLES, Manaus Free Trade Zones, basic food exoneration, and other selected programs. - Measures under discussion include reforming taxation of closed-end funds and recent taxation of offshore financial revenues and transfer pricing. *Source: Excerpts from the IMF chapter on Brazil fiscal framework and revenue and spending measures (provided content).* ### 18. The upcoming indirect and direct tax reforms also provide opportunity to eliminate ### 18. The upcoming indirect and direct tax reforms also provide opportunity to eliminate ### Tax reforms and tax expenditures - Most existing consumption tax expenditures would be automatically phased out by the indirect tax reform, provided they are not replaced with new tax expenditures. - The direct tax reform should aim at eliminating PIT and CIT deductions and exemptions to increase revenues and redistribution. - Broaden scope to rationalize tax expenditures by: - (i) reforming SIMPLES; - (ii) gradually phasing out the presumptive CIT regime; - (iii) replacing payroll tax exemptions with targeted incentives for formal job creation. - Illustrative numeric point on SIMPLES: Reducing the threshold eligibility for SIMPLES to BRL 1 million would only affect 10 percent of registered taxpayers that contribute two-thirds of total tax collection, and considerably reduce foregone revenue (Coelho, 2021). ### Spending measures — overview - Total general government spending reached 46 percent of GDP in 2022 (5 percent of GDP above the OECD average). - Primary general government spending is about 38 percent of GDP, the second highest in a group of comparable countries. - Wage bill: 12 percent of GDP. - Gross pension spending: 12 percent of GDP. - Gross public investment spending: 1.5 percent of GDP versus about 3 percent on average in the OECD. - About 60 percent of general government primary current spending (net of pension contributions) goes to public sector salaries and public and private pensions; 13 percent is allocated to social assistance/targeted transfers. - Estimated potential savings from spending reforms: about 2-3 percent of GDP materializing over time, including measures on: - Pension reform - Public administration reform - Reforms to budget rigidities - Efficiency gains and PFM tools ### Pension reform — current situation and drivers - The 2019 pension reform introduced a minimum retirement age and linked replacement rates to years of contribution, stabilizing RGPS deficits at around 2.5 percent of GDP until 2030. - Combined deficits of RGPS and RPPS reached 5.7 percent of GDP in 2022, or 20 percent of general government spending. - The RPPS deficit is equivalent to the RGPS deficit, even though RGPS covers 10 times as many pensioners as RPPS. - RGPS deficits are expected to resume an upward trend from 2030 and reach 6 percent of GDP by 2060. - Staff estimates the net present value (NPV) of RGPS pension deficits at 70 percent of 2023 GDP (discounted at current interest rates). The NPV becomes 118 percent of GDP when discounted at staff’s estimate of the neutral interest rate. - Replacement rates are over 90 percent on aggregate (partly driven by a high share of minimum wage pensions). - Contribution rates average 9.5 percent of wages. - Over 60 percent of RGPS pensioners have a minimum wage pension; non-contributory and de facto non-contributory pensions represent about 20 percent of pension expenditures. - Staff estimates that an increase of 5 percent of the minimum wage increases the RGPS deficit by 0.15 percent. - Average civil servant pensions are 5 times as high as private sector pensions; deficits per pensioner are 7 times higher for civil servants than for private sector employees. - Pension spending distribution: 35 percent of pension deficits benefit the richest 20 percent; 4 percent of deficits benefit the bottom 20 percent. Over 70 percent of beneficiaries of both non-contributory programs do not belong to the poorest 40 percent. ### Pension reform — recommended measures - Consider measures including: - (i) Reduced replacement rates for newcomers and existing pensioners via gradual alignment of accrual rates for the first 15 to 20 years of service with the 2 percent per year that is earned after the minimum years of contribution, a cap on pension indexation, and/or a de-linking of pension growth from minimum wage growth; - (ii) Increases in the effective retirement age, notably by closing early retirement loopholes; - (iii) Higher contribution rates to move closer to the OECD average, while avoiding unintended effects on formalization; - (iv) Elimination of the partial PIT exemption for pensioners above 65 years old (individuals 65 or older are eligible for double the standard personal exemption on the PIT); - (v) Coordination of non-contributory regimes with other social programs to avoid duplication and improve targeting, and potential de-linking from the minimum wage. - In the medium term, RGPS could adopt automatic adjustment mechanisms (e.g., adjustments to retirement age and minimum contribution periods based on evolution of life expectancy after 65 years old). - Subnational RPPS reforms: encourage full convergence of all RPPS to the federal RGPS with acceptable transition periods; federal government can require pension reforms as part of fiscal recovery programs for heavily indebted states; capping the share of pension spending in subnational budgets could encourage RPPS convergence. ### Public administration reform — wage bill and labor conditions - Brazil’s wage bill: 12 percent of GDP, above comparators (advanced economies 10 percent of GDP; emerging market economies about 9 percent of GDP; Latin American economies about 8 percent of GDP). - Share of civil servants comparable at about 9 percent of the working age population. - Public pay is about 30 percent higher than pay in the formal private sector on average (controlling for observable characteristics). - Federal headcount and salary freezes reduced the federal wage bill by 0.9 percent of GDP in five years; wage bill peaked at 13.2 percent of GDP in 2017 and returned to 12 percent of GDP in 2021. - Wage bill at subnational level has been growing; many states hover around the ceiling of 60 percent of net revenues set in the Fiscal Responsibility Law. - Constitutional constraints: job stability after three years, prohibition of nominal cuts in government salaries, automatic seniority adjustments and career progressions (examples: salary readjustments have exceeded 30 percent in some states). - Suggested near-term actions to achieve medium-term fiscal savings: - Reduce wage premia between public and private sectors by reviewing compensation structure, aligning entry salaries with private sector, increasing interval for progressions, reducing automatic seniority increases, merging allowances into base wage, and transitioning towards merit-based remuneration; aim to cap wage growth closer to inflation. - Replace fewer workers than those retiring in targeted areas via hiring freezes, targeted attrition, and incentives for workforce flexibility. - Estimated savings: public administration reforms could enable total savings of up to 1 percent of GDP. Freezing average remuneration in nominal terms and halting new hiring for five years could reduce federal wage bill by about 0.5 percent of GDP and subnational wage bill by another 0.5 percent of GDP. ### Reforms of budget rigidities - Key legal and constitutional rigidities include: - Automatic indexation: indexation of minimum contributory and non-contributory pensions to the minimum wage creates automatic spending increases; by constitution the minimum wage cannot decline in real terms and should be adjusted by inflation every year. Up until 2020 there was also a legal requirement to increase the minimum wage by lagged real GDP growth; a draft law to reinstate a modified form is under discussion. Many spending items must grow by inflation by law. - Revenue earmarking: Over 400 rules (30 set in the constitution) channel shares of certain revenues to spending items. Almost 80 percent of total federal revenue is earmarked, including to public wages, transfers to subnational governments, and health and education spending. By constitution, at least 18 percent of tax revenues should be allocated to education at the federal level and 25 percent at the subnational level. At least 15 percent of federal spending should be dedicated to health. - Mandatory spending: Most major spending items cannot be modified without legal or constitutional changes. Mandatory spending exceeds 90 percent of total primary spending. - Reducing these rigidities would increase the discretionary portion of the budget, support compliance with the new fiscal rule, help reduce procyclicality, foster efficiency gains (including in health and education), and free resources to respond to shocks and new priorities. ### Efficiency gains and PFM tools - Transitional constitutional amendment of 2022 increased social assistance spending to about 2.5 percent of GDP (slightly above the average of 2 percent of GDP in emerging and LA6 countries). - Ongoing efforts to improve targeting of social assistance: integration of poverty and family cadasters enables identification of non-eligible beneficiaries; further measures could include linking stipends to individuals rather than households, reintroduction of means testing, and stronger links to training, education, employability, and formality. - Authorities aim to recover federal investment capacity; public investment declined dramatically from already low levels. - The new fiscal rule sets a floor on investment to provide medium-term visibility, but also adds to budget rigidities. - Enhancing public investment management needed on: - Strategic prioritization: develop a broad national investment strategy. - Project selection and appraisal: strengthen and standardize procedures and central guidelines. - Project execution: enhance project management capabilities, accountability, and modernize public procurement. - Coordination across levels of government: develop a national investment project pipeline, improve subnational capacity, and improve coordination between federal, subnational, SOEs, and public banks. - Climate adaptation: make investment planning climate-aware and consistent with climate objectives; yearly infrastructure investment needed for climate action estimated at 1.2 percent of GDP beyond current investments. - Public procurement efficiency: centralized procurement planning, supplier diversification, demand management, waste reduction, and process standardization could yield up to 0.2 percent of GDP in savings. *BRAZIL INTERNATIONAL MONETARY FUND* ### 41. The authorities are in the process of implementing PFM tools that would increase ### The authorities are in the process of implementing PFM tools that would increase spending control, enhance efficiency, and support fiscal consolidation efforts ### Medium-Term Budgetary Framework (MTBF) and spending control - MTBF objective: - Authorities aim to complement the MTFF with the introduction of an MTBF in the 2025 budget law. - MTBF (medium-term expenditure framework) refers to the institutional process by which annual budgeting is guided by: - reliable granular multi-year expenditure projections (including consistent expenditure baselines and costing of new measures); and - prioritization of competing spending priorities for the whole government by institution and item based on the limits set in the MTFF. - The process typically involves cabinet decision-making and strategic reform decisions to reflect multi-year spending ceilings in annual budget formulation and execution. - The introduction of an MTBF in Brazil could build on the examples of France or South Africa. - Spending reviews: - Purpose: periodic reviews of major spending programs to monitor cost-effectiveness, alignment with stated objectives, and identify efficiency gains. - Modalities: - Line-ministry-led (e.g., ministries asked to comply with a savings target, or “efficiency dividend”). - Central-agency-led for larger exercises. - Rolling spending reviews (example: the UK conducts comprehensive spending reviews every 2-3 years). - Country examples and outcomes: - UK: comprehensive spending reviews every 2-3 years (and achieved a reduction of 5 percent of GDP in spending in 5 years). - France: budget appropriations include multi-year commitment authorization ceilings. - Recommendations for Brazil: - Launch a comprehensive central agency-led spending review process, including reviewing key spending items and budget rigidities. - Introduce in parallel a rolling program of spending reviews for large and fast-growing programs and efficiency dividends on ministries’ operational expenses to generate savings in the short term. ### Conclusion: fiscal stance, reforms, and sequencing - Overall assessment: - Improving Brazil’s fiscal position calls for revenue and spending measures. - Indirect tax reform plan would streamline the tax regime and boost potential growth. - Direct tax reform and the elimination of inefficient tax expenditures will be key to generate additional revenues and increase progressivity. - Aiming for a sizable and rapid increase in revenues carries implementation risks given slowing cyclical conditions in the near term and an already significant revenue ratio on a structural basis, and could be harmful for growth. - Spending-side priorities and constraints: - Spending reforms, while complex, are needed to put spending growth on a sustainable path and create space for priority programs. - Reforms of pensions and public administration would support consolidation and increase progressivity. - Revisiting budget rigidities would provide flexibility and additional room to respond to shocks. - Preparatory work for spending reforms could start as soon as feasible, recognizing careful design and communication are required. - There is room for efficiency gains in social spending and public procurement. - Public investment management reforms would maximize value-for-money from the upcoming public investment floor. - Spending initiatives should be supported by the swift implementation of MTBFs and spending reviews. ### Public debt measures and the financial relationship with the Central Bank (overview) - Purpose of chapter: - Analyze properties of different debt measures and suggest considerations to enhance transparency and comparability, building on extensive data published by Brazilian authorities. - Discuss incremental changes in BCB’s financial autonomy to reduce non-fiscal influences on public debt while preserving efficiency of public debt and monetary policy operations. - Key contextual points: - The financial relationship between the Central Bank of Brazil (BCB) and the National Treasury (NT) has distinctive features influencing government debt measures. - A government debt measure should capture key government debt obligations and be influenced primarily by fiscal policy; however, BCB/NT arrangements and interactions with monetary and exchange rate operations impact debt levels and dynamics. - Important items to account for when assessing fiscal policy impact on debt: stock of repurchase agreements (repos), holdings of Federal Securities (FS) by the BCB, and the Treasury Single Account (TSA). ### Public debt measures: definitions and unique Brazilian features - Institutional classification: - The BCB’s fiscal statistics consider the BCB to be part of the non-financial public sector; the Fiscal Responsibility Law (FRL) considers BCB’s personnel and administrative expenditures as part of federal expenditure set in the Annual Budgetary Law. - Main debt measures and features: - Federal Public Debt (FPD): - FS held by the BCB are consolidated as debt held between government institutions. - FPD held by the public includes domestic debt (DFPD) and external debt (EFPD) based on currency of denomination. - More than 90 percent of the FPD is in four types of marketable securities held by the public (NTN-F, NTN-B, LTN, and LFT). - General Government Gross Debt (GGGD-authorities): - Includes regional governments; consolidation items between federal and regional governments are substantial (close to 6 percent of GDP of regional debt is owed to the federal government). - 2008 methodological changes for disseminating GGGD-authorities: - Excluding the FS held by the BCB (due to rollover/monetary updating features that minimize refinancing risks; the FRL allows BCB to obtain securities exclusively for rolling over those that are maturing and to rollover principal and “monetary updating”). - Including the BCB’s repos (considered BCB liabilities against the financial sector); rationale: repos can be seen as an alternative to FS for the public and, over time, are absorbed by FS issuance. - General Government Gross Debt (GGGD-IMF): - IMF utilizes the pre-2008 GGGD measure. - BCB’s repos are not counted as GGGD liabilities, and all FS held by the BCB are part of GGGD irrespective of use as collateral for repo operations. - Non-Financial Public Sector Debt (NFPS–IMF): - IMF’s debt sustainability analysis aims to include liabilities of nonfinancial public corporations (NFPCs); liabilities as of end 2022 are around 1 percent of GDP. - Note: in 2009–2010 the two largest NFPCs (Petrobras and Eletrobras) were removed from reporting perimeter; Eletrobras was privatized in 2022. - General Government Net Debt (GGND): - Deducts from GGGD-IMF the financial assets of the general government, such as the TSA held at the BCB and the worker assistance fund (FAT). GGND includes all FS held at the BCB like GGGD-IMF. - Public Sector Net Debt (PSND): - Historically the main debt indicator used by the government. - Compared to GGND, PSND includes BCB’s assets and liabilities, such as repos, international reserves, the monetary base, deposits of financial institutions, and the net debt of NFPCs. - Key balance sheet items between the BCB and the federal government (FS held at the BCB and the TSA) are consolidated in PSND since both institutions are part of the public sector. ### Debt dynamics: FS held by BCB and repos - Core distinction between gross measures: - Inclusion of either a) FS earmarked for repo operations or b) all FS generates materially different stock-flow adjustments; dynamics of these items are a key component of debt projections. - Drivers of changes in stock of repos: - Fiscal, monetary, and exchange rate policies jointly drive repo stock movements. - Historical episodes: - 2006-12: - Since end-2005, the repo stock increased by 9 percent of GDP, pushing up the GGGD-authorities. - Large international reserve accumulation prompted the BCB to sterilize inflows by almost 15 percent of GDP through repos. - In 2010, increase in reserve requirements led to a large reduction in the repo stock. - Fiscal policy had a slightly contractionary impact on liquidity as primary surpluses were offset by rollover ratios below 100 percent. - 2018-22: - Since end-2017, the repo stock declined by 7 percent GDP, pushing down the GGGD-authorities. - Cumulative impact of liquidity-enhancing primary deficits was offset by other fiscal factors, such as rollover ratios above 100 percent and repayments of BNDES loans. - Monetary factors that contributed to the bulk of the reduction in the GGGD-authorities measure: sale of FX reserves during early stages of the pandemic, use of FX repos, and introduction of voluntary deposits as a sterilization tool in 2021. - Losses in FX swaps due to currency depreciation during the pandemic led to an increase in sterilization needs. ### BCB’s repos, FS portfolio drivers, and conditioning factors - FS drivers depend on NT–BCB financial relationship rules: - Negative financial results of the BCB: - Bulk of FS held by the BCB were created to cover past “exchange equalization” losses. - Prior to the 2019 reform, all negative results of the BCB were covered with FS. - Post 2019, “exchange equalization” profits flow into an accounting reserve of the BCB; this reserve can be used to cover future losses. - Depletion of non-earmarked FS: - Depending on sterilization needs, the BCB’s portfolio of FS may be fully earmarked for repo operations. - A 2009 ordinance determined that the NT should issue securities in favor of the BCB whenever its portfolio of non-earmarked bonds reaches a volume of less than R$20 billion. - The 2019 law improved this rule by creating an automatic mechanism for transfer of FS when the non-earmarked portfolio declined to 4 percent of the total portfolio. - Snowball dynamics: - The rollover properties of FS imply their stock tends to rise proportionally to the price index used to calculate the inflation accrual. - Given that the price index tends to be lower than nominal GDP growth, the stock of FS tends to decline as a percent of GDP. - For transparency, the actual financing cost for these FS is not readily available in debt statistics, so: - Estimates of historical and projected debt servicing costs for GGGD-IMF can inflate actual borrowing needs. - Calculations using GGGD-authorities can underestimate actual borrowing needs. - Note on price index: historically IGP-M and the IPCA after 2020; the index used is defined in the Budgetary Guidelines Law every year. - Repo conditioning factors and examples that increase the stock as percent of GDP: - Public debt operations: net redemptions to the public, TSA declines. - Federal primary result: expenses exceed revenues, TSA declines. - Other operations: increase in financial expenses, TSA declines. - International reserves: purchase of spot reserves increases the monetary base. - FX swaps cash results: currency depreciation generates losses to the BCB. - Compulsory deposits: decrease in rates increases credit in the economy. - Voluntary deposits: banks switch out from deposits to repos. - Snowball effect: Repo interest rate > Nominal GDP growth. ### Pros and cons of different debt measures and operational implications - GGGD-authorities feature: - Standard debt management practices such as the use of the TSA are neutralized in the GGGD-authorities measures. - For a public debt manager with significant cash buffers (as in Brazil), this neutrality is desirable. - Example: if the debt manager reduces the TSA to repay market debt, liquidity in the system will increase, necessitating an increase of repos by the BCB; every time the TSA is used, the GGGD-authorities measure responds to these operational interactions. *Source: Excerpt from IMF country chapter on Brazil (public financial management tools, fiscal consolidation, public debt measures, and BCB/NT financial relationship).* ### 0.25 percent of its assets. ### 1braea2023002 - 0.25 percent of its assets. ### Debt measures, definitions, and interpretation - GGGD-authorities: - Immediately reflects the primary balance due to the impact of repos on the repo stock. - Can be influenced by non-fiscal factors (e.g., FX swaps, sale of FX reserves, use of voluntary deposits, changes in reserve requirements). - Used for nearly 15 years and well understood by market participants and rating agencies. - Example: In December 2022, FX repos increased by 0.5 percent of GDP due to year-end FX liquidity support by the BCB to banks, leading to an equivalent decrease in the year end debt ratio; these operations were reversed by early 2023. - GGGD-IMF: - Changes through a stock-flow adjustment to reflect the repayment or accumulation of debt; does not immediately reflect the primary balance unless a surplus is used to redeem market debt or when government bonds are issued to finance a deficit. - Less affected by non-fiscal factors after the 2019 reform. - GGND / Net measures: - Provide a relevant view to assess debt risks if financial assets can be liquidated in a timely manner to cover liabilities. - Allow international comparability and underscore Brazil’s significant liquidity buffers. - Cons: can conceal build-up of fiscal risks if assets are riskier or not freely usable for debt repayment (example: FAT, earmarked TSA subaccounts). - As of end-2022, TSA assets were 18 percent of TSA assets with around one third linked to bodies and programs or earmarked by law; the remaining two thirds comprise the “liquidity reserve” in statistical releases. - PSND: - Sensitive to exchange rate valuations prior to 2019 due to automatic transfers of exchange equalization profits to the TSA; post-2019 some valuation effects remain through revaluation of BCB assets. - Summary table findings (text description): - GGGD-IMF and GGND are less influenced by BCB operations and FX reserve valuations compared with GGGD-authorities. - GGGD-authorities immediately reflects primary balance; GGGD-IMF reflects primary balance only when surpluses are used to redeem debt. ### BCB financial position, recapitalizations, and operations - Effects of the 2019 reform: - Post-2019, BCB can utilize its reserves before relying on Fiscal Securities (FS) to rebuild net worth, making recapitalizations less frequent. - 2019 reform changed treatment of exchange equalization, reducing some impacts on GGND and GGGD-IMF. - 2020–21 developments: - Large exchange equalization gains in H1 2020 helped build a reserve buffer. - Government reduced this buffer by almost 70 percent through an exceptional transfer of R$325 billion from BCB’s reserve in August 2020 (allowed by 2019 law upon a CMN decision to repay federal debt during stress market conditions). - Despite the transfer, equity-to-assets ratio remained around 8 percent in 2020-21, compared to 4 percent in 2014-19. - 2022 valuation losses and recapitalization: - Exchange equalization income was -R327bn while other operations contributed R28 bn. - Negative net income of 2022 was covered by: - using the reserve of R179bn, - a reduction of equity worth R83bn, - a credit from the NT of R37bn to maintain BCB’s net worth at the minimum legal limit of 1.5 percent of assets. - The credit from the NT will be settled through the transfer of FS. ### Balance sheet risks and risk metrics - Main balance sheet risks in 2022: exchange rate reserves and currency swaps. - Sensitivity analysis (simple examples): - A currency appreciation of 4 percent or an increase in foreign interest rates of 100 basis points would be enough to generate losses close to the legal minimum net worth (1.5 percent of assets). - Value at Risk (VaR): - Annualized VaR increased from R324 billion in 2021 to R404 billion in 2022. - Note: VaR estimate is annualized losses with a confidence level of 95 percent; losses above this level are estimated to occur with a probability of 5 percent. ### International context on central bank profit distribution - Profit distribution approaches described: - Full transfers: Any income in excess of expenses is automatically transferred; building buffers may be explicitly prohibited. - Fixed or contingent distributions: Retain a fixed percentage of annual profits or a variable percentage toward target ratios (e.g., equity to assets). - Discretionary risk buffers: Creation of general or specific buffers, possibly model-based (VaR, expected shortfall) and considering exchange rate, interest, and credit risks. - Distribution smoothing: Decouples volatility from distributions to make transfers more predictable. - Examples and practices: - Bundesbank since 2020 increased general risk provisions and did not distribute profits, using model-based approaches. - Some central banks (Germany, India, Malaysia, Singapore, Slovakia, South Africa, Turkey) can make discretionary provisions. ### Policy considerations and recommendations - Enhance flexibility and transparency: - Provide the BCB with some discretion to determine its needs for reserves, considering current and future income, existing risk buffers, and estimates of balance sheet exposures. - Consider allowing profit distributions that account for accumulated past losses (profits distributed only in the absence of accumulated past losses). - Prioritize repayment of BCB-held federal securities from BCB profits before allocation to reserves or profit distribution to reduce reliance on NT recapitalizations. - Reporting and transparency improvements: - Publish the actual debt servicing needs of FS held by the BCB, since FS securities are rolled over by the BCB and do not create a financing need for the NT. - Include projections of GGND in main fiscal planning instruments (Multiyear Plan, Budget Guidelines Law, Annual Budget Law) to complement GGGD-authorities and PSND. - Provide information on the impact of BCB operations on the repo stock and GGGD (authorities) at the same monthly frequency as other debt reports; decompose BCB operations included in the interest bill as memo items in monthly debt statistics. - Institutional reforms suggested: - Increase BCB flexibility in setting risk buffers to reduce frequency of recapitalizations and provide the government with more revenues when balance sheet exposures decline. - Facilitate a reduction of FS held by the BCB, using BCB profits primarily to pay down FS accumulated for previous losses while ensuring the BCB retains adequate and efficient monetary policy tools. - Cautionary point: - Any changes to the financial relationship should not undermine efficient liquidity and debt management practices that have worked for decades (e.g., FS accumulation rules and alignment of debt issuance with interest rate futures). ### Key statistics and exact figures cited - 0.25 percent of its assets. - FX repos increased by 0.5 percent of GDP in December 2022 (year-end FX liquidity support). - TSA assets as of end 2022: 18 percent (of TSA assets); around one third of TSA assets linked to bodies/programs or earmarked by law; remaining two thirds labelled as “liquidity reserve.” - Exceptional transfer from BCB reserve: R$325 billion (August 2020), representing almost 70 percent reduction of the reserve buffer. - Equity-to-assets ratio: around 8 percent in 2020-21 vs 4 percent in 2014-19. - 2022 exchange equalization income: -R327bn; other operations: R28 bn. - Reserve used in 2022: R179bn; reduction of equity: R83bn; credit from NT: R37bn. - Legal minimum net worth: 1.5 percent of assets. - Sensitivity thresholds: currency appreciation of 4 percent; foreign interest rates increase of 100 basis points. - Annualized VaR: R324 billion in 2021; R404 billion in 2022. - VaR confidence level: 95 percent; probability of losses above this level: 5 percent. *Source: IMF staff.* ### References ### References ### Bibliographic references - Archer, David and Paul Moser-Boehm, 2013, “Central Bank Finances,” BIS Papers, No. 71 (April). - Banco Central do Brasil, 2019, “Patrimônio Financeiro Líquido do Governo Geral,” Nota Técnica do BCB 50, Brasilia. - Bell, Sarah, Michael Chui, Tamara Gomes, Paul Moser-Boehm, and Albert Pierres Tejada, 2023, "Why are Central Banks Reporting Losses? Does it matter?," BIS Bulletins 68. - Bunea, Daniela, Polychronis Karakitsos, Niall Merriman, and Werner Studener, 2016, “Profit Distribution and Loss Coverage Rules for Central Banks,” ECB Occasional Paper Series, No. 169, (April). - International Monetary Fund, 2017, “Brazil: Fiscal Transparency Evaluation,” IMF Country Report No. 17/104 (Washington: International Monetary Fund). - International Monetary Fund, 2019, “Liquidity Management and Public Debt: Institutions, Unforeseen Consequences, and Recent Reforms,” IMF Country Report No. 19/243 (Washington: International Monetary Fund). - International Monetary Fund, 2022, “Staff Guidance Note on the Sovereign Risk and Debt Sustainability Framework for Market Access Countries,” IMF Policy Paper No. 2022/039 (Washington: International Monetary Fund). - Mendes, Marcos, 2016, “A Lei 11.803/2008 e a Relação Financeira Tesouro - Banco Central,” Texto para Discussão nº 32, Publicado em IEPE/CdG (Rio de Janeiro). - Salviano, Cecilia de Souza, Daniel Carvalho Cunha, Flavia Fernandes Rodrigues Barbosa, Luiz Fernado Alves, Mario Augusto Gouvea de Almeida, Rafael Perez Marcos, Seiji Kumon Fetter, and Thais Riether Vizioli, 2022, “Reforming the Brazilian Fiscal framework: Strengthening the Expenditure Limit and Fiscal Planning,” Texto para Discussão, n. 35. - Stella, Peter, 2008, “Central Bank Financial Strength, Policy Constraints and Inflation?,” IMF Working Paper 09/49 (Washington: International Monetary Fund). ### Pix: Brazil’s Successful Instant Payment System — key findings and statistics - Background and uptake - Pix launched in November 2020 by the Central Bank of Brazil (BCB). - Objectives: reduce reliance on cash, increase financial inclusion, strengthen competition, modernize payments. - Usage (BCB statistics as of May 2023): - More than 140 million individuals (about 80 percent of the adult population). - 13 million firms. - More than 3 billion transactions each month. - Average ticket size of about US$88. - Facilitated transactions by 71.5 million individuals (as of December 2022) who had not made any electronic credit transfers over a one-year period prior to Pix and are Pix users now. - Payment volumes for Pix are almost five times greater than those for debit and credit cards combined. - Brazil recorded the fastest adoption rate globally in terms of transactions per capita gained since implementation. - Competition and market effects - Growth of payment services institutions and fintechs; many established banking subsidiaries. - Open sharing of transaction information strengthened competition for deposits and banking products. ### How Pix works — structure and participant rules - System components and functions - BCB owns the payment scheme and manages the real-time settlement infrastructure (SPI) and the user address database (DICT). - DICT contains identifying information and aliases (phone numbers, email addresses, randomly generated IDs). - Payment services: instant or scheduled payments and transfers, cash withdrawals, payment invoices. - Short-term borrowing via Pix can occur between retail users and merchants operating via a PSP; merchants may receive immediate payment at a discount from the PSP. - Authorities can track monthly payments and economic activity by geographical location, transaction types, and borrower demographics (including age group). - Participants and regulatory perimeter - Participants: institutions regulated by the BCB and entities outside the regulatory perimeter that, if allowed to participate, become subject to certain BCB requirements and supervision. - Transaction volumes by provider type (annual volume): banks about 57 percent, payment institutions and fintech entities 39 percent, credit unions about 4 percent. - Regulated participants with more than five hundred thousand accounts are required to participate; others may participate voluntarily. - As of end-May 2023, there were 799 active participants, of which 34 were mandatory. - Requirements for off-perimeter participants include: - (i) a signed contract with an existing direct participant; - (ii) technical and operational capacity to operate within Pix; - (ii) equity of at least BRL 1 million. - All participants are subject to proportional risk-based supervision and basic regulation for liquidity risk management, cybersecurity, data usage, and AML/CFT procedures. - Standards for simple and intuitive user access, including registration, transactions, and authentication. - Liquidity management - BCB remunerates balances of all direct participants’ accounts in SPI. - Provides liquidity lines to participants with direct access to the SPI. - Allows a 30-minute window after the normal operating hours of the BCB’s Reserve Transfer System (STR) (6.30pm-6.30pm Monday through Friday) for transfer of Reserve Requirements and Electronic Currency balances to SPI Accounts. - Banking participants may carry out short-term reverse repos of government securities with the BCB for liquidity outside normal business hours. ### Design features contributing to Pix’s success - Speed and settlement - Pix payment settles in 3 seconds on average versus 2 days for debit cards and 28 days for credit cards. - Transaction limits and flexibility - No centrally imposed transaction size limit; participants may impose user limits based on risk profile. - Costs - Pix must be free for individuals. - Cost for firms/merchants: 0.33 percent of the transaction amount, versus 1.13 percent for debit cards and 2.34 percent for credit cards. - Participation and governance - Mandatory participation by big banks fostered interoperability and an effective initial network. - BCB acts as infrastructure provider and regulator, limiting rapid market capture by big technology companies. - Early definition of governance and technical standards via public consultation; participants follow a procedural “manual”. - A Pix forum enables public-private dialogue (government, banks, press, business associations, law firms). - Security and user experience - Emphasis on network security: user identification, KYC compliance, suspicious transaction flagging, risk-based transactional limits. - Pix rulebook allows extra time for settlement of suspicious transactions. - Centralized fraud database (DICT), a precautionary block, and a special refund mechanism enabled by transaction tracing technology. - Standardized user interface and API facilitate switching providers and integration with company systems; Pix developed as a brand with a logo. ### Features in the pipeline - Recurrent payments functionality (e.g., mortgage, subscription, utility bills) to enhance interoperability with Open Finance and Digital Real platforms, enabling access to financial services via Pix or Digital Real wallets. - Pix international: planned cross-border payments with currency conversion and potential integration with other jurisdictions’ instant payment schemes (including BIS Nexus). - Security-related improvements: making the centralized antifraud database more robust and enhancing the special refund mechanism. ### Cross-country comparisons and design trade-offs - Regulatory separation - Some jurisdictions separate operator from regulator (India and China); Brazil consolidates operator, regulator, and supervisor functions within the BCB (by different departments). - Transaction limits and settlement - India: transaction size limit around ~$2K; China: significantly higher (~$150K). - Brazil: no central limit; participants set user limits. - Brazil: real-time settlement; India and China: deferred net settlement multiple times per day (India 4x/day, China 6x/day). - Finality and revocability - Brazil: transactions typically irrevocable, with refund mechanisms in defined situations. - India and China: transactions are revocable. - User identifiers and centralization - Brazil: centralized user information and multiple alias types (phone, taxpayer ID, email, random strings). - India: multiple aliases allowed. - China: mobile phone numbers only. - Centralized storage in Brazil enables granular tracking of transactions by user type and geography. - Tabled country observations (selected) - Brazil (PIX): Owner/Operator/Regulator/Supervisor all BCB; Participants: Banks, Non-Banks; Fees for persons: None; User Info: Centralized; Alias: Multiple; Transaction Limit: None; Settlement: Real-time; Liquidity: BCB lines; Payment Finality: Irrevocable. - India (IMPS/UPI): Owner/Operator NPCI; Regulator/Supervisor RBI; Participants Banks, Non-Banks; Fees for persons: (IMPS/UPI) None noted; User Info: Decentralized; Alias: Multiple; Transaction Limit: ~$2K; Settlement: Deferred net; 4x / day; Liquidity: NPCI SGF; Payment Finality: Revocable. - China (IBPS): Owner PBoC; Operator CNCC; Regulator/Supervisor PBoC; Participants Banks only; Fees for persons: None; User Info: Decentralized; Alias: Mobile; Transaction Limit: ~$150K; Settlement: Deferred net; 6x / day; Liquidity: PBoC; Payment Finality: Revocable. ### Implementation challenges and measures taken - Supervision of real-time activity - Challenge: sheer volume (two thousand per second and over 90 million per day). - Measures: deployment of RegTech and SupTech for real-time compliance and participant monitoring; proportional risk-based supervision. - Liquidity assurance - STR is closed at nights, holidays, and weekends; participants need to manage shortages via interbank market. - Settlements: SPI accounts of non-banks remunerated; participants can conservatively fund settlement accounts without opportunity cost, helping minimize liquidity risk on nights and weekends. - Note: STR's liquidity provision exceeds US$6 billion per day, reflecting high availability of resources in SPI, especially after normal working hours when Reserve Requirements and Electronic Currency balances can be freely transferred to SPI Accounts. - Consistent capital regulations - Issue: earlier capital-regime asymmetry when payment institutions were apex of conglomerates, giving competitive advantage versus large banks. - Measure: authorities established commensurate capital regulations across different conglomerate models. - Crisis management testing - Suggestion: scope for operational tests (simulating failure of one or more institutions). - Authorities’ view: potential failures unlikely to trigger systemic contagion in Pix; customers could access alternative payment means (credit cards, debit cards, credit transfers). - Mitigation of AML/CFT and fraud risks - Risks: dummy account creation, ability of blocked account holders to open accounts elsewhere. - Regulatory position: no separate AML/CFT policy solely for Pix; every Pix participant must comply with Brazil’s AML/CFT rules under BCB supervision. - Enhancements: improvements to centralized database of accounts and aliases to prevent dummy accounts and minimize fraud. - Information sharing: PSPs obtain user transaction metadata (account opening date, historical transaction volumes, fraud/scam warnings related to Pix aliases and owners). - Future data sharing: PSPs will receive information on the number of times an alias has been flagged as a risk by other participants and the number of accounts associated with that alias. *Source: 1braea2023002 - References* ### 12. The Pix system is highly successful. The authorities designed the PIX system after careful ### 12. The Pix system is highly successful. ### Pix system: design and adoption - The authorities designed the PIX system after careful and deliberate study of instant payment systems in a number of countries. - Selected design features contributing to rapid adoption: - speed; - cost; - flexibility to cover multiple use cases; - ease of access for individuals; - interface standardization; - mandatory participation by major banks. - Rapid adoption occurred in a country with wide dispersion in financial literacy. ### Ongoing challenges and policy recommendations for Pix - Credit functionality and indirect credit risks: - Pix does not have a credit functionality. - Widespread adoption of Pix has supported the rapid growth of payment institutions, which have then fostered the growth of risky credit to households in other lines of business. - Given powerful functionalities available and being developed, the authorities’ ongoing financial literacy initiatives will be important to ensure these features are used safely by households. - Account creation and fraud risk mitigation: - Authorities are appropriately strengthening the monitoring of account creation at PSPs. - Consideration could be given to whether reducing the number of possible aliases for accounts could help reduce the risk of fraud. - Operational resilience: - There may be a case for carrying out simulations and drills of procedures to support confidence in case of one or more potential participant failures, even though these may not be systemic in nature. *Italicized references and bibliographic listings present in the source have been omitted from this summary.* ### Transition to climate and green economy topics - The source continues into a Selected Issues Paper titled "POLICY OPTIONS TO ADDRESS CLIMATE VULNERABILITIES AND GREEN THE ECONOMY" addressing Brazil’s climate strategies and policy options. --- ### POLICY OPTIONS TO ADDRESS CLIMATE VULNERABILITIES AND GREEN THE ECONOMY ### Introduction: climate impacts and macro relevance - Projected temperature changes: between +1°C and +5°C by the end of the century. - Most common extreme events: floods, which have more than doubled relative to the 1980s-90s. - Floods produce physical and human capital losses, temporary productivity losses, infrastructure disruptions, significant fiscal costs, and sometimes durable output scarring. - Second most frequent yet costliest hazards: droughts (impacting agricultural output and electricity prices) and extreme heat waves (mainly in urban areas). - World Bank estimate: extreme weather events have generated yearly output losses of 0.13 percent of GDP on average over the past 20 years (World Bank CCDR, 2023). - More than 5 percent of Brazil’s road and railway infrastructure is exposed to flood risks (World Bank CCDR, 2023). ### Sectoral vulnerabilities and financial exposure - Agriculture and power generation are key sectors at risk, with potential repercussions for the financial sector. - Drought risk increases with frequency and lengthening of dry seasons across Northern and Southern regions; impact is more severe in the Northeast due to rainfed small‑scale agriculture and limited irrigation and significantly lower insurance coverage. - Droughts have diminished the Amazon and Cerrado biomes’ resilience and, aided by deforestation, increased the likelihood of reaching a tipping point that would durably disrupt water cycles. - Estimated output loss of reaching the Amazon tipping point for Brazil alone: 10 percent of 2022 GDP through 2050 (World Bank CCDR, 2023). - Hydropower generation is being affected by lower water availability and changing rainfall patterns, lowering the system’s capacity to store energy. - About 20 percent of the financial sector’s credit portfolio is exposed to sectors vulnerable to climate change, with the share of agriculture (businesses and rural households) increasing to around 12 percent of total bank loans over the past decade (BCB, 2022). - Agriculture is estimated to lose 1 percent of its sectoral GDP per year due to extreme weather events (World Bank CCDR, 2023). - Only about 20 percent of farming activity is covered by insurance, mainly concentrated in Southern regions (Superintendência de Seguros Privados (SUSEP)). ### Brazil’s opportunities to green the economy - Brazil can boost economic potential without facing a tradeoff between energy use, emissions, and growth, building on: - Brazil’s very green energy mix; - world-wide leading biodiversity. - Private sector opportunities include energy exports, export-oriented manufacturing of green goods and services. - Plans to complement the voluntary carbon market with a mandatory trading system would further help green Brazil’s economy from a regulatory perspective. ### The authorities’ climate strategies - The Ministry of Finance’s sustainability strategy: steer ecological transformation by enhancing technology and productivity in a green and equitable way while decarbonizing the economy. Six pillars: - Promoting green finance by establishing a mandatory Emissions Trading System (ETS) by end-2023, a green taxonomy, regular issuances of green bonds, and green financial regulation; - Enhancing productivity through green R&D and its transformation into businesses, including leveraging funds from the oil sector for the transition and incentivizing credit allocation; - Shaping a “bio economy” via integrating agricultural production with forest protection including through ecotourism, biotechnologies, and payment for environmental services; - Accelerating the energy transition by becoming an exporter of energy with green hydrogen, building on success in using ethanol in transport (including from biomass), and investing in energy storage; - Leveraging the circular economy by using waste and sewage systems to produce electricity; - Building resilient infrastructure to deal with climate shocks and restore climate justice for poorer households. - The BCB Sustainability Agenda: covers regulation, supervision, policy design, internal measures, and research; aims to incentivize the financial system with appropriate targets and metrics while focusing on financial stability and resilience. Elements include: - Regulation: - Incorporating sustainability aspects into prudential regulation following the Network for Greening the Financial System’s recommendations. - Initial qualitative disclosure requests (governance, strategy, risk management); from end-2023 disclosure expanded to quantitative aspects including metrics and targets, mapping exposures to climate-related transition risk and voluntary decarbonization targets by financial institutions. - Further steps after publication of the new Basel Committee on Banking Supervision Pillar 3 standards. - Enhancements to the risk assessment regulation inserting social, environmental, and climate-related financial risk into institutions’ integrated management frameworks, embracing physical and transitional drivers. - Application of traditional financial risk requirements (stress testing, risk appetite statements, board involvement) to social, environmental, and climate-related risks. - Rules related to the Social, Environmental and Climate Responsibility Policy (PRSAC) requiring institutions to establish PRSAC covering climate-related aspects defined as “the positive contribution of the institution to the adjustment towards a low-carbon economy, in which the emission of greenhouse gases is reduced or compensated, and natural carbon sinks are preserved.” Actions must be monitored and evaluated with clear, objective, and verifiable criteria. - Sustainable Rural Credit Bureau: - BCB established a green credit bureau (Sicor) for agribusiness to register rural credit operations (about 2 million per year and R$300 billion). - The Bureau enables beneficiaries to make registered information available without intermediaries and allows effective monitoring of projects to help enforce social and environmental regulations, including preventing farming credit operations in protected lands. - Consideration could be given to further incorporating sustainability criteria in credit provision. - Supervision: - Information collection on climate risks is being enhanced to map social, environmental, and climate aspects associated with credit and securities operations on financial institutions’ balance sheets. - Exposure to physical risks assessed through sensitivity analyses of the credit portfolio with respect to extreme drought (BCB, 2022) and heavy rainfalls (BCB, 2023b). - Central Bank Operations: - BCB pursuing greening its own balance sheet by including sustainability criteria in the selection of counterparties. - Considering a liquidity facility offering preferential conditions to bonds based on ESG criteria. - The Real Digital initiative could offer opportunities for tokenization of ESG financial assets and development of financial instruments supporting the Sustainability Agenda. ### Policy options to support the authorities’ agenda - Overall focus: policies to (i) boost the Amazon’s resilience; (ii) invest in climate-smart agriculture and insurance; (iii) diversify power sources; and (iv) leverage opportunities for green growth. Boosting the Amazon’s Resilience - Fiscal incentives and feebate scheme: - To meet pledges to eliminate illegal deforestation by 2030 and restore 12 million hectares of forests, a revenue-neutral feebate scheme could provide comprehensive incentives for forest protection. - The scheme would cover large landowners at the forestry/agriculture border, with fees on landowners converting forest land and subsidies for putting farmland into conservation. - Incentives could be linked to carbon sequestration (building off monitoring capacity under the REDD+ Readiness Program) and local ecological benefits. - Prerequisites: secure property rights for covered farms and capacity for monitoring environmental indicators and applying incentives. - Nearer-term option: Payment for Environmental Services Program - Redirect some farm support funding to establish a program where landowners bid for contracts paying them for habitat preservation projects (Box 1 reference to Costa Rica experience). - Refinements for Brazil could include contract renewals, coverage of small farms, and targeting high-priority lands. - Other measures: land tax/production subsidy schemes or incentives to enhance livestock productivity and reduce farmland per unit of output. - Establishing an index for valuing habitat for different land parcels at the forestry/agricultural border would help target conservation incentives. - Scaling up private sector Zero-Deforestation Commitments (ZDCs): - ZDCs bar suppliers who produce goods on recently deforested areas. - Example: 2009 G4 Agreement established deforestation cut-off dates for suppliers; studies suggest a reduction in cattle-driven deforestation by an estimated 15 percent in the Amazon between 2010 and 2018 (Levy and others, 2023). - Limitations: do not cover small-scale packagers, indirect suppliers, much production for domestic consumption, and do not provide incentives for reforestation. - ZDCs could be scaled up through more comprehensive monitoring of cattle farms and assistance for farmers to shift to legal, deforestation-free production. - Opening the Amazon Fund to private sector participants: - In 2023 the Amazon Fund resumed projects stopped in 2019, focusing on control-and-command policies to halt illegal deforestation. - A new action plan will guide the Fund’s projects in the coming four years, including satellite imaging and investment in the bioeconomy. - Fundraising is linked to both Brazil’s current emissions and commitments to halt deforestation; granting access to private sector participants could boost the Fund’s resources and create private sector buy-in. Investing in Climate-Smart Agriculture and Strengthening Insurance - Strengthening adaptation capacity would increase productivity and contribute to food security. - Existing regional programs (Adapta Sertao, MAIS, ABC CERRADO) provide a base, but Brazil lags peers in adaptation capacity regarding food loss, farm infrastructure, and supply chains (ND-GAIN, Food Security Index). - Scaling up good practices requires targeted and better-structured support and investment focused on: - Agricultural infrastructure: investments in irrigation systems; soil and water resource management; and food loss reduction. - Technology and innovation: investments in R&D targeted to climate change impacts; knowledge management and information-sharing systems, especially for small- and medium-scale farmers. *Selected references and full bibliographic listings in the source document have been omitted from this summary.* *Italicized source: Content unit "1braea2023002 - 12. The Pix system is highly successful. The authorities designed the PIX system after careful" (PDF chapter/section).* ### 13. To accelerate the adoption of climate-smart infrastructure and technologies in ### 13. To accelerate the adoption of climate-smart infrastructure and technologies in ### Insurance and climate-smart agriculture - Insuring on-farm investments for innovative environmental practices, complemented by existing social safety nets, could shield (smaller) farmers’ income effectively and protect against catastrophic shocks during the 12 to 24-month adoption period. - Consideration to re-direct public funds from credit to insurance, complementing existing programs (e.g., ABC+ or Climate-smart Ag. Subsidies) with insurance products. - Recently launched climate-indexed insurance schemes for farmers should be promoted throughout Brazil’s rural insurance market, together with other market-based instruments that foster competition and expand Brazil’s lower-than-peers insurance coverage. - Current benchmark insurance coverage estimates (mid-2000s): India about 40 percent, China close to 70 percent, United States about 90 percent, Brazil’s 15-20 percent. - Linking agricultural loans to a broader set of sustainability criteria could further help with adaptation and transition. - Co-benefits of climate-smart agriculture: - Reduces deforestation pressures associated with the expansion of agricultural land. - Utilizes agricultural land more sustainably and efficiently, contributing to lowering emissions. ### Fiscal incentives and feebate options - A revenue-neutral feebate for large farmers is proposed to provide incentives to reduce emissions efficiently, while protecting competitiveness. - The feebate could rely on emissions measured using a proxy approach based on a farm’s inputs, potentially similar to that under IPCC reporting standards (Parry and others, 2022). - The feebate could complement the existing ABC+ program that provides concessionary finance for agricultural emission reduction investments. - Design considerations: - A pure feebate covering all agricultural products and linking fees/subsidies directly to emissions-intensity would provide the strongest incentive to reduce emissions but result in redistribution from high to low emitting products. - Alternative: apply feebates at the product-level or tax the entire sector and provide subsidies to all producers taking actions to reduce emissions (more in line with New Zealand’s proposed approach). - Agricultural emissions vary substantially across products in Brazil—design must consider differences in emissions-intensity. ### Renewable energy expansion and current mix - Brazil’s energy mix in 2022: almost 90 percent of electricity generated by renewables. - Hydropower is the largest energy source; solar and wind, together with biomass, represent about 20 percent of total electricity generation (from close to zero 20 years ago). - The expansion in solar and wind capacity has almost exclusively been financed through private investments. - Jobs created in Brazil’s renewable sector outpaced regional peers, though remain relatively low skilled. - Over 111 GW non-hydro renewable capacity is projected to come on stream between 2024 and 2030, which is more than enough to meet higher future demand and fill power gaps. ### Climate impacts on hydropower, demand, and potential gaps - Past deviations from mean temperatures by +0.1C have led to a lower capacity utilization of 2-3 percent, estimated by staff. - Slow-moving temperature increase and precipitation changes would lower dispatchable hydro capacities by approximately 9 to 28 percent from 2030 to 2050 under a high emission scenario that closely mirrors current trends. - Total power demand is estimated to increase by 2-4 percent due to changing demands for cooling and heating (in addition to an estimated growth of 3½ percent in the baseline). - Absent an expansion in power generation, staff estimates these effects could result in power deficiency up to 82 TWH in 2030 (or 14 percent of the power supply in 2021, Box 2). ### Infrastructure bottlenecks and investment priorities - Strengthen the grid and cross-border connections to alleviate infrastructure limitations caused by: - More decentralized power generation. - Varying availability of wind and solar. - Increased temperature and precipitation volatility. - Maintain hydro capacity and expand energy storage: - Capitalize and retrofit existing dams and hydro plants with more flexible design, such as incorporating pumped storage. - Alternative storage facilities under consideration include batteries and hydrogen. - Mainstream climate risk management into energy sector planning, including monitoring and response systems to adjust hydro supplies and meet power demands. - The realization likelihood of the ANEEL-collected pipeline’s investments depends on improvements in grid infrastructure. ### Box 2 — Alternative Investment Scenario and higher fossil fuel consumption - Strict continuation of the current trajectory of investments in renewables would lead to a moderate increase of approximately 2-5 percent compared to the baseline in 2030, bringing cumulatively 28.6 GW new capacity sourced from wind, solar, and other renewables. - Under this trajectory, power gaps arising from hydro deficiency and increasing demand may be filled by higher fossil fuel consumption. - IMF staff estimate between 2024 and 2030: - Fossil fuel consumption could experience a cumulative increase by 20-70 percent due to power gaps. - This could reintroduce up to 150 megatons of CO2 into the atmosphere over the same period. - Note: Equivalent to around 10% of total emission in Brazil in 2019. ### Leveraging green growth opportunities - Further expansion in renewables could allow for production and export of energy, for instance via green hydrogen. - Brazil has competitive advantages: - Biofuel production: 11 percent global market share. - Hydropower equipment: 4 ½ percent global market share. - Brazil’s strong biodiversity could be leveraged as input to R&D. - Potential for technology transfer between oil and gas and renewable energy sectors, particularly offshore wind. ### Emissions Trading System (ETS) considerations - Brazil is considering the introduction of a mandatory ETS. - Achieving cost-efficiency calls for encompassing all sectors and greenhouse gases; administrative and political constraints make it challenging to include forestry and methane from agriculture. - Price stability mechanisms (e.g., a price floor or program to purchase surplus allowances) can increase certainty over future prices and support overlapping mechanisms. - Auctioning emissions allowances generates government revenue, part of which can be recycled to support vulnerable households and energy-intensive, trade-exposed industries (EITI). - Allowing forestry offsets requires robust rules and monitoring to ensure afforestation delivers additional, long-term GHG removal; without such systems, offsets can result in a net increase in emissions. - International ETS lessons: - Varied coverage across jurisdictions (EU, South Korea, California). - Mechanisms to reduce price volatility and clear pathways for reductions in emissions allowances. - Caution against nature-based offsets: not allowed in the EU’s ETS, removed from California’s as of 2021, and limited in Korea. - Use of free allowances to address competitiveness concerns for EITI. ### Conclusion: main vulnerabilities and policy directions - Brazil’s main vulnerabilities to rising temperatures and changing precipitation patterns are in agriculture and power generation. - Policy initiatives underway include: - The new government’s holistic approach to steer Brazil’s ecological transformation and decarbonization. - The BCB’s drive to green and sustainable regulation and supervision. - Four main policy options discussed: 1. Fiscal incentives and private sector crowding-in for forest protection to boost the Amazon’s resilience. 2. More investment in climate-smart agriculture, including through the expansion of insurance schemes, to reduce food loss and price volatility amid increasing drought frequency. 3. Investment in renewable energy infrastructure to fill power gaps from climate-related shocks and avoid fossil fuel consumption in the short term. 4. Build on Brazil’s green energy mix and biodiversity to pursue low- or negative-emission growth opportunities such as energy export or export-oriented manufacturing for green goods and services. ### Annex I — Methodological notes (power sector effects) - Power demand impacts drawn from GCAM (Global Change Analysis Model, PNNL); commercial power demand set to rise by around 3 ½ percent in addition to the baseline under a high emission scenario. - Hydropower generation projections taken from Xanthos (PNNL’s global hydrological model); Xanthos projections were used to parametrize an upper bound on hydropower generation by year. - The IMF’s Climate Policy Assessment Tool (CPAT) was expanded to: - Incorporate impacts of climate change on power demand and hydropower generation. - Introduce an upper bound on hydropower generation parametrized with Xanthos projections. - Base dispatch decisions on the minimum between the upper bound and the historical capacity factor. *International Monetary Fund — Chapter 13, Brazil country analysis* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1braea2023002.pdf_