## 1braea2024001-print-pdf ## Source details **Canonical URL:** [1braea2024001-print-pdf](https://www.imf.org/-/media/files/publications/cr/2024/english/1braea2024001-print-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2024/english/1braea2024001-print-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2024/english/1braea2024001-print-pdf.pdf.json) --- ### Economic resilience and recent macro developments - Real GDP rose by a cumulative 5.9 percent during 2022 and 2023, exceeding the October 2022 WEO projection by over 2 percentage points. - Real GDP growth: 2.9 percent in 2023; projected 2.1 percent in 2024 and 2.5 percent over the medium term. - Private consumption growth: 3.1 percent in 2023. - Investment: declined by 3.0 percent in 2023; grew by 2.7 percent year-over-year in Q1 2024. - Unemployment rate: 7.5 percent in the moving quarter through April. - Current account deficit: narrowed from 2.5 percent of GDP in 2022 to 1.4 percent of GDP in 2023; expected to widen to 1.8 percent of GDP in 2024 and remain around 1.5 percent of GDP over the medium term. - FDI inflows: 1.7 percent of GDP in 2023; portfolio inflows: 0.3 percent of GDP in 2023. - Brazilian real: appreciated by an average of 3.4 percent against the US dollar in 2023 from the 2022 average; REER appreciated by 4.6 percent. As of May, the real had depreciated by about 4.5 percent against the US dollar since December 2023. - Headline inflation: peaked at 12.1 percent (y/y) in April 2022; was 3.9 percent (y/y) in May (within the target tolerance interval of 3.0 percent ±1.5 percentage points). - BCB policy rate: reduced by 325 basis points to 10.50 percent in May after cuts starting August 2023; unchanged in June. - Net interest payments: nearly 6 percent of GDP in 2023. - Treasury foreign currency issuance: US$4.5 billion largest foreign currency bond issuance in early 2024. ### Fiscal stance, public finances, and projections - Federal primary balance: surplus of 0.5 percent of GDP in 2022; deficit of 2.4 percent of GDP in 2023. - Higher social benefits increased by 1.2 percent of GDP in 2023; settlement of precatórios amounted to 0.8 percent of GDP. - Staff estimates structural primary balance declined by 1.5 percent of potential GDP in 2023 (abstracting from one-off payments). - Fiscal policy tightening in 2024 targeting a zero federal primary deficit; 2025 draft LDO lowered fiscal targets for 2025-26. - Staff baseline federal primary deficit projections: - 2024: -0.6 percent of GDP - 2025: -0.7 percent of GDP (predicated on additional measures of 0.3 percent of GDP) - Gradual fiscal effort to a primary surplus of 1.5 percent of GDP in 2033 under staff baseline. - Staff recommended alternative fiscal path: - Achieve zero federal primary deficit in 2025. - Improve primary balance by 0.5 percentage point of GDP per year thereafter. - Reach a primary fiscal surplus of 2.5 percent of GDP by 2030. - Government authorities’ targets (LDO proposals): - Zero federal primary deficit target for 2025 (excluding 0.3 percent of GDP of precatórios). - Indicative target path rising to a surplus of 1.0 percent of GDP by 2028. - Authorities envisage longer-term primary surplus of 1.7 percent of GDP. - General government gross debt: projected to stabilize at around 95 percent of GDP over the extended policy horizon (staff baseline). ### Policy reforms and structural measures - VAT reform (2023 constitutional amendment): merges five taxes into a dual VAT (federal CBS and subnational IBS) and an excise tax (IS); phased implementation 2026–2033 with federal taxes phased out by end-2027; regional compensation funds transition period of 50 years. - Staff estimates VAT reform will lift output by 6-11 percent depending on informality assumptions and full implementation; one-sector neoclassical model yields an 11 percent long-run GDP gain under full crediting of input taxes; MIMMI model yields a 6 percent GDP increase. - Implementational challenges: integrating CBS-IBS management, timely refunding of excess credits, harmonizing revenue administrations, and risks to revenue neutrality from informality and exemptions. - Reference rate example: around 27.3 percent standard rate discussed. - Ecological Transformation Plan and climate initiatives: - Deforestation in the Amazon halved in 2023, implying an estimated reduction in emissions of half a gigaton. - ETS expected to target emitters >25,000 tons CO2e annually (about 5,000 companies above the cap); reporting requirement for entities >10,000 tons CO2/year. - Forest Law (May 2023) enables carbon credits in conservation areas. - First green and social sovereign bond issued in November 2023; second issuance expected later in the year. - ECO Invest Brasil launched in February as capital mobilization and FX hedging program; Eco Invest to offer four credit lines and long-term FX hedging (10–25 years). - World Economic Forum estimate of climate finance gap by 2030: about R$1 trillion (nearly 10 percent of GDP). - Financial sector reforms and innovation: - Pix adoption high; Drex (CBDC/tokenization) planned with launch aim in 2025 pending privacy and governance issues. - Recommendation: provide BCB additional flexibility to cover operating expenses to retain talent for innovation while ensuring accountability and cybersecurity. - Public banks: better capitalization and profitability; BNDES to focus on catalyzing private finance; careful management to mitigate fiscal and market distortions. ### Box — Potential Impact of Artificial Intelligence on Brazil’s Productivity and Output - Exposure and distribution: - Approximately 45 percent of jobs in Brazil are estimated to be exposed to AI. - Brazil's overall exposure to AI is greater than other emerging market economies (Cazzaniga and others 2024). - AI is expected to enhance productivity in over one-third of exposed jobs (about 15 percent of all jobs). - Women’s share in occupations susceptible to AI is more than 20 percentage points larger than that of men. - For about 30 percent of all jobs, AI integration could automate tasks, potentially reducing labor demand and wages and leading to job obsolescence. - Model-based scenarios and quantitative estimates: - AI adoption is estimated to raise output by about 5 percent based on the model analysis (highly uncertain). - If AI provides additional productivity spillovers supporting workers and capital across tasks, output expands by nearly 8 percent and TFP increases by almost 4 percent. - Gains concentrated in the first decade of transition; incomes for all workers increase, with larger gains for initially high-income workers, implying greater income inequality. - Uncertainty: wide range of estimates in the literature (e.g., Briggs and Kodnani (2023) vs. Acemoglu (2024)). ### Monetary policy, reserves, and FX-related measures - National Monetary Council adoption of a continuous 3 percent inflation target from 2025. - Headline inflation expected to decline to 3.7 percent by end-2024 and reach the 3 percent target in the first half of 2026. - BCB policy rate expected to approach neutral in 2026 with short-term real interest rates in the 4.5 to 5.0 percent range. - FX reserves: around US$350 billion at end-2023; reserve adequacy at 130 percent of IMF ARA metric as of end-2023. - BCB outstanding FX swaps: stable at around US$100 billion; staff advice: reduce outstanding FX swaps when conditions allow; continue phasing out IOF-FX to zero by 2029 as planned. ### Financial stability, inclusion, and household financial health - Financial sector resilience metrics: - Liquidity coverage ratios: 185 percent at end-2023. - CET1 capital ratio: 14.8 percent at end-2023. - Asset quality/profitability improved in H2 2023; provisions remain above expected losses. - Household and micro/small enterprise credit: - Household DSTI ratio: eased to 26.5 percent in March after peaking at 28.4 percent in June last year. - NPLs on mortgage loans: under 2 percent. - Desenrola program helped over 15 million people renegotiate about R$50–R$53 billion in overdue debt (R$50 billion cited in Box 2; R$53 billion cited elsewhere). - Staff recommends close monitoring of DSTI and NPLs and considering a DSTI limit when necessary. - Non-bank financial institutions: - Step-in risk from investment funds halved since 2022 per stress tests. - BCB actions to strengthen NBFI oversight include a new prudential framework for payment-institution conglomerates. ### Risks, buffers, and balance of risks - Downside external risks: slower-than-expected decline in core inflation in major AEs, abrupt global slowdown (notably China and US), monetary policy miscalibration, commodity price volatility. - Downside domestic risks: Rio Grande do Sul flood supply disruptions; lower-than-envisaged fiscal effort. - Upside risks: stronger household consumption, faster structural reform implementation, investment in green growth, AI rollout boosting productivity (with potential labor displacement). - Buffers and resilience: sound financial system, adequate FX reserves, low reliance on FX debt, large government cash buffers, flexible exchange rate. - Risk assessment highlights: - Likelihood of slower-than-envisaged medium-term fiscal consolidation: High; impact: Medium. - Probability of debt non-stabilization (DSA module): 72.6 percent (probability figure reported in DSA outputs). - Debt fanchart index (DFI): 2.9; risk signal: High. - Average baseline Gross Financing Needs (GFN): 16.1 percent of GDP; GFN financeability index (GFI): 13.9; risk signal: Moderate. ### Growth drivers, potential growth, and policy priorities - Potential growth: estimates have risen recently but remain below the G20 emerging market average; gains since 2017 driven by rising TFP. - Projected contributions: - VAT reform: could raise annual growth by 0.3-0.5 percentage points on average during transition; staff estimates output lift of 6-11 percent depending on assumptions. - Hydrocarbon expansion: Rystad Energy estimates a 56 percent rise in oil output between 2023 and 2031; staff estimate this could contribute 0.2 percentage points to annual GDP growth during 2024-2031. - Structural reforms across several areas implemented together could raise output by an estimated 5 percent (implying an extra 1 percentage point in annual growth per year). - Policy recommendations to boost growth and inclusion: - Advance trade integration and simplify business regulation; accompany with active labor-market policies and training. - Strengthen anti-corruption, judiciary efficiency, and AML/CFT capacity. - Intensify efforts to boost labor force participation and skill upgrading; narrow gender gaps (e.g., daycare, pay transparency). - Pursue public investment prioritization within a medium-term budget framework; improve coordination across levels of government. - Increase the effectiveness and progressivity of social transfers and tax system; eliminate inefficient tax expenditures estimated at 4-5 percent of GDP; consider PIT reform including taxation of dividends. ### Climate finance, carbon markets, and public investment - Eco Invest Brasil and related instruments aim to mobilize long-term FX hedging and blended finance; IDB to provide up to $3.4 billion (0.2 percent of GDP) for FX derivative acquisition. - Proposed cap-and-trade for larger emitters: ~five years to become operational; potential market value about R$100 billion (nearly 1 percent of GDP) by 2030; could generate around 0.3 percent of GDP of additional fiscal revenues annually. - Federal capital expenditure: 0.7 percent of GDP in 2023. - World Economic Forum estimate of climate finance gap to 2030: about R$1 trillion (nearly 10 percent of GDP). ### Key numeric tables and memoranda (selected figures preserved) - GDP growth at constant prices (percent): 2022: 3.0; 2023: 2.9; 2024: 2.1; 2025: 2.4; 2026: 2.4; 2027: 2.4; 2028: 2.5; 2029: 2.5. - Consumer prices (IPCA, average): 2022: 9.3; 2023: 4.6; 2024: 4.0; 2025: 3.2; 2026: 3.1; 2027: 3.0; 2028: 3.0; 2029: 3.0. - Consumer prices (IPCA, end of period): 2022: 5.8; 2023: 4.6; 2024: 3.7; 2025: 3.2; 2026: 3.0; 2027: 3.0; 2028: 3.0; 2029: 3.0. - Current Account (US$ billions): 2022: -48.3; 2023: -30.8; 2024: -40.0; 2025: -40.8; 2026: -42.9; 2027: -44.7; 2028: -45.5; 2029: -47.4. - Trade balance (US$ billions): 2022: 44.2; 2023: 80.6; 2024: 78.2; 2025: 80.4; 2026: 83.4; 2027: 90.0; 2028: 95.4; 2029: 100.9. - Gross reserves (US$ billions, eop): 2022: 324.7; 2023: 355.0; 2024–2029: 355.0 (each year). - Public sector net debt (percent of GDP): 2022: 56.1; 2023: 60.9; 2024: 61.4; 2025: 65.9; 2026: 68.3; 2027: 70.0; 2028: 71.1; 2029: 71.8. - Selected social indicators: Population (2023): 216.3 million; GDP, dollars (2023): US$2,174 billion; GDP per capita (2023): US$10,050; Unemployment rate (Q1, 2024): 7.9. *Source: IMF staff report excerpt provided in the content unit.* ### 1. Potential Impact of Artificial Intelligence on Brazil’s Productivity and Output _________________ 13 ### 1. Potential Impact of Artificial Intelligence on Brazil’s Productivity and Output ### Economic resilience during disinflation - Real GDP rose by a cumulative 5.9 percent during 2022 and 2023, surpassing the October 2022 WEO projection by over 2 percentage points. - Growth in 2022–23 reflected supportive demand (including higher government spending and robust private consumption) and a supply-side expansion (including record agricultural and hydrocarbon output). - Inflation returned to the target tolerance interval in March 2023. - The general government gross debt-to-GDP ratio declined in 2021-22 to below its pre-pandemic level, then increased in 2023 and is set to rise further in the near term before stabilizing over the longer policy horizon. - Net interest payments reached nearly 6 percent of GDP in 2023. - Estimates of potential growth have risen in recent years but remain below the average of the Group of Twenty (G20) emerging market economies. ### Policy and structural reforms supporting medium-term prospects - Adoption of a continuous 3 percent inflation target from 2025 by the National Monetary Council. - Progress on the Ecological Transformation Plan, including: - Deforestation in the Amazon halved in 2023, implying an estimated reduction in emissions of half a gigaton. - Emissions Trading System (ETS) expected to be approved before August; targets emitters releasing more than 25,000 tons of CO2 equivalent annually (about 5,000 companies above the cap); entities responsible for emissions over 10,000 tons of CO2 per year will be required to report emissions. - Forest Law approved in May 2023 enables carbon credits and other environmental services in conservation areas. - First green and social sovereign bond issued in November 2023; a second issuance expected later in the year. - ECO Invest Brasil launched in February as a capital mobilization and FX hedging program. - BCB disclosure requirements of quantitative emission targets expected to start in 2025. - Brazil’s Sustainable Taxonomy expected to be operational by mid-2025. - Implementation of a landmark VAT reform in 2023; four complementary laws presented to Congress in April to specify characteristics of the dual federal (CBS) and subnational (IBS) VAT system, governance for joint revenue administration, excise tax regulation, and administrative processes, with approval expected by December. ### Recent macroeconomic developments (2023–early 2024) - Real GDP growth: 2.9 percent in 2023. - Private consumption growth: 3.1 percent in 2023. - Investment: declined by 3.0 percent in 2023, then grew by 2.7 percent year-over-year in Q1 2024. - Unemployment rate: 7.5 percent in the moving quarter through April (lowest over same period since 2014). - Trade and external sector: current account deficit narrowed from 2.5 percent of GDP in 2022 to 1.4 percent of GDP in 2023. FDI inflows: 1.7 percent of GDP in 2023; portfolio inflows: 0.3 percent of GDP in 2023. - Brazilian real: appreciated by an average of 3.4 percent against the US dollar in 2023 from the 2022 average; REER appreciated by 4.6 percent. As of May, the real had depreciated by about 4.5 percent against the US dollar since December 2023. - Headline inflation: peaked at 12.1 percent (year-over-year) in April 2022; was 3.9 percent year-over-year in May (within the target tolerance interval of 3.0 percent ±1.5 percentage points). - BCB policy rate: after cuts starting August 2023, reduced by 25 basis points to 10.50 percent in May; unchanged in June. BCB adjusted guidance in March and removed explicit signaling in May. - Credit growth: bank credit growth declined to 9 percent year-over-year in April (from 18 percent in mid-2022). Market share of earmarked credit increased slightly in 2023 to about 41.6 percent. - Treasury foreign currency issuance: largest foreign currency bond issuance in early 2024 of US$4.5 billion. ### Fiscal stance and public finances - Federal primary balance: surplus of 0.5 percent of GDP in 2022; deficit of 2.4 percent of GDP in 2023. - Higher social benefits increased by 1.2 percent of GDP in 2023; settlement of precatórios amounted to 0.8 percent of GDP. Over half of these payments relate to public wages, social security, and social assistance. - Staff estimates structural primary balance declined by 1.5 percent of potential GDP in 2023 (abstracting from one-off payments and accounting for economic and commodity cycles). - Fiscal policy is tightening in 2024, with authorities targeting a zero federal primary deficit. The 2025 draft Budget Guidelines Law (LDO) submitted in April lowered fiscal targets for 2025-26. ### Outlook and key projections - Growth: projected to moderate from 2.9 percent in 2023 to 2.1 percent in 2024, then strengthen to 2.5 percent over the medium term (an upward revision of 0.5 percentage point compared with the 2023 Article IV Staff Report). The 2024 projection includes a positive 0.3 percentage point contribution from payment of precatórios in late 2023. - Inflation: headline inflation expected to decline to 3.7 percent by end-2024 and reach the 3 percent target in the first half of 2026. - Monetary policy: BCB policy rate expected to approach its estimated neutral level in 2026, with short-term real interest rates in the 4.5 to 5.0 percent range. - Fiscal balance and government debt: federal primary deficit expected to narrow from 2.4 percent of GDP in 2023 to 0.6 percent of GDP in 2024 and 0.7 percent of GDP in 2025 before gradually rising to a surplus of 1 percent of GDP in 2029 and 1.5 percent of GDP over the extended policy horizon, contingent on implementation of measures. General government gross debt projected to stabilize at around 95 percent of GDP over the extended policy horizon. - Current account: expected to widen to 1.8 percent of GDP in 2024 and remain around 1.5 percent of GDP over the medium term. The decline in medium-term current account deficits of 0.5 percentage points, compared with previous projections, reflects a stronger trade balance driven by structural factors such as increased oil exports and upward revisions in nominal GDP. Current account deficits projected to be financed by FDI inflows. *Source: IMF staff report excerpt provided in the content unit.* ### 14. The balance of risks to the growth outlook has improved since the 2023 Article IV ### 14. The balance of risks to the growth outlook has improved since the 2023 Article IV Consultation but remains somewhat tilted to the downside, while uncertainty remains ### Risk assessment: downside, upside, and resilience - Downside risks (external): - Slower-than-expected decline in core inflation in major advanced economies that leads financial markets to revise up their interest rate expectations and puts pressure on the borrowing costs and currencies of emerging market economies. - An abrupt global slowdown, in particular in Brazil’s major trading partners such as China and the US, could weaken exports and growth. - Monetary policy miscalibration in major central banks and commodity price volatility. - Downside risks (domestic): - Supply disruptions from the 2024 flood calamity could be more severe than currently expected; estimates of the impact are still uncertain, including for growth and the fiscal balance. - A lower-than-envisaged fiscal effort could reduce policy credibility and increase policy uncertainty, resulting in higher borrowing costs and weaker investment and increasing risks of de-anchoring inflation expectations. - Upside risks (domestic): - Stronger-than-expected household consumption amid a still-tight labor market and higher real household income (noting this could also produce positive inflation surprises and a tighter monetary stance). - Faster-than-expected implementation of structural reforms. - Investment in green growth opportunities that could boost economic potential. - Rollout of AI and enhancements to worker productivity, given a relatively high share of jobs susceptible to AI; caveat that AI integration could also lead to job obsolescence in some professions (see Box 1). - Upside risks (external): - Greater-than-envisaged fiscal support in major economies in the context of elections in 2024 (see IMF April 2024 WEO). - Buffers and resilience factors: - A sound financial system, adequate FX reserves, low reliance on FX debt, large government cash buffers, and a flexible exchange rate. *Authorities’ Views (summary)* - Broad agreement with staff’s near-term outlook and the upward medium-term growth revision. - Drivers of resilience cited: robust consumption, tight labor market with rising real incomes, minimum wage increases, and lower household debt vulnerabilities supported by the Desenrola program. - Noted uncertainty over macroeconomic effects of floods in Rio Grande do Sul and the possibility that reconstruction could raise activity in the second half of 2024. - Viewed the Ecological Transformation Plan as contributing to stronger, greener, more sustainable and inclusive growth. - BCB concurred that inflation declined with fading relative price shocks and proactive monetary policy; emphasized that uncertainty is likely to fade as policy rates remain restrictive and the fiscal deficit is expected to fall. - Agreed that the 2023 external position was broadly in line with fundamentals and that higher hydrocarbon output entails a structural medium-term improvement. *Source: Risk Assessment Matrix referenced in Annex V.* ### Box 1 — Potential Impact of Artificial Intelligence on Brazil’s Productivity and Output - Conceptual framework: AI exposure (Felten, Raj, and Seamans 2021, 2023) and AI complementarity (Pizzinelli and others 2023). - Key estimates and findings: - Approximately 45 percent of jobs in Brazil are estimated to be exposed to AI. - Brazil's overall exposure to AI is greater than other emerging market economies (based on estimates by Cazzaniga and others 2024). - AI is expected to enhance productivity in over one-third of these exposed jobs (about 15 percent of all jobs). - Women are better positioned to experience productivity gains than men; the share of women in occupations susceptible to AI is more than 20 percentage points larger than that of men. - For about 30 percent of all jobs, AI integration could automate tasks, potentially reducing labor demand and wages and even leading to job obsolescence. - Model-based scenario results: - AI adoption is estimated to raise output by about 5 percent based on the model analysis, although the impact remains highly uncertain. - When an additional productivity impact is considered (AI supporting performance of workers and capital in all tasks), output expands by nearly 8 percent and TFP increases by almost 4 percent. - These gains occur primarily in the first decade of transition; incomes for all workers increase, with greater gains for initially high-income workers, implying greater income inequality. - Uncertainty note: Existing studies show a range of estimates (e.g., Briggs and Kodnani (2023) vs. Acemoglu (2024)). ### Policy discussions — A. Guiding inflation and expectations back to target - Recent monetary policy actions and stance: - The pace of policy rate reductions since August 2023 is characterized as appropriate and consistent with the inflation targeting framework. - A 325-basis point reduction in nominal policy rates so far to 10.50 percent in May is estimated to have reduced real policy rates while keeping them in restrictive territory. - BCB initial guidance of cuts of 50 basis points per meeting effectively steered market expectations. - Medium-term inflation expectations have remained at about 50 basis points above target, possibly reflecting uncertainties over fiscal consolidation and BCB Board composition after three out of nine members’ terms expire in December 2024. - Guidance and conditional path: - As disinflation proceeds and inflation is projected to remain within the target tolerance interval, maintaining flexibility on the pace and length of the easing cycle is prudent given labor market resilience and inflation expectations above target-consistent levels. - Contingent on underlying inflation data and expectations anchoring around the 3 percent target, a path for the policy rate that approaches its neutral level in 2026 would be prudent. - Monetary transmission and framework: - Staff estimates using a Bayesian VAR model show no clear evidence of a change in monetary policy transmission to output and the CPI compared to past tightening episodes. - Phillips curve estimates suggest the relationship between the output gap and inflation has remained largely unchanged compared with the pre-pandemic period (Annex IV). - The National Monetary Council decision in June 2023 to adopt a continuous 3 percent target from 2025 onwards has reduced uncertainty and strengthened monetary policy effectiveness. - FX reserves and swap policy: - FX reserves: around US$350 billion in FX reserves, with reserve adequacy at 130 percent of the IMF ARA metric as of end-2023; notable improvement in 2023 due to wind down of the FX repo stock, interest earnings, and price changes. - No spot intervention in 2023. - The BCB presence in the onshore non-deliverable market through FX swaps has been stable at around US$100 billion over the last few years. - Staff advice: reduce the stock of outstanding FX swaps when market conditions are conducive to create additional policy room; FX intervention could address episodes of higher risk premia but should not substitute for warranted macroeconomic adjustment. - Financial transaction tax (IOF-FX): - Staff advised continuing to reduce the IOF-FX to zero as planned. - IOF-FX increases transaction costs and gives rise to a multiple currency practice (MCP), an exchange restriction under the Fund’s new MCP policy. - The gradual reduction path from 2022 aims to reach a zero rate by 2029; the path is predetermined and well communicated with limited economic impact. - Authorities’ views on monetary policy: - BCB committed to the inflation-targeting framework, agreed on maintaining flexibility for the easing cycle, reiterated exchange rate flexibility, and described FX swap strategy as balancing spot and forward market conditions to reduce cost of carry. - Confirmed the IOF-FX gradual reduction path began in 2022 aiming to bring the IOF-FX tax to zero in 2029, with little economic impact. ### Policy discussions — B. Safeguarding financial stability while promoting financial inclusion and innovation - Financial sector resilience and statistics: - Liquidity coverage ratios reached 185 percent at end-2023. - CET1 capital ratio of 14.8 percent at end-2023. - Asset quality and profitability improved in H2 2023; provisions remain well above expected losses. - Authorities’ stress tests underscore resilience to credit, market, fiscal deterioration, liquidity shocks, and climate shocks. - Non-bank financial institutions (NBFI) risks: - Risks from growing NBFIs are contained; stress tests indicate step-in risk from investment funds has halved since 2022. - BCB steps to strengthen NBFI oversight include a new prudential framework for conglomerates composed of payment institutions specifying methodologies for calculating regulatory capital and capital requirements. - Credit risks for micro and small enterprises: - Problem assets in micro and small enterprises stabilized but remained at high levels at end-2023 amid still restrictive monetary policy rates. - Debt servicing capacity for corporates expected to improve as real interest rates decline and activity remains robust. - Authorities reallocating existing budgetary resources to a package of credit support measures for micro and small enterprises. - Household financial health and measures: - Household debt service-to-income (DSTI) ratio eased to 26.5 percent in March after peaking at 28.4 percent in June last year. - Non-performing loans (NPLs) on mortgage loans remain low (under 2 percent). - Desenrola program helped over 15 million people renegotiate about R$50 billion (about 0.5 percent of GDP) in overdue debt. - Staff recommendation: closely monitor household DSTI and NPLs and consider applying a DSTI limit when necessary, complementing existing supervisory and prudential measures. ### Box 2 — Measures to Improve Household Financial Health - Context and concerns: - As of end-2023, more than 40 percent of consumers in Brazil had defaulted on some form of debt. - Overall DSTI ratio declined after peaking at 28 percent in June 2023 but remains above its pre-pandemic level. - Contributing factors to household financing burdens: - High cost of credit; interest rate spread in Brazil is higher than in regional peers. - Relatively low financial literacy, especially among new credit cardholders. - Low household wealth leading to reliance on credit during downturns; debt-to-income ratio rose by 8 percentage points during the pandemic. - Desenrola Brasil program (July 2023–May 2024): - Aimed to assist households in default to regain access to credit. - Program design: creditors participated in an auction; those offering the largest discounts became eligible; low-income borrowers could consolidate and settle debts on the Desenrola platform or through post offices. - Borrowers could pay upfront or refinance with a new bank loan of up to 60 months; refinancing of up to R$5,000 per borrower was guaranteed by the government. - Total budget envelope: R$8 billion (less than 0.1 percent of GDP). - Outcomes: more than 600 financial and non-financial sector creditors participated; discounts averaged 83 percent. - The program provided infrastructure for potential future debt renegotiation and promoted financial education. - Additional measures: - Launched a comprehensive financial literacy campaign. - Improved transparency rules for credit card lending. - Established a limit on credit card charges: a cap on credit card interest and fee charges of 100 percent of the original amount; note that possible negative implications for quantity and quality of credit need careful assessment. *Italic: IMF staff summary of Chapter 14 from the source document.* ### 26. The authorities’ ongoing reform efforts aimed at lowering credit costs, based on a ### 1braea2024001-print-pdf - 26. The authorities’ ongoing reform efforts aimed at lowering credit costs, based on a ### Financial sector reforms and credit costs - Ongoing reform efforts aimed at lowering credit costs are welcome and based on a sound diagnosis. - Recent financial innovation reduced transaction costs and facilitated competition, but interest rate spreads remain above 20 percent. - Large part of the spread is attributable to structural challenges in the credit market: - inefficient collateral enforcement, - low debt recovery ratios, - margins of financial institutions. - The government established a new secretariat for economic reforms in 2023 to advance regulatory reforms to increase financial market competition and improve recovery of delinquent loans. - Sustaining reform efforts would: - reduce costs and distortions, - enhance efficiency of credit allocation, - support competition and productivity across economic sectors. ### Role of public banks and BNDES - Lending by public banks can be warranted for well-established market failures, but must minimize distortions to the private credit market. - Since 2017 reforms, public bank funding cost shifted from subsidized TJLP to government-funding-reflective TLP. - At present, public banks are described as well-capitalized, profitable, and liquid; they have been paying dividends and pre-paying liabilities (mainly BNDES) to the government. - Government plans to invest in specific sectors through BNDES; careful management of an expanded public-bank role is needed to mitigate risks to: - the fiscal position, - monetary policy transmission, - market efficiency. - Ongoing initiatives to issue loan guarantees and on-lending to private banks to resolve market failures are considered appropriate. ### Central Bank of Brazil (BCB), financial innovation, and Drex - The BCB remains at the forefront of financial innovation amid internal resource constraints. - Financial innovation agenda has promoted financial inclusion, efficiency, and competition. - Pix (instant payment system) adoption has exceeded expectations and made Brazil a global leader in transactions per capita. - Development of new Pix functionalities (e.g., automatic payments and cross-border payments) has been delayed due to BCB resource constraints, notably staffing. - Recommendation: Providing the BCB with additional flexibility to cover operating expenses would allow it to attract and retain talent necessary for financial innovations and sustainable finance initiatives, while ensuring effective accountability mechanisms and cyber security. - Drex (CBDC initiative) aims to “tokenize the economy” by underpinning an interoperable public blockchain infrastructure to facilitate innovative financial services within a regulated environment. - Early-stage benefits expected: easing access to credit for borrowers with tokenizable collateral (for example, government bonds) and encouraging new entrants of financial service providers. - Remaining challenges before operational launch: - technical difficulty of offering scalable token-based financial services while ensuring compliance with Brazil’s data protection and bank secrecy laws, - privacy and governance challenges, - rules and mechanisms for smart contracts and user cases still under discussion. - Authorities aim to launch Drex platform in 2025 but note the need to address privacy issues before opening to the public. ### Authorities’ views on financial stability and policy tools - Authorities concurred that: - the financial sector remains resilient, - systemic risks are contained. - They expect credit risks in the household sector to improve; risks in micro and small enterprises warrant close monitoring. - No current need seen for a limit on the debt service-to-income ratio, but such limits are part of their toolkit for future use if needed. - Supervisory action, timely monitoring, and macroprudential measures used in past credit cycles have been effective at containing risks. - Authorities expressed no concern about risks from non-bank financial institutions or the sovereign-bank nexus, citing robust prudential measures and contagion analysis results. - Noted that most loans of BNDES are at market rates and fill gaps in private financing of infrastructure and long-term projects. - Highlighted ongoing reform efforts to reduce credit costs, including strengthening legal framework for bankruptcy, guarantees, capital markets, and resolution. - Emphasized importance of covering BCB operating expenses to continue financial innovations and sustainable finance initiatives while ensuring accountability and cyber security. ### Securing fiscal sustainability and revamping taxation — policy framework and targets - Authorities reaffirmed commitment to the zero primary deficit target for 2024 in the 2025 draft Budget Guidelines Law (LDO) submitted in April. - LDO proposes: - zero federal primary deficit target for 2025, excluding 0.3 percent of GDP of precatórios, - an indicative target path rising to a surplus of 1.0 percent of GDP by 2028. - Authorities envisage additional adjustment over the longer term to a primary fiscal surplus of 1.7 percent of GDP. - Authorities estimate revised fiscal targets would stabilize public debt (authorities’ definition) by 2028 followed by a gradual decline. - Authorities plan a more balanced mix of additional revenues and expenditure rationalization; recently introduced limitations on tax credits for federal PIS/COFINS to compensate for extension of payroll exemptions ahead of the 2025 Budget to be submitted to congress in August. - Staff estimate that meeting the authorities’ targets would require additional measures amounting to: - 0.7 percent of GDP in 2025, - 1.3 percent of GDP by 2028. - Authorities intend to continue enhancing fiscal data quality (Annex VI). ### Recent revisions to Brazil’s fiscal framework (Box 3 summary) - 2023 constitutional amendment replaced the zero-growth federal real spending cap with a spending corridor: floor of 0.6 percent and ceiling of 2.5 percent real federal spending growth, contingent on revenue collection and distance to primary balance target. - If primary balance in year t is within the band: planned real federal spending growth in year t+2 = 0.7 x real revenue growth in t+1 (mid-year). - If primary balance in year t is outside the band: planned real federal spending growth in year t+2 = 0.5 x real revenue growth in year t+1 (mid-year). - Education and health spending floors reinstated; new floor on public investment of 0.6 percent of GDP. - Up to 70 percent of overperformance of the primary balance relative to target can be used towards higher capital spending, limit of 0.25 percent of previous year’s GDP. - Payments of precatórios were removed from the base of the spending corridor for 2025 and 2026. - Revised indicative federal primary balance path: improvement from a deficit of 0.5 percent in 2023 to a surplus of 1 percent of GDP in 2026 within tolerance band of +/-0.25 percent of GDP. - 2025 draft LDO proposed zero-deficit target for 2025 (revised down by 0.5 percentage point of GDP) binding for 2025 Budget preparation; indicative targets for federal primary balance of: - 0.25 percent of GDP for 2026 (down from 1.0 percent of GDP), - 0.5 percent of GDP for 2027, - 1.0 percent of GDP for 2028. - Within-year correction mechanisms include bans on new hiring, increases in public wages, new mandatory spending, social assistance policies, or tax benefits if primary balance target at risk. ### Staff baseline projections and fiscal outlook - Staff baseline scenario projects a more gradual fiscal improvement: - For 2024, staff projects a federal primary deficit of 0.6 percent of GDP, narrowing from a deficit of 2.4 percent of GDP in 2023. - Structural primary balance projected to improve by about 0.7 percentage point of potential GDP (abstracting from one-off factors). - Approved tax measures expected to increase revenue by 1.1 percent of GDP in 2024. - Planned emergency spending for Rio Grande do Sul estimated at 0.2 percent of GDP, with an additional 0.2 percent of GDP in reprofiling of state debt owed to the federal government. - For 2025, staff projects a federal primary deficit of 0.7 percent of GDP, predicated on additional (currently unallocated) measures of 0.3 percent of GDP. - For subsequent years, staff’s baseline foresees gradual fiscal effort leading to a primary surplus of 1.5 percent of GDP in 2033. - Projection assumes increase in commodity-related revenues associated with the expanding hydrocarbon sector and implementation of additional (currently unallocated) measures amounting to 1.6 percent of GDP. - With this path, general government gross debt is projected to stabilize at around 95 percent of GDP in 2032 (Annex VII). ### Staff recommendations and alternative fiscal path - Staff recommends a sustained and more ambitious fiscal effort to put public debt on a firmly downward path and open space for priority investments. - Staff’s debt sustainability assessment: risks of debt distress moderate under baseline, but debt trajectory highly sensitive to shocks to borrowing costs, real GDP growth, and contingent liabilities. - Staff recommends a path for the primary fiscal balance that: - starts with achieving the zero-deficit target in 2025, - followed by improvements of 0.5 percentage point of GDP per year, - resulting in a primary fiscal surplus of 2.5 percent of GDP by 2030. - Expected benefits of this path: - general government gross debt on a firmly downward trend, - improved sovereign financing conditions, - strengthened anchoring of inflation expectations around the 3 percent target, - increased space for productivity-enhancing investments, including resilient infrastructure. - Recommendation to enhance fiscal framework: adopt a medium-term debt anchor, stricter provisions to ensure consistency between spending corridor and fiscal targets, and mechanisms to limit procyclicality. ### Revenue measures, tax-expenditure rationalization, and VAT reform - Staff suggests focusing on elimination of inefficient tax expenditures, estimated at 4-5 percent of GDP, and broadening the tax base by closing loopholes. - Reforming the PIT, including taxation of dividends, could generate additional revenues and increase progressivity. - Any increases in the personal exemptions threshold for the PIT, currently exempting about 80 percent of the population, should be cautiously weighed against increasing marginal PIT rates for higher-income brackets and phasing out or capping deductions for health and education. - Concomitant reform of SIMPLES would discourage PIT avoidance through incorporation. - Tackling spending rigidities is a priority: spending reviews of pension and social programs underway to create space for new initiatives. - Considerations welcomed on de-indexing spending items from minimum wage increases and reforming education and health floors. - Priorities to restrain mandatory spending increases: - public administration reform to reduce wage premia between (federal) public and private sectors and review career paths, - pension reform to align special regimes to RGPS and ensure longer-term sustainability, - seeking efficiencies in social programs while ensuring targeted support for vulnerable households. - VAT reform: - Merges five taxes over three levels of government into a dual VAT and an excise tax. - Staff estimates reform will lift output by 6-11 percent, depending on informality assumptions and full implementation (Annex VIII). - Reform expected to foster formal job creation and make consumption taxes less regressive via cashback system, shift of tax burden from goods to services, and lower statutory rates. - To amplify equity gains, expand cashback system and limit planned exemptions and reduced rates (also generating fiscal savings). - Implementation challenges (transition phase 2026-2033) to address: - integrating management of CBS-IBS, - fully refunding excess credits on a timely basis, - harmonizing revenue administrations to enable a single, risk-based compliance strategy. - Authorities’ goal: ensure VAT reform is revenue neutral; risks to revenue neutrality include: - lower statutory rates in sectors currently facing higher tax burdens, - frictions in increasing statutory rates due to special tax regimes, - challenges in bringing informal sector into tax base, - reduction in revenues from intermediate inputs absent complete shift in tax base from producers to consumers. - Federal government committed resources for capitalization of five funds to compensate states for possible revenue losses: amounting to 0.7 percent of GDP; continuation of certain tax benefits already granted by states: 1.5 percent of GDP; recognition of accumulated legacy tax credits under old system (none of these are considered under staff’s baseline). - Authorities expect tax gap for federal PIS/COFINS taxes to decline from estimated 22 percent to around 10 percent with better compliance, e-invoicing, and harmonized systems. *Source: Extracted from the supplied IMF PDF content.* ### 38. The authorities reaffirmed their commitment to improve Brazil’s fiscal position. They ### The authorities reaffirmed their commitment to improve Brazil’s fiscal position. ### Fiscal stance, targets, and measures - Authorities view the zero-deficit target for 2024, with the tolerance margin of 0.25 percent of GDP, as achievable on the back of strong revenue performance. - Automatic spending freezes could be activated if needed to compensate for higher-than-expected expenses on social security. - Emergency related spending for Rio Grande do Sul would be outside the spending ceiling of the fiscal rule, in line with the declaration of calamity. - A recent Supreme Court ruling reinforced the Fiscal Responsibility Law principle requiring that tax breaks and structural increases in spending be offset by structural measures, including in initiatives proposed by Congress. - Authorities saw the revised primary balance path for 2025-28 as sufficient for achieving a stabilization of public debt by 2028. - Following the successful implementation of revenue measures that recovered the tax base lost after the 2022 tax cuts, authorities noted that efforts on the spending side could increase the flexibility of spending to facilitate fiscal adjustment. - Spending reviews are expected to contribute to opening fiscal space. - A revenue-neutral direct tax reform to improve equity could be considered in the coming years. ### VAT Reform: revamping indirect taxation (design and implementation) - Reform objective: gradually replace existing consumption taxes with a dual VAT by 2033 to reduce distortions from complexity, cascading taxes, litigation costs, and interstate double taxation. - Structure: dual VAT with a federal component (CBS) and a subnational component (IBS); a new excise (IS) will focus on goods harmful to the environment and health. - Phasing and timelines: - Federal taxes on goods and services to be phased out by end-2027. - Taxes of states and municipalities will gradually merge into the IBS from 2028 to 2033. - Regional compensation funds will stay in place for a transition period of 50 years. - Small enterprises regime (SIMPLES) will remain, but businesses can opt-in to VAT taxation benefiting from tax credits while maintaining their preferred rates, preparing for a gradual adjustment of SIMPLES terms and conditions over the longer horizon. - Both federal and subnational VAT components are applied on the same tax base anchored in the constitution since December 2023. - After an initial freeze, states and municipalities would have some discretion in setting their IBS rate. - Transition mechanisms: the reform includes a mechanism to adjust the reference rate during the transition period to compensate for any risks to revenue neutrality from informality and service sectors. - Sectoral heterogeneity note: with a new reference rate of around 27.3 percent for all goods and services, some sectors would adjust their combined rates downwards while others would see their rate increase relative to the status quo. - Disclosure gap: the stock of accumulated (ICMS, PIS/COFINS) tax credits is still undisclosed; a GETAP (2020) study shows that 41 large companies surveyed hold 0.3 percent of GDP tax credits. ### Potential growth: recent trends and drivers - Potential growth is estimated to have increased in recent years after a significant decline during the 2014-2016 downturn. - Since 2017, the increase in potential growth has been driven by rising TFP, reflecting catch-up toward the technological frontier and increasing trade integration; contributions from capital and labor accumulation remained broadly constant. - Firm-level evidence indicates an increase in worker productivity since the 2017 major labor reform (Annex IX). - The decline since 2017 in labor litigation cases and costs associated with the reform is expected to continue supporting productivity, particularly for labor- and trade-intensive firms. ### Projected contributions to medium-term growth - VAT Reform: assuming full implementation, the reform could raise annual growth by 0.3-0.5 percentage points on average during the transition to the new steady state, depending on the role of informality (Annex VIII). Complete crediting of taxes on intermediate inputs is expected to boost corporate investment, improve resource allocation (particularly in manufacturing), and increase formal sector activities. Legal uncertainty is likely to remain in early phases, possibly offsetting some near-term positive effects. - Hydrocarbon production: Rystad Energy estimates a 56 percent rise in oil output between 2023 and 2031, making Brazil the world’s fourth largest oil producer. Staff estimates this expansion could contribute 0.2 percentage points to annual GDP growth during 2024-2031. Oil output is projected to decline thereafter, with extended forecasts inherently uncertain. - Structural reforms: closing gaps with LA5 peer economies in first-generation reforms (external sector, business regulation, governance) could increase annual growth by about 0.3 percentage point per year for five years for each reform area. Implemented together, these reforms could raise output by an estimated 5 percent, implying an extra 1 percentage point in annual growth per year. ### Policies to support growth and inclusion - Trade and business regulation: - Advance trade integration and simplify business regulations to reduce tariff and non-tariff barriers, support participation in global value chains, and increase productivity. - Accompany trade integration with labor-market policies (job search assistance, training, income support, social insurance) to improve labor mobility and mitigate adjustment costs. - Simplify regulations, reduce administrative burden on start-ups, and ease entry barriers to support competition. - Governance and AML/CFT: - Further strengthen the anti-corruption framework and the efficiency and independence of the judiciary. - Address AML/CFT gaps identified by FATF/GAFILAT: strengthen COAF capacity, integrate the Federal Revenue Office into the AML/CFT regime, broaden availability of beneficial ownership and financial information, and reconsider court order requirements for access. - Labor force and skills: - Intensify efforts to boost labor force participation and facilitate skill upgrading to mitigate the drag from population aging (working-age population peaked in 2021 at 70 percent of total population and is expected to decline by more than 1 percentage point by 2030). - Narrow gender gaps in labor force participation and wages (including increasing daycare services and implementing pay transparency measures). - Address bottlenecks to digital technology adoption and enhance public education attainment (building on programs such as Pé-de-Meia). - Ensure adjustments to minimum wages are commensurate with productivity growth. ### Public investment and the Growth Acceleration Plan - Authorities envisage increasing public investment while preserving debt sustainability as part of the Growth Acceleration Plan. - Federal capital expenditure amounted to 0.7 percent of GDP in 2023. - Increasing investment requires creating space through tackling spending rigidities as outlined in staff’s recommended scenario. - Recommendations: incorporate well-prioritized investment plans in a medium-term budget framework; improve coordination across levels of government to support public investment efficiency and sustainability. - Continue timely and comprehensive fiscal reporting on PPPs, SOEs, and public bank lending to support monitoring of fiscal risks. - The new industrial policy, Nova Indústria Brasil, shifts sectoral focus to innovation and sustainability across agriculture, health, infrastructure, decarbonization and energy transition, digitalization, and defense; trade and investment measures should be targeted, WTO-consistent, and avoid favoring domestic producers over imports. ### Energy transition and climate financing - Brazil’s electricity mix is exceptionally clean, with renewables accounting for 90 percent of total electricity production and projected to rise further. - The energy transition acceleration program (Paten) will promote renewable fuels (aviation biokerosene, biodiesel, low-carbon hydrogen) and incentivize sustainable energy production parks through favorable negotiations on tax debts. The hydrogen regulatory framework is expected in the first half of 2024. - Financing gaps and instruments: - World Economic Forum estimates Brazil’s gap to finance the climate transition by 2030 at about R$1 trillion (nearly 10 percent of GDP, WEF 2023). - The government’s Eco Invest program will offer four credit lines: (i) a blended finance facility with longer-maturity credit; (ii) a long-term FX liquidity facility for projects with inflation-indexed revenues facing temporary cash flow shortfalls due to FX depreciation while servicing FX debt; (iii) an FX derivatives program to provide de-risking to local financing institutions for long-term FX hedging; (iv) financing for project structuring. - One goal of Eco Invest is to increase supply of long-term FX hedging; the program will focus on hedging operations between 10 and 25 years. - The IDB will provide up to $3.4 billion (0.2 percent of GDP) for acquisition of FX derivatives to leverage its AAA rating; the BCB will act as intermediary; local banks will post collateral to the BCB and assume credit risks related to transactions with end investors. - Carbon markets: - A proposed cap-and-trade system for larger emitters would take about five years to become operational and its potential market value could reach about R$100 billion (nearly 1 percent of GDP) by 2030, generating around 0.3 percent of GDP of additional fiscal revenues annually. - Expanding sectors covered and greenhouse gases would increase cost-efficiency and revenue potential. - Voluntary carbon markets could generate additional market value if accompanied by strong safeguards and robust rules and monitoring to ensure additionality and minimize reputational risks. - The 2023 Forestry Law allows companies with forestry concessions to generate carbon credits for forest preservation; domestically used credits focused on emissions avoidance could support new climate finance approaches, with mandatory participation of local communities in proceeds to ensure support and ownership. *Source: Excerpt from IMF Brazil report content unit.* ### 45. The authorities have made significant progress towards mobilizing financing for the ### 1braea2024001-print-pdf - 45. The authorities have made significant progress towards mobilizing financing for the ### Ecological Transformation and Climate Finance - A second ESG bond issuance is scheduled for late 2024, with about 40 percent of funds earmarked for green projects. - Complementary funding activities include: - expansion of earmarked credit for low-carbon agriculture; - redirection of tax-advantaged infrastructure bond issuance towards social and environmental infrastructure. - Multilateral banks and international donors engagement; a record financial contribution to the Amazon Fund was secured in 2023. - Private sector (and SOE) green bond issuances have been very active, with an important share of climate projects being privately financed, notably for renewable energy. - The BCB’s sustainability agenda advanced, including preparations for a green liquidity line to be launched upon finalizing the Sustainable Taxonomy. - Staff view: Implementation of the Ecological Transformation Plan is accelerating and expected to facilitate the transition to a low-carbon economy, encourage investment in sustainable projects, and boost economic output. - Authorities emphasized progress on: - launching innovative liquidity and FX hedging lines; - establishment of a sustainable taxonomy; - design of carbon market safeguards to ensure additionality and mitigate reputational risks. ### Inequality, Poverty, and Social Transfers - Long-term income share improvements: - bottom 10 percent: from 0.8 percent of total income in 1995 to 1.2 percent in 2022; - bottom 20 percent: from 2.4 percent in 1995 to 3.6 percent in 2022. - Gini index estimates (IBGE): modest decline from 0.54 in 2012 to 0.52 in 2022. - Regional variation: highest inequality in the Northeast region and lowest in the South region. - Social protection spending and poverty impacts: - Pandemic-related social protection spending amounted to 4.4 percent of GDP during the pandemic. - General government social assistance spending: 1.3 percent of GDP (2016-2019 average) → 5.5 percent of GDP in 2020 → 2.5 percent of GDP in 2023. - Box 6 findings: - Pre-pandemic (2012-19) poverty (extreme poverty) including transfers: about 33 (6) percent; excluding transfers: 35 (9) percent. - For 2020, poverty and extreme poverty rates were reduced by, respectively, about a fifth and a half, after accounting for transfers. - Children under 15: almost 10 percent living in extreme poverty (vs. population average of about 6 percent). - People aged 60 or older: extreme poverty about 2.3 percent in 2022. - Informal workers, low-income households, the poor, and the less educated experienced higher labor income volatility and larger labor income losses; unemployment rates higher among female, younger, and less educated workers. ### Policy Recommendations and Program Effectiveness - Increase effectiveness and progressivity of social transfer programs and the tax system to further reduce inequality and poverty while supporting fiscal sustainability. - Steps to enhance efficiency and progressivity: - continued monitoring of adherence to conditionality of social transfer programs; - ensure data quality and resume regular updates of the single registry (Cadastro Único) and address pandemic-related backlog; - increase coordination across social protection programs (avoid duplication and address deficiencies, e.g., Bolsa Família, Salário Família, child-related income-tax deductions); - improve cross-checks on enrollments and beneficiaries across programs to identify overlaps and improve coverage; - reforms to make the PIT more efficient and progressive, including eliminating regressive and inefficient tax expenditures. - Authorities’ priorities highlighted: - boost female labor force participation; law on equal pay passed in 2023 to narrow gender wage gaps; - invest in education (e.g., Pé-de-Meia program); - introduce benefits for young children under Bolsa Família and ensure accuracy of Cadastro Único; - ensure Nova Indústria Brasil is in line with WTO obligations; - AML/CFT framework: Financial Intelligence Unit has extensive powers; address AML/CFT gaps identified by FATF/GAFILAT assessment. - On climate finance, authorities affirmed safeguards for carbon markets and the establishment of a sustainable taxonomy. ### Macroeconomic Outlook and Staff Appraisal - Growth projections: - Growth projected to moderate to 2.1 percent in 2024 before strengthening to 2.5 percent over the medium term. - Inflation and monetary policy: - Inflation expected to reach 3.7 percent by end-2024 and the 3 percent inflation target in the first half of 2026. - The careful pace of monetary easing is appropriate; maintain flexibility on pace and length of easing given resilient labor markets and expectations above target-levels. - FX and reserves: flexible exchange rate and adequate FX reserves are valuable shock buffers; FX intervention could address episodes of higher risk premia without substituting for macro policy adjustment. - IOF-FX tax: gives rise to an MCP under the Fund’s new MCP policy and to an exchange restriction; authorities are phasing it out and expect elimination in due course. - Financial system and innovation: - Financial system resilient: banks highly liquid and adequately capitalized; risks from non-bank financial institutions contained. - Credit risks for micro and small enterprises warrant close monitoring. - Recommendations: consider debt-service-to-income limit for consumer loans when necessary; careful management of expanded public bank roles. - BCB innovations: Pix instant payment expands inclusion; Drex CBDC initiative at the frontier—privacy and security challenges being addressed; providing flexibility to cover operating expenses would help retain talent. - Fiscal stance and recommendations: - Draft 2025 LDO reaffirmed the 2024 federal primary zero-deficit target and proposed a zero-deficit target for 2025. - Authorities envisage raising the primary balance to a surplus of 1.0 percent of GDP by 2028. - Staff recommends: - achieve zero federal primary deficit target in 2025; - gradual improvement to a primary surplus of 2.5 percent of GDP by 2030 to put debt on a firmly downward trend and open space for priority investments; - enhance fiscal framework with a strong medium-term fiscal anchor; - eliminate inefficient tax expenditures and broaden the tax base by closing loopholes; - reform PIT, including taxation of dividends, to generate additional revenues and increase progressivity; - control spending pressures and tackle budget rigidities. - Debt sustainability and risks: - Staff assessment: general government gross debt sustainability finds risks of debt distress to be moderate under the baseline, but debt trajectory remains highly sensitive to shocks and contingent liabilities. - Mitigating factors: overwhelmingly domestic investor base, low external debt, large public sector cash buffers. - Structural reforms and potential growth: - VAT reform expected to remove inefficiencies (notably incomplete crediting of taxes on intermediate inputs) and could lift output by 6-11 percent during the transition, assuming full implementation. - Authorities’ goal of revenue neutrality is welcome; if revenue losses materialize, additional measures needed. - Further reforms to advance potential growth: trade integration, simplify business regulations, narrowly targeted industrial policy, strengthen anti-corruption and judiciary efficiency, boost labor force participation, facilitate skill upgrading, increase public investment, and enhance effectiveness of social transfers and tax progressivity. *Source: 1braea2024001-print-pdf - 45.* ### 60. Staff recommends that the next Article IV consultation for Brazil be held on the ### Staff recommends that the next Article IV consultation for Brazil be held on the standard 12-month cycle. ### Real sector developments - Growth is expected to moderate in 2024 before converging to 2.5 percent over the medium term. - Following a sluggish 2023, real investment growth picked up in 2024Q1. - Growth in manufacturing has been positive and rising in recent months. - Broad and core retail sales of recent months suggest robust consumption. - Though falling, inequality remains high, especially in the Northeast states; poverty rates are higher among children. - Table 5: GDP growth at constant prices (percent) — 2022: 3.0; 2023: 2.9; 2024: 2.1; 2025: 2.4; 2026: 2.4; 2027: 2.4; 2028: 2.5; 2029: 2.5. - Table 1: GDP at current prices — 2022: 11.8; 2023: 7.7; 2024: 7.2; 2025: 6.0; 2026: 5.9; 2027: 6.0; 2028: 6.1; 2029: 6.1. ### Inflation and labor market - Headline, core, and near-term inflation expectations are within the target tolerance interval. - The easing of price pressures has been broad-based across goods and services. - Real wages have recovered amid a tight labor market and are near their pre-pandemic path. - Inflation expectations across economic agents have declined to pre-pandemic levels. - Tradeable and, to a lesser extent, non-tradable inflation has declined sharply. - Policy rates have declined, including in real terms, and remain above pre-pandemic levels. - Table 1: Consumer prices (IPCA, average) — 2022: 9.3; 2023: 4.6; 2024: 4.0; 2025: 3.2; 2026: 3.1; 2027: 3.0; 2028: 3.0; 2029: 3.0. - Table 1: Consumer prices (IPCA, end of period) — 2022: 5.8; 2023: 4.6; 2024: 3.7; 2025: 3.2; 2026: 3.0; 2027: 3.0; 2028: 3.0; 2029: 3.0. ### External sector developments - The current account deficit narrowed in 2023, driven by a higher trade surplus. - Favorable terms of trade and record agriculture and crude oil output benefited the trade balance. - FDI inflows declined slightly in 2023 while portfolio investment registered positive inflows. - The NIIP continued to decline mostly due to negative valuation effects. - Financial flows have been volatile; the exchange rate appreciated in 2023 and FX reserves increased. - Table 2 / Table 6: Current Account (billions of US dollars) — 2022: -48.3; 2023: -30.8; 2024: -40.0; 2025: -40.8; 2026: -42.9; 2027: -44.7; 2028: -45.5; 2029: -47.4. - Table 2: Trade balance (billions of US dollars) — 2022: 44.2; 2023: 80.6; 2024: 78.2; 2025: 80.4; 2026: 83.4; 2027: 90.0; 2028: 95.4; 2029: 100.9. - Table 2: Exports (fob, billions of US dollars) — 2022: 340.3; 2023: 344.4; 2024: 345.6; 2025: 350.4; 2026: 357.1; 2027: 369.3; 2028: 380.1; 2029: 391.7. - Table 6: Gross reserves (US$ billions, eop) — 2022: 324.7; 2023: 355.0; 2024–2029: 355.0 (each year). ### Financial sector developments - Credit to the private sector slowed in 2023 in the context of high real interest rates. - Corporates are increasingly relying on debt securities. - The household-debt-to-income ratio is trending down. - NPL ratios started to decline in mid-2023. - Banking sector profitability has been stable, with additional income offset by higher noninterest expense. - The financial system has adequate capital and remains highly liquid. - Table 4 (end-2023): Base money — 1,152.3 (billions of reais); Broad money (M2) — 10,958.8 (billions of reais); Credit to private sector — loans to private sector 5,408.2 (of which). - Table 10 (Financial Soundness Indicators, percent): Non-performing loans to total gross loans — 2023: 2.8; Return on assets — 2023: 1.6; Return on equity — 2023: 13.7; Regulatory capital to risk-weighted assets — 2023: 17.9; Liquidity coverage ratio — 2023: 184.6. ### Fiscal sector developments and medium-term fiscal outlook - Revenue growth picked up since mid-2023; the strong increase in primary expenditure is explained by the payment of precatórios in late 2023. - New tax measures and the phasing out of pandemic-related tax cuts helped arrest the decline in revenue. - Fiscal balances fell in 2023 but are expected to rise gradually over the medium term. - The general government expenditure-to-GDP ratio is expected to decline gradually over the medium term in line with the fiscal rule with the revenue ratio above its 2023 level. - Unfavorable interest rate-growth differentials are expected to add to debt in coming years. - Gross and net debt ratios are expected to increase over the medium term and stabilize in 2032. - Table 3 (Federal government national representation, percent of GDP): Total primary expenditure — 2022: 22.5; 2023: 23.8; 2024: 23.6; 2025: 23.6; 2026: 23.6; 2027: 23.2; 2028: 23.0; 2029: 22.8. - Table 3: Primary balance — 2022: 0.5; 2023: -2.4; 2024: -0.6; 2025: -0.7; 2026: -0.4; 2027: 0.1; 2028: 0.6; 2029: 1.0. - Table 3: Overall balance — 2022: -4.5; 2023: -8.1; 2024: -6.3; 2025: -6.1; 2026: -5.4; 2027: -4.8; 2028: -4.4; 2029: -4.0. - Table 3: Public sector net debt — 2022: 56.1; 2023: 60.9; 2024: 61.4; 2025: 65.9; 2026: 68.3; 2027: 70.0; 2028: 71.1; 2029: 71.8. - Table 7 (General Government GFSM 2014, percent of GDP): Revenue — 2022: 39.5; 2023: 37.8; 2024: 38.9; Total expenditure — 2022: 43.4; 2023: 45.4; 2024: 45.7; Net lending and borrowing — 2022: -4.0; 2023: -7.6; 2024: -6.8. ### Balance of payments and external debt dynamics - Table 2: Capital and Financial Account (billions of US dollars) — 2022: 47.0; 2023: 29.7; 2024: 40.0; 2025: 40.8; 2026: 42.9; 2027: 44.7; 2028: 45.5; 2029: 47.4. - Table 5 (External debt, billions of US dollars): Total external debt — 2022: 681.1; 2023: 732.6; 2024: 741.2; 2025: 762.7; 2026: 781.7; 2027: 798.6; 2028: 812.6; 2029: 825.6. - Table 5 (External debt, percent of GDP): Total external debt — 2022: 34.9; 2023: 33.7; 2024: 32.6; 2025: 32.3; 2026: 31.0; 2027: 29.7; 2028: 28.6; 2029: 27.5. - Table 6 (External Vulnerability): Amortization of external MLT debt (in percent of GNFS exports) — 2022: 20.7; 2023: 24.6; 2024: 27.3; 2025: 28.8; 2026: 29.3; 2027: 29.2; 2028: 29.2; 2029: 29.0. ### Selected social, demographic, and memorandum indicators - Table 1 (Social and Demographic Indicators): Area (thousands of sq. km.) — 8,510; Agricultural land (percent of land area) — 30.2; Population (2023) total (millions) — 216.3; Annual rate of growth (percent) — 0.7; Density (per sq. km.) — 25.4. - Health and education: Physicians per 1000 people (2023) — 2.6; Hospital beds per 1000 people (2023) — 2.4; Access to safe water (2022) — 88.0; Adult illiteracy rate — 5.4; Net enrollment rates, percent: Primary education — 99.4; Secondary education — 92.2. - Poverty and inequality: Poverty rate (in percent, 2022) — 31.6; Palma ratio 3/ — 3.6; Gini coefficient (post taxes and transfers) — 51.8. - Table 1 (Memoranda): GDP, dollars (2023) — US$2,174 billion; GDP per capita (2023) — US$10,050; Unemployment rate (Q1, 2024) — 7.9. *Source: IMF staff estimates and projections as presented in the provided Brazil Article IV consultation material.* ### Annex I. Economic Resilience During 2022-23: ### Annex I. Economic Resilience During 2022-23: Insights from Forecast Errors ### Key finding: stronger-than-expected GDP and lower-than-expected inflation - Real GDP growth performance in 2022-23 was stronger than envisaged in forecasts. - Compared with forecasts in the October 2022 WEO, cumulative real GDP growth during 2022-23 was stronger by over 2 percentage points. - Inflation was slightly lower than expected. ### Sources of growth over-performance - Greater-than-expected real government consumption drove part of the over-performance. - Greater-than-expected real private consumption also contributed to the over-performance. - Real exports grew more strongly than projected in the October 2022 WEO, amid record agricultural supply. - Reflecting the strength in domestic demand, real imports also exceeded projections, although to a lesser extent. - By contrast, investment in Brazil was slower than expected. ### Comparative context - Brazil’s growth over-performance was significantly greater than for the world economy and the median of other LA5 economies. - Exports and imports in the rest of the world and in other LA5 economies on average slowed compared with forecasts. *This Annex was prepared by Daniel Leigh (WHD).* ### Annex V. Risk Assessment Matrix ### Annex V. Risk Assessment Matrix ### Domestic Risks — Downside - Impact of Rio Grande do Sul Flood - Likelihood: Medium - Impact: Medium. Greater-than-expected supply disruptions could result in higher inflationary pressures and negatively impact growth and the fiscal accounts. - Policy Response: - Monetary policy should remain vigilant and flexible in case of increased price pressures. - The government could provide targeted support to vulnerable households who are victims of the flood calamity. - A well targeted package for the recovery and reconstruction can help offset some negative effects on growth. - Over the longer run, additional initiatives on flood prevention, mitigation, and adaptation are warranted. - Slower-than-envisaged Medium-term Fiscal Consolidation - Description: Identified measures deliver less than expected fiscal consolidation. - Likelihood: High - Impact: Medium. Medium-term inflation expectations remain unanchored, slowing the decline of policy rates toward neutral levels. Risk premia increase, raising borrowing costs. Currency depreciation occurs amid lower investor sentiment. Investment and growth are lower than projected. - Policy Response: - Monetary policy should remain vigilant in case inflationary pressures materialize. - Efforts to strengthen the fiscal position, supported by an enhanced fiscal framework, a further broadening of the tax base, and reforms that tackle spending rigidities should accelerate, while protecting the most vulnerable through targeted support. - Extreme Climate Events - Description: Extreme climate events driven by rising temperatures cause loss of human lives, severe damage to infrastructure, supply disruptions, lower growth, and financial instability. - Likelihood: Medium - Impact: Medium. The electricity sector is dependent on hydropower and thus prone to swings in electricity production and cost increases. Given geography, as well as less underdeveloped infrastructure particularly in townships, frequent mudslides destroy buildings and livelihoods. - Policy Response: - The government can provide targeted support to mitigate the impact of natural disasters on the most vulnerable and establish funds for reconstruction. - Policies should aim to diversify energy sources by further broadening solar and wind energy; adjust grids and storage capacity for electricity; invest in safer infrastructure; and protect biomes to conserve precipitation patterns as much as possible. - Strengthened early warning systems could help mitigating risks from mud slides and flooding. ### Domestic Risks — Upside - Stronger-than-expected Household Consumption - Description: Supported by the tight labor market and rising real income. - Likelihood: Medium - Impact: Medium. Higher real GDP growth from boost in private consumption, improvement in poverty and social outcomes if this percolates to lower income households. Tighter labor markets and higher real wage growth slow the decline in inflation. - Policy Response: - Monetary policy should remain vigilant should inflation risks materialize and calibrate policy to incoming data. - Faster-than-expected Implementation of Structural Reform Agenda - Description: Including in Growth Acceleration Program and investments in green growth opportunities. - Likelihood: Medium - Impact: High. Higher-than-expected boost in medium-term growth through improved productivity and investment. Improvement in social outcome and better job opportunities. - Policy Response: - Policies to upgrade skills and education, particularly in an inclusive manner, will ensure more sustainable and inclusive growth. - Policies (e.g., better childcare provision) would help to improve female labor force participation. ### Global Risks — Downside - Intensification of Regional Conflict(s) - Description: Escalation or spread of the conflict in Gaza and Israel, Russia’s war in Ukraine, and/or other regional conflicts or terrorism disrupt trade (e.g., energy, food, tourism, supply chains), remittances, FDI and financial flows, payment systems, and increase refugee flows. - Likelihood: High - Impact: Medium. Lower investment confidence and broader EM capital outflow pressures could give rise to a repricing of risk assets, dent growth, and increase depreciation and inflationary pressures. However, exports could benefit in the near-term due to positive terms-of-trade effects from commodity price increases. - Policy Response: - Exchange rate flexibility should remain instrumental to absorb shocks. - FX intervention could be used when exchange rate flexibility is associated with costly frictions (e.g., due to shallow FX markets) but should not substitute for warranted adjustments of macroeconomic policies. - Introducing comprehensive outflow CFMs in line with the Fund’s Institutional View could be considered in imminent crisis circumstances. However, this should not substitute for any warranted macroeconomic adjustments. - Commodity Price Volatility - Description: A succession of supply disruptions (e.g., due to conflicts, export restrictions, and OPEC+ decisions) and demand fluctuations causes recurrent commodity price volatility, external and fiscal pressures in EMDEs, cross-border spillovers, and social and economic instability. - Likelihood: High - Impact: Low. Low and volatile oil prices will compress investment, primarily by Petrobras, and reduce growth. On the other hand, high and volatile oil prices could increase inflation pressures in an unpredictable manner. - Policy Response: - Higher oil prices should be allowed to pass through to consumers, accompanied by targeted support for the poor as needed. - Monetary policy needs to remain vigilant in case there is need to pause the easing cycle to contain second-round inflationary effects of prolonged volatile and high commodity prices. - Deepening Geoeconomic Fragmentation - Description: Broader conflicts, inward-oriented policies, and weakened international cooperation result in a less efficient configuration of trade and FDI, supply disruptions, protectionism, policy uncertainty, technological and payments systems fragmentation, rising shipping and input costs, financial instability, a fracturing of international monetary system, and lower growth. - Likelihood: High - Impact: Medium. Decline in global economic productivity and higher input costs could weaken economic activity. However, Brazil’s trade-to-GDP ratio is relatively low, which would contain negative growth effects. Possible nearshoring effects from North America could mitigate some of the downside growth effects. - Policy Response: - The government should accelerate structural reforms and policies related to upgrading skills and education to ensure that the economy can adjust swiftly to shift in trade and FDI patterns and lower global economic growth. - Abrupt Global Slowdown - Description: Global and idiosyncratic risk factors cause a synchronized sharp growth downturn, with recessions in some countries, adverse spillovers through trade and financial channels, and market fragmentation triggering sudden stops in EMDEs. Scenarios noted: - China: Sharper-than-expected contraction in the property sector weighs on private demand, further amplifies local government fiscal strains, and results in disinflationary pressures and adverse macro-financial feedback loops. - Europe: Intensifying fallout from Russia’s war in Ukraine, supply disruptions, tight financial conditions, and real estate market corrections exacerbate economic downturn. - U.S.: Amid tight labor markets, inflation remains elevated, prompting the Fed to keep rates higher for longer and resulting in more abrupt financial, housing, and commercial real estate market correction. - Likelihood: Medium - Impact: Medium. A sharp decline in global economic activity could undermine consumer and investment confidence and dampen trade, in particular if the slowdown occurs in Brazil’s major trading partners. However, Brazil is relatively closed, which would contain negative growth effects. - Policy Response: - The pace of monetary policy easing could be accelerated if incoming data provide strong evidence of a sharp disinflationary force. - The government could provide targeted social support for the vulnerable within the budget envelope. - Fiscal stimulus can be considered in a severe downturn scenario while maintaining debt sustainability. - Monetary Policy Miscalibration - Description: Amid high economic uncertainty, major central banks loosen policy stance prematurely, hindering disinflation, or keep it tight for longer than warranted, causing abrupt adjustments in financial markets and weakening the credibility of central banks. - Likelihood: Medium - Impact: Medium. Spillovers could be more limited in Brazil than peers, given Brazil’s high domestic real rates, net FX creditor status, and limited reliance on portfolio flows. - Policy Response: - Exchange rate flexibility should remain instrumental to absorb shocks. - Monetary policy should be guided by incoming data. - Liquidity support may need to be provided if banks come under pressure. - Targeted support could be provided to vulnerable households while a tighter fiscal stance should be adopted to support disinflation efforts. - Systemic Financial Instability - Description: High interest rates and risk premia and asset repricing amid economic slowdowns and political uncertainty (e.g., from elections) trigger market dislocations, with cross-border spillovers and an adverse macro-financial feedback loop affecting weak banks and NBFIs. - Likelihood: Medium - Impact: Medium. Systemically important banks are adequately capitalized and liquid with securities’ portfolios mostly marked-to-market and interest-rate risk hedged appropriately. The authorities’ stress tests suggest the banking system would be resilient to a variety of risks, including a significant deterioration in credit quality. - Policy Response: - The authorities are appropriately taking steps to pass resolution legislation as recommended in the 2018 FSAP to ensure that any problem banks are addressed efficiently and swiftly. - Cyberthreats - Description: Cyberattacks on physical or digital infrastructure and service providers (including digital currency and crypto assets) or misuse of AI technologies trigger financial and economic instability. - Likelihood: Medium - Impact: High. Cyberattacks could disrupt economic activity and damage the financial sector given the high degree of digitalization in Brazil; resulting loss of confidence could hinder progress on digitalization. - Policy Response: - Continue to extensively monitor risks and regularly perform cybersecurity tests. - Further build resilience by strengthening cybersecurity frameworks and ensuring robust cybersecurity laws. *This Annex was prepared by Bunyada Laoprapassorn (WHD).* ### 1. Debt coverage in the DSA: 1/CGGGNFPSCPSOther ### 1. Debt coverage in the DSA: 1/CGGGNFPSCPSOther ### Coverage decision and subsectors included - Chosen coverage: budgetary central government (Yes). - Subsector inclusion (baseline): - Budgetary central government: Yes - Extra budgetary funds (EBFs): No - Social security funds (SSFs): Yes - State governments: Yes - Local governments: Yes - Public nonfinancial corporations: No - Central bank: No - Other public financial corporations: No - 1a. If central government, are non-central government entities insignificant? n.a. ### Debt consolidation, recording, and valuation notes - Comments: Gross debt covers the General Government (GG) following the GFSM 2014 manual. - GG gross debt includes all Treasury securities on the BCB balance sheet. - Authorities’ GG gross debt definition includes the stock of Treasury securities used for monetary policy purposes by the BCB (those pledged as security in reverse repo operations) but excludes the rest of the government securities held by the BCB. - Reporting on intra-government debt holdings: references to CG, CPS, NFPS, GG expected, and CPS non-consolidated appear in the reporting matrix. - Basis of recording and valuation terms listed in source glossary: - Loans, IPSGSs 3/ - Other accounts payable 2/ - Market value 7/ - Nominal value 5/ - Face value 6/ - Non-cash basis 4/, Cash basis, Consolidated, Non-consolidated. - Footnotes preserved as in source: - 1/ CG=Central government; GG=General government; NFPS=Nonfinancial public sector; PS=Public sector. - 2/ Stock of arrears could be used as a proxy in the absence of accrual data on other accounts payable. - 3/ Insurance, Pension, and Standardized Guarantee Schemes, typically including government employee pension liabilities. - 4/ Includes accrual recording, commitment basis, due for payment, etc. - 5/ Nominal value definition preserved verbatim. - 6/ Face value definition preserved verbatim. - 7/ Market value definition preserved verbatim. ### Public debt structure (key characteristics and risks) - Commentary summary: - Debt composition is favorable with small amounts of FX and foreign law debt. - Limited reliance on foreigners for local currency debt. - Large stock of securities held by the BCB that pose negligible refinancing risks. - Debt projections are highly sensitive to changes in interest rates given the high share of short-term and variable coupon debt. - Residual maturity: 6. years (as reported). - Projection notes: - Marketable vs nonmarketable debt, foreign currency vs local currency vs local-linked, and governing law breakdowns are presented for 2014–2032 horizons in figures. ### Baseline and medium-term risk assessment (figures and indices) - Debt Fanchart module: - Debt fanchart width: 56.3 - Contribution: 0.8 - Final Fanchart (Percent of GDP): (displayed in source) - Debt fanchart index (DFI): 2.9 - Risk signal: High - Probability and terminal metrics: - Probability of debt non-stabilizaiton (percent): 72.6 - Contribution: 0.6 - Terminal debt-to-GDP x: 67.0 - Contribution: 1.5 - Gross Financing Needs (GFN) module: - Average baseline GFN (percent of GDP): 16.1 - Contribution: 5.5 - Initial Banks' claims on the gen. govt (pct bank assets): 25.2 - Contribution: 8.2 - Change in banks' claims in stress (pct banks' assets): 0.7 - Contribution: 0.2 - GFN financeability index (GFI): 13.9 - Risk signal: Moderate - Medium-term index: - Medium-term index (Index Number) summarized combining modules above. - Final assessment: Prob. of missed crisis, 2024-2029, if stress not predicted: 54.5 pct. - Prob. of false alarms, 2024-2029, if stress predicted: 5.7 pct. - Commentary: Of the two medium-term tools, the Debt Fanchart Module points to high level of risk, while the GFN financeability module suggests lower, but still moderate, level of risk. Large availability of liquid assets (15 percent of GDP in cash buffers) and negligible refinancing risks for central bank held securities (25 percent of the total debt stock) further mitigate GFN risks. ### Stress testing and scenarios - Triggered stress tests visualized across scenarios including commodity prices, natural disaster, and financing provided by banks. - Stress visualization highlights percentile bands (5-25 pct, 25-50 pct, 50-75 pct, 75-95 pct) for projected outcomes 2019–2029. - Financing provided by banks compared across Actual, Baseline, and Stress scenario lines in source figures. ### Realism of baseline assumptions - Forecast track record and comparator group: emerging markets, non-commodity exporter, surveillance. - Commentary: - Composition of debt-creating flows relies on significantly higher real interest rates compared to lower rates prevailing during the pandemic. - The 3-year adjustment in the cyclically adjusted primary balance is within historical norms. - Distributional diagnostics in figures: - 3-year debt reduction percentiles and 3-year adjustment in cyclically-adjusted primary balance (percent of GDP). - Laubach (2009) rule referenced: bond spreads increase by about 4 bps in response to a 1 ppt increase in the projected debt-to-GDP ratio (source note preserved). ### Long-term risk analysis - Triggered modules: Pensions, Health, with projections and risk indications for GFN-to-GDP ratio and Amortization-to-GDP ratio. - Overall risk indication: Brazil: Long-Term Risk Assessment: Large Amortization. - Commentary: Over the long-term, Brazil's rollover risk is moderate. In the event of abnormally large amortization, staff factored in the country's capabilities to engage in proactive debt management. Refinancing risks are mitigated by: - Overwhelmingly domestic investor base, - Large liquid assets held by the treasury, - Substantial Central Bank holdings of federal securities that pose negligible refinancing risks. - Note: Historical scenario simulation might not be representative as it reflects historically elevated deficit, including the impact of the COVID-19 pandemic. ### Annex VIII (VAT reform) — high-level findings relevant to macro and fiscal outlook - Reform background: - Congress approved a landmark VAT reform in 2023 after more than three decades of debate. - Reform addresses inefficiencies from complexity and unique features of Brazil’s current indirect taxation system. - Macroeconomic and productivity effects: - One-sector neoclassical model: reducing the tax on intermediate inputs to zero while imposing revenue neutrality via VAT adjustment would increase GDP by 11 percent relative to the status quo in the long run (stylized result; does not account for sectoral, rural-urban divide nor the informal sector, ~20 percent of Brazilian value added). - MIMMI (Multisector Incomplete Markets Macro Inequality) model: full crediting of sales taxes on intermediate goods boosts GDP by 6 percent and rural and urban formality by 7 and 6 percent, respectively. - Sectoral effects: removing taxes on intermediates for formal manufacturing and services boosts sectoral efficiency, lowers prices, and raises wages; agricultural prices increase in relative terms. - Distributional effects and equity: - Current combined tax rates estimated around 33.5 to 34.4 percent (Treasury and Receita Federal do Brasil estimates). - Current system substantially regressive: poorest decile faces consumption tax liability of 20-45 percent of monetary income vs 10 percent for the richest decile (estimates vary with income definition and survey coverage). - Proposed cashback system reimburses 20 percent of VAT paid to the poorest; exemptions and reduced rates on products relatively more consumed by lower-income households; standard VAT rate capped at 27.3 percent. - SimVAT Tool results: smoother distribution of tax liability across income deciles, mainly due to reduction in lower income deciles; poorest decile’s burden would remain about twice that of the richest decile under the proposed design. - Cashback scenarios considered (four scenarios summarized; three explicitly described in source): - Reform: exemptions on Cesta Básica’s food and medicines, urban transport, and books; reduced rate (40 percent of the standard rate) on specified items; households in Cadastro Único receive a refund of VAT paid. - Cash Back: single VAT standard rate; households in Cadastro Único receive refund on VAT paid for a specified basket (Cesta Básica, water and sewage, cooking gas and fuels, energy, education and health). - Cash Back (full): single VAT standard rate; households in Cadastro Único receive refund of all VAT paid. - Footnote numbers and parameter assumptions preserved in source (refund amounts to 30 percent on water, sewage and energy, 47 percent on cooking gas and fuels, and 20 percent on other goods and services; excise tax schedule on alcoholic drinks, fuels, tobacco specified in source). - Governance and implementation: - Efficient governance of dual VAT requires an integrated managing body for both CBS and IBS. - New management council (Comitê Gestor) for CBS responsibilities: unified legislative interpretation, managing collection and revenue sharing, resolving administrative reviews, overseeing reviews and audits. - No similar council for integrating CBS and IBS in the reform as currently designed; governance framework still to be defined. - Implementation and digitalization: - Reform emphasizes harmonization of tax procedures, digitalization, and exchange of information. - Potential compliance and targeting advantages if cashback compensation can be done in real-time and with e-invoicing already in place. *Source: IMF.* ### 8. Achieving complete and timely crediting of input VAT will minimize uncertainty ### 8. Achieving complete and timely crediting of input VAT will minimize uncertainty ### VAT transition and timely crediting - Full crediting of taxes paid on inputs purchased domestically or abroad is a key feature to lock in an irreversible path towards full implementation, build credibility, and lower uncertainty during the transition. - The reform foresees to refund excess credits promptly and without first carrying them forward, in line with good practice. - The proposed refund timeframe of 60 days (270 for special cases) should be aligned with international good practice of 30 calendar days. - The split payment mechanism should be introduced with caution to avoid turning the VAT into a cash-based tax. ### Leveraging synergies across levels of government - High degree of autonomy of each state and heterogeneous capacity across municipalities create significant challenges for harmonizing operations and approaches for compliance. - Technology could centralize certain functions or manage them through regional centers of excellence. - A clear understanding of each revenue administration’s role in operating the dual VAT is required, agreed in a well-defined regulation or MOU. - Segmentation, commonly by taxpayer size, can help find a balanced distribution of roles across revenue administrations. ### Risks to revenue neutrality - Potential risks stem from fundamental shifts in revenue bases, compliance and policy gaps, and informality. - Benefits from changes in relative prices and price adjustments will take time, while downward adjustment in some rates will be immediate. - Compliance and policy gaps will need to narrow significantly to reach targeted revenues, outperforming OECD countries. Key quantified risks and shifts: - Shift from Producer to Consumer Tax Base: - Full crediting of intermediate inputs will shift tax liability from producers to final consumers. - Around 4½ percent of GDP is currently collected on intermediate inputs in Brazil. - Considerable uncertainty remains about how quickly firms will pass on lower prices to consumers. - Shift across Sectoral Tax Bases: - The reform sets the reference rate for CBS-IBS, which functions as an upper bound on VAT rates. - This implies lower statutory rates for manufacturing; information and communications; and electricity, gas water, and waste. - Revenue losses would need to be compensated by higher statutory rates for agriculture and retail (sectors with higher informality) and services in general (typically associated with higher avoidance). - Compliance Gap: - The estimated tax gap of 22.3 percent on PIS/COFINS is relatively high compared to peers, yet commensurate to Brazil’s current tax rate and collection. - The reform is expected to boost compliance through harmonization and lower complexity, but a shift to services typically implies a larger compliance gap. - Policy Gap: - A wide range of reduced rates, exemptions, and special regimes have already been granted, with the reference rate close to the maximum. - The continuation of the SIMPLES special tax regime further adds uncertainty. - Informality: - Staff estimates that revenue gaps of around 1-2 percent of GDP could arise due to informality. ### Annex IX — Impact of labor litigation cases on firm-level productivity (summary) - Labor litigation cases dropped markedly in Brazil since 2017 following significant changes to Brazilian Labor Law aimed at reducing litigation and increasing flexibility. - Data and empirical strategy: - Analysis uses over 4,500 private and public firms from 2014 onwards from Bureau van Dijk’s (BvD) Orbis global database, combined with state-level PNAD survey data and TST data on number of labor litigations by state. - TFP estimated using a gross output approach, with cost of goods sold and tangible fixed assets as inputs. - State-level exposure measure constructed from number of labor disputes as a share of both the state’s labor force and employment. - Intensity measures: sectoral labor intensity (median ratio of labor cost over total costs in advanced economies) and sector-level trade intensity (median ratio of export revenue over sales). - Regression specification includes post-2017 dummy, sector-time, state-time, and firm fixed effects, and lagged firm-level variables; parameter of interest β captures differential productivity changes. - Main findings: - Firms in the average state in labor intensive sectors (90th percentile of the sectoral distribution) witnessed an increase in TFP of about 15 percent after the 2017 reform due to the decline in litigation cases, compared to firms in low labor-intensive sectors (10th percentile). - High trade-intensive firms witnessed a similar increase in TFP after the reform compared to firms in low trade-intensive sectors. - Effects are statistically significant. - Translating to aggregate terms, the estimated impact implies an aggregate productivity increase of 5 percent relative to a counterfactual where litigation did not change. - Robustness and caveats: - Orbis reports the state of firm headquarters, while labor employment and litigation data are based on firm location; this may be less relevant for Brazil where around two thirds of active companies are individual entrepreneurs. - Robustness checks include removing top-sized firms and large states (Brasília, Rio de Janeiro, and São Paulo) and using pre-reform litigation levels; results remain robust. ### Annex X — Past IMF recommendations and implementation status (selected fiscal and policy items) - Fiscal Policy: - Recommendation: Implement more ambitious fiscal effort beyond 2026, anchored in an enhanced fiscal framework that builds on the new rule. - Implementation status: The 2024 Draft Budget Guidelines Law submitted to Congress in April proposes a zero federal primary deficit target for 2025 with a narrow tolerance band, and targets for increase in subsequent years to a federal primary surplus of 1.0 percent of GDP in 2028. - Recommendation: Pursue expenditure reforms to tackle spending rigidities. - Implementation status: Authorities are undertaking spending reviews of pension and social program. - Recommendation: Advance planned revenue-neutral indirect tax reform that streamlines tax regime and reduces the cost of tax compliance. - Implementation status: The implementation of the 2023 VAT reform is advancing with four complementary laws under preparation. - Monetary and Exchange Rate Policies: - Recommendation: Ensure that monetary policy action and communication strengthen credibility around the recently adopted continuous inflation target. - Implementation status: The pace of monetary easing has been appropriately cautious. After 50 basis point rate cuts for six meetings, the central bank reduced rates by 25 basis points to 10.5 percent in May and kept rates unchanged in June. - Financial Sector Policy: - Recommendation: Supplement planned measures to facilitate household debt restructuring with targeted prudential limits. - Implementation status: The BCB closely monitors household credit risks and issued warnings in early 2023 which helped persuade private banks to tighten lending standards on credit cards. The BCB has the legal mandate to implement new macroprudential limits when needed. - Structural and Climate Policies: - Recommendation: Pursue supply-side reforms to boost potential growth, including tackling spending rigidities to make room for public investment. - Implementation status: Authorities envisage increasing public investment, while preserving debt sustainability, as part of the Growth Acceleration Plan. - Recommendation: Pursue policies to protect economic activity, assets, and livelihoods, including boosting the Amazon’s resilience to climate shocks and developing a green and social taxonomy. - Implementation status: Deforestation in the Amazon was cut by half in 2023. The government is committed to halting illegal deforestation by 2030. Important progress has been made on establishing Brazil’s Sustainable Taxonomy. The ETS was approved by the Lower House and is now being considered by the Senate. The Forest Law was approved in 2023, enabling carbon credits and other environmental services in conservation areas. Brazil’s first Global ESG sustainable government bond was issued in November 2023. *Source: International Monetary Fund (excerpt).* ### Annex XI. Implementation of Key FSAP Recommendations ### Annex XI. Implementation of Key FSAP Recommendations ### Microprudential and Macroprudential Institutional Arrangements - Recommendation: Establish a multi-agency high-level committee, with an explicit mandate for macroprudential policy and the power to issue policy recommendations on a comply-or-explain basis. Time: ST - Authorities’ Actions: The BCB, CVM, Previc and SUSEP finalized the “Financial Stability Coordination Law”, a draft bill which is now being discussed with the Ministry of Finance. - Recommendation: Strengthen the crisis management institutional arrangements for inter-agency cooperation and exchange of information, including for contingency planning. Time: MT - Authorities’ Actions: The “Financial Stability Coordination Law” draft bill proposes the creation of a “Financial Stability National Committee” that would have authority over macroprudential policy and crisis management (including contingency plans/crisis management). The BCB’s contingency planning has already been implemented. - Recommendation: Strengthen legal protection of all supervisors (BCB, SUSEP) through clear rules, including fixed term, condition of dismissal, public disclosure of reasons for dismissal and qualification criteria for appointments. Strengthen the independence of the BCB. Time: ST - Authorities’ Actions: - In 2021, Complementary Law 179 of 2021 was enacted, establishing the objectives of the BCB, its autonomy and the procedures to appoint and remove Board members. - The law defines price stability as the primary objective of the BCB and sets four-year terms (with one possible renewal) for Board members. Most Board member terms do not coincide with the presidential term. - The law also establishes the cases in which the removal of Board members is admissible (proven and recurring underperformance, with approval by an absolute majority of the Senate). - The law also provides for aspects of operational autonomy, delegation of decisions about other monetary policy and macroprudential tools from CMN to BCB, and enhances policy transparency, such as through the publication of inflation and financial stability reports. However, it does not establish legal protection for BCB’s staff. Neither does it grant effective financial and administrative independence to the BCB. - The Bank Resolution bill – submitted to the lower house and currently being discussed by a special congressional committee – provides for protection of public agents. As it stands, this bill includes both a provision for legal protection and for legal defense by the General Counsel, to be covered by the BCB. - There is a proposal of Constitutional Amendment (PEC 65/2023), which is devoted to establishing the financial and administrative independence to the BCB. The bill rapporteur is the senator Plínio Valerio (PSDB-AM). - Decree nº 9.727/2019 and Decree nº 10.829/2021 have established qualification criteria for appointments to strategic positions in the Administration, including supervisory institutions. - SUSEP has drafted a bill to merge with the pension funds supervisor (Previc), addressing, among other issues, the structure and responsibilities of the new authority. - Recommendation: Increase resources of CVM and SUSEP. Time: ST - Authorities’ Actions: Both CVM and SUSEP are subject to budget constraints, given Brazil ́s fiscal situation and a freeze in public wages over the past years. ### Systemic Risks - Recommendation: Use Pillar 2 capital requirements to handle bank-specific risk profiles to boost their resilience as needed and to mitigate risks. Time: ST - Authorities’ Actions: - Structured and by Reference Add-ons are implemented in the BCB’s supervisory methodology. The Structured Add-on is fully implemented (segments from S1 to S4). - The Add-on by Reference is applied to financial institutions allocated to Segments S1 and S2 and includes metrics for credit concentration risk and Interest Rate Risk of Banking Book (IRRBB). - Financial institutions identified as having an exposure not adequately considered in Pillar 1 capital requirements – according to BCB’s estimates – in one of these two approaches have reported add-on regularly to the BCB. ### Financial Sector Oversight - Recommendation: Upgrade the banking sector’s regulatory and supervisory approach to credit risk— including identification and definitions, limits, and reporting requirements—for related party exposures and transactions, large exposures, country and transfer risk and restructured loans. Time: MT - Authorities’ Actions: - Completed actions: - (i) CMN has issued Resolution 4,677/2018 (Basel III reform on Large Exposure Limits), establishing limits and report requirements for single client and large exposures. Rules have been applied for Prudential Segments S1 and S2 since January 2019 and for Segments S3, S4 and S5 since January 2020. The Report on Operational Limits—DLO (Circular Letter 3,926) includes information on large exposure limits. - (ii) The CMN issued Resolution 4.693/2018 addressing credit operations between related parties. Accordingly, accounting items were created as of January 2019 to collect information from Related Parties, in which financial institutions report the greatest exposure (natural person and legal entity) and other exposures with related parties. A field is also included in the SCR to inform whether the contracted operation is being carried out with related parties. - (iii) The CMN amended regulation on risk management (Resolution 4.557/2017) to include section establishing specific requirements for country and transfer risks, with specific treatment of indirect risks. - Other initiatives under analysis or being drafted include: - (i) Regulation on prudential treatment of transactions with related parties. - (ii) Requirement of producing concentration risks data on a regular basis. - (iii) Structured assessment of country, transfer and indirect risk. - (iv) IFRS9 regulation is already published and implementation is scheduled for January 2025. It will enhance the credit risk framework definitions, including the definition of credit risk exposure and problem assets. - Recommendation: Strengthen enforcement function of CVM by raising the level of sanctions and ensuring adequate resources for prosecution; strengthen cooperation allowing CVM proper oversight of ANBIMA’s SRO activities in the investment fund sector. Time: ST - Authorities’ Actions: - The expansion of the scope of the agreement with ANBIMA is ongoing, to include the subject of supervision of mandate (portfolio breaches). Funds ruled by CVM instruction 555 (which represent more than 85% of the industry) are included. An extended version of this agreement was adopted in 2021. - CVM Instruction 607 of July 2019 was issued to establish procedures related to the Law 13.506/17 that expanded CVM’s enforcement power. - Recommendation: Implement (BCB, ANS and SUSEP) consistent group-wide supervision of insurance groups and conglomerates with joint rulemaking, implementation, and on-site inspections and granular data sharing. Time: MT - Authorities’ Actions: The authorities’ efforts in this area are ongoing. The granular data sharing depends on legal provisions and on the establishment of partnerships among the supervisors. The creation of the “Financial Stability National Committee” would partially bridge this gap. ### Crisis Management and Bank Resolution, Safety Nets - Recommendation: Revise the draft resolution law in line with the FSAP team’s recommendations and promptly enact it. Time: ST - Authorities’ Actions: The draft bill was submitted to Congress in December 2019. The Bill of Law 281 of 2019 is pending appreciation by the Lower Chamber. - Recommendation: Revise the ELA framework to provide for a solvency test tied to enhanced supervision, remedial plans, and possibly restructuring measures, and allow for ELA in systemic circumstances upon a MoF indemnity. Time: ST - Authorities’ Actions: - The BCB reaffirms its point on this recommendation. While solvency analysis is important for ELA assessment, the BCB does not agree that being solvent on a point-in-time basis should be the main determinant of ELA approval, as it may bind ELA approval and lead to high moral hazard. - The systemic impact of a negative response to an ELA request is also relevant, so the BCB prefers to retain the flexibility to decide, with its discretionary power. - The recommendation of indemnity of the MoF in case of ELA in systemic circumstance will not be implemented since it may increase moral hazard risk and the BCB balance sheet is part of the government accounts (which means the National Treasury will have to indemnify the BCB anyway, in case of BCB balance sheet loss). - The BCB deployed Temporary Liquidity Facilities (ELA for the COVID-19 crisis) in April 2020. New permanent liquidity facilities were implemented in November 2021, as planned. - Broadening the collateral framework to include new facilities is ongoing, with the acceptance of CCB (securitized individual bank loans) expected by 2024Q3. - Recommendation: Put in place mechanisms to ensure lending from the deposit insurance fund is not used to maintain weak or insolvent banks in operation; and transform FGC into a fully owned public institution. Time: ST; MT - Authorities’ Actions: - The FGC has already amended its by-laws to establish communication to the BCB prior to each assistance operation. - The BCB has signed a MoU with the FGC to grant access to detailed information on financial institutions that are FGC members. - The Administration Committee of the MoU was set as a permanent forum for information sharing and collaboration between the parties to facilitate FGC assessment and avoid the use of lending to maintain weak or insolvent banks in operation. - The recommendation to transform the FGC into a fully public-owned institution will not be implemented. ### Financial Integrity - Recommendation: Complete the national AML/CFT risk assessment and introduce a risk-based approach specific to AML/CFT supervision. Time: ST - Authorities’ Actions: - The coordination of the activities related to the National AML/CFT Risk Assessment is attributed to the Brazilian Intelligence Unit (Coaf). - The decree to establish the Strategic Committee for the National AML/CFT Risk Assessment was issued in March 2020. - The risk assessment was completed and published in 2021. ### Financial Intermediation Efficiency - Recommendation: Foster competition through client mobility and financial product cost transparency and comparability. Time: ST - Authorities’ Actions: - The CMN issued Resolution 4,639/2018 to make it easier for customers to exert their right to have their compensation deposited in the institution of their preference. Specifically, it allowed salaries being transferred to payment accounts besides deposit accounts (creating a levelled playing field for banks and payment institutions); and it allowed costumers to request their salary’s portability directly to their preferred institution, avoiding frictions and embarrassments when customers decide to transfer their salary to a different institution. - Resolution CMN 4,639/2018 has been consolidated by Resolution CMN 5,058/2022, which maintained the salary’s portability rules. - The Credit Registry Law, in effect since 2011, was amended by Complementary Law 166/2019, and regulated by Resolution 4,737/2019, to adopt an opt-out instead of an opt-in model. - Resolution 4,734/2019 and Circular 3,952/2019 set rules for registering and blocking credit and debit card receivables pledged as collateral in credit operations. With these measures, the volume of blocked receivables cannot exceed the outstanding balance of the transaction, which precludes a previous practice of totally blocking the receivables. Moreover, it allows retailers to discount their receivables at any financial or accrediting institution of their choice. - In 2022, the regulation on credit portability were revised and consolidated under the Resolution 5,057/2022, issued by the CMN in December. The consolidation aimed mainly at simplifying and unifying the different normative acts, with some clarifications made to foster the portability of credit operations by legal entities. - The set of credit modalities eligible for portability between financial institutions was expanded in 2019 by Resolution CMN 4,762/2019, which included credit granted to individual microentrepreneurs and to legal entities. Additionally, different credit modalities were included in the list of credit portability, providing a larger menu of options to customers. - Moreover, the implementation of Open Finance in Brazil, mainly regulated by Joint Resolution CMN-BCB No. 1/2020 and observing the General Data Protection Law (No. 13,709/2018), has the potential to help client mobility and improve cost transparency and comparability. - Pix, the Brazilian instant payment system, is an innovation under open finance and has helped reduce transaction cost and encourage competition. ### Reform of Public Banks - Recommendation: Change product offering of BNDES under new strategy with focus on catalyzing private sector finance and developing the financial sector. Time: ST - Authorities’ Actions: - In January 2023, a new administration took office in BNDES with an agenda to revitalize the industry sector and promote an inclusive, green, digital, innovative, and creative economy. BNDES wants the private sector to be its partner on this agenda, gathering strengths to induce sustainable development. - Since then, BNDES is making efforts to enlarge and develop market-based financial instruments to promote long term development. This initiative includes fostering domestic credit and capital markets, and improving access to international funding. The Bank is also seeking to improve lending operations through partnerships with multilateral development institutions. - The BNDES strategic plan envisages the reduction of risks on infrastructure investment, which will help catalyze private sector finance. The environmental agenda embraces the climate agenda, including raising green funds and fostering the decarbonization of the economy. Among the initiatives on social inclusion, BNDES wants to promote credit cooperatives and intensify its support through microcredit. The Bank also intends to design better financial solutions dedicated to SME’s, including through capital markets. - Recommendation: Focus Caixa on core activities, improve governance, and invite a strategic investor. - Authorities’ Actions: - CAIXA continues to reposition its credit operations by prioritizing loans to micro companies, payroll-deducted loans and loans to the housing sector, strengthening its operations in the “Minha Casa Minha Vida” program. - CAIXA also continues to improve its corporate governance practices, in line with principles such as transparency, equal treatment, inclusion, accountability, corporate social responsibility, and sustainability. Gender diversity is a priority, and CAIXA is the first major Brazilian bank to have more female than male Board members. - Through its subsidiaries, Caixa has since 2019 entered several strategic partnerships in insurance and card segments. In parallel, Caixa’s insurance holding company (Caixa Seguridade Participações S/A) raised capital through an IPO in April 2021. - CAIXA's investment banking group was strengthened with the internal reallocation of professionals, aiming at expanding the Bank's pre-existing fixed income capital markets’ operation and create a complete structure of investment bank products. CAIXAPAR, a subsidiary of CAIXA, sold all its shares in Banco Pan to BTG Pactual in 2021. *Annex XI. Implementation of Key FSAP Recommendations — 1braea2024001-print-pdf* ### 1.4 million formal-sector jobs, lower unemployment, and higher real wages. The strong ### 1braea2024001-print-pdf - 1.4 million formal-sector jobs, lower unemployment, and higher real wages. The strong ### Economic activity and labor market - GDP increased by 0.8 percent quarter-over-quarter (s.a.) in Q1 2024, slightly exceeding market consensus. - Growth in Q1 2024 supported by strong private consumption and a rebound in investment. - Market consensus for 2024 GDP growth increased from 1.5 to 2.1 percent between January and May. - Formal job creation accelerated, participation rate increased, and real wages grew faster than anticipated. - The strong harvest contributed to the highest exports on record, leading to a trade surplus of almost US$100 billion. - Inflation fell from 5.8 percent in 2022 to 4.6 percent in 2023 and is expected to fall further towards the 3 percent target in 2024. - Adverse effects from devastating floodings in the state of Rio Grande do Sul weighed on activity in Q2 2024; supply disruptions described as temporary and sector-specific. ### Balance of risks to the growth outlook - The balance of risks is seen as broadly neutral. - Staff’s assessment: global scenario poses important downside risks; domestic risks considered by the authorities to be somewhat less negative. - The floods in Rio Grande do Sul produced a humanitarian disaster; expected national economic and public spending impact described as limited and partially offset by reconstruction in subsequent quarters. ### Fiscal framework, spending, and revenue measures - A fiscal framework enacted in 2023 constrains expenditures to grow at a pace typically below that of revenues. - Government established primary fiscal balance targets aiming for public debt stabilization in 2028 and subsequent decline. - The primary deficit in 2023 was in line with the government’s goal, aided by Congressional approval of measures to restore eroded revenue sources. - Full impact of revenue measures under discussion will be felt from this year onwards, aiding the effort to achieve a zero primary balance target in 2024. - Tax expenditures amount to almost 5 percent of GDP; authorities intend to revisit these in the upcoming 2025 Budget bill to be submitted to the Congress by August. - Ongoing spending reviews aimed at streamlining expenditures, addressing budget rigidities, and reinforcing fiscal consolidation. - Policy objective: contain spending while preserving investment, protecting those most in need, and enhancing overall fiscal progressivity. - Confidence indicators: upgrades to Brazil’s debt rating or outlook by major rating agencies in 2023; high demand for Brazil’s largest-ever long-maturity sovereign bond issuance and lower-than-expected spreads. - Fiscal risk mitigants: diversified and largely domestic investor base, low foreign currency debt, and large public sector cash buffers. ### Landmark tax reform - Constitutional amendment approved in 2023 replaces five different taxes with a dual VAT and introduces an excise tax on goods and services harmful to health or the environment. - Reform is revenue-neutral on aggregate by design and will lower the tax burden on the consumption basket of the poor. - Expected benefits: elimination of distortions, avoidance of race-to-the-bottom tax wars between subnational entities, substantial reduction in compliance costs, increased transparency, and reduced litigation. - Efficiency gains from the reform are estimated to be large, potentially reaching more than 10 percent of the level of GDP in steady state. - Implementing legislation is under discussion in the Congress; gradual phase-in of the new tax system will begin in 2026. ### Monetary policy and inflation - BCB began raising rates early in 2021. - Core inflation receded from a peak of 10.6 percent in June 2022 to 3.5 percent in May 2024. - Falling inflation enabled the Central Bank to begin easing monetary policy in July 2023, with policy rate cuts totaling 325 basis points. - Recent developments led the BCB to interrupt the easing cycle; Copom maintained the policy rate at 10.50% in its latest meeting. - Copom’s stance: monetary policy will remain contractionary until disinflation is firmly consolidated and inflation expectations are anchored at the target. - The floating exchange rate regime remains central; BCB intervenes only when FX market conditions are dysfunctional. - Brazil has an appropriate level of international reserves; use of FX swaps guided by spot and forward market conditions to preserve market functioning and reduce cost of carry. - Any change in the stock of FX swaps will be conditional on market developments and communicated by the BCB in a timely fashion. ### Financial system resilience and innovation - Financial system described as solid, well capitalized, and highly liquid. - Capital and liquidity stress tests by the BCB show adequate capital and liquid assets across simulated adverse scenarios. - Growth of fintech companies has increased competition and financial inclusion; BCB has enhanced oversight of fintechs through prudential measures and monitoring, including contagion risk analysis between banks and non-bank financial institutions. - Key financial innovation initiatives: Open Finance, Pix instant payment system, and Digital Real (Drex). - Drex, a wholesale CBDC, is nearing conclusion of initial pilot phase; pilot revealed technical issues including ensuring appropriate privacy levels in CBDC transactions; BCB working with private sector on solutions and new use cases. - Institutional improvements underway to reduce cost of credit: new law on collaterals approved in 2023 to improve recovery of delinquent loans; legislation debated to improve insolvency framework for non-financial companies and strengthen minority shareholder rights. - Desenrola program helped over 15 million people reorganize their finances and rejoin the formal credit market through renegotiation of R$53 billion in overdue obligations in a little over six months. ### Inclusive and sustainable growth, ecological transformation - Authorities welcome upward revision in the Fund’s medium-term growth projections. - Wide-ranging reform agenda expected to boost total factor productivity and improve business environment; VAT reform singled out as increasing potential growth in medium to long run. - Ecological Transformation Plan aims to promote decarbonization and the green transition. - First-year results of the Plan include: Brazil’s first sustainable sovereign bond issue; a record financial contribution to the Climate Fund; earmarked credit for low-carbon agriculture; redirection of tax-advantaged infrastructure bond issuance towards social and environmental infrastructure; significant progress in proposed carbon market legislation; establishment of a national sustainable taxonomy. - Planned actions include measures related to renewable energy, green fuels, transportation, forests, and foreign exchange hedging solutions for green transition investments. ### Social policies and equity - Transfers to poor families with children aged zero to 6 years enrolled in Bolsa Familia were increased, benefiting about 9 million children and mitigating risks to health and education prospects. - In 2023, a Federal Gender Pay Gap Law was enacted requiring large employers to bi-annually report differences in pay between men and women in management and leadership positions. - Authorities expect the Gender Pay Gap Law to boost female labor force participation and narrow the gender gap. ### Outlook and policy priorities - Authorities committed to: convergence of inflation to the target; rebalancing fiscal stance to stabilize public debt and put it on a firmly downward path; addressing poverty and inequality in an inclusive and environmentally sustainable growth model. - Emphasis on tapping ecological transformation potential to tackle economic and social challenges. - Recognition that structural reforms are time-consuming and politically sensitive but necessary for a more efficient, sustainable, and just economy. *Source: 1braea2024001-print-pdf - 1.4 million formal-sector jobs, lower unemployment, and higher real wages. The strong* --- _Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1braea2024001-print-pdf.pdf_