## _cr12191

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---

### Context and challenges
- Past decade: marked social transformation underpinned by macroeconomic stability and rising living standards supported by fiscal responsibility, inflation targeting, and a flexible exchange rate.
- Key structural needs:
  - Higher investment and saving required to rebalance demand from consumption to investment and net exports.
  - Closing infrastructure gaps to boost productivity and private investment.
  - Recent pension and tax reforms noted as steps toward rebalancing.

### Cyclical state and recent performance
- Growth and activity:
  - Expected moderation in 2011 from 7½ percent in 2010 to 4 percent in 2011; actual growth slowed to 2.7 percent in 2011.
  - Activity stalled in 2011 Q3; large downward revision relative to peers.
  - Contributing factors to the slowdown include deterioration in global sentiment in H2 2011; fall-off in intra-regional trade with Argentina; tighter credit conditions in certain segments; stronger exchange rate and rising relative unit labor costs affecting industrial production.
- Monetary stance and credit:
  - Central bank lowered policy rate by 400 bps since August 2011 to 8.5 percent.
  - Consumer credit (notably auto loans) picked up strongly in 2010; maturities extended and credit quality deteriorated for that vintage.
  - Macroprudential measures introduced end-2010 to constrain sectoral excesses.
- Labor, consumption, and investment:
  - Consumption recovered since Q3 2011, growing at an annual rate of 4 percent.
  - Tight labor market; a 14 percent minimum wage increase contributed to disposable income gains.
  - Investment remained weak and contracted in recent quarters.
- Inflation and expectations:
  - Headline inflation peaked at 7.3 percent y/y in September 2011 and dropped to 5 percent y/y in May.
  - Wholesale price inflation at 3.7 percent y/y in April has picked up in recent months.
  - Medium-term inflation expectations have worsened; swap curve anchored at 2‒3 year horizon; break-even inflation from inflation-linked bonds shows only a small drift upward at longer horizons.
- Financial stability:
  - Overall NPLs at 3.8 percent of loans; public banks NPLs at 2 percent of loans.
  - A small bank accounting for 0.2 percent of system assets had management replaced after irregularities; market reaction contained.
  - System remains highly capitalized with low liquidity risks.

### External sector and capital flows
- Current account and trade:
  - External current account broadly unchanged in 2011; trade balance improved modestly as export volume deceleration was more than offset by terms of trade gains and slowing imports.
  - Jan–April 2012: trade surplus moderated due to lower external demand, declining iron ore prices, and regional trade disturbances.
- Capital flows:
  - Q1 2012: capital flows and resident borrowing averaged US$8 billion per month, compared to US$4½ billion in the last quarter of 2011.
  - Q2 2012: flows weakened; portfolio investments moribund and some reductions in equity investments; outflows of short-term financing observed.
  - FDI inflows remained buoyant and continue to largely fund the current account.
- Exchange rate and reserves:
  - The real depreciated almost 8½ percent this year (25 percent compared to July 2011 levels).
  - International reserves: US$370 billion (compared with US$200 billion in mid-2008).
  - Equity markets declined recently and external spreads have risen somewhat; local bond market held up due to expectations of lower interest rates and strong domestic investor base.

### Outlook and projections
- Short-run staff baseline:
  - After 2.7 percent in 2011, output expected to expand by over 4 percent q4/q4 in 2012 (but weak carryover keeps full year growth to 2½ percent).
  - Output gap expected to close by late 2013.
  - Economy projected to grow at about 4½ percent in the year (late 2013) and close to 4 percent thereafter.
  - Substantial monetary easing expected to feed through by second semester 2012; transmission somewhat slower due to rising NPLs.
- Inflation outlook:
  - Inflation projected to hover just above the target mid-point through 2013 assuming future policy tightening.
  - Factors reducing inflation by end-2012: tax cuts on consumer durables, slowing economy, absence of supply shocks or large corrections in administered prices.
  - Upward pressures likely in 2013 from recovering economy and pass-through of exchange rate depreciation.
  - Staff analysis (Annex II): if current policy settings are maintained through 2013, odds are that inflation will remain well above the target mid-point.

### Risks and policy implications
- Risk assessment (broadly balanced):
  - Prominent downside risk: intensifying crisis in Europe leading to tighter external financing conditions and lower commodity prices.
  - Other downside scenarios: hard-landing in China/Europe; disorderly unwinding of the credit boom and real estate price collapse.
  - Upside risks: increased lending from public banks accelerating credit and demand into 2013; greater pass-through from exchange rate depreciation raising inflation risks.
- Policy guidance:
  - Allow sufficient time for current policy easing to play out while standing ready to take further action should downside risks materialize.
  - Use exchange rate and international reserves as first shock absorbers for external shocks.
  - Unwind monetary and fiscal policy stimulus, including public credit, when appropriate.
  - If shocks intensify: larger-than-expected policy easing and liquidity provision, including intervention in FX market and support for individual banks; maintain flexible exchange rate; room for further monetary and fiscal stimulus to smooth shocks.

### Medium-term outlook and fiscal projections
- Potential output growth envisaged at about 4 percent.
- External current account deficit at the current real exchange rate projected to widen by over 1 percent of GDP in the medium term.
- Fiscal framework:
  - Primary balance objective: 3.1 percent of GDP (full unadjusted primary fiscal surplus target).
  - With this objective maintained, gross public debt levels expected to fall by almost 10 percent of GDP in the medium term — reaching 55 percent of GDP by 2017 (from 65 percent of GDP in 2011).
- Public investment challenge: boost public investment while financing it out of fiscal saving.

### Near-term policy settings and recent moves
- Authorities’ strategy: commitment to the full unadjusted 3.1 percent of GDP primary fiscal surplus target, allowing monetary policy to be the main countercyclical tool.
- Monetary easing:
  - Policy rate was about 12½ percent before easing.
  - Interest rates lowered significantly and reported at 8½ percent.
  - Central bank signaled that low rates will be maintained for some time; swap curve flattened through end-2012.
- Fiscal measures:
  - 2012 budget targets a primary balance of 3.1 percent of GDP.
  - Treasury transfers to BNDES of about 1¼ percent of GDP in 2012 (unchanged from last year).
  - Continued spending restraint and a structural fiscal withdrawal of about 1 percent of GDP in 2012 (both with and without BNDES lending).
  - Fiscal settings assumed broadly neutral in 2013 and beyond, maintaining a 3.1 percent of GDP primary surplus in the medium term.
- Alternative under fiscal rule:
  - Target could be lowered to allow higher investment; in some scenarios this year the primary surplus target could fall to 2.6 percent of GDP.

### Fiscal risks, timing, and implementation issues
- Timing of normalization:
  - Staff view: monetary settings are now more than sufficiently supportive; key issue is timing start of normalization to support convergence of inflation back to target through 2013‒14.
  - Staff recommendation: stand ready to unwind some monetary stimulus through 2013 and before the end of the year if needed.
- Fiscal implementation risks:
  - Minimum wage increase estimated fiscal cost: ½ percent of GDP in 2012.
  - Moderation in tax revenues, particularly corporate taxes, could strain budget execution.
  - Brazil has a highly rigid spending structure with over 80 percent of spending pre-committed.
  - Keeping fiscal program on track may require extraordinary revenues or other one-offs; authorities note one-off revenues have been quite stable and reflect investment income from public sector corporations and asset management.
- Buffers:
  - International reserves: US$370 billion.
  - Liquidity buffers at commercial banks: some 10 percent of GDP.
  - Corporate external leverage remains low despite increased issuance in the last year.

### Financial sector, credit growth, and macroprudential policy
- Credit-to-GDP:
  - Rose from 26 percent in 2004 to 49 percent in 2011.
  - Credit-to-GDP in Brazil stands at about 50 percent of GDP (about 25 percent in 2002).
  - Credit gap has started to shrink.
- Household sector risks:
  - Consumer credit represents 46 percent of total credit (compared to 43 percent in 2005 and 23 percent in 2002).
  - Consumer credit annual growth: 20.7 percent in 2011 versus 22.4 percent in 2010.
  - Consumer indebtedness exceeds 40 percent of disposable income; consumer debt service ratio at 23 percent of disposable income.
  - Interest rates on unsubsidized consumer loans average around 50 percent (range: 30 percent for loans on durables to 175 percent for overdrafts).
  - Housing credit rates range between 4−12 percent; mortgages are about 20 percent of the consumer portfolio (vs. >60 percent in regional peers).
  - By early 2012, non-performing loans to loan ratio for unearmarked consumer credit reached 7.6 percent (up by 1.9 since December 2010).
- Public banks and BNDES:
  - BNDES balance sheet grew from 7½ percent of GDP in 2007 to 14 percent of GDP in 2011.
  - Staff suggestion: conduct strategic review of BNDES role and size; consider gradual disengagement from commercial activities and focus on developing market for long-term finance and co-financing infrastructure projects.
  - Authorities’ position: BNDES will remain a key factor in development strategy.
- Macroprudential measures:
  - Targeted MaPs introduced in late 2010 in auto, credit card, and personal loans; features included raising capital requirements for longer duration lending.
  - Authorities considering advancing implementation of the counter-cyclical capital charge under Basel III; Brazil already implements a risk based provisioning framework which mimics a counter-cyclical capital regime.
  - Staff recommendation: introduce more broad-based measures to manage credit-cycle related stability risks.

### FSAP findings and supervisory framework
- FSAP conclusions:
  - Financial sector regulation and supervision are strong; risk-based supervisory process robust and high compliance with the Basel Core Principles.
  - Insurance and capital markets supervision more risk-based; compliance with international standards improved.
  - Planned early implementation of elements of Basel III.
- System metrics and resilience:
  - Financial assets doubled to 180 percent of GDP over the past decade; more than half held by depository institutions.
  - Profitability consistently high; solvency ratios strong; exposure to cross-border and FX risk limited; liquidity ratios favorable.
- Remaining challenges and FSAP recommendations:
  - Establish multipartite high-level committee for financial stability and crisis coordination.
  - Issue regulation on credit bureaus; publish national housing price index based on purchases.
  - Improve operational procedures for emergency liquidity assistance (ELA); remove legal impediments and strengthen purchase-and-assumption and bridge bank statutes.
  - Enhance operational autonomy and legal protection of insurance and pension supervisors; implement required regulation for consolidated supervision.

### Rebalancing, savings, investment, and external stability
- Saving and investment:
  - Brazil has a relatively low rate of saving and investment compared with peers; household saving modest in part due to a generous pension system.
  - Investment levels low relative to other G-20 emerging markets (including ex-China), reflecting structurally high real interest rates, burdensome taxation, and infrastructure gaps.
  - Consumption share of income has risen far more than in most global peers over the last decade.
- Current account and exchange rate assessment:
  - Current account deficit: 2.1 percent of GDP last year and 1¾ percent of GDP on a cyclically adjusted basis.
  - Staff assessment of current-account-consistent-with-fundamentals: about ½‒1 percent of GDP.
  - Staff considers the real exchange rate on the strong side at current levels; cumulative nominal appreciation since 2004 is some 60 percent.
  - Relative manufacturing ULC-based real exchange rate suggests a level currently about 10 percent more appreciated than relative price-based measures.
- Commodities and oil:
  - At 2005 commodity prices the current account deficit was 4½ percent of GDP in 2011.
  - Brazil expected to become a major oil producer with net oil exports projected to rise to 1 percent of GDP in the longer term (with potential to be larger).

### Box: Oil sector developments and prospects
- Current oil production: 2 million barrels per day (mbbl/d).
- Proven oil reserves: 15 billion barrels.
- Discovery (2007) of offshore “pre-sal” fields estimated to add from 50 to 100 billion barrels to Brazil’s probable and potential reserves.
- Projected boost to oil production: by almost 3 mbbl/d by 2020.
- Petrobras is already producing more than 100 thousand barrels per day from the pre-sal oilfields.
- Petrobras plans to invest more than US$220 billion over the next 5 years—almost 10 percent of GDP—to develop the fields and build onshore downstream facilities.
- Local-content requirements: currently about 50‒60 percent of total costs for pre-sal projects; set to increase to 90 percent over the medium term.
- Short-term effect: pre-sal development currently generates negative net current account flows due to high capital import needs.
- Medium-term projection: increasing oil exports projected to improve the current account balance by almost 2 percent of GDP over the next decade.
- Regulatory changes: commencement of production sharing agreements for future pre-sal fields; increase in royalties (from 5 percent to 10+ percent for certain high yielding fields).
- Government plans: invest part of oil revenues in education, science, and research to raise productivity in non-oil sectors and mitigate Dutch disease risks.

### Manufacturing performance and Annex I empirical findings
- Industrial production (IP) stagnated since late 2009 after a v-shaped recovery from the Lehman crisis.
- Import penetration in industrial sector (imports/sales) increased 34 percent between 2009 and 2011.
- In vehicles segment: import penetration rose 42 percent; export orientation rose 12 percent.
- Unit labor costs (ULCs) in manufacturing increased nearly 20 percent relative to ULCs of Brazil’s main trade partners.
  - Real average wages rose almost 11 percent; manufacturing employment expanded near 5 percent; productivity increases did not match these rises.
- Empirical regression (2006–2012) highlights (OLS / GMM-IV estimates):
  - Domestic Demand: 0.488 (0.216)** / 0.795 (0.471)*
  - External Demand: 0.923 (0.357)*** / 0.582 (0.469)
  - Lagged NEER: 0.362 (0.057)*** / 0.360 (0.076)***
  - Lagged NEER * Post-crisis dummy: -0.224 (0.072)*** / -0.233 (0.098)**
  - Lagged ULC/ULC*: -0.220 (0.061)*** / -0.258 (0.113)**
  - Adjusted R-sq: 0.89 / 0.88
- Policy implications:
  - Short-term: manage cyclical capital flow pressures to alleviate pressure on the exchange rate.
  - Medium-term: boost productivity via better infrastructure, lower shipping and electricity costs, lower tax burden, and increase supply of skilled workers.

### Neutral real interest rate (NRIR) and monetary normalization
- Historical and model-based estimates:
  - Real short-term interest rates reached 17 percent during 2002–2003 crisis; trended down to about 4−4½ percent currently.
  - CRRA model suggests NRIR in the 4–8 percent range; habit models suggest 3−6 percent range.
  - Central Bank surveys: market analysts’ estimates of NRIR down from 6¾ percent to 5½ percent (first quarter).
  - Yield curve slope approach: term premium average since 2006 ≈ 100 basis points; term premium stood at 165 basis points by end-March 2012; excess term premium 65 basis points as of end-March; real short-term interest rate 3½ percent as of end-March; proxy NRIR ≈ 4 percent.
  - State space (Kalman filter) models: NRIR around 4¾ percent, ±75 basis points.
- Staff view on normalization:
  - Achieving inflation convergence back to the target mid-range by end 2013 will likely require a pause in the rate-cutting cycle; model projects the Selic interest rate rising modestly by early 2013.
  - Alternative: policy rates held at current levels through 2013 → inflation rising above the top end of the target range by end-2013.
- Assumptions:
  - First period of model projection is Q4 2012.
  - For Q2-Q3 2012, Selic assumed held at 8½ percent.

### Budget rigidities and fiscal simulation (2012−17)
- Since 2005, real primary spending increased 7 percent on average—mostly on current spending—surpassing GDP growth.
- Mandatory spending and earmarks account for 90 percent of spending.
  - Constitutional earmarks: at least 25 percent of tax revenue allocated to education; 12 and 15 percent of states’ and municipalities’ tax revenues earmarked to health care services.
  - DRU: 20 percent of federal revenues (net of intergovernmental transfers) withheld by federal government; extended until 2015.
- Public investment at 2½ percent of GDP—less than half the average of other emerging markets.
- Simulation assumptions and findings (2012−17):
  - Primary surplus maintained at 2.2 percent of GDP (central government assumption in simulation).
  - Discretionary spending could only increase by 2.9 percent in real terms per annum (vs. 8.1 percent historical average).
  - Discretionary spending in percent of GDP would have to decline by 0.5 percentage points.
  - If discretionary spending remained constant in percent of GDP, capital spending would have to decline by 1.7 percent in real terms.
  - 60 percent of discretionary spending is related to social programs (e.g., Minha casa, Minha Vida).
- Policy options to free space for investment:
  - Rationalize mandatory spending and revenue flexibilization; introduce mechanism to de-earmark marginal tax gains stemming from nominal output growth.
  - Consider expenditure growth ceilings (example cited: 2.5 percent per year ceiling for payrolls and charges).
  - Delink pension growth from minimum wage.
  - Strengthen costing, monitoring, and evaluation of public spending; pilot evaluation programs.

### External sector assessment (models and diagnostics)
- Staff assessment:
  - Structural current account deficit of about 1 percent of GDP over the medium term.
  - Real exchange rate depreciation of about 5‒15 percent would be consistent with fundamentals and desirable policies.
  - IMF EBA and CGER approaches suggest medium-term current account deficit norms between ½ to 1½ percent of GDP.
  - Estimated real exchange rate overvaluation in the 13 to 20 percent range relative to fundamentals; recent depreciation reduces estimated misalignment by about 7 percent.
- Key historical/current account numbers:
  - Current account deficit: 2.1 percent of GDP in 2011; cyclically adjusted -1.7 percent of GDP.
  - Under unchanged policies and current REER, current account deficit expected to widen further over the medium term to over 3 percent of GDP.

### Statistical issues and data quality
- Overall: quality of macroeconomic statistics improved significantly; data adequate for surveillance.
- National accounts compiled in accordance with System of National Accounts 1993; IBGE released revised national accounts for 1995‒2006 benchmarked in 2000.
- Government finance statistics: converted to GFSM 2001 classifications; migration plan for full GFSM 2001 implementation and move to IPSAS by 2013.
- Monetary and financial statistics: BCB compiles broadly in line with MFSM; STA assisting with standardized report forms and financial corporations survey.
- Balance of payments: compiled according to BPM5; BCB supplements FX registry with surveys on services; disseminates quarterly IIP and monthly BOP.
- Selected social and demographic indicators (selected exact figures):
  - Area (thousands of sq. km): 8,512
  - Total population (million) (est., 2011): 194.9
  - GDP (2011) R$4,143 billion; US$2,493 billion
  - GDP per capita (Est., 2011): US$12,778
  - Unemployment rate (average, 2011): 6.0
  - Poverty rate (in percent, 2006): 19.3
  - Gini coefficient (2009): 0.54

### Key medium-term tables and projections (selected exact figures)
- GDP at constant prices (percent): 6.1, 5.2, -0.3, 7.5, 2.7, 2.5, 4.6, 4.1 (series as in table).
- Consumer prices (IPCA, end of period): 4.5, 5.9, 4.3, 5.9, 6.5, 4.8, 5.0, 4.5.
- Gross domestic investment (percent of GDP): 18.3, 20.7, 17.8, 20.2, 20.6, 21.2, 21.7, 23.4.
- NFPS Primary balance: 3.5, 4.1, 2.2, 2.5, 3.1, 3.1, 3.2, 3.1.
- NFPS gross debt: 65.2, 63.5, 66.9, 65.2, 64.9, 64.2, 61.7, 55.0.
- Financial sector credit to the private sector (percent of GDP): 30.4, 34.6, 42.1, 48.0, 47.3, 50.9, 58.0.
- Gross official reserves (in billions US$): 180.3, 193.8, 238.5, 288.6, 352.0, 380.3, 401.1, 462.8.

### Main staff appraisals and recommendations (summary)
- Fiscal policy: welcome shift in policy mix and commitment to maintain 3.1 percent of GDP primary surplus target during 2012‒13; fiscal policy should focus on increasing saving over the medium term and bringing gross debt down through the cycle.
- Monetary policy: easing appropriate; current settings very supportive. Key issue is pace and timing of normalization to facilitate inflation convergence back to target during 2013; staff believes authorities should stand ready to unwind monetary stimulus through 2013 and before the end of this year if needed.
- External buffers and exchange rate: flexible exchange rate and central bank liquidity provision should remain first external shock absorbers.
- Rebalancing and structural reforms: need to rebalance from consumption to investment and net exports; raise saving and investment to boost competitiveness and potential growth.
- Financial sector: continue active use of macroprudential tools; monitor rapid consumer credit growth, rising real estate prices, and public bank credit expansion.

*Source: 2012 ARTICLE IV REPORT — BRAZIL, INTERNATIONAL MONETARY FUND (selected excerpts from content unit _cr12191).*

### 1.  Selected Economic and Social Indicators  _____________________________________________________  32

### 1. Selected Economic and Social Indicators

### Context and challenges
- Past decade: marked social transformation underpinned by macroeconomic stability and rising living standards supported by fiscal responsibility, inflation targeting, and a flexible exchange rate.
- Key policy and structural needs:
  - Higher investment and saving required to rebalance demand from consumption to investment and net exports.
  - Closing infrastructure gaps to boost productivity and private investment.
  - Recent pension and tax reforms noted as steps toward rebalancing.

### Cyclical state and recent performance
- Growth and activity:
  - Expected moderation in 2011 from 7½ percent in 2010 to 4 percent in 2011; actual growth slowed to 2.7 percent in 2011.
  - Activity stalled in 2011 Q3; large downward revision relative to peers.
  - Contributing factors to the slowdown include: (i) deterioration in global sentiment in H2 2011, (ii) fall-off in intra-regional trade with Argentina, (iii) tighter credit conditions in certain segments, (iv) stronger exchange rate and rising relative unit labor costs affecting industrial production.
- Monetary stance and credit:
  - Central bank lowered policy rate by 400 bps since August 2011 to 8.5 percent.
  - Credit: consumer credit (notably auto loans) picked up strongly in 2010; maturities extended and credit quality deteriorated for that vintage.
  - Macroprudential measures introduced end-2010 to constrain sectoral excesses.
- Labor and consumption:
  - Consumption recovered since Q3 2011, growing at an annual rate of 4 percent.
  - Tight labor market conditions; a 14 percent minimum wage increase contributed to disposable income gains.
- Investment:
  - Investment remained weak and contracted in recent quarters; slump in domestic demand especially investment noted.
- Inflation and expectations:
  - Headline inflation peaked at 7.3 percent y/y in September 2011 and dropped to 5 percent y/y in May.
  - Wholesale price inflation at 3.7 percent y/y in April has picked up in recent months.
  - Medium-term inflation expectations have worsened; swap curve anchored at 2‒3 year horizon; break-even inflation from inflation-linked bonds shows only a small drift upward at longer horizons.
- Financial stability and non-performing loans:
  - Overall NPLs at 3.8 percent of loans; public banks NPLs at 2 percent of loans.
  - A small bank accounting for 0.2 percent of system assets had management replaced after irregularities; market reaction contained.
  - System remains highly capitalized with low liquidity risks.

### External sector and capital flows
- Current account and trade:
  - External current account broadly unchanged in 2011; trade balance improved modestly as export volume deceleration was more than offset by terms of trade gains and slowing imports.
  - Jan–April 2012: trade surplus moderated due to lower external demand, declining iron ore prices, and regional trade disturbances.
- Capital flows:
  - Q1 2012: capital flows and resident borrowing averaged US$8 billion per month, compared to US$4½ billion in the last quarter of 2011.
  - Q2 2012: flows weakened; portfolio investments moribund and some reductions in equity investments; outflows of short-term financing observed.
  - Foreign direct investment inflows (FDI) remained buoyant and continue to largely fund the current account.
- Exchange rate and financial markets:
  - The real depreciated almost 8½ percent this year (25 percent compared to July 2011 levels).
  - Equity markets declined recently and external spreads have risen somewhat; local bond market held up due to expectations of lower interest rates and strong domestic investor base.

### Outlook and projections
- Short-run outlook (staff baseline under current policy settings):
  - Output growth: after 2.7 percent in 2011, output expected to expand by over 4 percent q4/q4 in 2012 (but weak carryover keeps full year growth to 2½ percent).
  - The output gap is expected to close by late 2013.
  - Growth: economy projected to grow at about 4½ percent in the year (late 2013) and close to 4 percent thereafter.
  - Monetary transmission: substantial monetary easing expected to feed through by second semester 2012, though transmission is somewhat slower due to rising NPLs.
- Inflation outlook:
  - Inflation projected to hover just above the target mid-point through 2013 assuming future policy tightening.
  - Factors reducing inflation by end-2012: tax cuts on consumer durables, slowing economy, absence of supply shocks or large corrections in administered prices.
  - Upward pressures likely in 2013 from recovering economy and pass-through of exchange rate depreciation.
  - Staff analysis (Annex II) suggests that if current policy settings are maintained through 2013, odds are that inflation will remain well above the target mid-point.

### Risks and policy implications
- Risk assessment (broadly balanced):
  - Prominent downside risk: intensifying crisis in Europe leading to tighter external financing conditions and lower commodity prices.
  - Other downside scenarios: hard-landing in China/Europe; disorderly unwinding of the credit boom and real estate price collapse.
  - Upside risks: increased lending from public banks accelerating credit and demand into 2013; greater pass-through from exchange rate depreciation raising inflation risks.
- Policy guidance and contingency actions highlighted:
  - Allow sufficient time for current policy easing to play out while standing ready to take further action should downside risks materialize.
  - Use exchange rate and international reserves as first shock absorbers for external shocks.
  - Unwind monetary and fiscal policy stimulus, including public credit, when appropriate.
  - If shocks intensify: larger-than-expected policy easing and liquidity provision, including intervention in FX market and support for individual banks; flexible exchange rate to absorb shock; room for further monetary and fiscal stimulus to smooth shocks.

*Source: 2012 ARTICLE IV REPORT BRAZIL, INTERNATIONAL MONETARY FUND.*

### 14.      Global and intra-regional spillovers have important effects on financial conditions and

### 14.      Global and intra-regional spillovers have important effects on financial conditions and growth in Brazil, while outward spillovers to near-neighbors can also be large

### Spillovers and transmission channels
- Global spillovers to Brazil operate primarily through:
  - Commodity prices, amplified by the increasing share of Brazil’s exports accounted for by primary products, including items sensitive to the global business cycle (e.g., iron ore).
  - Capital flows and asset prices, reflecting Brazil’s role as a net capital importer and an emerging economy with relatively deep financial markets.
- Brazil’s vulnerability relative to other G-20 emerging economies:
  - Exposure to foreign banks is close to peers; local funding structures of foreign subsidiaries mitigate risks from foreign deleveraging.
  - Liability structure is more equity-based, facilitating more risk-sharing.
- Intra-regional effects:
  - Disruptions to trade flows (including auto exports to Argentina) have had meaningful effects on domestic activity.
  - Brazil’s spillovers can have large effects on the output of nearest neighbors, both directly and by amplifying global financial shocks.

### Medium-term outlook and fiscal projections
- Staff medium-term baseline:
  - Potential output growth envisaged at about 4 percent.
  - External current account deficit at the current real exchange rate projected to widen by over 1 percent of GDP in the medium term.
- Fiscal framework and debt dynamics under the maintained objective:
  - Primary balance objective: 3.1 percent of GDP (full unadjusted primary fiscal surplus target).
  - With this objective maintained, gross public debt levels are expected to fall by almost 10 percent of GDP in the medium term — reaching 55 percent of GDP by 2017 (from 65 percent of GDP in 2011).
- Public investment challenge:
  - Boosting public investment while financing it out of fiscal saving is identified as a key policy challenge.

### Near-term policy settings and recent policy moves
- Authorities’ strategy:
  - Commitment to the full unadjusted 3.1 percent of GDP primary fiscal surplus target, allowing monetary policy to be the main countercyclical tool.
- Monetary policy easing:
  - Policy rate was about 12½ percent before easing.
  - Interest rates have been lowered significantly and are reported at 8½ percent.
  - Central bank signaled that low rates will be maintained for some time; swap curve has flattened through end-2012.
- Fiscal policy stance and measures:
  - 2012 budget targets a primary balance of 3.1 percent of GDP.
  - Government announced treasury transfers to BNDES of about 1¼ percent of GDP in 2012 (unchanged from last year).
  - Combined implications imply continued spending restraint and a structural fiscal withdrawal of about 1 percent of GDP in 2012 (both with and without BNDES lending).
  - Fiscal settings assumed broadly neutral in 2013 and beyond, maintaining a 3.1 percent of GDP primary surplus in the medium term.
- Alternative under fiscal rule:
  - Target could be lowered to allow higher investment; in some scenarios this year the primary surplus target could fall to 2.6 percent of GDP.

### Risks, timing of normalization, and fiscal implementation issues
- Timing of unwinding stimulus:
  - Staff view: monetary settings are now more than sufficiently supportive; key issue is timing the start of normalization to support convergence of inflation back to target through 2013‒14.
  - Staff recommendation: stand ready to unwind some monetary stimulus through 2013 and before the end of the year if needed to keep inflation on target during 2013‒14.
  - Acknowledged uncertainty over the level of the neutral policy rate.
- Fiscal implementation risks:
  - Spending pressures from the large minimum wage increase with an estimated fiscal cost of ½ percent of GDP in 2012.
  - Moderation in tax revenues, particularly corporate taxes, could strain budget execution.
  - Brazil has a highly rigid spending structure with over 80 percent of spending pre-committed, complicating finding spending cuts to meet the fiscal target.
  - Keeping the fiscal program on track may require increased resort to extraordinary revenues or other one-offs; authorities note one-off revenues have in practice been quite stable and reflect investment income from public sector corporations and asset management.
- Consensus on resilience to downside risks:
  - International reserves: US$370 billion (compared with US$200 billion in mid-2008).
  - Liquidity buffers at commercial banks: some 10 percent of GDP.
  - Corporate external leverage remains low despite increased issuance in the last year.
  - Growth weaker: running now at an annual rate of about 1 percent compared to 4½ percent in early 2008.
  - Public sector bank balance sheets have expanded substantially since 2008, which could constrain capacity to act as counter-cyclical tools, though authorities view public banks as prudently managed with sufficient depth to step in if needed.

### Shock preparedness and recommended policy toolkit
- Agreed primary tools for responding to shocks:
  - Flexible exchange rate and liquidity provision would be the first policy tools deployed in the event of shocks.
  - Past experience (2008–09) has created ready-to-activate f/x and local currency liquidity facilities to address sectoral strains, including trade finance.
  - Monetary policy could respond aggressively to a shock similar in magnitude to 2008 with recent removal of the implicit floor on the policy rate.
  - Staff view there is sufficient space for fiscal policy easing should an external shock cause a large adverse output impact.
- Staff caution:
  - Against excess efforts to stimulate demand before an external shock materializes, including use of an overly wide range of instruments and ad hoc fiscal incentives that could increase distortions and undermine the business environment and investment.
  - Authorities reaffirm intent to rely on monetary policy as the main counter-cyclical tool in the event of downside risks.

### Rebalancing, savings, investment, and external stability
- Saving and investment profile:
  - Brazil has a relatively low rate of saving and investment compared with peers; household saving is especially modest (in part due to a generous pension system).
  - Investment levels low relative to other G-20 emerging markets (including ex-China), reflecting structurally high real interest rates, burdensome taxation, and infrastructure gaps.
  - Public sector savings and investment are constrained relative to global peers.
  - Consumption share of income has risen far more than in most global peers over the last decade.
- Current account and exchange rate assessment:
  - Current account deficit: 2.1 percent of GDP last year and 1¾ percent of GDP on a cyclically adjusted basis.
  - Staff’s assessment of a current account consistent with fundamentals and desirable policies: about ½‒1 percent of GDP (i.e., deficit larger than this range, largely reflecting shortfalls in private savings).
  - The staff considers the real exchange rate on the strong side at current levels; cumulative nominal appreciation since 2004 is some 60 percent.
  - Equilibrium and alternative measures:
    - Relative manufacturing unit labor cost (ULC)-based real exchange rate suggests a level currently about 10 percent more appreciated than relative price-based measures.
  - Staff analysis links rising relative ULCs and post-Lehman nominal appreciation to dented industrial production in recent years.
- Commodities and oil outlook:
  - Booming commodity prices have helped contain the current account deficit.
  - Resource-related uncertainty noted: at 2005 commodity prices the current account deficit was 4½ percent of GDP in 2011; Brazil is expected to become a major oil producer with net oil exports projected to rise to 1 percent of GDP in the longer term (with potential to be larger).

*Source: IMF 2012 Article IV Consultation (selected excerpts).*

### Box 1. Brazil: Oil Sector Developments and Prospects

### Box 1. Brazil: Oil Sector Developments and Prospects

### Overview: current position and outlook
- Current oil production: 2 million barrels per day (mbbl/d).
- Proven oil reserves: 15 billion barrels.
- Discovery (2007) of offshore “pre-sal” fields estimated to add from 50 to 100 billion barrels to Brazil’s probable and potential reserves.
- Projected boost to oil production: by almost 3 mbbl/d by 2020, which would make Brazil one of the top-five oil economies in the world.
- Petrobras is already producing more than 100 thousand barrels per day from the pre-sal oilfields.

### Technological, capacity, and investment challenges
- Pre-sal development complexity:
  - Fields lie up to 300km offshore beneath up to 5 km of salt and rock.
  - Requires cutting edge technologies for drilling, extracting, and transporting oil and gas.
- Investment plans and scale:
  - Petrobras plans to invest more than US$220 billion over the next 5 years—almost 10 percent of GDP—to develop the fields and build onshore downstream facilities.
- Local-content requirements:
  - Currently about 50‒60 percent of total costs for pre-sal projects.
  - Set to increase to 90 percent over the medium term as a local industry adapts.
  - High local-content requirements may create near-term production bottlenecks given ambitious production targets.

### External balance and macroeconomic implications
- Short-term effect: development of pre-sal fields currently generates negative net current account flows reflecting high capital import needs.
- Medium-term projection: increasing oil exports are projected to improve the current account balance by almost 2 percent of GDP over the next decade.
- Large petroleum reserves present opportunities to:
  - Increase the country’s low savings rate.
  - Develop domestic value-added industry and services to support the oil sector.
  - Address infrastructure and social needs.

### Regulatory changes, revenue sharing, and fiscal use
- Recent regulatory changes:
  - Commencement of production sharing agreements for future pre-sal fields.
  - Increase in royalties (from 5 percent to 10+ percent for certain high yielding fields).
- Revenue distribution:
  - Exact distribution of oil revenues among federal government, states, and municipalities is still under review.
- Government plans for prudent use of oil receipts:
  - Invest part of oil revenues in education, science, and research to raise productivity in non-oil sectors and mitigate potential Dutch disease type effects on competitiveness.

*Sources: Brazilian National Petroleum Agency, British Petroleum, Petrobras, U.S. Energy Inf. Admin., and staff estimates.*

### 35.      Staff highlighted that rapid trend credit growth bore close monitoring, while noting

### _cr12191 - 35.      Staff highlighted that rapid trend credit growth bore close monitoring, while noting

### Financial stability and credit growth
- Credit-to-GDP ratio:
  - Rose from 26 percent in 2004 to 49 percent in 2011.
- Staff assessment:
  - Rapid trend credit growth of this duration and magnitude has been associated with risks to stability in cross-country studies.
  - A significant portion of the increase likely reflects financial deepening: gains in income and inclusion post-2003 have given new borrowers access to finance; legal reforms have strengthened creditor rights.
  - Overall level of financial development remains low by international standards, which lowers stability risks.
  - The credit gap has started to shrink (the credit gap is the difference between the current level of aggregate credit and its trend value).
- System buffers and resilience:
  - Large buffers in the system remain a major mitigant of systemic risk.
  - Banks have strong buffers and stress tests suggest most would manage even extreme shocks.
  - Liquidity shocks are manageable overall, though small and medium sized banks remain a concern.

### Household credit risk and housing
- Household leverage and debt service:
  - Household leverage, while still low by international standards, has risen rapidly.
  - Debt service costs are high.
  - NPLs started to increase in early 2011 despite strong employment and economic conditions.
  - Authorities view consumer NPL ratio could be expected to fall in the second half of this year, reflecting digestion of weaker credits extended during the post-Lehman bounce-back in the second part of 2010.
- Data and supervisory measures:
  - Authorities began a process to substantially strengthen collection of highly granular micro-level data on household credit risk to support supervision and improve the credit bureau framework.
  - A “positive” credit bureau has been established (previously credit bureaus only contained information on borrowers behind on some debt payment; positive bureaus will have information on credit profiles of all participating borrowers).
- Housing sector specifics:
  - House prices in prime urban areas have more than doubled over the last 4‒5 years.
  - Housing credit rose from about 2 percent of GDP in 2006 to 4 percent of GDP last year.
  - Much new lending is from the public housing bank, with emphasis on low-income borrowers.
  - Staff urged strengthening data on the housing sector, including on price statistics.

### Role of public banks and macroprudential policies
- Public banks:
  - Private bank credit has moderated in the current cycle, while public banks have stepped in to maintain overall high lending growth.
  - Risk of public credit becoming procyclical as the economy recovers and private credit could rebound.
  - Authorities noted public banks are supervised and regulated in the same manner as private banks and are subject to the same prudential and capital requirements.
- Macroprudential measures (MaPs):
  - MaPs have been used to contain financial stability risks in certain market segments.
  - Targeted MaPs introduced in late 2010 in auto, credit card, and personal loans; features included raising capital requirements for longer duration lending.
  - Authorities view MaPs as aimed at stability considerations and complementary to monetary policy (leaving cyclical management to monetary policy).
  - Authorities are considering advancing implementation of the counter-cyclical capital charge under the Basel III agenda; critical details (calibration, differentiating by type/size of intermediaries) remain open.
  - Brazil already implements a risk based provisioning framework which in many ways mimics a counter-cyclical capital regime.
- Recommendation from staff:
  - Introduce more broad-based measures to manage credit-cycle related stability risks.

### BNDES and public development banking
- BNDES balance sheet:
  - Grew from 7½ percent of GDP in 2007 to 14 percent of GDP in 2011.
  - Growth reflected counter-cyclical lending to avoid a credit crunch during the crisis.
- Staff suggestion:
  - Conduct a strategic review of the role and size of BNDES.
  - Consider gradual disengagement from commercial activities (including large lending to prime corporates with access to other financing).
  - Focus BNDES on developing a market for long-term finance and co-financing infrastructure projects with the private sector.
- Authorities’ position:
  - BNDES will remain a key factor in development strategy.
  - Plans to leverage BNDES expertise in capital market development while expanding role in funding long-term infrastructure and energy investments.

### FSAP findings and recommendations (achievements and challenges)
- System-wide developments:
  - Financial assets doubled to 180 percent of GDP over the past decade; more than half are held by depository institutions.
  - Profitability has been consistently high; solvency ratios are strong; exposure to cross-border and foreign exchange risk is limited; liquidity ratios are favorable.
- Remaining challenges and key FSAP recommendations (summary):
  - Financial stability: establish multipartite high-level committee for financial stability and crisis coordination; issue regulation on credit bureaus; publish a national housing price index based on purchases.
  - Safety nets and crisis management: improve operational procedures for emergency liquidity assistance (ELA); remove legal impediments and strengthen purchase-and-assumption and bridge bank statutes; extend legal protection to supervisory agencies and related officials; reinforce procedures for use of deposit insurance fund (FGC), cap FGC funding beyond least cost assistance at 50 percent of FGC’s cash resources, and secure adequate funding for systemic crises.
  - Capital markets: extend tax incentives on infrastructure bonds to infrastructure funds; refocus BNDES operations toward facilitating long-term financing and disengaging from low-risk commercial activities; issue stricter market-making rules to strengthen secondary market trading.
  - Insurance and pensions: enhance operational autonomy and legal protection of insurance and pension supervisors; implement required regulation for consolidated supervision.

### Staff appraisal: macroeconomic and policy guidance
- Fiscal policy:
  - Welcome shift in policy mix and commitment to maintain the 3.1 percent of GDP primary surplus target during 2012‒13.
  - Fiscal policy should focus on increasing saving over the medium term and bringing gross debt down through the cycle.
  - Delivery of the full unadjusted fiscal target in 2011 sent an important signal of commitment.
  - Meeting the full unadjusted primary surplus target of 3.1 percent of GDP in 2012‒13 is important to contain external current account risks.
- Monetary policy:
  - Monetary policy has been appropriately eased; current settings are very supportive.
  - Under the staff’s baseline, policy rates around current levels are sufficient to support a robust cyclical recovery starting in the second half of 2012.
  - Key issue: pace and timing of normalization to facilitate inflation convergence back to target during 2013; staff believes authorities should stand ready to unwind monetary stimulus through 2013 and before the end of this year if needed.
  - Staff recognizes real interest rates may stabilize at a somewhat lower level than in past cycles.
- External buffers and exchange rate:
  - Flexible exchange rate and central bank liquidity provision should remain first external shock absorbers.
  - Authorities have built sizable buffers in international reserves and liquid resources of banks.
  - Some room to ease fiscal policy if a severe demand shock and credit tightening similar to the Lehman experience arise; interim advice against excessive use of ad hoc fiscal incentives that are hard to reverse.
- Rebalancing and structural reforms:
  - Need to rebalance from consumption to investment and net exports to foster growth and external stability.
  - Saving rate in Brazil is below most G-20 emerging economies; investment is subdued relative to peers.
  - Raising saving and investment is critical for competitiveness, potential growth, and labor productivity.
  - Measures needed to boost investment financed out of higher domestic saving: address budget rigidities to create space for public investment; develop the longer end of the yield curve; increase average maturity of public debt; promote corporate bond market.
  - BNDES can play a major role by focusing on long-term finance and gradually disengaging from lending to prime corporates.
- Tax and pension reforms:
  - Recent reforms welcomed: improvements to tax system to help competitiveness and reduce distortions; pension reform, while having relatively small fiscal impact, is an important step to increase saving to finance investment.
  - Further reform of states’ VAT should be revenue-neutral for states and not compromise fiscal framework integrity; further simplification of complex federal tax system would reduce cost of doing business.
- Capital flow management:
  - CFMs have been useful in managing cyclical pressures; authorities used a mix of flexible exchange rate, FX intervention, macroeconomic policies, and CFMs.
  - CFMs have been applied countercyclically and eased when flows reversed.
  - As the economy rebalances and absorptive capacity increases, need for CFMs should decline.

*International Monetary Fund — 2012 Article IV Report: Brazil (selected excerpts from the referenced content unit)*

### 48.      Brazil’s financial sector regulation and supervision are strong. This was a central

### _cr12191 - 48.      Brazil’s financial sector regulation and supervision are strong. This was a central

### Supervisory framework and regulatory strengths
- Brazil’s financial sector regulation and supervision are strong; this was a central conclusion of the recent Financial Sector Assessment Program Update (FSAP).
- Banking: the risk-based supervisory process is robust and with a high degree of compliance with the Basel Core Principles.
- Insurance and capital markets supervision: has become more risk-based and compliance with international standards has improved in tandem.
- Identified challenges for the supervisory framework:
  - Coping with constraints on budget and human resources.
  - Ensuring adequate legal protection.
  - Enhancing the operational independence of insurance and pensions supervisors.

### System resilience and macro-financial linkages
- Large macro-financial linkages are contained by the strength of the system; FSAP stress tests show that the banking system in general is very well placed to deal with even severe shocks.
- Planned early implementation of elements of Basel III is a testament to the strength of the system.
- Expectation: banks should be able to generate sufficient internal capital to manage this transition.
- Risks to monitor:
  - Bank profitability: spreads could be compressed going forward, reducing returns.
  - Duration: will likely increase, raising interest rate and liquidity risks.

### Liquidity, market stress, and funding structure
- The system is well-placed to manage shocks to liquidity and market conditions.
- Liquidity and market stress tests run by the FSAP find the system well-positioned to manage strains, including tail risks such as in the Lehman episode.
- Ongoing concern: structure of funding in parts of the small and medium banking sector—authorities are closely monitoring these segments.

### Credit growth, financial deepening, and key statistics
- Credit has grown very fast in the last decade.
- Exact figures:
  - Credit-to-GDP ratio rose from 26 percent in 2004 to 49 percent in 2011.
- Contextual observations from FSAP:
  - Credit booms of this duration and magnitude have been associated with risks to stability in cross-country studies.
  - A significant portion of the increase in Brazil reflects financial deepening: gains on income and inclusion post-2003 led to new borrowers obtaining access to finance.
  - Legal reforms have substantially strengthened creditor rights.
  - Overall level of financial development remains low by international standards, which is associated with lower stability risks.

### Pressure points requiring close monitoring
- Household sector:
  - Household indebtedness has risen rapidly.
  - Aggregate debt service burden appears high relative to peers.
  - Non-performing loans have increased in early 2011 despite strong employment conditions.
- Real estate:
  - Real estate price appreciation has been very rapid, though housing credit is small in aggregate.
  - Need to address information gaps regarding housing price indicators (e.g., publishing an index based on purchases with broad geographic coverage).
- Public banks:
  - Risk profile of public banks needs close monitoring as they look set to expand credit at a sizeable rate going forward.
  - Containing public bank credit is needed for the coherence of overall steps to manage credit growth as recovery takes hold.

### Policy measures, progress, and recommendations
- Past steps to manage credit growth risks are welcome; a key issue going forward will be the design and introduction of broader based measures.
- Authorities have introduced various macroprudential measures to contain financial risks in specific sectors; they have made clear that MaPs are targeted at financial stability.
- Specific reforms and initiatives noted:
  - Progress towards implementing a positive credit bureau.
  - Improvements to the central bank’s credit information system.
  - Plans to bring forward the implementation of countercyclical capital buffers envisaged under Basel III; design and implementation issues will take further time to be worked out.

*Source: 2012 ARTICLE IV REPORT BRAZIL, INTERNATIONAL MONETARY FUND*

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

### _cr12191 - 54.      It is recommended that the next Article IV consultation takes place on the standard 12-

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

### Key Social and Demographic Indicators
- Area (thousands of sq. km): 8,512
- Agricultural land (percent of land area): 31.2
- Physician per 1000 people (2001): 2.1
- Hospital beds per 1000 people (2002): 2.7
- Access to safe water (2007): 84.3
- Total population (million) (est., 2011): 194.9
- Annual rate of growth (percent, 2008): 0.9
- Density (per sq. km.) (2010): 22.9
- Adult illiteracy rate (2007): 10.0
- Unemployment rate (average, 2011): 6.0
- Net enrollment rates, percent in: Primary education (2005): 94; Secondary education (2004): 78
- Life expectancy at birth (years): 72
- Infant mortality (per thousand live births): 24
- Poverty rate (in percent, 2006): 19.3
- Income distribution (2009) By highest 10 percent of households: 42.5; By lowest 20 percent of households: 3.3
- Gini coefficient (2009): 0.54
- GDP (2011) R$4,143 billion; US$2,493 billion
- GDP per capita (Est., 2011): US$12,778

### National Accounts and Prices (selected annual figures)
- GDP at current prices (percent change) series: 12.3, 13.9, 6.8, 16.4, 9.9, 8.1, 9.9, 9.4 (columns correspond to 2007–2017 as in table)
- GDP at constant prices (percent): 6.1, 5.2, -0.3, 7.5, 2.7, 2.5, 4.6, 4.1
- Consumption (percent): 5.9, 5.1, 4.1, 6.3, 3.6, 2.2, 4.0, 3.6
- Investment (percent): 11.4, 11.3, -11.7, 20.8, 2.5, 3.7, 5.9, 5.7
- Consumer prices (IPCA, end of period): 4.5, 5.9, 4.3, 5.9, 6.5, 4.8, 5.0, 4.5
- Gross domestic investment (percent of GDP): 18.3, 20.7, 17.8, 20.2, 20.6, 21.2, 21.7, 23.4
  - Private sector: 16.6, 18.5, 15.7, 17.9, 18.4, 18.8, 19.3, 20.7
  - Public sector: 1.7, 2.2, 2.1, 2.4, 2.2, 2.4, 2.4, 2.7
- Gross national savings (percent of GDP): 18.4, 19.0, 16.3, 18.0, 18.5, 18.6, 18.7, 20.1

### Balance of Payments and External Sector (selected figures)
- Trade balance (in billions US$): 40.0, 24.8, 25.3, 20.1, 29.8, 9.9, 8.5, -3.0
- Exports (in billions US$): 160.6, 197.9, 153.0, 201.9, 256.0, 260.0, 273.7, 338.0
- Imports (in billions US$): -120.6, -173.1, -127.7, -181.8, -226.2, -250.1, -265.2, -341.0
- Current account (in billions US$): 1.6, -28.2, -24.3, -47.3, -52.5, -63.4, -75.9, -107.2
- Capital account and financial account (in billions US$): 89.1, 29.3, 71.3, 71.3, 99.6, 109.4, 91.7, 96.7, 122.2 (as table layout)
- Foreign direct investment (net, in billions US$): 27.5, 24.6, 36.0, 36.9, 76.0, 55.6, 53.2, 62.8
- Overall balance (in billions US$): 87.5, 3.0, 46.7, 48.8, 55.7, 28.3, 20.8, 15.0
- Total external debt (percent of GDP): 14.1, 12.0, 12.2, 12.0, 12.0, 13.5, 14.4, 15.1
- Current account (in percent of GDP): 0.1, -1.7, -1.5, -2.2, -2.1, -2.6, -3.0, -3.3
- Gross official reserves (in billions US$): 180.3, 193.8, 238.5, 288.6, 352.0, 380.3, 401.1, 462.8

### Fiscal Aggregates (public sector; percent of GDP)
- Central government primary balance: 2.2, 2.8, 1.3, 1.8, 2.2, 2.2, 2.2, 2.2
- NFPS Primary balance: 3.5, 4.1, 2.2, 2.5, 3.1, 3.1, 3.2, 3.1
- NFPS Overall balance: -2.6, -1.3, -3.0, -2.7, -2.6, -1.9, -2.1, -1.9
- NFPS Overall balance (including net policy lending): -2.7, -2.3, -6.1, -5.7, -3.8, -3.1, -2.6, -1.9
- Public sector net debt: 45.1, 38.0, 41.5, 39.1, 36.4, 34.6, 32.5, 27.5
- NFPS gross debt: 65.2, 63.5, 66.9, 65.2, 64.9, 64.2, 61.7, 55.0

### Government Revenue, Expenditure, and Fiscal Structure (federal government; percent of GDP)
- Nonfinancial revenue: 23.6, 22.8, 24.4, 23.9, 23.9, 24.1, 24.2
  - Revenue administered by SRF: 15.4, 14.1, 14.1, 15.2, 15.1, 15.1, 15.3
  - PIT: 2.7, 2.5, 2.3, 2.6, 2.5, 2.5, 2.6
  - CIT: 4.7, 4.4, 4.1, 4.5, 4.4, 4.4, 4.5
  - Indirect Taxes: 7.2, 6.3, 6.7, 6.9, 7.0, 7.0, 7.0
- Total primary expenditure: 20.6, 21.0, 22.6, 22.1, 21.7, 21.9, 22.1
- Current expenditures: 19.7, 20.0, 19.9, 21.0, 20.4, 20.5, 20.5
  - Pension benefits: 6.6, 6.9, 6.8, 6.8, 7.0, 7.0, 6.9
- Primary balance (federal): 2.8, 1.3, 1.8, 2.2, 2.2, 2.2, 2.2
- Net central government debt (memorandum): 25.1, 30.0, 27.7, 25.6, 23.8, 21.9, 17.6
- Net public sector debt (memorandum): 38.0, 41.5, 39.1, 36.4, 34.6, 32.5, 27.5
- Growth Acceleration Program: 0.4, 0.6, 1.0, 1.0, 1.0, 1.0, 1.0 (percent of GDP series)

### Monetary Aggregates and Depository Corporations (selected levels and ratios)
- Net foreign assets (end of period, in billions of reais): 131.3, 195.8, 321.3, 494.1, 436.5, 506.2, 678.1
- Net international reserves (in billions of reais): 123.7, 181.0, 290.2, 450.2, 415.0, 480.4, 659.8
- Base money (end of period): 181.4, 204.2, 248.8, 205.1, 228.9, 530.5, 587.7
- Broad money (M2, end of period): 1,172.1, 1,390.3, 1,645.8, 1,942.4, 2,249.7, 2,595.3, 3,080.8
- Financial sector credit to the private sector (percent of GDP): 30.4, 34.6, 42.1, 48.0, 47.3, 50.9, 58.0
- Money multipliers and shares: Multiplier (M2/base money): 6.5, 6.8, 6.6, 9.5, 9.8, 4.9, 5.2

### Medium-Term Macroeconomic Framework (baseline projections, percent unless noted)
- GDP growth at constant prices (percent): 5.2, -0.3, 7.5, 2.7, 2.5, 4.6, 4.1, 4.1, 4.1, 4.1 (series across 2008–2017 table)
- Consumer prices (IPCA, end of period): 5.9, 4.3, 5.9, 6.5, 4.8, 5.0, 4.5, 4.5, 4.5, 4.5
- Gross domestic investment (percent of GDP): 20.7, 17.8, 20.2, 20.6, 21.2, 22.1, 22.5, 22.8, 23.4
- External current account balance (percent of GDP): -1.7, -1.5, -2.2, -2.1, -2.6, -3.0, -3.2, -3.3, -3.3, -3.3
- Consolidated non-financial public sector primary balance (percent of GDP): 4.1, 2.2, 2.5, 3.1, 3.1, 3.2, 3.1, 3.1, 3.1, 3.1
- Public sector net debt (percent of GDP): 38.0, 41.5, 39.1, 36.4, 34.6, 32.5, 30.9, 29.6, 28.4, 27.5
- NFPS gross debt (percent of GDP): 63.5, 66.9, 65.2, 64.9, 64.9, 64.2, 61.7, 59.9, 58.3, 55.0

### Debt and Financing (selected projections and scenarios)
- Public sector net debt baseline path (percent of GDP): 41.5, 39.1, 36.4, 34.6, 32.5, 30.9, 29.6, 28.4, 27.5 (2009–2017 series in Table 9)
- NFPS gross debt baseline path (percent of GDP): 66.9, 65.2, 64.9, 64.2, 61.7, 59.9, 58.3, 56.1, 55.0 (Table 10)
- Public sector debt-to-revenue ratio (percent): 122.6, 110.5, 104.0, 98.8, 92.3, 87.8, 83.8, 80.4, 77.8
- Gross financing need (in billions of US$): 244.3, 300.7, 303.5, 247.6, 231.9, 225.0, 227.0, 232.1, 237.1 (Table 9)
- Gross financing need (in billions of US$, NFPS basis): 372.4, 410.4, 441.7, 382.5, 374.0, 375.1, 385.3, 399.0, 407.8 (Table 10)
- Debt-stabilizing primary balance implied indicators provided in debt sustainability framework tables (Tables 9–11)

### External Vulnerability and Stress Tests
- Exports of GNFS (12-month percent change, US$): 30.6, 23.2, 17.1, 17.4, 23.7, -20.9, 29.2, 26.0
- Imports of GNFS (12-month percent change, US$): 25.8, 22.3, 23.0, 31.0, 39.6, -20.7, 39.8, 23.8
- Current account (in percent of GDP) historical series: 1.8, 1.6, 1.3, 0.1, -1.7, -1.5, -2.2, -2.1
- Gross reserves (in billions US$): 52.9, 53.8, 85.8, 180.3, 193.8, 238.5, 288.6, 352.0
- Gross reserves (months of prospective GNFS imports): 6.5, 5.4, 4.5, 6.8, 9.2, 8.1, 8.0, 8.9
- Ratios of reserves to short-term external debt by residual maturity and other reserve adequacy indicators reported in tables and figures
- Bound tests and scenario analyses illustrated in Figures 6–8:
  - Public debt and NFPS gross debt subject to shocks: growth shock, primary balance shock, interest-rate shock, combined shock, and real depreciation/contingent liabilities shocks (detailed percentages and trajectories shown in figures and captions)
  - External debt sustainability bound tests include B1–B5 scenarios (nominal interest, real GDP growth, non-interest current account, combined shocks, one-time 30 percent real depreciation)

### Memoranda and Other Notable Figures
- Main export products: Airplanes, metallurgical products, soybeans, automobiles, electronic products, iron ore, coffee, and oil.
- Oil price (Brent blend; US$ per barrel): 97.0, 61.8, 79.0, 104.0, 101.8, 94.2, 87.6 (series as in table)
- Nominal exchange rate (R/US$, annual average) historical series: 1.84, 2.00, 1.76, 1.66 (ellipsis thereafter in tables)
- GDP (in billions of US$) series: 1,650, 1,622, 2,143, 2,493, 2,438, 2,523, 2,696, 2,878, 3,072, 3,279 (tables)

*Source: 2012 ARTICLE IV REPORT BRAZIL, INTERNATIONAL MONETARY FUND (tables and figures cited within the source PDF).*

### Annex I. Brazil: The Post-Lehman Performance of Brazilian

### Annex I. Brazil: The Post-Lehman Performance of Brazilian

### Manufacturing output: post-Lehman stagnation
- Industrial production (IP) in Brazil stagnated since late 2009 after a v-shaped recovery from the Lehman crisis.
- Prior to the crisis the sector grew by almost 5 percent per annum on average.
- Output collapsed in Q4 2008, returned to pre-crisis level by late 2009, and then showed very weak performance despite sustained growth in demand and the services sector.
- The post-crisis recovery of Brazilian IP has been at the weaker end of emerging market peers.

### Exchange rate, import penetration, and sectoral demand
- The ratio of imports to sales in the industrial sector (imports and sales for final consumption) increased 34 percent between 2009 and 2011.
- In the vehicles segment:
  - import penetration rose 42 percent,
  - export orientation rose 12 percent.
- Post-2009 through its peak, the real exchange rate appreciated some 15 percent even as the real/US$ exchange rate fully recovered to pre-crisis levels.

### Unit labor costs and labor market dynamics in manufacturing
- Unit labor costs (ULCs) in the Brazilian manufacturing sector, measured as the ratio of the wage bill to the value-added of that sector, increased nearly 20 percent relative to ULCs of Brazil’s main trade partners.
- In absolute terms, post-Lehman shifts in Brazil’s ULCs are explained by:
  - a rise in real average wages of almost 11 percent,
  - an expansion in manufacturing employment of near 5 percent,
  - productivity increases did not match these wage and employment rises.
- In relative terms, ULC differentials exceeded inflation differentials between Brazil and its main trade partners—especially advanced economies—implying an even stronger appreciation of the real exchange rate post-Lehman.
- Monthly data since 2003 were used; each variable enters regressions as 3-month moving average growth rates (period “t” vs. “t-3”).

### Empirical model: determinants of manufacturing performance
- Basic specification (variables measured as logs of quarterly growth rates):
  - Dependent variable: growth rate of manufacturing production (volume) (IP).
  - Explanatory variables: Domestic Demand (DD, proxied by retail sales index), External Demand (ED, trade-weighted average domestic demand of Brazil’s main trade partners), NEER (nominal effective exchange rate), ULC (relative unit labor costs in manufacturing).
  - The specification separates nominal exchange rate (NEER) and a relative price variable (ULC) to assess their separate effects.
  - A nominal exchange rate interacted with a post-Lehman dummy tests threshold effects; post-crisis dummy equals one for periods after July 2010, and zero otherwise.
  - Models estimated with OLS and a GMM procedure to address potential endogeneity; errors adjusted for autocorrelation and heteroscedasticity; HAC standard errors reported.

### Regression results (2006–2012): OLS and GMM-IV estimates
- Dependent variable: Growth of manufacturing production (volume)
- OLS estimates / GMM-IV estimates (HAC standard errors in parentheses):
  - Domestic Demand: 0.488 (0.216)** / 0.795 (0.471)*
  - External Demand: 0.923 (0.357)*** / 0.582 (0.469)
  - Lagged NEER: 0.362 (0.057)*** / 0.360 (0.076)***
  - Lagged NEER * Post-crisis dummy: -0.224 (0.072)*** / -0.233 (0.098)**
  - Lagged ULC/ULC*: -0.220 (0.061)*** / -0.258 (0.113)**
  - Constant: -0.017 (0.005)*** / -0.019 (0.008)**
  - Adjusted R-sq: 0.89 / 0.88
  - S.E. of regression: 0.01 / 0.01
  - Sum squared resid: 0.01 / 0.01
  - Prob(F-statistic): 0.00 / 0.00
- Interpretation highlights:
  - External demand has the largest positive effect on IP.
  - A 1 percent increase in domestic demand is associated with a ½ percent pick-up in IP (elasticity reading).
  - Rising ULCs are negatively correlated with growth in IP, underscoring the need to raise productivity alongside wages and employment.
  - Pre-Lehman nominal exchange rate appreciation is positively correlated with manufacturing growth (commodity-driven wealth effect), but post-Lehman exchange rate appreciation (partly reflecting capital inflows) has not been associated with continued IP growth (negative interaction term).

### Policy implications and recommendations
- Short-term:
  - Managing cyclical capital flow pressures to alleviate pressure on the exchange rate can provide breathing room for the manufacturing sector.
- Medium-term / structural:
  - Strengthen competitiveness by boosting productivity through fundamental measures, including:
    - improving infrastructure,
    - reducing shipping and electricity costs,
    - lowering the tax burden,
    - increasing the supply of skilled workers to match local manufacturing needs and global market standards.
  - Sustained social and economic gains should be matched by improvements in productivity.

*Prepared by Roberto A. Perrelli (Annex I).*

### 3.1 percent of GDP. This means that the current role of fiscal policy in the model is to provide a

### _cr12191 - 3.1 percent of GDP. This means that the current role of fiscal policy in the model is to provide a

### Fiscal policy, baseline scenario, and interest rate outlook
- Current modeled fiscal role: provide a modest counter-cyclical impulse when output is below potential.
- Baseline scenario projection:
  - Achieving inflation convergence back to the target mid-range by end 2013 will likely require a pause in the rate-cutting cycle.
  - The model projects the Selic interest rate rising modestly by early 2013.
  - This outcome is consistent with inflation converging back to the 4½ percent mid-point by the end of 2013.
  - The scenario is predicated on an unchanged fiscal stance.
- Alternative scenario:
  - Policy rates held at current levels through 2013 → inflation rising above the top end of the target range by end-2013.
- Modeling assumption note:
  - The first period of the projection from the model is Q4 2012.
  - For Q2-Q3 2012, the Selic policy rate is assumed to be held at 8½ percent.

### Baseline vs. low real rates (model charts summary)
- Charts shown (staff estimates) include:
  - Output Gap (percent) 2010–2017: Baseline vs. Unchanged rates scenario.
  - Real GDP Growth (year-on-year, percent) 2010–2017.
  - Policy rate (percent) 2010–2017.
  - Inflation (year-on-year, percent) 2010–2017.

### Global spillovers to Brazil — trade channel
- Trade openness and partner diversification:
  - Trade (imports plus exports) ≈ 25 percent of Brazil’s GDP.
  - Share of exports to the euro area ≈ 20 percent (steady over last decade).
  - Share of exports to China ≈ 15 percent (rose mainly at the expense of the United States at 10 percent).
- Commodity concentration:
  - Primary commodities ≈ 45 percent of total merchandise exports (up from just over 25 percent a decade ago).
  - Minimally processed secondary goods ≈ 14 percent of merchandise exports.
  - Increased dominance of iron ore and soybean products.
- Commodity price sensitivity:
  - Spot price of a basket of Brazil’s largest commodity exports exhibits high correlation with global activity, particularly during large upswings and downswings.
  - Financial investor participation and iron ore pricing increasingly set in spot markets → commodity export prices more sensitive to growth prospects.

### Global spillovers to Brazil — capital flows and asset prices
- Capital flow reversals during global stress:
  - Reversals in net capital flows have averaged about 5 percent of GDP since 1995 (annualized terms and excluding 2008).
  - In 2008, capital flow reversal reached over 11 percent of GDP.
  - In 2008, reversal in lending flows ≈ 8 percent of GDP (much larger than average of previous global shocks).
- Composition of financing:
  - FDI is the most stable form of financing and has largely funded current account deficits since 2008.
  - Portfolio debt and equity flows typically reverse sharply during global stress episodes.
- Foreign bank claims and funding:
  - Foreign bank claims on Brazil are only slightly higher than the average for other major emerging economies.
  - Known-maturity claims: about 70 percent of total claims on Brazil with known or allocated maturity are two years and less, compared to 65 percent for average claims on other G-20 emerging market economies.
  - Foreign bank participation ≈ 20 percent of banking assets in Brazil (lower than other large Latin American countries).
  - Foreign subsidiaries are mostly funded locally, limiting direct spillover effects; indirect confidence effects remain possible but hard to quantify.
- International investment position:
  - Brazil’s net liability fell by 25 percentage points over the last decade to reach 28 percent of GDP at end-2011.
  - Decline largely explained by large reduction in external debt; equity-based liabilities now account for most of the country’s liability.
- Financial market sensitivity:
  - Portfolio flows moderated in recent quarters (reducing prospects of very large reversal), but asset prices remain susceptible to spillovers.
  - Brazil’s equity prices highly correlated to global equity index and exhibit a higher beta than emerging markets average, amplified in U.S. dollar terms by a flexible exchange rate and tendency for the real to depreciate as global risk aversion rises.
  - Equity price changes can affect domestic confidence, investment incentives, and domestic wealth.

### Sovereign CDS and empirical spillover analysis
- Sovereign CDS behavior:
  - CDS correlations remain steady and high—notably to the euro area—while betas have declined significantly.
  - Brazil’s CDS often moves in the same direction as those in the euro area, but the size of moves is substantially smaller.
- Empirical VAR results (2000–11, quarterly):
  - Seven endogenous variables: VIX, CRB commodity price index, non-U.S./China external demand (EU and remaining Asia real GDP growth), Brazil's real effective exchange rate, and Brazil's real GDP growth.
  - Direct effect of a growth shock in trading partners is relatively limited.
  - Shocks involving substantial declines in commodity prices or increases in risk aversion (broad tightening in financial conditions) have meaningful effects on Brazil’s output.

### Outward spillovers to neighbors
- Direct and amplification channels:
  - Brazil’s direct growth spillovers mainly affect Southern Cone countries (Argentina, Bolivia, Chile, Paraguay, Uruguay).
  - These countries have trade exposures to Brazil ranging from about 20 to 40 percent of total exports.
  - Brazil-specific output shocks transmit rapidly, typically during the same quarter.
  - Brazil can amplify global financial shocks, producing knock-on effects on less globally financially integrated neighbors.

### Neutral real interest rate (NRIR) in Brazil
- Historical RIR trend:
  - Real short-term interest rates (RIR) reached 17 percent during 2002–2003 currency and confidence crisis.
  - RIR have trended down, reaching about 4−4½ percent currently.
- International comparison:
  - Large emerging market economies with inflation-target regimes often have real interest rates below 2 percent—less than half of Brazil’s current level.
- Consumption-based model calibration (CRRA and habit models):
  - Brazil’s average per capita income growth since 2006: 2.7 percent per annum.
  - CRRA model (range of parameters): suggests NRIR in the 4–8 percent range.
  - Consumption model with habit persistence: suggests NRIR in the 3−6 percent range.
  - Central Bank surveys: market analysts’ estimates of NRIR have come down over the past two years from 6¾ percent to 5½ percent (survey in the first quarter).
  - Sensitivity note: If Brazil’s per capita GDP grows 1 percentage point faster than recent period, the coefficient of relative risk aversion would have to drop by 0.5 percentage points to match the NRIR in this exercise.
- Filter-based estimates:
  - Applied filters: Hodrick-Prescott, Ravn-Uhlig, Baxter-King, Christiano-Fitzgerald.
  - Filters applied to Selic deflated by markets’ expected inflation (12-month ahead) and Selic deflated by mid-point of inflation target (4½ percent).
  - Filtered RIR levels currently range between 4−6 percent (higher bound from using BCB’s inflation target).
  - Gap between current RIR levels and trend value, adding in 12-month ahead inflation expectations, ≈ 100 bps (negative gap implies monetary expansion in chart notation).

*BRAZIL 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND*

### 5.      An approach based on the evolution of the average yield curve slope also shows a

### _cr12191 - 5.      An approach based on the evolution of the average yield curve slope also shows a

### Neutral real interest rate (NRIR) — yield curve slope approach
- In well-anchored inflation targeting regimes, the slope of the yield curve reflects mostly the term premium.
- Average term premium in Brazil since 2006 has been around 100 basis points.
- Term premium stood at 165 basis points by end-March 2012.
- Excess term premium (actual term premium less its historical average) was 65 basis points as of end-March.
- Real short-term interest rate was 3½ percent as of end-March.
- Proxy NRIR (real short-term rate plus excess term premium) from this approach: about 4 percent.

### NRIR — state space (Kalman filter) models
- State space models interpret the neutral real interest as the unobservable common factor in short- and long-term rates after controlling for inflation expectations and other cyclical components.
- Using data up to end-March, these models suggest an NRIR of around 4¾ percent, with a ±75 basis points confidence interval.
- These estimates are noted as consistent with most other methods presented.

### Caveats and identification issues
- A common assumption in inferring the unobserved NRIR from observed RIR is that inflation is well-anchored; while credibility has generally been increasing in Brazil, inflation outcomes have been more mixed.
- Using yield curve data relies heavily on identification of cyclically neutral positions to anchor the average term premium computation, which is hard to demonstrate in emerging markets with limited experience under inflation targeting.
- Circularity: the term structure can be interpreted as an indication of market expectations of future monetary policy decisions.

### Budget rigidities and spending trends (Annex V)
- Since 2005, real primary spending has increased 7 percent on average—mostly on current spending—surpassing GDP growth.
- Budget rigidities in the form of revenue earmarking and mandatory allocations account for 90 percent of spending.
- Constitutional earmarks:
  - At least 25 percent of tax revenue at all levels of government allocated to education.
  - 12 and 15 percent of the states’ and municipalities’ tax revenues earmarked to health care services.
- DRU (Desvinculação das Receitas da União): an arrangement to withhold federal earmarked revenues; extended until 2015. Accordingly, 20 per cent of federal revenues (net of intergovernmental transfers) are withheld by the federal government.
- Mandatory spending guarantees funding for:
  - Revenue sharing with states and municipalities;
  - Salaries and pension for government employees;
  - Interest on and repayment of the public debt.
- Mandatory spending (federal level) accounts for ¾ of total spending.
- Public investment at 2½ percent of GDP—less than half the average of other emerging markets.
- Discretionary spending decreased ¾ percent in real terms at the federal level (part of the 2011 slowdown).

### Simulated spending path and key assumptions (2012−17 simulation)
Assumptions for simulation:
- Primary surplus maintained at current level: 2.2 percent of GDP.
- Revenue elasticity is one.
- Transfers to subnational governments as percent of revenue remain constant at the 2011 level.
- Public wages increase with nominal GDP.
- Pensions and social benefits evolve according to projected increases in the minimum wage and inflation (Law 12.382 (2011) rule applied through 2017 for the simulation).

Simulation findings:
- Discretionary spending could only increase by 2.9 percent in real terms per annum (vs. average growth rates of 8.1 percent over the last decade).
- Discretionary spending in percent of GDP would have to decline by 0.5 percentage points.
- If current discretionary spending remained constant in percent of GDP during 2012−17, capital spending would have to decline by 1.7 percent in real terms.
- 60 percent of discretionary spending is related to social programs (e.g., Minha casa, Minha Vida), leaving little room for public investment.

Table 1 (assumptions; numbers are averages over the period indicated)
- 2001-11 / 2012-17
  - Real GDP growth: 3.6 / 3.9
  - Inflation: 6.7 / 4.7
  - Minimum wage real growth: 5.4 / 4.4
  - Central government primary surplus (percent of GDP): 2.2 / 2.2
  - Revenue real growth: 7.0 / 4.3
  - Mandatory spending real growth 2/: 6.4 / 4.8
  - Discretionary spending real growth 3/: 8.1 / 2.9
  - Memo item: Increase in NFPS revenue (percent of GDP): 2.3 / 0.0

Notes:
- Mandatory spending refers to the central government and excludes transfers to subnational governments.
- Discretionary spending refers to the central government.

### Policy options to reduce rigidities and free space for investment
- Rationalization of mandatory spending and revenue flexibilization combined with more effective medium-term planning and rolling multi-year budget plans.
  - Option: introduce a mechanism to de-earmark marginal tax gains stemming from nominal output growth—i.e., stabilize earmarks at their current nominal levels.
  - Increasing the rate of the DRU is unlikely to yield much near-term relief since most DRU-de-earmarked revenues finance mandatory expenditures.
  - Once earmarking is reduced, consider introducing expenditure growth ceilings (example cited: government considering a 2.5 percent per year ceiling for increases in real terms of payrolls and charges in the federal sector).
  - Delinking pension growth from the minimum wage to reduce downward rigidities and projected rapid rise in pension outlays.
- Strengthening costing, monitoring, and evaluation of public spending to increase efficiency.
  - Option: develop “pilot evaluation programs” to assess efficiency of public expenditures and determine alignment with intended objectives in key sectors (especially health and education).

### External sector assessment (Annex VI) — overview and findings
- Staff assess that Brazil’s current account deficit is somewhat below a range of estimates for its medium-term norm and the exchange rate is somewhat above levels explained by fundamentals and appropriate policy settings.
- Further efforts to increase savings and investment would help address imbalances; options include continuing with pension reform and shifting public spending from consumption to investment.
- A macro policy mix that moderates demand and facilitates rebalancing is important; capital flow management measures (CFMs) can be used in transition to manage volatile capital flows.

Current account
- Despite large terms of trade gains, Brazil’s current account has swung into deficit over recent years.
- Imports volumes more than doubled since 2004; export volumes remained broadly flat.
- Illustration: were the terms of trade to return to their 2005 level, Brazil’s current account deficit would have reached 4½ percent of GDP in 2011 (compared with the actual 2.1 percent of GDP).
- Observed worsening largely reflects a pick-up in the investment-to-GDP ratio; saving rate has remained low.
- Policy measures to increase domestic saving: reform pension system, slow growth of public consumption, capital market reforms.
- With unchanged policies and current level of the real exchange rate, current account deficit expected to widen further over the medium term to over 3 percent of GDP.
- Oil sector uncertainty: oil balance (oil exports net of direct oil imports and imports of capital goods related to the oil sector) expected to improve by one percentage point of GDP from 2011 to 2017.
- By 2020, net oil exports projected to increase to almost 3 million barrels per day and, all else equal, would reduce the current account deficit further by an additional one percentage point of GDP.

Exchange rate and relative prices
- Real exchange rate (REER) appreciated almost 90 percent between 2004 and mid-2011, then depreciated about 12 percent through May 2012.
- As of end-May 2012, REER was about 20 percent above its 10-year average.
- Terms of trade increased about 30 percent since 2004 (with some reversal since late 2011).
- Overall capital flows averaged about 4 percent of GDP during 2009‒11, with a shift in composition from portfolio to foreign direct investment flows.
- PPP-adjusted prices in 2011 exceeded unity relative to the United States, implying similar goods are more expensive in Brazil than in the U.S.; projected divergence in price levels given expected inflation differentials and constant nominal exchange rate.

Model-based valuations
- Staff analysis suggests:
  - Structural current account deficit of about 1 percent of GDP over the medium term.
  - Real exchange rate depreciation of about 5‒15 percent would be consistent with fundamentals and desirable policy settings.
- IMF EBA (adjusted and unadjusted) and CGER approaches suggest medium-term current account deficit norms between ½ to 1½ percent of GDP.
- Estimated real exchange rate overvaluation in the 13 to 20 percent range relative to current and medium-term fundamentals.
  - Recent depreciation of the real exchange rate relative to the reference assessment period would reduce the estimated misalignment by about 7 percent.

*Source: 2012 ARTICLE IV REPORT BRAZIL, INTERNATIONAL MONETARY FUND.*

### 7.      In recent years Brazil has attracted sizable capital inflows that have helped to finance

### _cr12191 - 7.      In recent years Brazil has attracted sizable capital inflows that have helped to finance

### Capital inflows, current account, and REER
- Recent capital inflows have helped finance the current account deficit and contributed to exchange rate appreciation.
- The bulk of capital flows comprised FDI, which have more than financed the widening current account deficit.
- Net portfolio flows were more volatile: increased markedly following the global crisis, especially during 2010‒11Q1, but tapered off since then.
- Brazil offered international investors large differentials in growth prospects and interest rates amid extraordinarily easy monetary policy in advanced economies, adding appreciation pressure on the real.
- Key reported current account and REER statistics (preserve source formatting):
  - CA Norm (% GDP) -0.4  -  (-1.5)...-1.2...-1.1
  - CA Gap (% GDP) -1.3  -  (-0.2)...-2.1...-2.2
  - Exchange rate gap 2 - 1118201317
  - Change in REER relative to the reference period (%) 4/7
  - Actual CA/Y (2011)-2.1
  - Cyclically Adjusted CA/Y (2011)-1.7
  - Medium term CA/Y (2017)-3.3
- Notes on methodologies (as reported):
  - For REER, positive values indicate overvaluation. The estimated gaps are adjusted to impose a multilateral consistency.
  - The first number for CA Norm (CA regression) is reported for unchanged policies, and the number in parenthesis is for desired policies, both gaps relative to the cyclically adjusted value. The exchange rate gap (RER regression) corresponds to a difference between the actual level of RER and RER under recommended policies.
  - The macroeconomic balance (MB) approach calculates the difference between the medium term CA balance and an estimated equilibrium CA "norm" (function of fiscal balance, old-age dependency ratio, NFA, oil balance, real GDP per capita, and real GDP growth).
  - The ERER is estimated as a function of medium-term fundamentals (NFA, relative productivity differentials, the terms of trade, and trade restrictions).
  - The ES approach calculates the difference between the actual CA balance and the NFA-stabilizing CA balance; the real exchange rate adjustment is the change needed to bring the CA in line with its NFA-stabilizing level.

### Policy response to capital flow pressures
- Authorities deployed a full range of policy tools to manage large capital flow pressures.
- Since 2010, capital flow measures (CFMs) were applied to moderate flows and influence composition; these measures slowed cyclical flows but attenuated over time, requiring periodic adjustments.
- Portfolio flows moderated in 2011 in response to CFMs and global conditions, but external borrowing surged in early 2012 due to low global rates.
- CFMs adjustment: raised the duration limit on foreign borrowing to be exempt from the IOF from 2 to 5 years to provide disincentives for short-term borrowing flows.
- The CFM framework was managed in a counter-cyclical manner (tightened when pressures rose, eased when pressures diminished).

### Central bank intervention and reserve position
- Central bank intervention aimed to reduce the pace and volatility of exchange rate changes.
- With moderation of external inflows, the pace of reserve accumulation slowed since mid-2011.
- International reserves stabilized around US$370 billion.
- Reserves at these levels were assessed as more than adequate with respect to various metrics, including the IMF’s composite adequacy measure.
- Brazil considered well placed to withstand various external shocks, though further reserve accumulation could occur when managing cyclical capital flows.

### Net foreign assets (NFA) and external composition
- Brazil’s NFA position improved from -45 percent of GDP in 2003 to -20 percent of GDP in 2011.
- FDI liabilities account for more than one-third of total liabilities.
- Brazil’s NFA position and external debt levels are relatively low compared with other emerging market economies.
- Under the baseline at unchanged real exchange rates, projected widening in the current account deficit would worsen the NFA position over the medium term.
- Financing composition in that scenario is expected to remain mainly FDI, with external debt rising only slightly from 13 percent of GDP in 2011 to 15 percent of GDP by 2017.
- Longer-term note: as Brazil’s large pre-sal oil reserves come on line, added efforts to increase savings and strengthen the external NFA position would be appropriate.

### Credit boom, household indebtedness, and financial stability risks
- Credit expansion:
  - Credit to GDP in Brazil stands at about 50 percent of GDP (about 25 percent in 2002).
  - The growth of credit relative to GDP moderated in recent years, shrinking the credit-to-GDP gap that emerged in 2008−09.
  - Overall level of credit-to-GDP remains relatively low by international standards.
- Drivers: structural transformation, capital inflows, development of domestic capital markets, economic stability, better business environment, stronger labor markets, and social mobility.
- International evidence: expanding too fast can lead to vulnerabilities; Dell’Ariccia et al (2012) find about one in three booms followed by sub-par growth or a banking crisis. Duration, size, and financial deepening are key determinants of boom risk.
- Authorities’ approach:
  - FSAP notes credit risks are well contained; much credit expansion reflects financial deepening from a low base (credit-to-GDP about 20 percent in 2004).
  - Monitoring and targeted policy intervention to sectors with excessive credit growth have been preferred.
  - December 2010: tightened macroprudential measures in specific consumer lending products.
  - January 2012: central bank credit risk information system began registering additional information to better monitor credit developments and risks.
- Consumer credit specifics:
  - Consumer credit now represents 46 percent of total credit (compared to 43 percent in 2005 and 23 percent in 2002).
  - Consumer credit annual growth: 20.7 percent in 2011 versus 22.4 percent in 2010 (decelerating slightly in 2011).
  - Consumer indebtedness (as a percentage of disposable income) currently exceeds 40 percent of income.
  - Consumer debt service ratio at 23 percent of disposable income.
  - Interest rates on unsubsidized consumer loans average around 50 percent (range: 30 percent for loans on durables to 175 percent for overdrafts).
  - Housing credit rates range between 4−12 percent; mortgages are about 20 percent of the consumer portfolio (vs. >60 percent in regional peers).
- Household risk indicators and data limitations:
  - Data limitations constrain household credit risk analysis; authorities launched efforts in the relevant year to collect more detailed household credit-risk information.
  - 2008–09 Household Budget Survey shows households with debt service commitments above 20 percent of income concentrated in low and middle income percentiles.
  - Recent trends indicate deterioration for some households:
    - 2010−11: number of new individuals borrowing from banking sector increased (increase decelerated in 2011).
    - 2010: demand for credit by low-income households increased significantly (Serasa Experian).
    - Composition shifted toward more expensive products; after late-2010 macroprudential tightening, use of credit cards and overdrafts surged.
    - Delinquency increases: by early 2012, non-performing loans to loan ratio for unearmarked consumer credit reached 7.6 percent (up by 1.9 since December 2010).
    - Surge in NPLs particularly sharp for loans for durables, overdraft accounts, and credit cards.
    - Other signs of household stress: bounced checks picked up; delinquency rates by origination increased, notably for vehicle loans.

*Source: 2012 ARTICLE IV REPORT — BRAZIL (extracted content unit)._

### Section 2, of the Fund’s Articles of Agreement through November 1999, while no longer maintaining

### Section 2, of the Fund’s Articles of Agreement through November 1999, while no longer maintaining

### Exchange rate and foreign exchange regime liberalization
- In a letter dated November 11, 1999, the Brazilian authorities informed the Fund that they accepted the obligations of Article VIII, Sections 2(a), 3, and 4, effective November 30, 1999.
- Foreign exchange regulations liberalized further in recent years:
  - March 2005: foreign exchange markets were unified; requirement that residents transferring foreign exchange abroad do so through CC5 accounts (nonresident financial institutions accounts) was eliminated; export surrender requirements were simplified; limits and restrictions for the purchase and sale of foreign exchange and for international transfers in reais were eliminated for most transactions, except for:
    - (a) investments in the capital and derivatives markets; and
    - (b) investments abroad made by institutions authorized to operate by the central bank and for all funds subject to specific regulations.
  - At present, central bank prior approval is no longer required for virtually all transactions.
  - August 2006: remaining foreign currency controls at the central bank on export proceeds and import payments were abolished.
    - Surrender of foreign exchange for exports extended to the last working day of the corresponding month in the year following the date of shipment (and 360 days before shipment).
    - Exporters allowed to permanently keep up to 30 percent of their export proceeds abroad.
    - Other August 2006 measures:
      - (a) elimination of fines for delays or lack of execution of foreign exchange contracts for operations up to US$3,000;
      - (b) possibility of registering in domestic currency (at the central bank) all foreign capital held by corporations in Brazil and not yet registered or subject to other forms of registration;
      - (c) possibility of making payments in reais for duty-free store purchases.
  - September 2006: restrictions for investments in the capital and derivatives markets were eliminated.
  - April 2007: regulations on investments abroad by investment funds liberalized further, subject to prudential rules set by the Securities and Exchange Commission of Brazil.
  - March 2008: exporters were allowed to keep 100 percent of their export proceeds abroad, up from the 30 percent limit established in August 2006.
  - May 2008: banks were authorized to hold accounts offshore in reais.
  - July 2008 changes:
    - (a) firms not registered to act in foreign exchange markets allowed to make transactions of up to US$3,000 without prior authorization;
    - (b) permitting settlement in reais of foreign exchange transactions between authorized Brazilian banks and foreign banks;
    - (c) raising to US$50,000 the limit on financial and trade transactions not subject to registration requirements for nonbank financial institutions.
  - November 2008: authorized banks permitted to use accounts in entities domiciled offshore to settle real-denominated obligations with nonresident accounts.

### Article IV consultations, FSAP and resident representation
- Last Article IV consultation with Brazil concluded by the Executive Board on July 20, 2011.
- Brazil is on the 12-month cycle.
- Joint Fund/World Bank missions:
  - Visited Brazil in 2002 for the Financial Sector Assessment Program (FSAP), discussed by the Board in December 2002.
  - A FSAP Update mission took place in March 2012.
- Resident Representative:
  - The Fund maintains a resident representative office in Brasilia.
  - The Resident Representative is Mr. Carlos Fernandez Valdovinos, who assumed the post in July 2011.

### IMF technical assistance (TA) and capacity building
- Fiscal Affairs Department (FAD):
  - September 2001: FAD mission conducted a fiscal ROSC.
  - December 2001: mission provided TA on tax reform.
  - Follow-up missions and activities include:
    - November 2004: visit discussing scope for increasing investment in infrastructure within a framework of continued fiscal responsibility.
    - July 2008: ROSC on fiscal transparency for the state of São Paulo; seminar on performance budgeting in November 2008.
    - December 2009: mission to São Paulo to examine the state’s medium-term expenditure framework.
    - November 2010: short-term expert visited Sao Paulo to provide advice on cost accounting.
    - February 2011: long-term advisor installed to support cost accounting efforts.
    - April (year not specified): follow-up mission evaluated progress in implementing program budgeting and cost accounting systems.
    - May 2011: short-term expert followed-up on implementation of program budgeting reforms.
    - Between July 2011 and May 2012: FAD conducted several missions on public financial management, focusing on review of cost accounting systems and improvements to the budgeting system.
- Statistics Department (STA):
  - Several missions during 1998–2011 provided TA on monetary and financial statistics, quarterly national income accounts, and government finance.
  - Assisted authorities in subscription to the SDDS, improving analytical quality of monetary aggregates, and implementation of GFSM 2001.
  - Recent missions assisted the Ministry of Finance, the Banco Central do Brasil and the Instituto Brasileiro de Geografia e Estatística with compilation of government finance statistics, price indices and the new national accounts framework, emphasizing consistency across macroeconomic statistics.
- Monetary and Capital Markets Department (MCM):
  - Missions visited Brazil in 2000 to assess observance of the Code of Good Practices on Transparency in Monetary and Financial Policies and compliance with the Basel Core Principles for Effective Banking Supervision.
  - August and December 2009: missions assisted the capital markets regulator (CVM) on mutual funds development and regulation, securitization and valuation of financial securities.
  - August 2009: mission on credit risk modeling for financial oversight.
  - March 2010: mission to the National Treasury to initiate a technical cooperation project on term-structure modeling and debt management.
    - Follow up: January 2011 mission to present preliminary results.
    - Project completed in May 2011 with publication of IMF working paper WP/11/113, “On Brazil’s Term Structure: Stylized Facts and Analysis of Macroeconomic Interactions”.

### Relations with the World Bank — strategy and program highlights
- World Bank Country Partnership Strategy (CPS):
  - Approved November 1, 2011, for FY 2012–2015; builds on FY 2008–2011 Country Strategy.
  - Emphasis: knowledge generation and transfer; greater emphasis on inclusiveness and eradicating extreme poverty.
  - Expanded support targeted to the Northeast and sustainable development in the Amazon, the Cerrado, and other fragile ecosystems.
- Brazil’s demand from the WBG:
  - Focus on second-generation development problems: improvements in national policy frameworks and new implementation methods with sub-national governments and firms.
  - Federal level demand concentrated in knowledge and strategy development services (AAA and knowledge-intensive lending).
  - Sub-national governments demand integrated multi-sector development solutions combining technical and financial support.
  - Private sector seeks customized financing packages.
- CPS strategic objectives (four):
  - (i) increase the efficiency of public and private investments;
  - (ii) improve the quality and expand the provision of public services for low income households;
  - (iii) promote regional economic development through improved policies, strategic infrastructure investments, and support for the private sector in frontier areas;
  - (iv) further improve sustainable natural resource management and enhance climatic resilience while contributing to local economic development and helping to meet rising global food demand.
- Indicative financing and principles:
  - Indicative IBRD lending program in the order of US$5.8 billion for FY 12–13.
  - IFC's own-account investment program forecast at about US$1.0 billion annually in FY 12–13.
  - Principles: Flexibility, Selectivity, Innovation, Leveraging.
- IFC activity:
  - FY 11: Brazil had IFC’s largest single country new business and mobilization program in the world.
  - As of May 31st, 2012, IFC commitments in Brazil stand at $3.75 billion.

### Joint World Bank–IMF country-level work program (provisional timing and approvals)
- World Bank work program (selected items and timing):
  - Development policy lending: Minas Gerais Partnership III DPL — July 2012; Belo Horizonte Urban DPL — September 2012; Rio de Janeiro State DPL III — September 2012; BR Sergipe DPL — March 2013.
  - Investment lending: Tocantins Integrated Sustainable Regional Development — July 2012; Additional Financing - Rio de Janeiro Sustainable Rural Devev. — July 2012; Parana Multi-Sector Development Project — September 2012; Alagoas Poverty Reduction and Economic Inclusion Project — October 2012; Rio State TAL AF - PROGET — December 2012; Embrapa Verde - Agricultural GHG Emissions Reduction Project — January 2013; Rio de Janeiro Strengthening Public Sector Management TAL — February 2013; South South Cooperation for Economic Development — March 2013; Rio Grande do Norte: Regional Development and Governance — March 2013; Ceara Swap SWAp III — March 2013; Sao Paolo Transport, Climate Change and Disaster Risk Manage — March 2013; Piaui integrated green growth sustablity and inclusion — March 2013; Additional Finance to Acre Social and Economic Inclusion and Sustainable Develp. Project — March 2013; Espirito Santo Integrated Sustainable Development Project — March 2013; BR Federal DRM Project — March 2013; Brazil - Federal Transport SWAp — April 2013/May 2013 (listed across March–May 2013).
  - Analytical advisory services and country studies: numerous items scheduled FY 13 (Long Term Capital Market Development Financial Sector NLTA; Brazil FBS for the Multimodal Transport Corridor Sao Francisco; Airports Public Private Partnerships in Brazil; and others).
- IMF work program in the next 12 months (as presented):
  - Technical Assistance: Performance budgeting and cost accounting (State of Sao Paulo) — Second half of 2012 / FY 13.
  - Staff visit — November 2012 / FY 13.
  - Article IV mission — May 2013 / July 2013 (timing entries include FY 13 and July 2013).

### Relations with the Inter-American Development Bank (IDB)
- IDB New Country Strategy with Brazil approved on May 9, 2012 for the period 2012−2014; six strategic objectives:
  - (1) stimulate social and productive inclusion;
  - (2) improve the condition of the country’s infrastructure;
  - (3) promote the development of sustainable cities;
  - (4) improve the institutional capacity of public entities;
  - (5) increase the sustainable management of natural resources and climate change mitigation and adaptation actions;
  - (6) promote development through the private sector.
- 2012 program and 2011 outcomes:
  - For 2012, total loan approvals are estimated to reach US$2,185.7 million.
    - Loans with sovereign guarantee: US$1,985.7 million.
    - Operations with the private sector: US$200 million.
    - Approvals of US$11.1 million in grants for Technical Cooperation.
  - 2011: IDB approved 14 loans amounting to US$2,186 million, including 5 operations for US$67.7 million for the private sector.
    - Distribution in 2011: productivity and infrastructure (63.8%); improving living conditions in cities (34.2%).
    - 88% of the volume borrowed by Brazil in 2011 went to subnational governments (all with sovereign guarantee).
  - Major 2011 operations highlights:
    - Mario Covas Rodoanel Project — US$1,148.6 million;
    - Environmental Sanitation Programs for Guanabara Bay Area and Igarapes in Manaus — US$732 million;
    - Rehabilitation for the Furnas and Luiz Carlos Hydroelectric Power Plants — US$128.6 million;
    - Profisco Credit Facility — US$5.6 million to State of Sergipe.
- Portfolio and outstanding debt:
  - Current active portfolio: 88 loans to the public sector (US$8.0 billion) and 10 loans to the private sector (US$453.7 million).
  - Brazil’s outstanding debt with the IDB amounts to US$13.9 billion (as of April 30, 2012).
  - From the current portfolio US$6.1 billion have not been disbursed yet.
- Composition of the portfolio by strategic area (as of June 11, 2012) — selected figures preserved verbatim from table:
  - Living conditions and efficiency in cities: Number of Loans 21; Amount (US$ million) 689.0; Available (US$ million) 479.0.
  - Institutional strengthening and modernization of the state: Number of Loans 27; Amount (US$ million) 1,094.7; Available (US$ million) 812.30.
  - Poverty, equity and human capital: Number of Loans 62; Amount (US$ million) 63.0; Available (US$ million) 163.0.
  - Productivity and infrastructure: Number of Loans 34; Amount (US$ million) 3,914.0; Available (US$ million) 4,339.0.
  - Total: Number of Loans 104; Amount (US$ million) 93.0; Available (US$ million) 274.00.
  - Private: Number of Loans 98.0; Amount (US$ million) 8,453.7; Available (US$ million) 6,067.3.
- Loans Approved 2011 (summary table line):
  - Total 748.6 1,395.0 20.8 21.6 2,186.0 14
  - Sub-lines in table (as presented): Subnational gov. 748.6 1,148.6 5.8 21.6 1,924.6 6; Central gov. - 178.7 15.0 - 193.7 3; Private sector- 67.7 - - 67.7 5; Total 748.6 1,395.0 20.8 21.6 2,186.0 14.
- Note: Table entries and labels preserved as they appear in the source.

*Source: 2012 ARTICLE IV REPORT—INFORMATIONAL ANNEX BRAZIL (excerpts).*

### ANNEX IV. STATISTICAL ISSUES

### ANNEX IV. STATISTICAL ISSUES

### Overall assessment
- The quality of macroeconomic statistics has improved significantly, and the statistical information provided to the Fund is adequate for surveillance.
- A mission to prepare the data module of the ROSC took place in early 2005 and recommended adoption of the Government Finance Statistics Manual 2001 (GFSM 2001).
- Brazil subscribes to the Special Data Dissemination Standard (SDDS).

### National accounts
- In March 2007, the Brazilian Statistical Institute (IBGE) released revised national accounts for 1995‒2006, benchmarked in 2000.
- Methodological improvements introduced:
  - Use of annual sectoral surveys and of corporate income tax collection data.
  - Enhanced coverage of economic activities (e.g., formal, unobserved activities).
  - Use of direct estimates of components of aggregate demand and economic activities (private and public consumption, gross capital formation, and mobile telephone services).
  - Annual and quarterly supply and demand tables for about 300 products.
- National accounts are compiled in accordance with the System of National Accounts 1993.
- Series through 2008 (data and supporting methodological notes) are available on the internet (http://www.ibge.gov.br) and in International Financial Statistics (IFS).
- Quarterly national accounts improvements:
  - Quarterly supply and demand tables compiled from critical products.
  - Recommended further methodological improvements: compilation of regular surveys on services and construction activities to cross-check sectoral estimates based on sectoral employment and input use (e.g., cement, soil, ferrous metals).

### Prices
- Since July 1999, the official consumer price index is the Broad Consumer Price Index (IPCA) compiled by IBGE.
- IPCA coverage: households earning between one and forty times the minimum wage in 11 metropolitan areas.
- Other compilers: IBGE, Getúlio Vargas Foundation (FGV), and the University of São Paulo prepare additional consumer price indices with differing coverage.
- Wholesale price indices are compiled only by the FGV.
- Wholesale and consumer price indices are reported regularly in IFS.
- Export price data in IFS: total unit values of exports, and unit values and wholesale prices of coffee exports.
- IBGE is moving toward compiling a producer price index for release in 2010, with technical assistance from the Fund.

### Government finance statistics (GFS)
- The Ministry of Finance and the Central Bank of Brazil compile and disseminate government finance statistics using GFSM 2001 presentation.
- Reported statistics include:
  - Statement of government operations and financial balance sheet for the consolidated Central Government (National Treasury and Social Security).
  - Financing operations and financial balance sheet for General Government.
- Conversion issues:
  - Reported data were compiled by converting nationally published data (broadly following GFSM 1986) to GFSM 2001 classifications.
  - Data reflect movements of the single treasury account and are on a cash basis, except interest which incorporates accrual-based information from the Central Bank of Brazil.
  - The Gross Debt indicator disseminated by the authorities excludes government securities under the Central Bank’s outright ownership, complicating international comparisons.
- Migration plan (2009) for full GFSM 2001 implementation:
  - Introduction of a new accounting framework based on International Public Sector Accounting Standards (IPSAS).
  - Framework merges traditional budgetary approach, accrual-based accounting, and additional internal controls into a single system.
  - Expected to enable compilation of complete GFS in a systematic way by 2013.

### Monetary and financial sector statistics
- The Brazilian Central Bank (BCB) compiles and publishes monetary and financial statistics broadly in line with the Monetary and Financial Statistics Manual (MFSM).
- In April 2008, an STA mission assisted BCB to include closed pension funds (around 50 percent of the total assets of other financial corporations) in institutional coverage of monetary statistics.
- STA is assisting BCB with:
  - Introduction of standardized report forms based on accounting data.
  - Compilation of a financial corporations survey with full institutional coverage.
- Financial Soundness Indicators (FSIs):
  - BCB regularly reports quarterly FSIs to the IMF for publication.
  - Currently reports all core and 17 encouraged FSIs, with data beginning in Q1 2005.
  - Plans underway to compile remaining encouraged FSIs.

### Balance of payments and external sector statistics
- External data compiled according to the fifth edition of the Balance of Payments Manual.
- BCB is supplementing the foreign exchange system registry with surveys on transportation, insurance, and other services.
- Compilation gaps:
  - Reinvested earnings and undistributed branch profits in the current account, and reinvested earnings in the financial account could be improved because the foreign exchange registry does not capture these transactions.
- Dissemination:
  - Brazil disseminates quarterly data on the international investment position.
  - Quarterly balance of payments data are reported regularly for publication in IFS.
  - BCB publishes monthly balance of payments and the Data Template on International Reserves and Foreign Currency Liquidity with a lag of one month.
  - Brazil reports quarterly total external debt position data with a three-month lag to the World Bank’s Quarterly External Debt Statistics (QEDS) database.

### Table of Common Indicators Required for Surveillance (as of June 12, 2012) — selected entries
- Exchange Rates: Date of Latest Observation 5/31/12; Date Received 5/31/12; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of Latest Observation 5/31/12; Date Received 6/4/12; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- Reserve/Base Money: Date of Latest Observation 4/30/12; Date Received 6/4/12; Frequency M/M/M.
- Broad Money: Latest observation April 12; Date Received 6/4/12; Frequency M/M/M.
- Central Bank Balance Sheet: Latest observation April 12; Date Received 6/4/12; Frequency M/M/M.
- Consolidated Balance Sheet of the Banking System: Latest observation April 12; Date Received 6/4/12; Frequency M/M/M.
- Interest Rates: Date of Latest Observation 5/31/12; Date Received 6/4/12; Frequency D/D/D.
- Consumer Price Index: Latest observation April 11; Date Received 5/07/11; Frequency M/M/M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: Latest observation April 11; Date Received 5/27/11; Frequency M/M/M.
- GDP/GNP: Latest observation Q1 2011; Date Received 6/9/11; Frequency Q/Q/Q.
- International Investment Position: Latest observation Q1 2011; Date Received 5/25/11; Frequency Q/Q/Q.
- Note: Frequency codes — Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A); Irregular (I); Not Available (NA).

### Selected statistical data and indicators (from Table: Brazil: Basic Data, 2006-2012)
- Real GDP (annual percentage changes): 2006 4.0; 2007 6.1; 2008 5.2; 2009 -0.3; 2010 7.5; 2011 2.7; 2012 2.5 (Prel. Proj.).
- Domestic demand (contribution to growth, percent): 2006 4.6; 2007 6.9; 2008 6.5; 2009 0.0; 2010 9.6; 2011 3.4; 2012 2.7.
  - Private consumption (growth rate): 2006 5.2; 2007 6.1; 2008 5.7; 2009 4.4; 2010 6.9; 2011 4.1; 2012 3.4.
  - Public consumption (growth rate): 2006 2.6; 2007 5.1; 2008 3.2; 2009 3.1; 2010 4.2; 2011 1.9; 2012 -1.7.
  - Gross investment (growth rate): 2006 5.8; 2007 11.4; 2008 11.3; 2009 -11.7; 2010 20.8; 2011 2.5; 2012 3.7.
  - Gross fixed capital formation: 2006 9.8; 2007 13.9; 2008 13.6; 2009 -6.7; 2010 21.3; 2011 4.7; 2012 5.8.
- Foreign balance (contribution to growth, percent): 2006 -0.7; 2007 -0.8; 2008 -1.3; 2009 -0.3; 2010 -2.0; 2011 -0.6; 2012 -0.2.
  - Exports of GNFS (contribution to growth, percent): 2006 0.6; 2007 0.7; 2008 0.1; 2009 -1.0; 2010 1.2; 2011 0.5; 2012 0.4.
  - Imports of GNFS (contribution to growth, percent): 2006 1.3; 2007 1.6; 2008 1.4; 2009 -0.7; 2010 3.2; 2011 1.1; 2012 0.6.
- Prices:
  - Consumer price index (IPCA, period average): 2006 4.2; 2007 3.6; 2008 5.7; 2009 4.9; 2010 5.0; 2011 6.6; 2012 5.2.
  - Consumer price index (IPCA, end of period): 2006 3.1; 2007 4.5; 2008 5.9; 2009 4.3; 2010 5.9; 2011 6.5; 2012 4.8.
  - GDP deflator: 2006 6.1; 2007 5.9; 2008 8.3; 2009 7.2; 2010 8.2; 2011 7.0; 2012 5.6.
  - Terms of trade: 2006 5.3; 2007 2.1; 2008 3.5; 2009 -3.2; 2010 17.0; 2011 7.8; 2012 -6.8.
- Public finances (percent of GDP) — Federal government:
  - Total revenues: 2006 23.0; 2007 23.3; 2008 23.6; 2009 22.8; 2010 24.4; 2011 23.9; 2012 23.9.
  - Total expenditures: 2006 26.1; 2007 25.5; 2008 24.4; 2009 26.1; 2010 26.0; 2011 26.0; 2012 24.8.
  - Of which: interest: 2006 5.3; 2007 4.5; 2008 3.6; 2009 4.6; 2010 3.3; 2011 4.4; 2012 3.1.
  - Primary balance: 2006 2.2; 2007 2.2; 2008 2.8; 2009 1.3; 2010 1.8; 2011 2.2; 2012 2.2.
- Consolidated public sector:
  - Primary balance: 2006 3.3; 2007 3.5; 2008 4.1; 2009 2.2; 2010 2.5; 2011 3.1; 2012 3.1.
  - Overall balance: 2006 -3.5; 2007 -2.6; 2008 -1.3; 2009 -3.0; 2010 -2.7; 2011 -2.6; 2012 -1.9.
  - Public sector net debt: 2006 47.0; 2007 45.1; 2008 38.0; 2009 41.5; 2010 39.1; 2011 36.4; 2012 34.6.
- Money and credit (12-month percentage changes):
  - Base money: 2006 12.6; 2007 21.8; 2008 -17.6; 2009 11.6; 2010 131.7; 2011 10.8; 2012 7.4.
  - Broad money (M2): 2006 18.6; 2007 18.4; 2008 18.0; 2009 15.8; 2010 15.4; 2011 18.7; 2012 15.5.
  - Credit to the private sector: 2006 21.8; 2007 28.9; 2008 28.3; 2009 13.3; 2010 22.9; 2011 20.2; 2012 18.1.
- Balance of payments (billions of U.S. dollars):
  - Current account: 2006 13.6; 2007 1.6; 2008 -28.2; 2009 -24.3; 2010 -47.3; 2011 -52.5; 2012 -63.4.
  - Merchandise trade balance: 2006 46.5; 2007 40.0; 2008 24.8; 2009 25.3; 2010 20.1; 2011 29.8; 2012 9.9.
  - Exports: 2006 137.8; 2007 160.6; 2008 197.9; 2009 153.0; 2010 201.9; 2011 256.0; 2012 260.0.
  - Imports: 2006 -91.4; 2007 -120.6; 2008 -173.1; 2009 -127.7; 2010 -181.8; 2011 -226.2; 2012 -250.1.
  - Services, income, and transfers (net): 2006 -32.8; 2007 -38.5; 2008 -53.0; 2009 -49.6; 2010 -67.4; 2011 -82.3; 2012 -73.3.
  - Capital and financial account: 2006 16.3; 2007 89.1; 2008 29.3; 2009 71.3; 2010 99.6; 2011 109.4; 2012 91.7.
  - Foreign direct investment: 2006 -9.4; 2007 27.5; 2008 24.6; 2009 36.0; 2010 36.9; 2011 76.0; 2012 55.6.
  - Portfolio investment: 2006 4.3; 2007 37.9; 2008 3.5; 2009 50.5; 2010 56.4; 2011 31.2; 2012 14.4.
  - Other capital (net): 2006 21.3; 2007 23.7; 2008 1.3; 2009 -15.2; 2010 6.3; 2011 2.2; 2012 21.7.
  - Errors and omissions: 2006 0.6; 2007 -3.2; 2008 1.8; 2009 -0.3; 2010 -3.5; 2011 -1.3; 2012 0.0.
  - Change in net international reserves: 2006 -4.3; 2007 -30.6; 2008 -87.5; 2009 -3.0; 2010 -46.7; 2011 -48.8; 2012 -55.7.
- Current account (in percent of GDP): 2006 1.3; 2007 0.1; 2008 -1.7; 2009 -1.5; 2010 -2.3; 2011 -2.1; 2012 -2.3.
- Outstanding external debt (in percent of GDP): 2006 0.0; 2007 0.0; 2008 12.0; 2009 12.2; 2010 12.0; 2011 12.0; 2012 12.7.
- Total debt service ratio (in percent of exports of goods & services): 2006 51.8; 2007 51.5; 2008 28.6; 2009 40.4; 2010 29.9; 2011 26.4; 2012 21.0.
- Gross reserves/short-term external debt (residual maturity, in percent): 2006 425.1; 2007 463.6; 2008 531.4; 2009 769.7; 2010 503.6; 2011 887.5; 2012 394.6.

### IMF Executive Board assessment (summary of July 9, 2012 Article IV)
- Directors commended Brazil’s strong policy framework (fiscal responsibility, inflation targeting, flexible exchange rate) and decade of macroeconomic stability and rising living standards.
- Policy considerations and guidance:
  - Appropriately calibrate policy to changing economic conditions and increase saving and investment.
  - Meet the deficit target for the year to secure a declining path for the debt ratio and bolster fiscal credibility.
  - Monetary policy has been appropriately eased; authorities should stand ready to unwind stimulus if inflation target is at risk.
  - Exchange rate flexibility and liquidity provision are first lines of defense against adverse external shocks.
  - Capital flow management measures (CFMs) have been useful in turbulent conditions, but some Directors cautioned CFMs do not fully address underlying drivers of inflows, could affect domestic liquidity, and may adversely impact other capital flow recipients.
  - Rebalance demand from consumption to investment and net exports; further reforms to raise productivity are needed despite steps on pension and tax reforms.
  - Public investment financed by fiscal saving and further capital market deepening are important.
  - Financial sector: FSAP Update findings welcome; banking system well regulated and able to cope with shocks, but rapid consumer credit growth, rising real estate prices, and continued credit expansion by public banks warrant vigilance and careful prudential oversight.
  - Directors commended plans to bring forward implementation of elements of Basel III, continue active use of macroprudential tools, and further boost financial sector soundness.

*Source: _cr12191 - ANNEX IV. STATISTICAL ISSUES (2012 Article IV Report — Informational Annex, Brazil).*

### 1. On behalf of the Brazilian authorities, we thank staff for the useful discussions during

### _cr12191 - 1. On behalf of the Brazilian authorities, we thank staff for the useful discussions during

### Monetary and fiscal policies
- Authorities welcome the Article IV report and the Financial Sector Stability Assessment (FSSA) as providing valuable policy advice.
- Macroeconomic change since the 2011 Board discussion:
  - Output gap narrowed and 12-month inflation was running above the upper limit of the inflation target range at that time.
  - GDP growth decelerated faster than expected; inflation has fallen significantly and is approaching the mid-point of the target range (4.5 percent).
- Policy stance:
  - Since the second half of 2011 the authorities adopted a more expansionary stance.
  - Monetary easing used as the main countercyclical tool; fiscal policy somewhat tightened to make room for more ambitious reductions of the policy rate.
- Interest rate developments:
  - Since late August 2011, the Selic rate has been cut by a cumulative 400 basis points, bringing it to historic lows in both nominal and real terms.
  - Authorities aim to bring the Selic rate more in line with interest rates in the rest of the world, citing consolidation of inflation targeting, eight consecutive calendar years of inflation inside the target range, a deeper credit market and changes in financial market structure.
  - Ample international liquidity and low international interest rates assist this objective.
- Savings account rule change:
  - In May the government announced changes: saving accounts will yield 70 percent of the Selic rate whenever the latter falls below the current level of 8.5 percent.
- Fiscal outcomes and targets:
  - Consolidated public sector primary surplus target for 2012 and 2013 set at the same level as in 2011 (3.1 percent of GDP).
  - Given the cyclical position, this corresponds to a small increase in the structural primary surplus (staff estimate).
  - Overall fiscal deficit expected to decline from 2.6 percent of GDP in 2011 to below 2 percent of GDP in 2012.
  - Current primary surplus target consistent with a continuing gradual decline of the public debt-to-GDP ratio.
  - Net public debt fell in May to 35 percent of GDP, the lowest since 1998 (compared to 36.4 percent of GDP in end-2011 and 39.1 percent of GDP in end-2010).
  - Debt dynamics benefit from lower financing costs and from a more depreciated exchange rate as the consolidated public sector is a net creditor in foreign currency.

### External sector
- Current account and financing:
  - Current account deficit at 2.2 percent of GDP in 2011, relatively stable compared to the previous year.
  - Small improvement in the trade balance surplus offset by higher deficits in services and income accounts, reflecting especially an increase in profit remittances.
  - Current account deficit fully financed by foreign direct investment flows; net foreign direct investment exceeded in 2011 the current account deficit by a considerable margin.
- Exchange rate and reserves:
  - Nominal exchange rate depreciated significantly — as much as 30 percent in the last 12 months (relative to the document’s time frame).
  - Depreciation reflects external factors (decline in international commodity prices, rise in investors’ risk aversion, safe haven concerns, appreciation of the dollar) and domestic factors (lower interest rate differentials, macroprudential measures adopted in 2010 and 2011).
  - International reserves at end June reached US$ 374 billion, approximately twice as high as in the pre-Lehman period.
- Capital flow management measures (CFMs):
  - Brazil continued to rely on CFMs to cope with large and volatile capital inflows; staff view CFMs for cyclical pressures as an “appropriate part” of the policy tool-kit.
  - CFMs substantially reduced some inflows (notably portfolio inflows), contributing to contain exchange rate pressures.
  - Authorities ready to adjust CFMs to evolving circumstances:
    - In March extended from two to five years the minimum term for exemption of the IOF tax on foreign borrowing by banks and corporations.
    - In June, in light of adverse external circumstances, this minimum term returned to two years.

### Economic activity
- Growth and outlook:
  - Available data indicates only a modest recovery of output in the first half of 2012.
  - Authorities expect the economy to gather momentum in the second half of 2012 as lagged effects of the monetary easing cycle take hold.
  - Annual GDP growth expected to be low due to weak carryover from 2011.
- Labor market and consumption:
  - Labor market remained relatively strong with the unemployment rate at historic lows.
  - Favorable labor market conditions and a real adjustment of the minimum wage early in the year supported consumption, which grew 1 percent quarter-on-quarter in the last quarter of 2011 and in the first quarter of 2012, well above the pace of GDP growth.
- Manufacturing:
  - After a sharp recovery post-2008 crisis, manufacturing output has stagnated since 2010.
  - Authorities and staff attribute industrial underperformance mainly to a stronger exchange rate and increasing import competition.
- Risks and policy buffers:
  - Main risks to growth are external: intensification of the euro area crisis and/or a deceleration of world growth (especially if led by China) could reduce commodity prices, export demand, investment inflows and confidence.
  - Flexible exchange rate and high international reserves would be main shock absorbers in case of international deterioration, opening additional room for monetary easing and other countercyclical tools if needed.
- Investment and public role:
  - Brazil has a relatively low saving rate and low investment rate compared with long-term needs, though both have been on a gradual upward trend.
  - Public sector role in fostering investment emphasized given infrastructure gap, especially in urban development, transportation and energy under the Growth Acceleration Program 2 (PAC 2).
  - National Development Bank (BNDES) continues to finance investment projects, particularly given still high interest rates and lack of private long-term financing mechanisms.

### Financial stability
- FSSA and system health:
  - Authorities broadly agree with the FSSA: Brazilian financial system is highly capitalized, profitable and well regulated and supervised.
  - Banks have significant capital and liquidity buffers; stress tests indicate resilience to a variety of severe shocks.
- Credit growth and risk assessment:
  - Authorities vigilant to build-up of risks, particularly from credit expansion.
  - Rapid credit growth seen as resulting from macroeconomic stabilization and structural changes that expanded access to financial products and reduced credit and legal risks.
  - Despite recent increase, credit-to-GDP is still relatively low for emerging market standards, especially in the housing segment.
  - Staff recognized that strong bank supervision and ample capital and income positions act as risk mitigants.
  - Authorities consider emphasis on credit growth creating “pockets of vulnerability” to be somewhat exaggerated.
- Crisis prevention and resolution:
  - Crisis prevention and crisis resolution frameworks described as robust.
  - High reserve requirements held by banks at the Central Bank act as main buffer against liquidity shocks.
  - Macroprudential tools extensively used to contain financial stability risks.
  - Credit Guarantee Fund (FGC) important in the banking safety net, promoting stability and helping avoid banking crises (including financing bank acquisitions).
  - Current resolution regime effective and complies with international standards.
  - Central Bank is studying a new banking resolution bill to address some legislative gaps.

*On behalf of the Brazilian authorities, we thank staff for the useful discussions during this year’s Article IV mission and for the comprehensive work as part of the joint IMF/World Bank Financial Sector Assessment Program (FSAP).*

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