## _cr13312 ## Source details **Canonical URL:** [_cr13312](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13312.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13312.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13312.pdf.json) --- ### What explains weak investment and recent investment dynamics - Gross fixed capital formation stood about 5 percent lower than its peak 2011 level at the end of 2012. - Real GDP growth stayed below 1 percent in 2012; recovery gradual with investment weak through mid-2011–2012 and a more recent pick-up as business confidence stabilized and capacity utilization reached cyclical highs. - Economy estimated to be operating close to potential but subject to supply-side constraints that hold back near-term recovery and exacerbate inflationary pressures. ### Macroeconomic and external context (key statistics) - Inflation above the 4½ percent target mid-point for almost three years; non-tradables inflation accelerated to almost 10 percent. - Headline index reductions from large cuts in household energy tariffs and tax cuts for food staples estimated to have shaved off about ¾ percentage point. - Unemployment rate estimated below the NAIRU. - Current account deficit: 2.4 percent of GDP (2012), up from 2 percent the previous year; current account norm estimated about 1 to -2 percent of GDP. - Real effective exchange rate depreciated by 9 percent during the 12 months through April 2013; nominal effective exchange rate depreciated by about 8–10 percent since early May (2013). - Unit labor costs in U.S. dollars: almost 45 percent above pre-Lehman levels (broadly unchanged). - Net portfolio inflows: about US$1 billion per month since Q1 2012, about US$3 billion less per month than 2010–11; direct investment inflows almost 3 percent of GDP in 2012. - International reserves: US$375 billion as of end-May 2013 (US$352 billion at end-2011). - Credit growth (past 12 months): public banks 25 percent and private banks 10 percent. - Private banks’ NPLs peaked at 5.4 percent mid-2012; public banks’ NPLs remained about 2 percent. - Mortgage lending annual growth rates close to 40 percent. ### Empirical analysis of investment drivers (regression and box findings) - Investment stalled starting mid-2011 and contracted, diverging from average emerging-market pattern. - Manufacturing capacity utilization near cyclical highs despite weak output, implicating industry as major contributor to investment decline. - Quarterly variation in overall investment growth (Q4-2002 to Q4-2012, dependent variable: log change in GFCF) — regression results: - Coefficient on change in commodity prices: 0.15 (standard error 0.05) - Coefficient on VIX: -0.11 (standard error 0.11) - Coefficient on change in GDP forecasts (change in level of GDP forecasts): 2.71 (standard error 1.11) - Coefficient on change in dispersion in GDP forecasts: -13.06 (standard error 7.65) - R-squared: 0.672 - Out-of-sample RMSE: 3.00 - Model estimation notes: - Two-stage least squares with lags of domestic variables and real interest rates as instruments. - Forecasts based on 12-month ahead median GDP forecast from the weekly BCB Focus survey; dispersion is change in standard deviation. ### Interpretation: global versus domestic drivers - Global factors (falling commodity prices and tighter global financial conditions) explain much of the initial 2011 investment weakness. - Since start of 2012, domestic factors—persistent downgrades to growth forecasts and greater domestic uncertainty—have become more important. - Model predicted an investment pick-up as global environment improved, but domestic headwinds prevented the expected rebound. ### Open questions and potential underlying factors - Analysis does not provide full structural proof whether the investment decline is permanent or transitory. - Potential underlying factors identified: - Impact of domestic policy uncertainty on the investment climate (may be unwound quickly). - Steady erosion of competitiveness (only partially reversed in 2012) and apparent decline in productivity (may take more time to address). ### Policy-relevant implications and recommendations - Reduce domestic uncertainty and improve growth expectations (given strong role of forecast dispersion and growth expectations). - Restore competitiveness and address productivity weaknesses for sustained investment recovery. - Monitor external spillovers (commodity prices, global risk conditions); domestic policy credibility and clarity are critical to convert global improvement into domestic investment recovery. - Fiscal consolidation and credibility: - Anchor fiscal consolidation on Brazil’s long-standing primary surplus target (3.1 percent of GDP) to rebalance demand and support monetary policy. - Prioritize reducing policy lending and ensure transparency of quasi-fiscal operations through the budget. - Monetary policy: - Front-loaded monetary tightening recommended to lower inflation expectations and inertia; real ex-ante policy rate at about 2½ percent remains below neutral. - Public banks: - Wind down reliance on public banks for demand management and quasi-fiscal operations; recognize transfers and lending to public banks raised gross public debt and contingent fiscal risks. - Structural reforms: - Step up investment, particularly infrastructure; mobilize domestic savings (about 2–3 percentage points of GDP uplift needed) and seek high-quality foreign saving (e.g., FDI). - Address minimum wage indexation mechanism to contain unit labor costs; simplify tax system (notably ICMS) and improve business conditions (“custo Brasil”). ### Fiscal policy, policy lending, and stimulus (findings and numeric estimates) - 2012 fiscal primary surplus (excluding sovereign wealth fund proceeds): 2.1 percent of GDP. - Authorities used all budget adjustors/deductions allowed; net lending to public banks increased by 1.5 percent of GDP in 2012. - Fiscal stimulus (announced measures, end-2011 through 12-Jun-13) — total estimated fiscal cost: - 25.9 (2012), 58.9 (2013), 66.8 (2014). - Total in percent of GDP: 0.6 (2012), 1.2 (2013), 1.3 (2014). - Of which, tax stimulus: 0.4 (2012), 1.0 (2013), 1.1 (2014). - Examples: - 1-Dec-11: IPI cuts on consumer durables — 0.4. - 3-Apr-12: Payroll tax exemptions 1/1.8 — 5.2 — 5.5. - 21-May-12: IPI reduction for cars — 1.7. - 22-Jun-12: Elimination of fuels tax (CIDE-Combustíveis) — 4.7 — 11.4 — 11.4. - 11-Mar-13: Exemption of basic consumer basket from PIS/Cofins — 5.7 — 9.3. - 5-Apr-13: Extension of payroll tax cuts to 14 new sectors — 5.4. - 12-Jun-13: Credit line for home appliances for MCMV beneficiaries — n.a. ### Monetary, macroprudential, and capital flow measures - Monetary policy: - April 2013 tightening cycle: policy rate raised by 75 basis points to 8 percent (later July meeting raised by 50 bps to 8.50 percent cumulative 125 bps since April per staff statement). - Cumulative cut of 525 basis points during 2011–12 brought rate to 7¼ percent. - Real ex-ante policy rate at about 2½ percent remains below neutral. - Macroprudential and CFMs: - Macroprudential measures adopted in 2010–11 partially unwound; reserve requirements and sectoral capital requirements eased. - IOF coverage and rates adjusted many times; recent easing includes narrowing IOF coverage, zero rate on fixed income inflows, exemption for certain investment vehicles, and zero percent IOF on short FX derivative positions. - Key CFM changes since mid-2012 (selected): - 14-Jun-12: IOF tax of 6 percent applied to foreign loans, bond issuance to non-residents and secondary bond market purchases by non-residents with maturities up to 2 years. - 5-Dec-12: IOF tax of 6 percent applied with maturities up to 1 year (from 2 years). - 31-Jan-13: IOF tax of zero percent applied on inflows to real estate investment funds. - 4-Jun-13: IOF tax of zero percent applied to all bond issuance to non-residents and secondary bond market purchases by non-residents. - 12-Jun-13: IOF tax of zero percent applied to all onshore net short positions in foreign currency derivatives (from 1 percent). ### Structural policies, infrastructure, and investment outlook - Authorities undertook targeted efforts since fall 2012: boosting infrastructure, reducing high energy costs; tax reform stalled. - Programs for concessions and PPPs expected to generate about R$159 billion (3 percent of GDP) over the next 5 years. - Industrial sector energy costs declined by an average 18 percent in 2013 due to renegotiated utility contracts. - Outlook (staff baseline): - Real GDP growth projected to rise to about 2½ percent in 2013; fixed investment growing by about 7 percent in real terms. - Over medium term, potential growth projected about 3½ percent (downward revision). - Absent decisive reforms, potential growth could revert to long-term average of about 3 percent. ### Risks, scenarios, and downside pressures (selected quantifications) - Domestic risks: - Protracted weak investment, policy stance that could exacerbate imbalances, gradual erosion of fiscal framework, higher/persistent inflation, real estate correction and household credit exposure risks. - External risks: - Sudden U.S. monetary tightening or intensified European crisis; sharp falls in commodity prices (notably from a slowdown in China). - Quantified examples: - If Brazil’s investment-to-GDP ratio rose to average G-20 levels but domestic saving remained unchanged, the external current account deficit would deteriorate by about 4 percentage points of GDP. - Scaling up investment to boost potential growth likely requires a sustained rise in domestic saving of about 2–3 percentage points of GDP. - If higher foreign saving is FDI, potential growth ~3½ percent may be sustained; if financed by more volatile capital, external vulnerabilities rise. ### Public banks, corporate sector, and financial soundness - Public banks’ rapid lending growth: lending by public banks grew over 25 percent per annum in 2011–12 versus about 10 percent for private banks; public banks’ share of total credit increased to 48 percent; Caixa expanded credit portfolio by over 40 percent. - Treasury lending to BNDES and Caixa/Banco do Brasil in 2012: 1 percent of GDP to BNDES and 0.5 percent to Caixa and Banco do Brasil; total net obligations from public banks to Treasury at end-2012: 9.2 percent of GDP (8.4 percent with BNDES). - Public banks’ NPLs: about 2 percent; private banks’ NPLs peaked at 5.4 percent mid-2012. - Caixa capitalization close to minimum regulatory requirement; CAR for public banks approaching regulatory minimum of 11 percent. - Corporate sector: rising leverage 2009–11 then stabilizing; liquidity improved; corporate bond issuance picked up and has been used to restructure balance sheets and lengthen maturities rather than finance new investment. ### Potential growth, decomposition, and Box 6 projections - Supply-side decomposition implies sustainable future growth about 3½ percent (about ¾ percentage point lower than earlier staff assumptions). - Range of statistical filters: potential growth at 2–3½ percent. - Key decomposition (annualized percent change, selected periods): - GDP: 1995-99 = 2.0; 2000-04 = 3.0; 2005-09 = 3.5; 2010-14 (projected) = 3.6; 2015-19 = 3.4; 2020-30 = 3.0 - Total factor productivity: 1995-99 = 0.3; 2000-04 = -0.1; 2005-09 = 2.3; 2010-14 = 0.3; 2015-19 = 1.7; 2020-30 = 1.7 - Capital deepening: 1995-99 = 0.3; 2000-04 = -0.8; 2005-09 = -0.5; 2010-14 = 0.3; 2015-19 = 0.2; 2020-30 = 0.3 - Working age population: 1995-99 = 0.8; 2000-04 = 0.4; 2005-09 = 0.4; 2010-14 = 0.3; 2015-19 = 0.2; 2020-30 = -0.2 - Inflation projection: headline inflation projected to remain at about 5¾ percent this year and into 2014, converging gradually thereafter. - External current account: projected to increase further through 2015; medium-term external current account deficit projected to stabilize at about 3¾ percent of GDP as pre-salt oilfields come online. - Baseline policy assumptions include monetary tightening to bring real policy rate near neutral by about mid-2014 and fiscal policy consistent with a primary balance of about 2 percent of GDP in 2013 and 2014. ### Fiscal baseline—selected numeric indicators (percent of GDP) - Primary Balance: 2010 = 2.5; 2011 = 3.2; 2012 = 2.1; 2013 = 1.9; 2014 = 2.0 - Non-financial Revenue: 2010 = 35.5; 2011 = 35.1; 2012 = 35.5; 2013 = 34.8; 2014 = 34.7 - Primary Expenditure: 2010 = 33.0; 2011 = 31.9; 2012 = 33.4; 2013 = 32.9; 2014 = 32.7 - Capital Expenditure: 2010 = 4.0; 2011 = 2.4; 2012 = 2.7; 2013 = 2.4; 2014 = 2.4 - Overall Balance: 2010 = -2.7; 2011 = -2.5; 2012 = -2.8; 2013 = -2.7; 2014 = -2.9 - Memo: Real primary expenditure growth: 2010 = 12.1; 2011 = -0.8; 2012 = 5.8; 2013 = 0.9; 2014 = 2.4 ### Outlook, projections, and selected macro-fiscal statistics (2012–2018) - Staff baseline projections (selected): - Real GDP growth: 2012 = 0.9; 2013 (Proj.) = 2.5; 2018 (Proj.) = 3.5 - Consumer prices (IPCA, end of period): 2012 = 5.8; 2013 (Proj.) = 5.8; 2018 (Proj.) = 4.5 - Investment (Gross domestic investment percent of GDP): 2012 = 18.4; 2013 (Proj.) = 18.8; 2018 (Proj.) = 19.7 - NFPS primary balance (percent of GDP): 2012 = 2.0; 2013 (Proj.) = 2.2; 2018 (Proj.) = 3.1 - NFPS gross debt (percent of GDP): 2012 = 68.2; 2013 (Proj.) = 68.6; 2018 (Proj.) = 65.0 - Current account (percent of GDP): 2012 = -3.6; 2013 (Proj.) = -3.6; 2018 (Proj.) = -3.7 - Gross official reserves (end period, billions US$): 2012 = 380.7; 2013 (Proj., year-to-date as of April) = 387.4 ### External sector assessment (Annex I) — summary and policy implications - External position: moderately weaker than implied by medium-term fundamentals and desirable policy settings. - Staff estimates: - Structural current account deficit consistent with fundamentals: about 1–2 percent of GDP. - Real exchange rate depreciation of about 10–15 percent would be consistent with fundamentals and desirable policy settings. - IMF EBA/CGER ranges suggest medium-term current account norm 0.8–2.5 percent of GDP and real exchange rate overvaluation of about 9–20 percent. - Capital flows and reserves: - Post-crisis capital inflows moderated to about 4½ percent of GDP in 2012; portfolio flows share declined to about 15 percent. - International reserves stabilized around US$380 billion and considered more than adequate; central bank conducted swap auctions totaling about $20 billion in June 2013. - Policy implications: increase domestic saving (pension reform, reorient public spending to investment), maintain macro policy stance that moderates demand, and use CFMs to manage volatile flows. ### Data adequacy, statistical issues, and publication notes (as of June 28, 2013) - Macroeconomic statistics quality improved; data provision adequate for surveillance. - National accounts compiled on 1993 SNA; IPCA official CPI since July 1999. - GFS compiled using GFSM 2001 presentation; migration plan to IPSAS-based accounting expected in 2015. - BCB compiles monetary and financial statistics broadly in line with MFSM 2000; FSIs reported quarterly from Q1 2005. - Brazil subscriber to SDDS since 2001; uses SDDS flexibility options. - Table of common indicators: latest observations include Exchange Rates (5/31/13), International Reserves (5/31/13), GDP Q1 2013, Consumer Price Index May 13, etc. ### Executive Board and staff interactions (selected outcomes) - Directors commended long-standing policy frameworks and recommended: - Monetary policy to focus on containing inflationary pressures; welcome start of tightening. - Steady fiscal consolidation anchored on a primary surplus target to place public debt on a downward path. - Gradual reduction of policy lending, stronger fiscal framework, maintain sub-national fiscal discipline, and ease budget rigidities. - Continue vigilance on financial sector, implement Basel III (BCB rules effective October 1, 2013 per Box 9), and monitor household credit growth. - Pursue comprehensive supply-side reforms to boost productivity and competitiveness. *Source: INTERNATIONAL MONETARY FUND (excerpts from IMF staff report, document _cr13312).* ### 1. What Explains Weak Investment in Brazil? _______________________________________________________5 ### 1. What Explains Weak Investment in Brazil? ### Recent economic backdrop and investment outcome - Gross fixed capital formation stood about 5 percent lower than its peak 2011 level at the end of 2012. - Real GDP growth stayed below 1 percent in 2012. - Recovery has been gradual: consumption remained resilient while investment was weak through mid-2011–2012, with a more recent pick-up in investment as business confidence stabilized and capacity utilization reached cyclical highs. - Economy estimated to be operating close to potential but subject to supply-side constraints that hold back near-term recovery and exacerbate inflationary pressures. ### Macroeconomic and external context (key statistics) - Inflation has remained above the 4½ percent target mid-point for almost three years. - Non-tradables inflation accelerated to almost 10 percent. - Headline index reductions from large cuts in household energy tariffs and tax cuts for food staples are estimated to have shaved off about ¾ percentage point. - Unemployment rate estimated below the NAIRU. - Current account deficit rose to 2.4 percent of GDP, up from 2 percent the previous year. - Current account norm estimated at about 1 to -2 percent of GDP. - Real effective exchange rate depreciated by 9 percent during the 12 months through April 2013. - Unit labor costs in U.S. dollars remained broadly unchanged at almost 45 percent above pre-Lehman levels. - Since early May (2013) the nominal effective exchange rate has depreciated by about 8–10 percent. - Net portfolio inflows averaged about US$1 billion per month since the first quarter of 2012, about US$3 billion less per month than monthly flows recorded during 2010–11. - Direct investment inflows were almost 3 percent of GDP in 2012. - International reserves: US$375 billion as of end-May 2013, compared to US$352 billion at end-2011. - Credit growth over the past 12 months: public banks 25 percent and private banks 10 percent. - Private banks’ NPLs peaked at 5.4 percent mid-2012; public banks’ NPLs remained about 2 percent. - Mortgage lending annual growth rates close to 40 percent. ### Empirical analysis of investment drivers (Box 1 findings) - Investment in Brazil stalled starting mid-2011 and contracted, diverging from the average emerging-market pattern where investment continued to expand. - Manufacturing capacity utilization near cyclical highs despite weak output, suggesting industry is a major contributor to the investment decline. - Variance decompositions and regressions identify the following as the most important drivers of quarterly variation in overall investment growth in recent years: - Implied U.S. equity volatility (VIX) and commodity prices as key external spillover channels. - Domestic expectations for output growth and investor uncertainty (dispersion of market forecasts) as key domestic drivers. - Regression results (Q4-2002 to Q4-2012), dependent variable: log change in GFCF: - Coefficient on change in commodity prices: 0.15 (standard error 0.05) - Coefficient on VIX: -0.11 (standard error 0.11) - Coefficient on change in GDP forecasts (change in level of GDP forecasts): 2.71 (standard error 1.11) - Coefficient on change in dispersion in GDP forecasts: -13.06 (standard error 7.65) - R-squared: 0.672 - Out-of-sample RMSE: 3.00 - Model estimation notes: - Estimated using two-stage least squares with lags of domestic variables and real interest rates as instruments. - Change in forecasts based on 12-month ahead median GDP forecast from the weekly BCB Focus survey; change in dispersion is change in standard deviation of the 12-month ahead forecast. ### Interpretation: global versus domestic drivers - Global factors (falling commodity prices and tighter global financial conditions) explain a significant part of the initial investment weakness in 2011. - Since start of 2012, domestic factors—most notably persistent downgrades to growth forecasts and greater domestic uncertainty—have been more important in weighing on investment. - The model forecast predicted an investment pick-up as the global environment improved, but the expected rebound did not materialize due to domestic headwinds. ### Open questions and potential underlying factors - The analysis does not provide a full structural explanation or definitive guidance on whether the investment decline is permanent or transitory. - Potential underlying factors (as identified in the source) include: - Impact of domestic policy uncertainty on the investment climate (may be unwound quickly). - Steady erosion of competitiveness (only partially reversed in 2012) and apparent decline in productivity (may take more time to address). ### Policy-relevant implications (drawn from the analysis) - Reducing domestic uncertainty and improving growth expectations could materially affect investment dynamics, given the strong role of forecast dispersion and growth expectations in the regressions. - Restoring competitiveness and addressing productivity weaknesses are important for a more sustained recovery in investment. - Monitoring external spillovers (commodity prices and global risk conditions) remains important, but domestic policy credibility and clarity are critical to convert global improvement into domestic investment recovery. *Source: INTERNATIONAL MONETARY FUND (excerpts).* ### 1. Issue regulation on credit bureau to ensure broad ### _cr13312 - 1. Issue regulation on credit bureau to ensure broad ### Status of Implementation of 2012 FSAP Key Recommendations (summary) - 1. Issue regulation on credit bureau to ensure broad availability of reliable positive information on borrowers. Implemented. - 2. Ensure compilation and publishing of a housing price index that is based on purchases, with broad geographic coverage. Implemented. - 3. Create a multi-partite, high-level committee, comprising all financial safety net providers, with an explicit mandate for systemic risk monitoring and crisis coordination. Not implemented. - 4. Strengthen the procedures and systems of the BCB to deliver Emergency Liquidity Assistance (ELA). In process. There is an ongoing project in the BCB to submit a proposal to improve ELA. - 5. Revise the composition of the board of the Fundo Garantidor de Créditos (FGC, Credit Guarantee Fund); use the least-cost principle in deciding FGC support for resolution, with OBA provided only when there is a grave systemic threat (capped at 50% of the FGC’s cash resources); and secure adequate funding for the FGC in the event of a systemic crisis. Partly implemented. A new bill of law is proposed. - 6. Remove legislative impediments and strengthen the purchase and assumption and bridge bank statutes. In process. A new bill for Brazilian bank resolution framework is proposed. - 7. Extend legal protection to all financial sector supervisory agencies, and elevate the threshold for actions against employees of these agencies, BCB-appointed directors, interveners, or liquidators to gross negligence. In process. A new bill of law is proposed. - 8. Extend tax incentives on infrastructure bonds to infrastructure FIDCs. In progress. The authorities note that the certificates of Certificados de Recebíveis Imobiliários (CRI, real estate receivables) and quotas of receivables investment funds (FIDC) are on the verge to be included in the list of instruments with tax incentives. - 9. Issue stricter market-making rules, e.g., apply a narrow set of the same benchmarks to all market makers, linked to improved incentives, e.g., access to Ministry of Finance (MOF)’s securities lending facilities. In progress. The authorities continue to improve the primary dealer system in Brazil. - 10. Shift BNDES operations towards co-financing with institutional investors of a broader set of companies and projects to provide market access and facilitate long-term financing. Implemented but further progress expected. - 11. Provide Superintendência de Seguros Privados (SUSEP, Superintendency of Private Insurance) and Superintendência de Previdência Complementar (PREVIC, Superintendency of Complementary Pensions) with the same legal status as Comissão de Valores Mobiliários (CVM, Securities and Exchange Commission) (e.g., fixed-term appointments and clear mandates for board members). Not implemented. - 12. Issue a secondary regulation on brokers’ self-regulation, which should include a mandatory affiliation to the self-regulating entity, and closely supervise its implementation. Not implemented. - 13. Implement the required regulation for consolidated supervision, including the introduction of ERM and capital requirements at group level. Not implemented. - 14. Establish a dedicated consumer financial protection unit. Implemented. A new deputy governor is appointed to enhance the BCB’s role in consumer protection and a dedicated department is established. *Box header: Brazil: Status of Implementation of 2012 FSAP Key Recommendations (concluded)* ### Monetary and exchange rate policy (findings) - In April 2013, the central bank started a monetary tightening cycle; the policy rate has been raised by a total 75 basis points, to 8 percent. - This followed a cumulative cut of 525 basis points in the policy rate during 2011–12 (that brought the rate to a decades-low of 7¼ percent). - The real ex-ante policy rate, at about 2½ percent, remains below the neutral rate, and the monetary policy stance remains loose. - The effectiveness of monetary policy appears to have been reduced during the easing cycle due to a temporarily weakened credit channel. - Market response to recent rate hikes and stepped-up central bank forward guidance has been positive and orderly, with medium- and long-term real interest rates remaining below the levels reached in past tightening cycles. - Inflation expectations show early signs of an inflexion point. - The central bank has intervened in both sides of the foreign exchange market, mainly through non-deliverable swaps, with little impact on international reserve levels; interventions have been geared at containing exchange rate volatility. ### Fiscal policy and policy lending (findings) - During 2012, the authorities adopted several measures, particularly tax stimuli, that ran counter to the fiscal consolidation initially envisaged in the budget. - The fiscal primary surplus in 2012 (excluding proceeds from the sovereign wealth fund) closed at 2.1 percent of GDP. - Authorities used all budget adjustors/deductions allowed by the budget; recourse to extraordinary revenue was insufficient to compensate for higher current expenditures and the cost of stimulus measures. - Net lending to public banks increased by 1.5 percent of GDP in 2012. - Stimulus measures continued in 2013, including a broadening of payroll tax cuts and an extension of tax incentives for car purchases. - The 2012 budget targeted a primary surplus equivalent to 3.1 percent of GDP, but allowed through the use of adjustors for a lower outturn of up to 0.9 percent of GDP, provided additional spending was on specific public investment projects under the Growth Acceleration Program (PAC). ### Fiscal stimulus (Box 4) — key measures and estimated fiscal cost (2012–14) - The table of announced measures (end-2011 through 12-Jun-13) lists numerous tax cuts, IOF reductions, payroll tax exemptions, IPI reductions, elimination of fuels tax (CIDE-Combustíveis), government purchase programs, and energy cost reductions. - Total estimated fiscal cost across the listed measures: 25.9 (2012), 58.9 (2013), 66.8 (2014). - Total in percent of GDP: 0.6 (2012), 1.2 (2013), 1.3 (2014). - Of which, tax stimulus: 0.4 (2012), 1.0 (2013), 1.1 (2014). - Examples of individual entries: - 1-Dec-11: Consumption tax cuts on consumer durables (IPI), mostly on home appliances — 0.4. - 3-Apr-12: Payroll tax exemptions 1/1.8 — 5.2 — 5.5 (table shows sequence under 2012, 2013, 2014). - 21-May-12: IPI reduction for cars — 1.7. - 22-Jun-12: Elimination of fuels tax (CIDE-Combustíveis) — 4.7 — 11.4 — 11.4. - 11-Mar-13: Exemption of basic consumer basket and other staples from PIS/Cofins — 5.7 — 9.3. - 5-Apr-13: Extension of payroll tax cuts to 14 new sectors — 5.4. - 12-Jun-13: Credit line for home appliances, for MCMV beneficiaries — n.a. entries. - Notes: - MCMV (Minha Casa Minha Vida) is a home buying subsidy program for low income households. - Other measures include support to internet access, government purchase of national items program, exporter credit line, support to cancer treatment services. - Sources: Ministry of Finance (including Receita Federal); JP Morgan and staff's calculations. ### Structural policies and investment outlook - Since fall 2012, authorities have undertaken targeted efforts to bolster investment by boosting infrastructure and reducing high energy costs; complementary tax reform efforts have stalled. - Program to increase private participation in infrastructure through concessions for new roads, ports and airports (anticipated for the second half of 2013) and a Public-Private Partnership model for railroads. - Additional programs focused on airports and seaports; these programs are expected to generate new investments of about R$159 billion (3 percent of GDP) over the next 5 years. - Efforts to simplify the complex inter-state VAT regime have stalled in the legislature. - The industrial sector has seen energy costs decline by an average 18 percent in 2013 due to the government’s renegotiation of contracts with utility companies. ### Macroprudential policy and capital flow measures (CFMs) - Macroprudential policies adopted in 2010–11 have been partially unwound recently, mainly by reducing effective reserve requirements and easing sectoral capital requirements. - CFMs have been actively managed; the coverage and rate of the IOF tax adjusted many times. - Over the last 12 months (prior to publication), CFMs have been eased by narrowing the coverage of the IOF tax, applying a zero rate on fixed income inflows, and exempting certain investment vehicles. - More recently, IOF tax applicable to short FX derivative positions was reduced to zero percent. Key changes since mid-2012 (Capital Flow Measures: Major Changes since mid-2012) - 14-Jun-12: IOF tax of 6 percent applied to foreign loans, bond issuance to non-residents and secondary bond market purchases by non-residents with maturities up to 2 years (from 5 years previously) - 28-Jun-12: Removal of restriction that limited export prepayment only to agreements with the importer as counterparty - 4-Dec-12: Removal of restriction that limited export prepayment up to 5 years (from 1 year) - 5-Dec-12: IOF tax of 6 percent applied to foreign loans, bond issuance to non-residents and secondary bond market purchases by non-residents with maturities up to 1 year (from 2 years previously) - 31-Jan-13: IOF tax of zero percent applied on inflows to real estate investment funds - 4-Jun-13: IOF tax of zero percent applied to all bond issuance to non-residents and secondary bond market purchases by non-residents - 12-Jun-13: IOF tax of zero percent applied to all onshore net short positions in foreign currency derivatives - long exposure reduction/ short exposure increases (from 1 percent) Source: Ministry of Finance, Central Bank of Brazil. ### Outlook and risks - The gradual recovery that started in 2012 is expected to continue through 2013, supported by a sustained pick-up in investment. - Real GDP growth is projected to rise to about 2½ percent in 2013, below medium-term potential growth because of supply-side constraints, with fixed investment growing by about 7 percent in real terms. - Infrastructure build-up will take time to relieve bottlenecks, but a decisive advance on concessions (including in the energy sector) may help bolster business confidence and private investment. - Private sector investment can have a more immediate effect on growth, particularly for upgrades and expansion of existing capacity (which would imply higher imports). - Consumption is expected to remain resilient as the labor market stays buoyant, with a more moderate increase in the minimum wage supporting a sustainable pace of household spending. - Net exports likely to impart a small negative contribution as improving external conditions are offset by higher investment-related imports and weak competitiveness. - Over the medium term, Brazil is projected to achieve potential growth of about 3½ percent (a downward revision of staff’s and market estimates). - Absent comprehensive and decisive reform efforts to boost investment and productivity, Brazil’s potential growth would revert to its long-term historical average of about 3 percent. ### Brazil’s Corporates: Rising Leverage But Improving Liquidity (Box 5) — key findings - Profitability: For the median firm, return on equity (RoE) and profit margin have fallen from their cyclical 2010 highs. - Leverage: Leverage (total debt to common equity) broadly increased from 2009–11 but stabilized last year and remains somewhat above the historical average; the distribution of leverage has become slightly more skewed. - Maturity and liquidity: Firms have lengthened average debt maturity; the proportion of short-term firm debt at residual maturity has declined. - Liquidity measures (including the quick ratio) show that liquidity has improved over the last decade; improving liquidity may partly reflect cyclically low interest rates. - Corporate bond issuance: Picked up in the last three years, largely offset by a reduction in new syndicated loans, with a greater proportion denominated in local currency. - Sector currency composition: New issuances by the non-tradable sector have largely been denominated in local currency; syndicated loans are principally to the tradable sector denominated in foreign currency. - Recent issuance has often facilitated balance sheet restructuring, including lengthening maturities, rather than financing new investment. - As global financial conditions tightened, issuance began to moderate in line with other major emerging markets. *Brazil: Status of Implementation of 2012 FSAP Key Recommendations; Monetary, fiscal, structural, macroprudential, and corporate sector findings as presented in the source document.* ### Box 6. How Fast Can Brazil Grow? ### Box 6. How Fast Can Brazil Grow? ### Potential growth and supply-side decomposition - Consensus estimates of potential growth have been steadily revised lower and are now at their lowest level since commodity prices began to surge in the mid-2000s. - A supply-side decomposition suggests Brazil’s sustainable future growth rate is about 3½ percent, about ¾ percentage point lower than assumed by staff in recent years. - This latest estimate is about the same as the average real growth rate from 2000–12. - A range of statistical filters show potential growth at 2–3½ percent. - Key decomposition (annualized percent change, selected periods and components): - GDP: 1995-99 = 2.0; 2000-04 = 3.0; 2005-09 = 3.5; 2010-14 (projected) = 3.6; 2015-19 = 3.4; 2020-30 = 3.0 - Total factor productivity: 1995-99 = 0.3; 2000-04 = -0.1; 2005-09 = 2.3; 2010-14 = 0.3; 2015-19 = 1.7; 2020-30 = 1.7 - Capital deepening (measured by change in capital output ratio): 1995-99 = 0.3; 2000-04 = -0.8; 2005-09 = -0.5; 2010-14 = 0.3; 2015-19 = 0.2; 2020-30 = 0.3 - Labor: Education contribution across periods includes 0.7, 0.9, 1.0, 0.6, 0.9, 0.9 - Working age population: 1995-99 = 0.8; 2000-04 = 0.4; 2005-09 = 0.4; 2010-14 = 0.3; 2015-19 = 0.2; 2020-30 = -0.2 - GDP per capita: 1995-99 = 0.5; 2000-04 = 1.6; 2005-09 = 2.5; 2010-14 = 2.7; 2015-19 = 2.7; 2020-30 = 2.5 - To achieve growth of 3½ percent, Brazil needs to step up investment (including infrastructure) and boost productivity above past levels. - Over the next decade, labor pool expansion will slow; growth will need to rely more on capital accumulation and productivity. - Projections assume: - foreign saving can finance only part of required investment; - domestic saving will rise only gradually and remain relatively low; - the government will successfully implement its infrastructure investment program with important positive effects on productivity. - Estimates are subject to considerable uncertainty; failure to attain higher productivity could lead to long-term growth falling short of the revised estimate. ### Inflation, external sector, and baseline macro assumptions - Inflation projection: - Headline inflation is projected to remain at about 5¾ percent this year and into 2014, and converge gradually to the target mid-point thereafter. - Slow convergence reflects lags from new investments to capacity expansion, continued tightness in labor markets, exchange rate depreciation effects (despite lower pass-through), and increased inflation inertia. - External current account: - Projected to increase further through 2015, partly due to recovery of investment. - With limited increases in public and private saving under current policies, the pick-up in investment must be financed by higher foreign saving. - Imports expected to rebound significantly given high income elasticities; exports to grow more gradually; terms of trade anticipated to worsen somewhat. - Medium-term external current account deficit projected to stabilize at about 3¾ percent of GDP as pre-salt oilfields come online and Brazil becomes a net oil exporter. - Baseline policy assumptions: - Continuation of monetary tightening, bringing the real policy interest rate close to its estimated neutral level by about mid-2014. - Fiscal policy consistent with a primary balance of about 2 percent of GDP in 2013 and 2014 (meeting targets will require strict expenditure restraint and full use of adjustors/discounts to the primary balance target). - Policy lending projected to return to levels close to 1 percent of GDP in 2013 and through 2015 and decline gradually thereafter (assumes recently announced subsidized credit line for Minha Casa Minha Vida equivalent to 0.4 percent of GDP is incorporated). ### Fiscal baseline—selected numeric indicators (Percent of GDP unless otherwise indicated) - Primary Balance: 2010 = 2.5; 2011 = 3.2; 2012 = 2.1; 2013 = 1.9; 2014 = 2.0 - Non-financial Revenue: 2010 = 35.5; 2011 = 35.1; 2012 = 35.5; 2013 = 34.8; 2014 = 34.7 - Primary Expenditure: 2010 = 33.0; 2011 = 31.9; 2012 = 33.4; 2013 = 32.9; 2014 = 32.7 - Current Expenditure: 2010 = 29.0; 2011 = 20.3; 2012 = 21.2; 2013 = 20.9; 2014 = 20.7 - Capital Expenditure: 2010 = 4.0; 2011 = 2.4; 2012 = 2.7; 2013 = 2.4; 2014 = 2.4 - Overall Balance: 2010 = -2.7; 2011 = -2.5; 2012 = -2.8; 2013 = -2.7; 2014 = -2.9 - Structural Primary Balance: 2010 = 1.4; 2011 = 2.7; 2012 = 2.1; 2013 = 1.9; 2014 = 2.0 - Memo: Real primary expenditure growth: 2010 = 12.1; 2011 = -0.8; 2012 = 5.8; 2013 = 0.9; 2014 = 2.4 ### Risks, scenarios, and downside pressures - Domestic downside risks (near term): - Protracted weak investment, worsening demand imbalances, and policy stance that could exacerbate imbalances — could lead to a more uneven and sluggish recovery, larger current account deterioration, and elevated inflationary pressures. - Gradual erosion of the fiscal framework: increasing reliance on extraordinary revenues and adjustors, large transfers to public banks (policy lending), and measures that may undermine credibility and reverse the downward trend in gross debt to GDP ratio. - Higher and more persistent inflation due to binding domestic supply constraints and tight labor markets; elevated inflation could increase indexation and inertia and raise the sacrifice ratio of returning to target. - Correction in the real estate market and household credit exposure could adversely affect financial and real sectors; rapid credit expansion to new customers, especially via public banks, may worsen asset quality in a low growth scenario. - External downside risks: - Global financial conditions: sudden U.S. monetary tightening or intensified European crisis could increase global risk aversion, reduce flows to emerging markets, tighten external financing, cause sharp real depreciation, increase inflationary pressures, and force monetary tightening that hinders investment recovery. - Commodity prices and terms of trade: exports of commodities accounted for almost half of goods exports in 2012; vulnerability is significant to large commodity price changes, though cross-correlation across major commodities is relatively low. - Risk quantification and examples: - If Brazil’s investment-to-GDP ratio rose to average G-20 levels but domestic saving remained unchanged, the external current account deficit would deteriorate by about 4 percentage points of GDP. - Scaling up investment to boost potential growth above historical average likely requires a sustained rise in domestic saving of about 2–3 percentage points of GDP, with contributions from both public and private saving. - If the bulk of higher foreign saving is FDI, positive productivity effects could allow sustaining a potential growth rate of about 3½ percent; if financed by more volatile capital, external vulnerabilities would increase. ### Financial sector and household soundness (selected points) - Household financial soundness improved in 2012; NPLs began to decline gradually at end-2012. - Household debt-service-to-income ratio declined 1.2 percentage points from 22.9 to 21.7 percent of disposable income in the last six months (both principal and interest contributed equal amounts). - Household NPLs decreased by 0.5 pp from the peak in May 2012 (6.0 percent), with significant declines in auto and mortgage loans (which represent 17.8 and 24.0 percent of household credit, respectively). - Banking sector vulnerabilities appear low: external liabilities of Brazilian banks account for 7 percent of bank assets; foreign banks represent less than 20 percent of banking sector assets. - Federal public debt structure changes (selected indicators, 2002 vs 2012): - Share in total debt: External debt 2002 = 23.8; 2012 = 3.0 - Domestic debt held by non-residents: 2002 = 1.9; 2012 = 13.9 - Domestic debt held by residents: 2002 = 74.2; 2012 = 83.1 - Average maturity (years): 2002 = 3.6; 2012 = 4.0 - Percentage maturing in 12 months: 2002 = 34.6; 2012 = 24.4 - Profile of domestic debt: Fixed rate 2002 = 2.2; 2012 = 41.2; Inflation linked 2002 = 12.5; 2012 = 35.5; Floating rate 2002 = 62.9; 2012 = 22.8; Exchange rate 2002 = 22.4; 2012 = 0.6 ### Policy implications and priorities - To achieve and sustain growth near 3½ percent, priority actions include: - Step up investment, particularly in infrastructure, while ensuring efficient implementation of projects to improve productivity. - Mobilize a sustained rise in domestic saving of about 2–3 percentage points of GDP, with contributions from both public and private sectors, to avoid widening the current account deficit. - Maintain fiscal discipline and the credibility of the fiscal framework, limiting reliance on extraordinary revenues, large adjustors, and transfers that could undermine fiscal credibility and raise gross debt. - Continue monetary policy tightening to bring the real policy interest rate near neutral by about mid-2014 to control inflation expectations; guard against inflation inertia and supply-side constraints. - Seek high-quality foreign saving (e.g., FDI) to finance part of the investment push to mitigate external vulnerability and support productivity gains. - Monitoring and mitigating risks: - Prepare for potential shifts in global financial conditions and commodity prices that could tighten external financing and raise inflationary pressures. - Strengthen oversight of rapid credit expansion, especially in public banks, to limit deterioration in asset quality in low-growth scenarios. *Source: Box 6. How Fast Can Brazil Grow?, IMF staff analysis.* ### 16. The authorities anticipate a continuation of the economic recovery and a sustained ### _cr13312 - 16. The authorities anticipate a continuation of the economic recovery and a sustained ### Authorities' outlook and risks - Authorities anticipate a continuation of the economic recovery and a sustained pick-up in private investment, supported by past and current policy stimulus and progress in boosting private sector participation in infrastructure investment. - Staff assessment: - Agreed investment was picking up. - Argued that greater policy predictability and measures to rebalance domestic demand and enhance competitiveness are important to strengthen investor confidence and raise growth on a sustained basis. - Main risks (authorities and staff): - External risks: - Prospect of tighter global financial conditions, including the eventual unwinding of monetary stimulus in the United States. - Sharp and prolonged falls in commodity prices, stemming from a sharp slowdown in China. - Further disruptions to trade among regional partners. - Domestic risks (staff emphasized): policy frameworks and the policy stance. ### Near-term policy stance - Authorities' intentions: - Indicated they would tighten macro policies, including fiscal policy, if the recovery proceeds as anticipated. - Central bank has recently stepped up monetary tightening and signaled actions to lower inflation towards the mid-point of the official target range. - Ministry of Finance expects an output growth rate above 3 percent in 2013; under such scenario they would not consider additional stimuli in 2013 and the fiscal primary surplus would improve slightly this year. - Note: In recent weeks, authorities emphasized the fiscal primary target for 2013 remains at 2.3 percent of GDP, which implies a partial use of the discretionary adjustors allowed by the budget law. - Staff views: - Welcomed policy intentions but noted supply constraints (weak investment, tight labor market) likely limit recovery strength. - Underscored necessity of gradual fiscal consolidation in the months ahead to rebalance demand and support monetary policy. ### Fiscal policy: findings and recommendations - Authorities' stance and actions: - Consider fiscal policy can continue to play an important counter-cyclical role, aimed at boosting investment and competitiveness. - Tax cuts: reductions in payroll taxes and tax-exemption of basic consumer goods viewed as permanent structural measures; other consumption and financial transaction-based taxes (IPI, gasoline taxes, IOF) used to respond to the cycle. - Do not anticipate further tax stimuli in 2013; not planning to make full use of the adjustors/discounts to the primary balance target allowed by the budget, provided the recovery proceeds as expected. - For sub-national governments: expect some consolidation in 2013, with no extension of the PROINVESTE program to support investment by state governments—implying a small increase in the primary surplus of the general government compared to last year. - Staff cautions and recommendations: - Noted the 2008–09 global financial crisis was exceptional; in normal times monetary policy should be geared to demand management and fiscal policy confined largely to automatic stabilizers. - Indicated recently enacted tax cuts will tend to have a transitory effect in reducing inflation and may ultimately exacerbate inflationary pressures by stimulating consumption and labor demand amid cyclically low unemployment. - Supported a credible path of gradual fiscal consolidation anchored on Brazil’s long-standing primary surplus target (3.1 percent of GDP). - Argued such consolidation and greater clarity about the target and its rationale would help rebalance demand, support monetary policy, rebuild policy buffers, and bolster confidence. - Policy lending through public banks: - Authorities expect policy lending to moderate; recent expansion aimed at filling void left by private banks (following rise in NPLs in 2010–11) and this process had likely concluded. - Public banks expected to provide the bulk of financing for infrastructure and energy concessions in coming years (between 70 and 80 percent). - Staff noted policy lending is a quasi-fiscal operation affecting fiscal stance and debt dynamics; argued lowering policy lending should take priority in fiscal adjustment as private sector has access to financing. - Footnote: Since then, authorities announced a subsidized credit line (Minha Casa Melhor) for beneficiaries of the Minha Casa Minha Vida program equivalent to 0.4 percent of GDP. ### Monetary and financial policies - Inflation and monetary policy: - Broad agreement reducing inflation and inflation expectations should be key priority. - Central bank reiterated commitment to inflation targeting; recent uptick in inflation partly due to transitory food supply shocks expected to unwind through the year. - Recent increases in the policy rate and strengthened communications intended to reinforce anti-inflation credentials. - Authorities acknowledged inflation inertia may be becoming entrenched; current policy action expected to contain inflation expectations and facilitate faster convergence to the target. - Staff noted a frontloaded policy course may limit potential sacrifice in activity and the extent policy rates would need to rise through the cycle. - Exchange rate and reserves: - Flexible exchange rate remains a key pillar and shock absorber. - Recent FX interventions described as sporadic and symmetric to moderate volatility, not to stabilize the nominal rate at a predetermined level. - Interventions conducted through the swap market to avoid direct effect on international reserves. - Authorities indicated reserve accumulation may be part of the response if large private capital inflows resume. - Capital flow measures (CFMs) and IOF: - CFMs helped insulate Brazil from large and volatile capital flows and remain part of the toolkit. - Since mid-2012, CFMs eased in response to a large decline in gross and net portfolio inflows. - IOF (including on net derivative positions adopted end-July 2011) and bank reserve requirements on short currency positions dampened short-term portfolio inflows and contributed to financial stability. - Authorities intend to continue actively managing the IOF, adjusting rate and coverage in response to capital flow pressures. - Staff concurred IOF appears effective, but emphasized CFMs involve material trade-offs and should be well integrated with other policies, temporary, and non-discriminatory. - Banking system and household balance sheets: - Staff recognized banking system is sound: credit growth moderated from peak, NPL ratios gradually declined, capital adequacy ratios among highest in the G-20, liquidity buffers ample. - Stress tests indicate banking system can withstand large shocks to growth, interest rates, and exchange rate. - Concern remains on rapid expansion of public bank balance sheets; authorities noted NPL ratios at public banks much lower than private banks and liquidity positions comfortable. - Household balance sheets improved; housing price increases moderated. - Authorities attribute household NPL improvements to shift toward lower risk loans (payroll and mortgage), lagged impact of lower interest rates, and macroprudential measures adopted in 2010. - Central bank’s new housing price index indicates recent real estate price increases less pronounced and starting to moderate. - Ongoing vigilance warranted given rapid mortgage loan growth (albeit from low levels) and potential feedback loops between house prices and mortgage lending. ### Strengthening Brazil’s policy frameworks - Fiscal framework and debt: - Authorities view current fiscal space as sufficient and want fiscal policy to continue active role in domestic demand management; cite reduced net debt as percent of GDP and improved public debt maturity structure. - Staff highlighted gross debt to GDP ratio has increased moderately in recent years and remains elevated; gross debt includes debt associated with on-lending to public banks. - Staff emphasized policy lending through public banks contributed to gross debt build-up and controlling such lending is important to a credible debt reduction strategy. - Staff recommended prioritizing strengthening the fiscal framework and setting a primary surplus target for the NFPS that allows less discretionary adjustment and places gross debt firmly on a downward path. - Sub-national fiscal discipline: - Authorities restated commitment to maintain fiscal discipline at sub-national level, relying on Fiscal Responsibility Law mechanisms and past debt renegotiation contracts. - Staff encouraged maintaining these long-standing mechanisms and retaining cross-compensation with federal government to meet the primary target for the nonfinancial public sector. ### Box 9 — Basel III Capital Requirements and Estimated Impacts: key points - Implementation and timing: - Banco Central do Brasil (BCB) published resolutions and circulars implementing Basel III recommendations; new rules go into effect on October 1, 2013. - Banks will need to build a capital conservation buffer and be subject to a countercyclical capital buffer requirement from 2016 (should authorities determine it is needed). - BCB simulations and estimated capital needs: - In a scenario with credit growth and earnings retention based on recent years, no bank will need to raise capital in 2013–16. - Over 2017–19, some banks may need to raise about R$15 billion in total, which represents just 2 percent of the total assets in the banking system at end 2012 (R$697 billion). - Phase-in and minimum requirements (selected figures preserved from tables): - Common Equity Tier 1 (CET1) requirement ranges shown: 7.0 – 9.5 percent (includes minimum 4.5 plus conservation buffer and countercyclical buffer components). - Tier 1 capital requirement ranges shown: 8.50 – 11.0 percent. - Total capital requirement ranges shown: 10.5 – 13.0 percent. - Phase-in process detailed for 2013–2019 with incremental CB and CCB additions and resulting CET1, Tier 1, and Total ranges. - Deferred Tax Assets (DTAs) and legal changes: - Revised Brazilian law allows DTAs derived from timing differences relative to loan loss provisioning to be included in CET1 capital under specified treatment (conversion into “deemed credits” as direct claims on government in certain circumstances). - Costs of the legal change estimated at R$2.84 billion over the 2014–16 period (R$851 million in 2014, R$945 million in 2015, and R$1.04 billion in 2016) and are acknowledged in the budget. - Size of DTAs from loan loss provisioning in Brazil is estimated to be approximately R$ 64 billion, which amounts to 16 and 1 percent of Brazilian banks’ Tier 1 capital and total assets respectively as of end-2012. - Other technical treatments and impacts: - Regulation does not require investments in affiliated insurance companies to be deducted from CET1; the BCB requires deduction of insurance company’s minimum regulatory capital requirements but not excess capital investment beyond regulatory minimum. - BCB estimates impact of new regulations on credit supply would be neutral; full compliance and phase-in expected to reduce borrowing cost and expand access to external sources. - Publication of resolutions and circulars expected to reduce regulatory uncertainty; banks and rating agencies signaled preparedness to adopt Basel III. *Source: IMF staff report excerpt (document _cr13312).* ### 31. The authorities would like public banks to continue playing an important role in the ### _cr13312 - 31. The authorities would like public banks to continue playing an important role in the ### Role of public banks and policy lending - Authorities want public banks to continue playing an important role in the provision of long-term financing to the private sector, retaining a major role in financing infrastructure and energy concessions. - Large transfers from the Treasury to public banks are envisaged to continue in coming years, and taper down only gradually over the medium term. - Public banks can help complete “missing markets” (for example, by providing long term financing for smaller companies without market access), but staff pointed to evidence of competition with private bank lending. - Staff recommendation: the reliance on public banks for demand management and other quasi-fiscal operations should be winded down. - Fiscal policy is more effective when done transparently through the budget and records all actual or potential costs. - The envisaged phasing out of policy lending is welcome, but plans to maintain this lending for several more years would continue to increase fiscal risks. - A bolder plan to reduce government-sponsored lending over the coming years would be advisable. - Risk note: the demand management role given to public banks has resulted in a rapid expansion of their balance sheets and increased gross public debt, creating a potential fiscal burden. ### Domestic demand rebalancing and boosting long-term growth - Infrastructure and energy investment programs are the centerpiece of the government’s efforts to increase potential output growth. - Progress cited: legislation for increased private participation in ports, recent airport concessions, upcoming road capacity concessions, and successful auction of oil exploration rights to 20 domestic and multinational energy companies. - Staff view: undertaking those investments, with appropriate transfer of risks to the private sector, should upgrade the country’s capital stock and raise productivity—essential given moderating labor force growth. - Authorities concur on the need to increase the investment ratio and consider it can largely be financed with foreign saving, particularly FDI. - Brazil’s net foreign asset position had improved in recent years, in part because FDI now represents a larger share of foreign liabilities. - Expansion of infrastructure and investment in the energy sector is expected to improve Brazil’s external position over the medium term. - Staff: external vulnerabilities appear moderate at present and there is some space to rely on foreign saving for a few more years, but a higher domestic saving rate is needed to support higher investment and keep external vulnerabilities in check. - Last year’s public pension reform marks an initial yet important step towards raising domestic savings. - Footnote: The public pension reform reduced about ½ percentage point of GDP from the about 7 percentage point of GDP long-term deterioration in the deficit of the social security system that was projected before the reform (IMF Country Report No. 12/191). - Real exchange rate and competitiveness: - The real exchange rate is moderately overvalued, hindering competitiveness. - Authorities saw room for a larger current account deficit if driven by higher investment, and viewed the gap from the EBA norm as reflecting higher investment financed by FDI. - Staff: indicators point to a significant deterioration in competitiveness, notably the large and sustained rise in unit labor costs; broad and sustained reform efforts are necessary to restore competitiveness. - Policy measures to improve competitiveness should include mobilizing domestic savings (public and private) and reviewing the minimum wage adjustment mechanism to keep unit labor costs in check. - Taxation and costs: - Authorities considered recent payroll tax cuts and lowering of energy tariffs as key to improving business conditions and the investment climate. - Staff underscored the importance of broad tax reform: simplify the tax system, lower tax rates, and reduce costs of compliance—notably addressing the ICMS (Imposto de Circulação de Mercadorias e Serviços). ### Staff appraisal: macro frameworks and policy priorities - Achievements and context: - Over the last decade, Brazil’s macroeconomic frameworks (fiscal responsibility law, inflation targeting regime, flexible exchange rate) contributed to macroeconomic stability, robust growth, and sustained poverty reduction. - A strong prudential framework underpinned a sound financial sector that withstood the 2008–09 global financial crisis. - Diagnosis of slowdown: - Brazil’s sharp growth slowdown since mid-2011 reflected binding supply constraints and heightened uncertainty about macroeconomic policies, including excessive fine tuning and stimulus. - Staff view: the situation calls for tightening the policy stance to rebalance demand away from consumption and restore confidence in macroeconomic frameworks. - Policy prescriptions (key recommendations): - Fiscal consolidation: - A steady process of fiscal consolidation, anchored on Brazil’s long-standing target for a fiscal primary surplus of 3.1 percent of GDP, would support monetary policy and bolster recovery in confidence and investment. - Authorities should place higher priority on fiscal consolidation. A steady decline in the gross debt to GDP ratio will lessen the burden on monetary policy, rebuild fiscal buffers, and enhance confidence in the fiscal framework. - The authorities’ intention of limiting the use of adjustors to the primary surplus target as well as reducing policy lending in 2013 is welcomed but should not be made contingent on a rapid pace of recovery. - Monetary policy: - A front-loaded monetary tightening will help lower inflation expectations and inertia and limit potential sacrifice effects in terms of activity. - Authorities should assign to monetary policy the main role in aggregate demand management and focus fiscal policy on rebuilding buffers. - The start of decisive monetary tightening is welcome; a front-loaded tightening and clear priority to meeting the target over the relevant horizon will help anchor medium-term inflation expectations, forestall indexation, and contain inflation inertia. - Public banks and fiscal transparency: - Wind down the reliance on public banks for demand management and quasi-fiscal operations; fiscal policy should record all actual or potential costs transparently through the budget. - Strengthening the fiscal framework (areas of action): - Adhere to a primary surplus target of about 3 percent of GDP that places gross public debt firmly on a downward path. - The primary surplus target of 3.1 percent of GDP, as established in the Budget Guidance Law (without the use of adjustors in normal circumstances or extraordinary operations, and maintaining cross-compensation between the federal government and sub-national governments), would ensure gross public debt is put firmly back on a downward path. - Maintain fiscal discipline of sub-national governments; their contribution to the consolidated primary surplus target has declined as current spending rose faster than revenue. - Ease budget rigidities to increase public saving; relaxing rigidities that contribute to high public consumption is critical. Modifying the minimum wage indexation mechanism to help contain costs associated with minimum pensions would be a key step. - Recognize contingent fiscal risks; contingent risks related to public sector involvement in infrastructure investment and public banks should be more fully quantified and reported in the Fiscal Risks Annex to the annual Budget Guidance Law. - Liabilities may arise from deterioration of assets held by public banks or commitments under concession agreements for infrastructure projects. - Financial sector vigilance: - Efforts to strengthen financial regulation and supervision are welcome but continued vigilance is warranted. - Brazil’s financial supervision and banking system remain sound and are well placed to implement Basel III. - Progress in strengthening the resolution framework and implementing FSAP Update recommendations is welcome, but advancing the full set of recommendations is important. - Although non-performing loans have declined, risks from the past rapid build-up of household credit (in a context of very low unemployment) warrant ongoing vigilance, especially as likely interest rate increases may offset recent improvements in debt service capacity. - A correction in property prices, although not systemic, could worsen asset quality in public banks due to rapid expansion of mortgage loans in recent years. - Corporate issuance has helped improve balance sheets, but increased leverage in some sectors should be monitored carefully. - Exchange rate policy: - The flexible exchange rate should remain the main shock absorber in periods of financial turbulence; intervention should aim at avoiding excessive volatility. - If global monetary conditions tighten unexpectedly and increase global risk aversion, the exchange rate should be allowed to depreciate and intervention should focus on avoiding disorderly market dynamics. - If large capital inflow pressures re-emerge, the exchange rate should be allowed to appreciate somewhat but be supported by other policies, including some further temporary reserve accumulation and CFMs. - Recent increases in tariffs, while consistent with WTO obligations, risk undermining G-20 commitments to avoid trade protectionism. - Supply-side reforms and productivity: - Authorities’ focus on easing supply-side constraints is welcome, but more decisive and comprehensive efforts are needed to enhance productivity and competitiveness and increase potential growth. - Market-based concessions for infrastructure projects that adequately transfer risks to the private sector are likely to increase private investment and bolster business confidence. - Increasing the investment to GDP ratio and boosting productivity will be critical to achieve a sustained potential growth rate above the historical average of 3 percent. - The increase in investment must rely importantly on domestic saving to avoid a buildup of external vulnerabilities; further pension reform efforts—following last year’s important reform of the public pension system—would be an important step. - Revising the minimum wage indexation mechanism, together with efforts to rebalance demand away from consumption, are essential to keep unit labor costs in check and prevent further erosion in competitiveness; this would help bolster the return on capital (particularly in manufacturing) and improve incentives for investment. - Other complementary policies include addressing high and complex taxation (notably the ICMS) and improving business conditions (“custo Brasil”). *Source: IMF staff report content provided in content unit _cr13312 - 31.* ### 42. It is recommended that the next Article IV consultation takes place on the standard ### _cr13312 - 42. It is recommended that the next Article IV consultation takes place on the standard 12-month cycle. ### Recent economic developments and demand - Growth is recovering gradually with the output gap virtually closed. - Investment has begun to recover after a prolonged weakness. - Weak investment performance during 2011-12 appears to be related with a sharp decline in business confidence. - Industrial production contracted until mid-2012, but seems to be recovering. - Consumption continues to be well supported by a tight labor market, largely due to the services sector. - Household consumption has remained strong, although moderated in Q1 2013. - Demand contribution to GDP growth (seasonally adjusted, annualized quarter-on-quarter percent change) shown across 2011Q1–2013Q1 with components: Private consumption, Government consumption, Investment, Net exports, Inventories, GDP. - Capacity utilization measure: Difference between the current rate and the 10-year average in percentage points. ### Inflation dynamics and expectations - Inflation has risen since mid-2012 and has reached the upper ceiling of the official target. - Non-tradable inflation is running well above the target range, reflecting robust domestic consumption and wage costs. - Administered inflation declined sharply since early 2012, and is currently below the target floor. - The inflation diffusion index has increased rapidly and remains elevated. - Wage growth remains strong (Broad economy earnings and Minimum wage series). - Focus Survey: Expectations for IPCA Inflation displayed for horizons: 12 months ahead, 2 years ahead, 3 years ahead (annual percent change). - Consumer Price Inflation and Central Bank Target Band series: Headline IPCA index and Core 1 / Target band mid-point shown (annual percent change). ### External sector and trade - Amid high unit labor costs, manufacturing exports have remained stagnant (Manufacturing export quantum index; Unit labor cost (US$)). - Terms of trade have stabilized at a relatively high level (Terms of Trade and Commodity Prices, Index, 2008=100). - Brazil's net IIP has remained stable. - The external current account remains in deficit despite weak growth and strong export prices. - Net capital inflows declined in 2012, reflecting lower portfolio flows. - International Reserves (EOP, Mil. US$) and REER (Jan 2005=100) depicted; gross reserves series presented. - Composition of the current account: Services, Current Transfers, Income, Trade Balance, Current account balance (percent of GDP, net). ### Macroeconomic policies and fiscal stance - After a substantial easing since mid-2011, the policy rate has been raised by 75 basis points recently. - Markets are pricing continued tightening through 2014 (Interbank Deposit Forward Interest Rate Curve data). - Macroprudential policies, including reserve requirements, were relaxed in 2012. - Fiscal policy turned expansionary, contributing to an increase in gross public debt. - Policy lending contributed to a deterioration in the primary balance. - Monetary Policy Target Interest Rate (SELIC) series: Nominal, Real (ex-ante), Trend real (estimated using a two-sided HP filter that incorporates staff's projections for nominal interest rates over the medium term). - Effective Commercial Bank Reserve Requirement Ratio series (Percent of deposits). - Non-financial Public Sector Debt (Percent of GDP): Net and Gross (right scale). ### Financial sector indicators - Credit Growth (annual percent change): Public banks, Private banks, Total—public banks offset a slowdown in private bank lending. - Lending rates have declined (new and old series distinctions noted in February 2013 Central Bank data). - Nonperforming loans: Non-earmarked (percent, more than 90 days overdue) and series comparisons (old/new). - Capitalization remains high, but rapid credit expansion by public banks has lowered their capital levels. - Household indebtedness indicators: Debt-Service-to-Income Ratio (Principal and Interest, RHS), Debt-to-Income Ratio (Percent of disposable income). - Profitability: Public vs. Private Banks (Return on assets, percent) and Capital Adequacy Ratio: Public vs. Private Banks (Percent), Minimum requirement (11%). ### Financial markets - The real depreciated in 2012, and weakened further in the first 5 months of 2013 (Nominal Exchange Rate cumulative percent change Jan. 1 to Mid June, 2013). - Following a correction in early 2012, the stock market has remained broadly stable and close to historical valuations. - Borrowing spreads have remained below the emerging markets average (EMBI Brazil, CEMBI Brazil). - Onshore dollar funding remains unstrained. - Long-term Local Currency Bond Yields and CDS: Bond Yield (10 year, generic bond index) and CDS (5 year, right scale). - Stock Market Indices: Change in index value since Dec. 31, 2012 (P/E current and 10 year average) and MSCI Brazil versus MSCI Emerging Markets with VIX (right scale). ### Public debt sustainability—gross NFPS (bound tests) - NFPS gross debt baseline: 65 (NFPS gross debt in percent of GDP). - Individual shocks: Permanent one-half standard deviation shocks applied to growth, primary balance, and interest rate in bound tests; permanent 1/4 standard deviation shocks applied in other scenarios. - Historical, Baseline, and Scenario boxes present average projections and ten-year historical averages for variables. - Combined shock and Real depreciation and contingent liabilities shocks: One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2014 (real depreciation defined as nominal depreciation minus domestic inflation based on GDP deflator). - Gross financing need under baseline and scenario comparisons: Baseline:2.9; Scenario:2.5; Historical:3.2 (figures shown in context of gross financing need and scenarios). - Scenario examples: Baseline and historical scenarios, Combined shock 3/, Contingent liabilities shock 30% depreciation. ### Public debt sustainability—net public sector debt (bound tests) - Net public sector debt baseline: 33 (Net public sector debt in percent of GDP). - Bound tests and scenarios parallel gross framework with shocks to growth, primary balance, and interest rate. - Combined shock and contingent liabilities / real depreciation scenarios presented. - Net financing need under baseline (right scale) and primary balance shock (percent of GDP) with no policy change scenario (constant primary balance): No policy change Baseline:2.9 Scenario:2.5 Historical:3.2 (numbers repeated in relevant panels). ### External debt sustainability (bound tests) - External debt baseline and scenarios: External debt in percent of GDP and sensitivity to shocks (nominal interest rate shock, growth shock, current account shock, combined shocks). - One-time real depreciation of 30 percent occurs in 2013 for the real depreciation shock scenario. - Gross financing need under baseline shown (right scale). - Representative baseline and scenario averages in boxes: Baseline/Scenario/Historical triple values appear for specific panels (examples include Baseline:4.2 Scenario:4.7 Historical:8.1; Baseline:3.1 Scenario:1.9 Historical:3.8; Baseline:-2.9 Scenario:-4.0 Historical:1.3). ### Key macro-fiscal and balance of payments statistics (selected figures from tables) - Population total (million) (2012): 196.5; Annual rate of growth (percent, 2012): 0.8; Density (per sq. km.) (2012): 23.1. - GDP at current prices and constant prices series and projections (selected entries): GDP at constant prices (percentage change) 2012: 0.9; 2013 (Proj.): 2.5; 2018 (Proj.): 3.5. - Consumer prices (IPCA, end of period): 2012: 5.8; 2013 (Proj.): 5.8; 2018 (Proj.): 4.5. - Investment (Gross domestic investment percent of GDP) series: 2012: 18.4; 2013 (Proj.): 18.8; 2018 (Proj.): 19.7. - NFPS primary balance (percent of GDP): 2012: 2.0; 2013 (Proj.): 2.2; 2018 (Proj.): 3.1. - NFPS overall balance (percent of GDP): 2012: -2.7; 2013 (Proj.): -2.9; 2018 (Proj.): -1.8. - NFPS gross debt (percent of GDP): 2012: 68.2; 2013 (Proj.): 68.6; 2018 (Proj.): 65.0. - Public sector net debt (percent of GDP): 2012: 35.0; 2013 (Proj.): 35.2; 2018 (Proj.): 32.9. - Current account (in percent of GDP): 2012: -3.6; 2013 (Proj.): -3.6; 2018 (Proj.): -3.7. - Gross official reserves (end of period, billions of U.S. dollars): 2012: 380.7; 2013 (Proj., year-to-date as of April): 387.4. - Exports of GNFS (12-month percent change, US$) 2012: -4.0; Imports of GNFS (12-month percent change, US$) 2012: 0.6. - Total external debt (in percent of GDP): 2012: 15.0; 2013 (Proj.): 15.3; 2018 (Proj.): 15.2. - Financial soundness indicators (2012): Regulatory capital to risk-weighted assets (Total banking system) 16.7; Nonperforming loans to total gross loans (Total banking system) 3.4; Return on assets (Total banking system) 1.6. - General government fiscal operations (percent of GDP, selected 2012 values): Nonfinancial revenue 33.8; Primary expenditure 30.7; Net lending/borrowing -3.4; Net interest payments 5.1. ### Fiscal projections and debt dynamics assumptions (selected) - NFPS gross debt baseline: 65.0 (percent of GDP) in 2010 baseline table; public sector gross debt series in projections: 2013 Baseline: 68.2, 2018 Baseline: 65.0. - Key macroeconomic assumptions underlying baseline (selected): - Real GDP growth (in percent): 2013: 2.5; 2014: 3.2; 2018: 3.5. - Average nominal interest rate on public debt (in percent): 2013: 11.9 (table-level) / 14.2 (alternate NFPS table), series shown across projections. - Inflation rate (GDP deflator, in percent): 2013: 6.0; 2014–2018: 5.0 (annual). - Primary deficit projections: 2013: -1.9 (percent of GDP); 2014–2018: -2.0 to -3.1 depending on table and scenario. - Debt-stabilizing non-interest current account and gross financing need series presented in external debt tables with baseline and bound-test scenarios. *Source: IMF staff report content as presented in the supplied PDF content unit.* ### Annex I. Brazil’s External Sector Assessment ### Annex I. Brazil’s External Sector Assessment ### Summary assessment - Brazil’s external position appears moderately weaker than implied by medium-term fundamentals and desirable policy settings. - Further efforts to increase savings would be needed, including by advancing with pension reform and shifting the structure of public spending away from consumption towards investment. - It will be important to maintain a macro policy stance and a policy mix that moderates demand and facilitates rebalancing, along with use of capital flow management measures to manage volatile capital flows. ### Current Account - The current account has turned into deficit over the last decade despite large terms of trade gains. - Import volumes doubled since 2004, while export volumes have remained broadly flat; the share of manufactured exports has declined. - Illustration: were the terms of trade to return to their 2005 level, Brazil’s current account deficit would have reached 4 percent of GDP in 2012 (compared with the actual 2.4 percent of GDP). - In 2013, the current account deficit widened further to a cumulative 3 percent of GDP in April 2013. - On-off factors related to the oil sector contributed to the widening of the current account balance in late 2012 and 2013, accounting for about one quarter of the increase in the current account deficit. - The worsening current account reflects recovery of investment and relatively low savings: - Both private and public savings are relatively low compared with other emerging economies. - Since 2004, consumption, both public and private, has accounted for almost all the growth in Brazil. - Policy implications to bolster savings: reform the pension system and contain the rate of growth of public consumption. - Outlook under unchanged policies and at the current level of the real exchange rate: - The current account deficit is expected to widen further over the medium term to about 3¾ percent of GDP. - This outlook assumes buoyant import growth and some gradual worsening in the terms of trade. - Uncertainty from development of off-shore (“pre-sal”) oil potential is considerable. - Staff estimates: the oil balance is expected to improve by half of one percentage point of GDP from 2012 to 2018. - Over the next decade, net oil exports are projected to increase to more than 3 million barrels per day, which would help contain the increase in the current account deficit if not offset by higher imports. ### Exchange rate and relative prices - The real effective exchange rate (REER) rose substantially since the early 2000s through mid-2011, but has depreciated since then, partly reversing prior appreciation. - Since end-2012, the REER depreciated by about 4 percent. - The REER remains about 15 percent above its long-term average levels. - Most REER movement was due to changes in the nominal effective exchange rate; in recent years inflation differentials have contributed more. - Terms of trade have increased about 30 percent since 2004, contributing to appreciation (with some reversal since late 2011). - Unit labor costs have grown much faster—by about 150 percent for the same period—driven by high nominal wage increases and tighter labor market conditions. ### Model-based current account and exchange rate valuations - Model-based estimates suggest the current account deficit is somewhat larger than its medium-term norm and the real exchange rate is on the strong side. - Staff analysis suggests: - A structural current account deficit of about 1–2 percent of GDP over the medium term would be consistent with fundamentals and desirable policies. - A real exchange rate depreciation of about 10–15 percent would be consistent with fundamentals and desirable policies. - Range of model estimates: - The IMF’s External Balance Approach and the traditional CGER approach suggest norms for the medium term current account deficit in Brazil in the range of 0.8–2.5 percent of GDP (estimates could understate the norm given upside uncertainty on oil production and export prospects). - Estimates for real exchange rate misalignment (EBA RER and CGER) indicate an overvaluation of about 9–20 percent relative to current and medium-term fundamentals. - Memorandum items (percent of GDP, unless otherwise noted) preserved from staff tables: - Change in REER relative to the reference period (%) 4/-4.0 - Actual C A/Y (2012) -2.3 - Cyclically Adjusted C A/Y (2012) -1.8 - Medium term C A/Y (2018) -3.7 ### Capital account flows, international reserves, and international investment position - Post-global crisis, Brazil attracted sizable capital inflows that helped finance the current account deficit and contributed to currency appreciation. - Foreign capital inflows reached 5¼ and 7½ percent of GDP in 2009 and 2010, respectively; portfolio flows contributed about half of total inflows. - Since mid-2011, capital inflows moderated to about 4½ percent of GDP in 2012, with the share of portfolio flows declining to about 15 percent. - Factors behind moderation: global uncertainty, tightening of capital flow measures (CFMs), a substantial slowdown in growth, and reduction in interest rate differentials driven by a cumulative cut in the policy rate of 525 bps. - Policy toolkit used to manage capital flows: exchange rate appreciation, reserves accumulation, macroprudential tools, and price-based CFMs (notably the tax on inflows, IOF). - IOF implementation adjusted rates and coverage, including on derivatives; IOF on fixed income instruments and net currency derivative positions was reduced to zero in June 2013. - Evidence: - CFMs appear to have been successful in helping reduce portfolio inflows, though evidence on a persistent effect on the exchange rate is unclear. - Central bank intervention focused on reducing exchange rate volatility: - With moderation of inflows, reserve accumulation pace stopped in 2012. - International reserves have stabilized at around US$380 billion and are considered more than adequate by various metrics, including the IMF’s composite adequacy measure. - Further temporary reserve accumulation may occur to manage capital flows. - In June 2013, the central bank conducted currency swap auctions for a total amount of about $20 billion. - Net foreign asset (NFA) position: - NFA strengthened from -45 percent of GDP in 2003 to -30 percent in 2012. - FDI liabilities account for about half of total liabilities. - Brazil’s NFA position and external debt levels are relatively low compared with other emerging market economies. - With envisaged widening of the current account deficit (at a constant real exchange rate), the NFA position would worsen over the medium term. - In the longer run, as “pre-sal” oil reserves come on line, added efforts to increase savings and strengthen the external NFA position would be appropriate. *INTERNATIONAL MONETARY FUND.* ### 7. Fiscal measures, particularly cuts in payroll taxes paid by employers, may have also ### _cr13312 - 7. Fiscal measures, particularly cuts in payroll taxes paid by employers, may have also ### Payroll tax cuts and labor demand - Most literature on Brazil’s labor market finds that payroll tax cuts tend to reduce unemployment. - The burden of the social security tax paid by employers has been reduced for various sectors a number of times during 2011–12. - Initially focused on the manufacturing sector, these payroll measures have been broadened over time and now encompass a wide range of sectors, including some services. - Measures aiming at reducing the payroll tax burden, including rates cuts and other changes, have been implemented 13 times in total during 2011–12 according to the Secretariat of the Federal Revenue of Brazil. - Empirical finding cited: Bosh and Esteban-Pretel (2009) found that payroll tax cuts, by boosting labor demand, tend to increase formal employment and reduce unemployment rate (a non-neutral effect). - Contextual note in source: Brazilian companies have been constrained by the hiring process where fixed contracts are prohibited for activities involving permanent tasks, particularly during the last two years when manufacturing GDP growth has declined substantially. ### Public banks’ rapid expansion and role in credit supply - Public banks have increased their lending operations very rapidly since the global financial crisis. - Mandates and focal areas: - Caixa focuses on housing loans. - Banco do Brasil supplies a large amount of rural credit. - BNDES provides financing for long-term investments in economic development programs. - Demand-management role: public banks helped offset private banks’ slower credit supply to sustain overall credit growth. Key statistics and developments: - In 2011 and 2012, lending by public banks grew over 25 percent per annum on average, compared to about 10 percent of private banks. - Public banks’ share of total credit increased to 48 percent. - Caixa expanded its credit portfolio by over 40 percent in this period. - In 2012, the Treasury lent 1 percent of GDP to BNDES and 0.5 percent to Caixa and Banco do Brasil. - By end-2012, total net obligations from public banks to the Treasury stood at 9.2 percent of GDP, of which 8.4 percent were with BNDES. - The long-term interest rate (TJLP)–the rate public banks pay on obligations to the Treasury—was reduced by 100 bps to 5 percent during 2012, with the lower rate applying to all outstanding loans. - BNDES increased its share of loans to 10 largest customers from 38.7 to 40.9 percent. - Mortgage loans increased about threefold from 2.3 to 6.8 percent of GDP after the financial crisis with Caixa’s share at about 70 percent of the total. - Banco do Brasil continued to expand both payroll-deducted loans and rural credit. - Caixa raised the share of overdraft, credit card, and non-payroll personal loans in its portfolio in 2012. *Source: IMF staff text in _cr13312 - 7. and Annex III. Public Banks’ Rapid Expansion.* ### 4. Rapid credit growth by public banks, particularly Caixa, warrants close monitoring. ### _cr13312 - 4. Rapid credit growth by public banks, particularly Caixa, warrants close monitoring. ### Public banks' risk profile and lending practices - Public banks’ credit portfolios have traditionally been less risky than those of private banks because of: - subsidized lending rates; - prudent loan-to-value ratios for mortgage loans and government guaranteed low-income housing loans (Caixa); - lending to low credit risk borrowers (BNDES). - Currently, public banks have low default rates: 2 percent. - Sources: Central Bank of Brazil; and IMF staff calculation. ### Capitalization and profitability - Public banks are capitalized above regulatory requirements: 11 percent. - Public banks’ return on assets dropped sharply in 2012, with reduced profit margins from lower lending rates. - Public banks’ capital adequacy ratio (CAR) has continued to decline. - Regulatory requirement (Total) = 11 percent. - Regulatory requirement (Core Tier 1) = 5.5 percent. - Charts/source indicators referenced: Central Bank of Brazil; and IMF staff calculation. ### Caixa-specific developments and risks - Caixa’s capitalization is close to minimum regulatory requirement. - Caixa’s NPL ratios by vintage show recently a marginal uptick. - Caixa: non-mortgage loan concession composition noted over periods 2008–2013Q1 (categories include Other loans, Payroll-deducted, Credit card, Overdraft, Other personal loans, Working capital, Rural credit, Other commercial credit). - Caixa: NPL ratios for mortgage loans by vintage and for non-mortgage loans by vintage are presented (vintages from 2007Q1 to 2012Q2 at 3 months, 6 months, 12 months, 18 months, 24 months horizons) and indicate rising patterns in recent vintages. ### Comparative indicators across public and private banks - NPL Ratio (December 2012) shown for: BNDES, CAIXA, BB, Top 10 private banks. - Capital Adequacy Ratio (December 2012) shown for: BNDES, CAIXA, BB, Top 10 private banks. - Return on Assets series displayed for Public Banks vs. Private banks (domestic and foreign) with Total (average over 2005-11) for periods Jan-11 to Sep-12, showing public banks’ returns weakened in 2012. - Capital Adequacy Ratio series displayed for Public banks vs. Private banks with minimum requirement (11%) line for Jan-11 to Sep-12, showing public banks approaching the minimum. ### Monitoring implications and takeaways - Rapid credit expansion in recent years at public banks represents a risk that warrants close monitoring. - Key signals to monitor: - continued decline in CAR for public banks; - Caixa capitalization relative to the regulatory minimum; - NPL ratios by vintage, especially recent upticks for Caixa; - profitability metrics (return on assets) following margin compression from lower lending rates. *Sources: Central Bank of Brazil; and IMF staff calculation.* ### 1. Pernambuco 2nd DPL ### 1. Pernambuco 2nd DPL ### B. Investment lending - Rio Grande do Norte IPF - Rio State Strengthening Public Management TAL - Alagoas Extreme Poverty IPF - Multi-Sector Espírito Santo - Multi-Sector Ceará P4R - Multi-Sector ProAcre Additional Financing - Multi-Sector Alto Solimões Additional Financing - Sergipe State IPF - Multi-Sector Piauí IPF - Multi-Sector Fortaleza Municipal - Bahia Transport Development - Recife Municipal DPL - Additional Financing Teresina Municipal - Paraíba Rural & Agricultural ### C. Analytical advisory services - Intergovernmental Finance (DLW) - Logistics and Trade Facilitation in Brazil NLTA - Leveling the Playing Field: Improving the Sustainable Protection and Promotion of Vulnerable Population - Involuntary Resettlement Policy TA - Rio de Janeiro Low Carbon City Development Program - Economic and Fiscal Impact of Natural Disasters - Pensions Brazil ### Country Studies Pipeline - Pernambuco State Equity Assessment - Brazil Productivity - Review of PPP Practice in Brazil - Chronic disease and the health system - Land Governance Assessment - Brazil: Skill and Jobs - (MST) Metropolitan Governance ### Implementation timing and IMF work program in the next 12 months - June 2013 - June 2013 - FY 14 (multiple entries for several items) - Second half of 2013: Technical Assistance — Performance budgeting and cost accounting (State of Sao Paulo) - Staff visit: November 2013 - Article IV mission: May 2014 - FY 14: additional items indicated - July 2014 ### Relations with the Inter-American Development Bank (IDB) - The IDB’s New Country Strategy with Brazil approved on May 9, 2012, for the period 2012–2014 with 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. - For 2013, total loan approvals are estimated to reach US$3,546 million, including US$1,530 million in Policy-Based Loans to four States (Amazonas, Alagoas, Pernambuco and Rio Grande do Sul). - The IDB program in the period estimates approvals of US$42.5 million in grants for Technical Cooperation. - In 2012, the IDB approved 23 loans amounting to US$2,009 million. - Distribution noted: institutional strengthening and modernization of the state (43%) and productivity and infrastructure (34%). - Lending to subnational governments corresponded to 66% of total lending to Brazil, and included two Policy-Based Loans (Rio Grande do Sul and Bahia) for US$800 million. - Brazil is the largest IDB borrower. Current active portfolio: - 101 loans to the public sector (US$9,463 million) - 9 loans to the private sector (US$584 million) - Brazil’s outstanding debt with the IDB amounts to US$14,340 million (as of end 2012). - From the current portfolio US$6,931 million have not been disbursed yet (as of June 2013). ### Loans Approved 2012 (IDB) — in US$ million (as presented) - Subnational gov.: 343.52; 669.21; 252.01; 60.00; 1,324.74; 16.00 - Central gov.: -; -; 610.00; 66.00; 676.00; 3.00 - Private sector: -; 9.00; -; -; 9.00; 4.00 - Total: 343.52; 678.21; 862.01; 126.00; 2,009.74; 23.00 ### STATISTICAL ISSUES (As of June 28, 2013) I. Assessment of Data Adequacy for Surveillance - General: The quality of macroeconomic statistics has improved significantly, and data provision is adequate for surveillance. - National Accounts: - Compiled based on the guidelines of the 1993 System of National Accounts. - Annual and quarterly supply and use tables available. - Series available on the internet (http://www.ibge.gov.br) and in International Financial Statistics (IFS). - Price Statistics: - Since July 1999, the official consumer price index is the Broad Consumer Price Index (IPCA) compiled by IBGE. - IPCA covers households earning between one and forty times the minimum wage in 11 metropolitan areas. - Wholesale price indices compiled by Getúlio Vargas Foundation (FGV). - IBGE compiles a monthly producer price index of manufacturing activity with a December 2009 base. - Government Finance Statistics: - Ministry of Finance and the Brazilian Central Bank (BCB) compile and disseminate GFS using GFSM 2001 presentation. - Reported statistics include consolidated central government and general government financing operations. - Reported data are compiled by converting nationally published data that still broadly follow GFSM 1986. - Data reflect movements of the single treasury account and are on a cash basis except for interest. - Gross debt indicator excludes government securities under the central bank’s outright ownership. - In 2009 authorities developed a migration plan for full implementation of GFSM 2001, including a new accounting framework based on IPSAS, expected to be in place in 2015. - Monetary and Financial Statistics: - BCB compiles and publishes statistics broadly in line with MFSM 2000. - Standardized report forms based on accounting data introduced in March 2013. - Institutional coverage needs expansion to include insurance corporations, open pension funds, capitalization funds, and exchange houses. - BCB reports quarterly FSIs to the IMF: all core and 17 encouraged FSIs, with data beginning in Q1 2005; plans to compile the rest of the encouraged FSIs. - External Sector Statistics: - Brazil disseminates quarterly balance of payments and international investment position data. - External data compiled according to the fifth edition of the Balance of Payments Manual. - BCB supplementing the registry of the foreign exchange system with surveys on transportation, insurance, and other services. - Compilation of reinvested earnings and undistributed branch profits could be improved. - Quarterly balance of payments data are reported. 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 database. II. Data Standards and Quality - Subscriber to the Fund’s Special Data Dissemination Standard (SDDS) since 2001. - Uses SDDS flexibility options on the timeliness of the general government operations and depository corporations survey. - Implementing G-20 DGI recommendations; further progress would focus on monetary and financial statistics, external position and flow statistics, real estate price indexes, general government statistics, and sectoral accounts. - No data ROSC is publicly available. Brazil: Table of Common Indicators Required for Surveillance (As of June 28, 2013) — selected entries and observation/receipt dates - Exchange Rates: Date of Latest Observation 5/31/13; Date Received 5/31/13; Frequency of Data D; Frequency of Reporting D; Frequency of Publication 5/31/13 - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: 5/31/13; 6/4/13; D; D; D - Reserve/Base Money: May 13; 6/18/13; D; D; D - Broad Money: April 13; 6/4/13; M; M; M - Central Bank Balance Sheet: May 13; 6/18/13; M; M - Consolidated Balance Sheet of the Banking System: April 13; 6/4/13; M; M; M - Interest Rates: 5/31/13; 6/4/13; D; D; D - Consumer Price Index: May 13; 6/07/13; M; M; M - Revenue, Expenditure, Balance and Composition of Financing – General Government: December 12; 5/13/13; M; M; M - Revenue, Expenditure, Balance and Composition of Financing – Central Government: May 13; 6/25/13; M; M; M - Stocks of Central Government and Central Government-Guaranteed Debt: May 13; 6/24/13; M; M; M - External Current Account Balance: May 13; 6/21/13; M; M; M - Exports and Imports of Goods and Services: May 13; 6/3/13; M; M; M - GDP/GNP: Q1 2013; 5/29/13; Q; Q; Q - Gross External Debt: May 13; 6/21/13; M; M; M - International Investment Position: May 13; 6/21/13; Q; Q; Q Notes (as presented) - 1: Any reserve assets that are pledged or otherwise encumbered should be specified separately... - 2: Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds. - 3: Foreign, domestic bank, and domestic nonbank financing. - 4: The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments. - 5: Including currency and maturity composition. - 6: Includes external gross financial asset and liability positions vis-à-vis nonresidents. - 7: Daily (D); weekly (W); monthly (M); quarterly (Q); annually (A); irregular (I); and not available (NA). ### Statement by the IMF Staff Representative on Brazil — Executive Board Meeting July 26, 2013 - The note reports on information available since the staff report and does not alter the thrust of the staff appraisal. - Monetary policy: - The central bank of Brazil continued tightening monetary policy, raising the policy rate by 50 bps to 8.50 percent in its July Monetary Policy meeting, for a cumulative 125 bps since April. - Staff baseline projections were in line with the tightening. - Headline inflation as of end-June was 6.7 percent year-on-year, above the ceiling of the inflation tolerance band (6.5 percent), but has started to decelerate at the margin linked in part to lower food inflation. - Social demonstrations: - A wave of social demonstrations in early June appears to have subsided. - Protests were nationwide and grievances included poor quality of public services, slow progress in fighting corruption, and dissatisfaction with institutions and political parties. - Government responses include: strengthening fiscal controls at all levels of government to help reduce inflation; organizing a plebiscite on political reform to eradicate corruption; stepping up investment in hospitals; increasing investment in urban transportation and reducing some taxes on diesel; earmarking for education the royalties from some oil concessions. - Specific measures taken: bus fare increases were rolled back; the state of São Paulo cancelled the scheduled increase in toll fares; the import tariff for beans was reduced to zero. *Prepared from the IMF staff report content provided.* ### 4. The global re-pricing of assets that followed the change in expectations regarding the ### _cr13312 - 4. The global re-pricing of assets that followed the change in expectations regarding the ### Global re-pricing and financial market impact (May–June) - Asset price volatility increased substantially in May-June following changes in expectations regarding the pace of normalization of U.S. monetary policy, but has subsided more recently. - Exchange rate and intervention: - The real has depreciated by about 5 percent in nominal terms against the US dollar since end-May. - The real depreciated by 2 percent in nominal effective terms since end-May. - Occasional central bank intervention through non-deliverable foreign currency swaps was used to limit excess volatility. - Interest rates and yields: - Local currency sovereign bond yields have increased by about 120 bps during the same period, reflecting global factors and expected tightening of monetary policy in Brazil. - Equities and other spreads: - Equity prices underperformed other emerging markets, linked in part to weaker growth prospects. - CDS and EMBIG spreads have moved broadly in line with emerging market peers. - Authorities’ measures in response: - Eliminated the term for pre-payment of exports subject to the Financial Transaction Tax (IOF). - Lowered to zero the rate for reserve requirements on short dollar positions held by local banks. - Reduced the capital requirements on bank exposure to currency fluctuations. - Further easing of capital flow management measures (CFMs) adopted in recent years. ### Macroeconomic context and outlook - Growth and demand: - Brazil’s economy is recovering gradually from the slowdown that began in mid-2011. - After a protracted period of weakness, investment has begun to recover in recent quarters while business confidence has firmed. - With the economy estimated to be operating close to potential, supply-side constraints have restrained near-term growth and exacerbated inflationary pressures. - Low unemployment has contributed to demand-pull and cost-push inflation pressures. - Inflation: - End-of-period inflation, the reference measure for inflation-targeting in Brazil, has been below the upper limit of the 4½ ± 2 percent target range for several years; it has been running in the upper range of the target band. - Medium-term inflation expectations have risen above the mid-point target. - The authorities have started to focus on alleviating supply-side constraints and containing inflationary pressures by tightening monetary policy. - External sector and capital flows: - The external current account deficit has widened, reflecting weaker external demand, buoyant consumption, a pickup in investment, and temporary disruptions in oil production. - The real exchange rate depreciated over the last year, most recently as part of a broader realignment across emerging markets. - Unit labor costs in U.S. dollars have remained broadly unchanged, limiting the impact on competitiveness. - Capital inflows, particularly portfolio flows, subsided in 2012 linked to a weaker growth outlook and lower interest rates in Brazil, and the use of capital flow measures. - More recently, global financial volatility and higher global risk aversion have further dampened portfolio inflows. - Equity prices declined and corporate debt and equity issuances slowed; foreign direct investment inflows remained robust. - International reserves remained broadly stable at a high level following a halt in reserves accumulation since mid-2012. - Financial conditions: - Financial conditions have tightened but credit growth has remained strong, driven by public banks’ lending. - Mortgage lending has continued to grow strongly, but remains a relatively small share of total credit. - Real estate prices, though moderating, have continued to increase. - Authorities made progress implementing key recommendations of the 2012 Financial Sector Assessment Program (FSAP) Update. ### Fiscal policy, public debt, and policy stance - Fiscal outcomes and targets: - The overall deficit of the consolidated public sector fell from 5.2 percent of GDP in 2003 to 2.5 percent in 2012. - Authorities reaffirmed commitment to a primary balance of 2.3 percent of GDP in 2013. - An additional reduction in current expenditure of 10 billion reais (0.2 percent of GDP) was announced for 2013; investment and priority spending in areas such as health, education and social transfers were not affected. - Fiscal stance and cyclical policy: - According to IMF staff estimates of changes in the structural primary balance, fiscal policy was contractionary in 2011, expansionary in 2012, and projected to be roughly neutral in 2013. - If “policy lending” is included in the structural primary balance as IMF staff does, the overall stance, broadly defined, was projected to turn contractionary in 2013 even before the additional measures announced. - Composition and improvements: - From 2002 to 2012 the wage bill dropped from 4.8 to 4.3 percent of GDP. - Interest payments fell from 7.7 to 4.9 percent of GDP over the same period. - The deficit in the social security system fell from 1.7 percent of GDP in 2007 to 0.9 percent of GDP in 2012. - Public debt dynamics and measurement issues: - Consolidated net public debt declined from 60 percent of GDP in 2002 to 35 percent in 2012. - Gross debt as defined in the staff report declined from 80 to 68 percent of GDP over the same period. - Discrepancy between net and gross debt reductions largely associated with accumulation of international reserves since 2006 and lending by the treasury to public financial institutions. - Measurement of gross public debt is contentious: staff’s definition includes all treasury securities held by the central bank; authorities argue exclusion of securities not used in liquidity-absorption repos is appropriate. ### Executive Board assessment and recommended policy priorities - Commendations: - Directors commended the authorities for long-standing commitment to sound policy frameworks: the fiscal responsibility law, inflation targeting, the flexible exchange rate, and a strong prudential regime. - Noted that these frameworks, together with social programs, underpinned macroeconomic stability and remarkable growth over the past decade, lifting living standards and reducing poverty. - Policy guidance: - Agreed that monetary policy should remain geared at containing inflationary pressures and anchoring inflation expectations; welcomed initiation of a monetary tightening cycle. - Recommended a steady, measured pace of fiscal consolidation anchored on Brazil’s long-standing primary surplus target. - Some Directors saw a continued role for fiscal stimulus as a counter-cyclical tool; generally, monetary policy should play the main role in aggregate demand management with fiscal policy focused on rebuilding buffers. - Highlighted importance of adhering to a primary surplus target that places public debt on a downward path. - Encouraged maintaining fiscal discipline at the sub-national level, easing budget rigidities to increase public savings, and recognizing fiscal risks associated with public bank assets and infrastructure concession agreements. - Recommended a gradual reduction of policy lending to public banks to improve debt dynamics. - Suggested more detailed assessment of Brazil’s public debt encompassing net and gross concepts for enhanced interpretation of fiscal developments. - Financial sector and exchange rate: - Welcomed progress in strengthening financial regulation and supervision; noted Brazilian banking system is sound and well placed to implement Basel III ahead of schedule. - Urged ongoing vigilance regarding risks associated with household credit and mortgage loans. - Concurred that the flexible exchange rate remains the main shock absorber and welcomed intention to limit FX interventions to moderating excessive volatility. - Agreed Brazil has an adequate toolkit to deal with capital inflow pressures, including allowing some exchange rate appreciation, temporary reserve accumulation, and carefully-considered capital flow management measures. - Structural reforms to boost supply and productivity: - Supported reforms to ease supply-side constraints; government’s market-based concessions program expected to boost investment and alleviate infrastructure bottlenecks. - Emphasized comprehensive efforts to boost productivity, competitiveness, and investment are critical for raising potential growth. - Recommended increasing domestic saving, improving the minimum wage indexation mechanism, and continuing pension system reform. - Suggested streamlining taxation and improving business conditions to foster private investment. ### Selected key statistics and indicators (2006–2012) - National accounts (annual percentage changes): - GDP at current prices: 2006: 10.4; 2007: 12.3; 2008: 13.9; 2009: 6.8; 2010: 16.4; 2011: 9.9; 2012: 6.3 - GDP at constant prices: 2006: 4.0; 2007: 6.1; 2008: 5.2; 2009: -0.3; 2010: 7.5; 2011: 2.7; 2012: 0.9 - Private consumption: 2006: 5.2; 2007: 6.1; 2008: 5.7; 2009: 4.4; 2010: 6.9; 2011: 4.1; 2012: 3.1 - Gross Investment: 2006: 8.0; 2007: 15.6; 2008: 15.6; 2009: -17.7; 2010: 31.1; 2011: 3.1; 2012: -9.0 - Exports: 2006: 5.0; 2007: 6.2; 2008: 0.5; 2009: -9.1; 2010: 11.5; 2011: 4.5; 2012: 0.5 - Imports: 2006: 18.4; 2007: 19.9; 2008: 15.4; 2009: -7.6; 2010: 35.8; 2011: 9.7; 2012: 0.2 - 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: 5.4 - 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: 5.8 - GDP deflator: 2006: 6.1; 2007: 5.9; 2008: 8.4; 2009: 7.1; 2010: 8.3; 2011: 7.0; 2012: 5.4 - Terms of trade: 2006: —; 2007: 5.3; 2008: 2.1; 2009: 3.5; 2010: -3.2; 2011: 17.0; 2012: 7.8; 2013: -5.8 (as listed) - Public finances (in percent of GDP): - Federal government nonfinancial revenue 2/: 2006: 23.0; 2007: 23.3; 2008: 23.6; 2009: 22.8; 2010: 24.4; 2011: 23.9; 2012: 24.1 - Primary expenditure: 2006: 20.9; 2007: 21.1; 2008: 20.6; 2009: 21.0; 2010: 22.6; 2011: 21.6; 2012: 22.5 - Primary balance: 2006: 2.2; 2007: 2.2; 2008: 2.8; 2009: 1.3; 2010: 1.8; 2011: 2.2; 2012: 1.7 - Nonfinancial public sector primary balance: 2006: 3.3; 2007: 3.5; 2008: 4.1; 2009: 2.2; 2010: 2.5; 2011: 3.2; 2012: 2.1 - Net interest payments: 2006: 6.8; 2007: 6.1; 2008: 5.5; 2009: 5.3; 2010: 5.2; 2011: 5.7; 2012: 4.9 - Overall balance: 2006: -3.5; 2007: -2.7; 2008: -1.4; 2009: -3.1; 2010: -2.7; 2011: -2.5; 2012: -2.8 - Policy lending 3/: 2006: -2.3; 2007: -2.7; 2008: -2.1; 2009: 3.2; 2010: 2.7; 2011: 1.0; 2012: 1.5 - Nonfinancial public sector gross debt 4/: 2006: 67.0; 2007: 65.2; 2008: 63.5; 2009: 66.8; 2010: 65.0; 2011: 64.7; 2012: 68.0 - Public sector net debt 5/: 2006: 47.3; 2007: 45.1; 2008: 38.0; 2009: 41.5; 2010: 39.1; 2011: 36.4; 2012: 35.2 - Money and credit (12-month percentage changes): - Base money 6/: 2006: 12.6; 2007: 21.8; 2008: -17.4; 2009: 11.3; 2010: 131.8; 2011: 10.8; 2012: -13.6 - Broad money (M2) 7/: 2006: 18.0; 2007: 18.7; 2008: 17.8; 2009: 16.3; 2010: 15.8; 2011: 18.5; 2012: 16.6 - Credit to the private sector: 2006: 21.7; 2007: 30.1; 2008: 28.1; 2009: 13.7; 2010: 23.0; 2011: 20.2; 2012: 15.8 - Balance of payments (in 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: -54.2 - Merchandise trade balance: 2006: 46.5; 2007: 40.0; 2008: 24.8; 2009: 25.3; 2010: 20.1; 2011: 29.8; 2012: 19.4 - Exports: 2006: 137.8; 2007: 160.6; 2008: 197.9; 2009: 153.0; 2010: 201.9; 2011: 256.0; 2012: 242.6 - Imports: 2006: -91.4; 2007: -120.6; 2008: -173.1; 2009: -127.7; 2010: -181.8; 2011: -226.2; 2012: -223.2 - Services, income, and current transfers (net): 2006: -32.8; 2007: -38.5; 2008: -53.0; 2009: -49.6; 2010: -67.4; 2011: -82.3; 2012: -73.6 - Capital and financial account: 2006: 16.3; 2007: 89.1; 2008: 29.3; 2009: 71.3; 2010: 99.6; 2011: 109.4; 2012: 76.7 - Foreign direct investment (net): 2006: -9.4; 2007: 27.5; 2008: 24.6; 2009: 36.0; 2010: 36.9; 2011: 76.0; 2012: 68.1 - Portfolio investment (net): 2006: 4.3; 2007: 37.9; 2008: 3.5; 2009: 50.5; 2010: 56.4; 2011: 31.2; 2012: 8.2 - Change in net international reserves: 2006: 32.0; 2007: 94.5; 2008: 13.4; 2009: 44.7; 2010: 50.1; 2011: 63.4; 2012: 21.1 - Current account (in percent of GDP): 2006: 1.3; 2007: 0.1; 2008: -1.7; 2009: -1.5; 2010: -2.2; 2011: -2.1; 2012: -2.4 - Outstanding external debt (in percent of GDP): 2006: 15.8; 2007: 14.1; 2008: 12.0; 2009: 12.2; 2010: 12.0; 2011: 12.1; 2012: 14.1 - Debt service ratio (in percent of exports of goods and services): 2006: 45.4; 2007: 44.8; 2008: 24.8; 2009: 34.2; 2010: 25.9; 2011: 23.0; 2012: 23.6 - Gross reserves/short-term external debt (residual maturity, in percent): 2006: 100.0; 2007: 231.3; 2008: 235.5; 2009: 314.6; 2010: 269.8; 2011: 394.6; 2012: 474.3 *IMF Executive Board Concludes 2013 Article IV Consultation with Brazil; Press Release No. 13/314; July 26, 2013; August 28, 2013.* ### 12. It should be noted that the Brazilian authorities adopted this methodology back in ### _cr13312 - 12. It should be noted that the Brazilian authorities adopted this methodology back in ### Public debt and fiscal metrics - Brazilian authorities adopted the referenced methodology in 2008 in a transparent and consistent manner. - According to this methodology, the gross debt to GDP ratio of the general government was 58.7 percent in December 2012. - IMF staff’s preferred definition overestimates the ratio of gross government debt to GDP by almost 10 percentage points. - Under the IMF staff’s definition, gross public debt was 64.2 percent in May 2013. - The May 2013 ratio (64.2 percent) is 3.2 percentage points lower than at the end of the previous year and 1.7 percentage points lower than in May 2012. - The ratio of gross debt to GDP has declined since 2002 (as shown in the referenced figure, noting staff omitted the most recent data point). - Public debt profile improvements over the last decade: - Fixed interest rate securities: 41.2 percent of total federal debt at end-2012 versus 2.2 percent in 2002. - Exchange rate-linked debt: 0.6 percent of total debt at end-2012 versus 22.4 percent in 2002. - Considering external assets, the Brazilian public sector is a net external creditor by as much as 14 percent of GDP, providing an automatic debt stabilizer when the currency depreciates. ### Monetary and financial sector policies - Policy rate actions: - From August 2011 to October 2012 the Central Bank of Brazil (BCB) lowered the policy rate by 525 basis points to 7.25 percent. - Twelve-month consumer inflation reached 6.6 percent in March 2013. - Beginning April 2013 the BCB started to gradually increase the policy rate; it now stands at 8.5 percent. - Monetary and fiscal policies are being tightened despite growth recovery having only recently begun. - Inflation expectations: BCB’s weekly survey indicates inflation is expected to close 2013 at the same level as 2012 and within the target range for the tenth consecutive year. - Financial sector regulation and supervision: - Recognized as traditionally strong by IMF staff and in last year’s FSAP. - Most 2012 FSAP recommendations have been implemented or are in process; some recommendations (e.g., creating a multi-partite, high-level financial stability committee) are not considered appropriate by authorities. - Existing coordination mechanisms cited: - Financial Stability Committee placed in the central bank. - Committee for Regulation and Supervision of Financial, Capital, Insurance, Pension and Capitalization Markets (COREMEC). - Several Memoranda of Understanding between financial regulators. - National Monetary Council (CMN) as top-level coordination body. - Non-performing loans (NPLs) and credit: - Overall credit-to-GDP ratio has almost doubled over the last 8 years. - Private banks’ NPLs are below 5 percent of total loans. - Public banks’ NPLs have been stable at about 2 percent of total loans. - Housing credit accounts for only 7 percent of GDP despite rapid growth from a low base. - Recent credit growth has moderated and housing prices have stabilized. - BCB considers staff’s concerns about financial stability and a possible large real estate correction to be overdone. - Bank capital and Basel III: - Central bank simulations (Box 9) show most banks will not need to raise additional capital to comply with Basel III rules. - Implementation of the Basel III parameters will start in October 2013 and follow the internationally agreed timeline. ### External sector - Current account and financing: - Current account deficit in 2012 was 2.4 percent of GDP, entirely financed by FDI inflows. - In 2013 the current account deficit rose and the central bank projects a deficit of 3.2 percent of GDP, nearly 90 percent of which covered by FDI. - External position: - High international reserves: US$ 369 billion dollars at end-June 2013. - Use of CFMs in times of abundant international liquidity has helped limit external vulnerability by containing excessive portfolio and other volatile capital flows. - Capital markets and FDI: - National treasury bonds (Global 2023) issued in September 2012 and May 2013 at yields of 2.7 and 2.8 percent per year respectively—the lowest rates ever for a Brazilian external bond issuance. - Foreign direct investment (FDI) reached US$ 65 billion in the prior year, positioning Brazil as the world’s fourth largest investment destination per UNCTAD 2013 World Investment Report. ### Investment and employment - Investment trends: - Staff report may be excessively negative; indicators show investment has begun to recover. - National Account data: investment rebounded since Q4 2012; in Q1 2013 the annualized quarter-over-quarter expansion reached almost 20 percent. - Infrastructure and programs: - Infrastructure investments have tripled in real terms over the last ten years, reaching about US$ 100 billion in 2012 (Finance Ministry data). - Growth Acceleration Program (PAC) phase two showing results in urban development, transportation and energy. - Logistics Investment Program (PIL) launched to renew and integrate transportation network via concessions (highways, railways, airports, ports); auction for first high-speed train construction/operation scheduled for next September. - Government proceeding with 11th and 12th bidding rounds for gas exploration and first bidding round of the pre-salt oil layer. - Electricity sector auctions between 2013 and 2017 for generation of 33,000 MW and installation of 23,200 kilometers of transmission lines. - Tax benefits and facilitating measures enacted for resident and nonresident investors, including infrastructure debentures and receivables investment funds (FDICs). - Competitiveness measures: - Payroll tax relief for 40 economic sectors. - New automotive regime for 2013-2017. - Program for reducing energy costs. - Labor market and social outcomes: - Net creation of formal jobs in 2012 reached 1.3 million. - Urban unemployment rate fell to 5.5 percent in 2012 (a historical low). - More than 16 million formal jobs created in the last ten years. - Share of employed population with 11 years or more of schooling increased from 33.6 to 46.3 percent since 2004. - Expansion of the formal labor market, targeted transfers to low-income households, and higher education levels have driven millions out of poverty and improved income distribution. *Source: _cr13312 - 12. It should be noted that the Brazilian authorities adopted this methodology back in* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13312.pdf_