## _cr15121 (IMF staff report excerpts)

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### Growth outlook and macroeconomic context
- Growth has decelerated markedly; economy stalled in 2014 with contractions in Q3 2013 and the first two quarters of 2014.
- Staff projection:
  - Real GDP to contract by 1.0 percent in 2015.
  - Real GDP to grow by 0.9 percent in 2016.
  - Under limited structural reform scenario, potential growth projected to reach 2.5 percent by 2020.
- Drivers of weak growth:
  - Loss of impulse from decade-old reforms, weaker investment since 2011, loss of competitiveness, and unwarranted microeconomic interventions.
  - Investment projected to contract for a second consecutive year in 2015; lowest point since 2009, with gradual recovery late 2015 and in 2016.
  - Private consumption projected to stay flat in 2015; government consumption assumed to contract as part of fiscal consolidation.
  - Net exports expected to contribute modestly to growth given a weaker real.

### Fiscal position, public debt, and debt measurement
- Recent outcomes:
  - NFPS primary balance: 1.9 percent of GDP in 2013; ‐0.6 percent of GDP in 2014 (despite one-off measures of about ½ percent of GDP).
  - NFPS gross debt: 71 percent of GDP (end-2014).
- Authorities’ announced fiscal targets:
  - Primary surplus target of 1.2 percent of GDP in 2015.
  - At least 2.0 percent of GDP in 2016 and 2017.
- Staff assessment and recommendations:
  - An ambitious, front-loaded fiscal adjustment is imperative; additional effort estimated at 1.2−1.4 percent of GDP required to meet the 2015 target (including cyclical effects).
  - Adjustment should fall preferentially on current spending; roll-back of temporary tax breaks recommended (tax exemptions introduced in 2012–13 represent a sacrifice of revenues of 2 percent of GDP).
  - Institutional reforms: anchor fiscal policies in a medium-term framework, publish a debt-sustainability analysis, and establish an independent fiscal council.
- Debt measurement divergence:
  - Fund’s GGGD includes treasury securities held by the BCB; authorities’ national GGGD excludes BCB “free securities”.
  - The divergence was nearly 7 percentage points of GDP in 2014 under the Fund’s approach.
- Baseline DSA projections (assume policy lending stops from 2015):
  - Gross debt: 72 percent of GDP in 2015; 68.8 percent of GDP in 2020.
  - Gross financing needs projected to remain above the high risk threshold of 15 percent of GDP on average over the medium term.
  - Primary balance required to stabilize debt (excluding interest revenue): 1.6 percent of GDP.
- Stress tests (selected outcomes):
  - Growth shock: gross debt increases above 81.5 percent of GDP by 2019 and 81.1 percent in 2020; gross financing needs reach almost 23 percent of GDP.
  - Combined macro-fiscal and contingent liabilities shocks: debt-to-GDP reaches about 85 percent by 2020.

### External sector and current account
- Current account developments:
  - Current account deficit reached 4.2 percent of GDP in 2014 (from 2.4 percent of GDP in 2012).
  - Drivers: worsening terms of trade, drop in exports to Argentina, increased fuel imports due to drought.
  - Staff estimates real was some 10−20 percent overvalued on average in 2014; by December 2014 real had depreciated by 6 percent in real effective terms relative to its 2014 average.
- Financing and reserves:
  - FDI financed more than 70 percent of the current account deficit in 2014; intercompany loans accounted for about 60 percent of total FDI.
  - Gross international reserves (cash concept): about US$362 billion (also cited as USD 364 billion in authorities’ note).
- External vulnerabilities and policy advice:
  - Increase national saving (pension reform, shift public spending away from consumption).
  - Exchange rate should remain main shock absorber; FX intervention appropriate only to smooth excessive volatility and not to resist fundamentals.
  - Staff expects current account to fall to 3.4 percent of GDP by 2020; oil balance expected to improve by around 1 percent of GDP by 2020.

### Inflation, monetary policy, and FX intervention
- Inflation status and outlook:
  - Headline and core inflation near the upper-edge of the 2.5 to 6.5 percent tolerance band for several years.
  - Inflation expected to converge toward the 4.5 percent target over the medium term; bringing inflation to target by 2016 likely requires further tightening in 2015.
- Monetary policy actions:
  - SELIC raised by 375 basis points to 11 percent between April 2013 and April 2014; increased by another 125 basis points between October 2014 and January 2015 (cumulative figures also reported as 500 and 550 basis points in various sections).
  - Recommendation: maintain a tightening bias, strengthen inflation-targeting framework (narrow tolerance band, legislate terms of central bank Board members).
- FX intervention program:
  - Pre-announced intervention using FX swaps (August 2013 onward); notional outstanding FX swaps at end-2014: US$110 billion.
  - Staff recommends limiting intervention to episodes of excessive volatility and refrain from renewing program further; use rollovers to temper stock of swaps outstanding.

### Petrobras, SOEs, and contingent fiscal risks
- Petrobras developments:
  - Equity price fell by more than 80 percent in U.S. dollar terms over 5 years by end-2014.
  - Debt levels increased to be the highest in the industry.
  - 2014−18 business plan projected production to 3.2 million barrels a day in 2018 (from around 2 million barrels a day in 2013) contingent on capital expenditures of around US$221 billion over 2014−18.
  - Company announced a cut in capital expenditure of 20 percent in 2015 (late January).
  - Petrobras accounts for about 10 percent of investment in Brazil.
- Fiscal and systemic risk implications:
  - Prolonged inability to access markets could necessitate government financial support, stressing government debt objectives.
  - Corruption probe involves 27 large construction companies banned from new contracts with Petrobras; supply-chain and financing spillovers possible.
- Policy recommendations for SOEs:
  - End policy lending to BNDES; correct relative prices and reduce subsidies.
  - Adopt market-related pricing formulas for administered prices to preserve SOE balance sheets.
  - Improve transparency and governance in SOEs; strengthen internal and external oversight.

### Financial sector soundness and vulnerabilities
- Key indicators (Q3 2014 / selected):
  - Credit growth: decelerated to 11.3 percent y/y in 2014.
  - Total capital ratio: 16.5 percent.
  - Tier 1 capital ratio: 13.1 percent.
  - Provisions: 170 percent of nonperforming loans.
  - Liquidity index (BCB concept analogous to LCR as of September 2014): 190 percent.
  - Overall NPL ratio: about 3 percent (stable), with uptick in overdraft, credit card, working capital, and SME loans—especially at public banks.
- Public banks and BNDES:
  - BNDES lending profile: long maturities (up to 40 years), implicit grant element about 52 percent; NPV of credit to BNDES below 4 percent of GDP at end-2014.
  - Public banks’ NPLs historically low but delinquencies in higher-risk segments started to pick up in 2014.
- Staff recommendations:
  - Close monitoring, targeted microprudential measures, bolster capital in public banks (including retained earnings), monitor corporate overseas borrowing and hedging.
  - Stress-test findings: in high stress some banks could breach capital requirements; capital shortfall estimated to be small (less than 0.5 percent of regulatory capital).

### Social programs and distributional outcomes
- Bolsa Família (BF) and Brasil sem Miséria:
  - BF expanded to 14.0 million families (end-2014), reaching nearly 50 million people or 1/4 of the population.
  - Fiscal cost: less than 0.6 percent of GDP per year; average monthly transfer per family R$169 (US$65) at end-2014.
  - Brasil sem Miséria launched 2011 to address extreme poverty via education, labor integration, access to services.
- Social outcomes:
  - An estimated 22 million people lifted from extreme income poverty since the 2011 expansion.
  - Improvements: higher school attendance and progression; reductions in low birth weight, infant mortality, malnutrition, and diarrhea; increased breastfeeding and vaccination.
  - Targeting women as recipients strengthened women’s financial independence.
- Program administration:
  - Poverty mapping, unified registry of beneficiaries, and coordination within government strengthened.
  - BF’s budget around 0.5 percent of GDP; administrative costs less than 5 percent of total.
  - About 1.3 million people excluded from BF in 2014 for noncompliance or failing to update data.

### Structural constraints and reform priorities
- Identified impediments:
  - Relatively closed economy, complex tax system, high unit labor costs, deteriorated infrastructure, and high applied MFN tariff (around 10 percent).
  - Goods trade about just above 20 percent of GDP in 2013; smaller trade volume relative to peers (LA5, BRICS).
- Policy recommendations to boost potential growth:
  - Implement infrastructure concessions program vigorously and address impediments to private participation.
  - Reduce level and complexity of trade taxes, extend preferential trade agreements, and pursue trade facilitation.
  - Lift domestic content requirements to foster integration into global value chains.
  - Simplify ICMS and other indirect taxes; consider rolling back tax exemptions introduced in 2012–13.
  - Reform pensions and indexation (including minimum wage indexation) to improve public saving and fiscal sustainability.

### Risks (from Risk Assessment Matrix and Appendices)
- Domestic high-impact risks:
  - Drought and power rationing (Likelihood: H; Expected impact: H) — policy: keep policies tight, avoid Treasury subsidies, let prices reflect scarcity while protecting vulnerable households.
  - Falling short of the fiscal target (Likelihood: M; Expected impact: H) — policy: identify additional consolidation, focus on competitiveness.
  - Delays in resolution of the Petrobras corruption probe (Likelihood: M; Expected impact: H) — policy: strengthen governance, ease domestic-content requirements, limit public funding pressures.
- External risks:
  - Abrupt surges in global financial volatility (Likelihood: H; Expected impact: H) — policy: flexible exchange rate as shock absorber, limited FX intervention for excessive volatility, provide FX liquidity if needed, tighten policy rate and fiscal policy if required.
  - Protracted slower global growth or commodity price declines (Likelihood: H; Expected impact: H) — policy: prioritize structural reforms; exchange rate adjustment as first line of defense.
- Severe downside scenario:
  - Combination of external shocks amplified by domestic vulnerabilities could trigger sovereign downgrade, large unemployment rise, worsening social indicators, sell-off of government debt, and financial sector repercussions.

*Source: International Monetary Fund — cr15121 (IMF staff report excerpts).*

### 1. Bolsa Família and Brasil sem Miséria: The End of Extreme Poverty in Brazil________________________ 5

### 1. Bolsa Família and Brasil sem Miséria: The End of Extreme Poverty in Brazil

### Context: Disappointing Growth
- Brazil’s growth has persistently decelerated in recent years due to:
  - Loss of impulse from decade-old reforms, expanding labor income, and favorable external conditions that had enabled consumption and credit-led growth.
  - A major expansion in BNDES operations that has failed to boost investment.
  - Sluggish investment since 2011 because the economy has lost competitiveness, the business environment has worsened, and commodity prices have fallen from record highs.
  - Structural pressures on fiscal spending necessitating a high tax burden.
  - Unwarranted microeconomic interventions that reduced dynamism and increased financial stress in key sectors (energy sector electricity price subsidy in 2012; high regulatory burden slowing infrastructure implementation).
- The economy stalled in 2014:
  - Activity contracted in the third quarter of 2013 and in the first two quarters of 2014.
  - Weak investment reflects tighter financial conditions, policy drift and uncertainty (including the run up to presidential elections), with business confidence at historical lows.
  - Consumption moderated despite strong wage increases as job creation halted and financial conditions tightened; consumer confidence is below levels seen during the global financial crisis.
  - Additional 2014 headwinds included the ongoing drought and the World Cup (reduction in working days and public demonstrations impacting confidence).
- Financial market volatility and confidence:
  - Following the Fed “taper” announcement (May 2013) and in the run-up to the October 2014 elections, asset price volatility rose.
  - During 2014, the Bovespa stock exchange index fell by about 7 percent and the exchange rate against the U.S. dollar fell by about 14 percent.

### Bolsa Família (BF) and Brasil sem Miséria: Program Design and Reach
- Program features:
  - Bolsa Família (BF), created in 2003, is a conditional cash transfer program; eligibility is determined by household income per capita.
  - Conditionalities include mandatory enrollment and minimum school attendance for children and adolescents, vaccination and good nutrition for young children, and pre- and postnatal care for women.
  - Brasil sem Miséria (launched 2011) builds on BF to overcome extreme poverty by promoting educational qualification, integration in the labor market, and improved access to public services.
- Reach and fiscal cost:
  - BF expanded from initially 3.6 to 14.0 million families (end-2014), reaching nearly 50 million people or 1/4 of the population.
  - Fiscal cost is less than 0.6 percent of GDP per year.
  - The average monthly transfer per family was R$169 (US$65) at end-2014.
- Administrative improvements:
  - Poverty mapping and coordination within government were strengthened.
  - A unified registry of beneficiaries was created for monitoring recipient families.

### Social Outcomes and Impact
- Poverty reduction:
  - An estimated 22 million people were lifted from extreme income poverty alone since the 2011 expansion of the program.
  - Extreme poverty has reached historically low levels.
- Education and health outcomes for participants:
  - Higher school attendance rates, higher school progression, and lower grade repetition.
  - Reductions in low birth weight, infant mortality, malnutrition, and diarrhea among participants.
  - Increases in breastfeeding and vaccination rates.
- Gender impact:
  - By targeting women as cash recipients, BF strengthened women’s financial independence.

### Labor Market Dynamics
- Long-term trends:
  - Unemployment fell from 11.7 percent in 2002 to a record low of 4.5 percent in mid-2014; stands at 5.4 percent (January 2015).
  - Recent declines in unemployment largely reflect contraction in the labor force rather than job creation.
- Job creation and participation:
  - Net employment in industry and construction contracted since early-2014.
  - Job creation in services and commerce remained positive but weakened.
  - Labor force participation declined from late 2012, with the strongest fall among those aged 18–24 years (partly due to scholarship financing programs FIES and ProUni delaying entry into the labor market).
  - Participation rates fell across all age groups but have increased again more recently.
- Wage dynamics:
  - Real wages continued to expand above productivity, reflecting strong increases in the minimum wage and low labor-force participation.
- Outlook and risks:
  - Unemployment is likely to increase due to continued weak economic activity and recovering participation.
  - If the participation rate were to return to its 2008−2014 average of 56.8 percent, the unemployment rate could rise to 6.5 percent, other things constant.

### Petrobras: Financial Difficulties and Spillovers
- Deterioration and causes:
  - Petrobras’ equity price fell by more than 80 percent in U.S. dollar terms over 5 years by end-2014.
  - Debt levels increased to be the highest in the industry.
  - Contributing factors: expensive domestic content procurement policy, persistent delays in domestic product price increases (quasi-fiscal subsidy), diminished international oil price prospects, and serious governance problems (corruption investigation).
- Investment plans and financing:
  - 2014−18 business plan projected production growth to 3.2 million barrels a day in 2018 (from around 2 million barrels a day in 2013), contingent on capital expenditures of around US$221 billion over 2014−18.
  - In late January, the company announced a cut in capital expenditure of 20 percent in 2015 to conserve cash.
  - Further revisions to the plan may be needed given halved international oil prices and breakeven concerns under the current tax regime.
  - Access to external financing has been constrained by delayed financial statements and uncertainty over asset write-downs; auditor withholding signatures closed access to international markets in early 2015.
  - Petrobras had a large cash cushion going into 2015 but needs to regain market access to continue expanding beyond 2015.
- Fiscal and systemic risks:
  - Petrobras accounts for about 10 percent of investment in Brazil.
  - Petrobras is excluded from the public sector definition for fiscal responsibility law purposes but has become a source of fiscal risk.
  - The corruption probe involves 27 large construction companies banned from engaging in new contracts with Petrobras; these companies may face financing difficulties with potential impacts on suppliers and creditors.
  - A prolonged inability of Petrobras to access markets could necessitate government financial support, stressing government debt reduction objectives.

### Inflation and Monetary Conditions
- Inflation status:
  - Headline and core inflation have been near the upper-edge of the 2.5 to 6.5 percent inflation tolerance band for several years.
  - Drivers include sustained wage cost pressures, lingering indexation practices, and the ongoing drought.
  - Longer-term inflation expectations have risen on average.
- Price adjustments and policy responses:
  - Modest increases in regulated energy and fuel prices helped hold back inflation; overdue adjustments are underway.
  - Petrobras raised gasoline and diesel prices in November 2014.
  - Electricity tariffs increased in January 2015 with a new system of color “flags” signaling high generation costs; tariffs are expected to increase further.
  - Tighter financial conditions and a negative output gap have moderated growth in market-determined prices, though nominal currency depreciation is creating new inflation pressures.

### Central Bank Foreign Exchange Intervention
- Intervention approach:
  - In response to exchange rate volatility after the Fed’s taper announcement, the central bank launched a program of pre-announced intervention starting in August 2013 using FX swaps settled in local currency rather than spot-dollar sales.
  - The program has been renewed three times and was in effect through end-March 2015.
  - The amount auctioned daily (excluding rollovers) was reduced in two steps and is now one fifth of its initial size.
- Scale and effects:
  - Intervention helped tame the real’s volatility in the second half of 2013 and early 2014.
  - The notional amount of outstanding FX swaps at end-2014 was US$110 billion, exceeding short-term external debt on a residual maturity basis.

*Source: IMF staff report excerpt (Brazil). Prepared sections and boxes as presented in the source document.*

### 8.       Despite weakening domestic demand, the current account deficit reached 4.2 percent

### _cr15121 - 8.       Despite weakening domestic demand, the current account deficit reached 4.2 percent

### Current account and external position
- Current account deficit reached 4.2 percent of GDP in 2014 from 2.4 percent of GDP in 2012.
- Deterioration drivers: worsening terms of trade, a drop in exports to Argentina, and an increase in fuel imports necessitated by the drought.
- Recent depreciation against the U.S. dollar has not translated one-for-one into gains against competitors in global markets.
- Persistently high unit labor costs continue to dampen competitiveness.
- Staff estimates for 2014:
  - Current account was weaker than its level implied by fundamentals and desirable policy settings.
  - The real was stronger than indicated by fundamentals by about 10−20 percent on average during the year.
  - By December 2014, the real had depreciated by 6 percent in real effective terms relative to its 2014 average, implying a corresponding reduction in the degree of overvaluation.
- Ongoing statistical revisions:
  - Authorities revising external sector statistics in line with BPM6 and SNA 2008; revised BOP data expected in April 2015 and revised external debt data expected in June 2015.
  - As part of conversion: foreign holdings of domestic debt securities will be included in external debt statistics; related income will be recorded separately in the income account.
  - Staff expects these changes will lead to upward revisions of both external debt and the current account deficit.

### International reserves and capital flows
- FDI financed more than 70 percent of the current account deficit in 2014, with intercompany loans accounting for about 60 percent of total FDI.
- About 60 percent of intercompany loans reflect proceeds from overseas borrowing by foreign incorporated subsidiaries of Brazilian parent companies.
- Portfolio inflows buoyant since 2013 following central bank tightening and rollback of CFMs on capital inflows (the IOF).
- Gross international reserves (cash concept) at about US$362 billion, well above the IMF’s reserve adequacy metric and other standard benchmarks.

### Banking system soundness and private sector vulnerabilities
- Credit growth decelerated to 11.3 percent y/y in 2014.
- Real growth in home prices slowed to about 1 percent as of November 2014.
- Capital and provisioning:
  - Total capital ratio: 16.5 percent (Q3 2014).
  - Tier 1 capital ratio: 13.1 percent (Q3 2014).
  - Provisions: 170 percent of nonperforming loans.
  - Liquidity index (BCB concept analogous to LCR) as of September 2014: 190 percent.
- Funding composition:
  - Banks rely mainly on domestic funding; ratio of foreign funding to total funding at less than 10 percent.
- Leverage and FX exposure:
  - FX debt accounts for about 30 percent of the total, largely hedged.
- Emerging signs of balance sheet pressures:
  - Overall NPL ratio about 3 percent, stable.
  - Uptick in NPL ratios for overdraft, credit card, working capital, and SME loans, particularly at public banks.
- Household indebtedness and debt-service indicators (chart references retained in source).

### Macroeconomic policy mix (mid-2013 through 2014)
- Fiscal stance:
  - NFPS primary balance declined to 1.9 percent of GDP in 2013 (undershooting 2.3 percent target).
  - NFPS primary balance: ‐0.6 percent of GDP in 2014 despite one-off measures of about ½ percent of GDP.
  - Policy lending to BNDES rose in 2014, including a transfer of 0.6 percent of GDP in December.
  - Gross public debt increased to 71 percent of GDP; net public debt increased to 37 percent of GDP.
  - Net interest bill of the nonfinancial public sector in 2014: 6 percent of GDP.
  - Sovereign rating developments: Standard & Poor’s cut Brazil to BBB- in March 2014; Moody’s revised outlook to negative in September 2014.
- Monetary policy:
  - SELIC hiked by 375 basis points to 11 percent between April 2013 and April 2014.
  - Policy tightening paused May–September 2014.
  - SELIC increased by another 125 basis points between October 2014 and January 2015.
- Macroprudential policy:
  - September 2013: limits on loan-to-value (LTV) ratios for mortgages (90 percent for constant amortization mortgage loans; 80 percent for all other mortgage loans).
  - July–August 2014: selective loosening of reserve and capital requirements (including reducing risk weights on vehicle and personal loans; increasing fraction of reserve requirements usable by extending loans or purchasing loan portfolios; allowing part of reserve requirements to increase working capital loans).

### New economic team and fiscal measures (Dec 2014–Jan 2015)
- Mandate: strengthen macroeconomic policies and restore credibility.
- Fiscal adjustment strategy announced: primary surplus targets of 1.2 percent of GDP in 2015 and at least 2 percent of GDP in 2016 and 2017.
- End policy lending from the treasury to public banks as part of strategy.
- Objective to reach 4.5 percent inflation target by end-2016.
- Early measures and announcements:
  - 125 bps increase in SELIC (see above).
  - Increase in the interest rate on subsidized loans (TJLP).
  - Adjustment measures on fiscal side worth about 0.9 percent of GDP in 2015 (tightening eligibility for unemployment benefits, salary bonuses, and survivor pensions, and reintroduction of the tax on fuels).
- Box 4 highlights:
  - Government estimates measures will yield about 0.5 percent of GDP savings in 2015 from expenditure-side measures.
  - Revenue-side changes (taxes raised on fuels, household credit operations, car sales, imports, and cosmetics; vetoed PIT bracket revision) yield 0.4 percent of GDP.
  - Starting point: 2014 primary deficit of 0.6 percent of GDP, implying further measures necessary to meet 2015/2016 targets.
  - Recommendation: fiscal adjustment should fall preferentially on current spending; rolling-back temporary tax breaks would be useful given tax exemptions introduced in 2012–13 represent a sacrifice of revenues of 2 percent of GDP.

### Structural constraints to growth
- Government focuses on infrastructure concessions (transportation, energy transmission and generation, telecommunications) and oil sector opportunities (Libra pre-salt field consortium).
- Persistent structural impediments:
  - Relatively closed economy with limited integration into global value chains.
  - Uncommonly complex tax system.
  - High unit labor costs.
  - Deteriorated infrastructure and competitiveness indicators relative to competitors.
  - Average applied MFN tariff at around 10 percent while peers have lowered import taxes and expanded preferential trade agreements.

### Outlook and risks
- Staff projection:
  - Real GDP to contract by 1.0 percent in 2015.
  - Real GDP to grow by 0.9 percent in 2016.
- Projection assumptions:
  - Policy implementation consistent with recent pronouncements.
  - Infrastructure concessions program functions broadly as programmed.
  - Pre-committed Petrobras’ investment projects (after late January cuts) proceed largely as planned.
  - Cuts in Petrobras investment enter projection with a relatively large multiplier to capture collateral effects on contractors and suppliers.
  - Planned fiscal consolidation in 2015 is a modest drag on growth; fiscal drag in 2016 expected to be lower as measures’ full-year effects are internalized.
  - Staff assumes policy lending will stop.
  - Some moderate additional tightening in SELIC and TJLP in 2015; monetary stance remains tight until inflation approaches 4.5 percent target.
- Sectoral projections:
  - Investment projected to contract for a second consecutive year in 2015, reaching its lowest point since 2009.
  - Investment growth expected to recover gradually in late 2015 and 2016 as policy uncertainty abates and confidence improves.
  - Private consumption projected to stay flat in 2015; government consumption assumed to contract as part of fiscal consolidation.
  - Net exports expected to make a modest contribution to growth reflecting in part the weaker real.

*Source: IMF staff report excerpt, _cr15121 - 8. Despite weakening domestic demand, the current account deficit reached 4.2 percent.*

### 16.      Growth should gradually rise over the medium term, but its long term potential will

### _cr15121 - 16.      Growth should gradually rise over the medium term, but its long term potential will

### Growth outlook and current account
- Under a scenario of macroeconomic policy strengthening and implementation of the infrastructure concessions program, but otherwise limited structural reforms, potential growth is projected to reach 2.5 percent by 2020.
- Despite some expected further weakening in commodity prices, the current account is projected to improve modestly on higher oil production and the more depreciated level of the real.
- Offshore oil exploration plans are assumed to be scaled down at the margin given the diminished prospects for world oil prices.

### Trade restrictiveness (Box 5 — key findings)
- Brazil’s goods trade was just above 20 percent of GDP in 2013.
- Brazil’s goods trade is about half the size of that in Peru, Russia, India and China and about a third of the size of trade in Chile and Mexico.
- Brazil shows the smallest volume of trade in goods and services relative to GDP among the LA5 and BRICS.
- Brazil’s applied MFN customs tariff is entirely ad valorem, with rates ranging from zero to 55 percent.
- Goods imports face a weighted average applied MFN tariff of around 10 percent according to the WTO, the highest among LA5 and BRICS peers.
- Brazil’s network of preferential trade agreements covers a relatively small share of world trade compared to its peers.
- The World Bank’s Doing Business indicators rank Brazil 123rd out of 189 countries in terms of ‘trading across borders’.
- Trading costs and the number of documents to export/import are high; authorities have introduced procedures such as streamlining customs to reduce bureaucratic hurdles.
- Policy recommendation: Reducing the level and complexity of the system of trade taxes―including by extending the network of preferential trade agreements―and pursuing trade facilitation should boost trade volumes and growth. Easing domestic content restrictions is recommended to promote inclusion in global value chains.

### Inflation outlook
- Inflation is expected to converge toward the 4.5 percent target over the medium term as a result of tight monetary policies.
- The rate of convergence will be affected by necessary adjustments in regulated prices, high inflation expectations, and lingering indexation, including in wages.
- Bringing inflation to target by 2016 will likely require some further tightening of monetary policy in 2015.

### Risks to the outlook
- Overall, risks to the outlook are significantly tilted to the downside.
- Domestic risks:
  - Investment, including in oil production and infrastructure concessions, may be hampered by the probe into corruption at Petrobras, involving several large construction companies; insufficient access to funding by these companies can cause adverse spillovers to their creditors.
  - Prolonged insufficient access to markets by Petrobras itself is a risk to the fiscal adjustment strategy.
  - Risk that fiscal targets for 2015−16 may not be met, undermining market confidence and affecting growth, debt outcomes, and sovereign rating (Brazil is only one or two downgrades away from losing investment grade, depending on which rating agency one looks at).
  - A sell-off of government debt by nonresidents could cause stress in financial institutions with large exposures to government securities and affect capital flows to other emerging markets.
  - Water and electricity rationing following a prolonged period of low rainfall and falling reservoir levels is a key near-term growth risk, especially in the Southeast where a large fraction of GDP originates.
- External risks:
  - Increase in financial volatility could raise Brazil’s risk premium, exert pressure on the real, and challenge financing of the large current account deficit.
  - Protracted slower growth in advanced and emerging economies could weaken exports.
  - Further declines in export commodity prices—such as iron ore and soy beans—resulting from a slowdown in China are a key vulnerability.
  - A further decline in oil prices could adversely affect Petrobras’ development plans for high-cost deep-sea oil and medium-term growth and the current account when Brazil is expected to become a net oil exporter.
  - Conversely, a sharp rise in oil prices would put pressure on the current account and Petrobras’ cashflow in the near term.
- Severe downside scenario:
  - A combination of external shocks amplified by domestic vulnerabilities would likely trigger a sovereign credit downgrade, larger rise in unemployment, worsening social indicators, a sell-off of government debt, and negative repercussions for the financial sector and the region.

### Policy assessment and staff views (overview)
- Policies implemented in 2014 were partially in line with previous Fund advice:
  - Monetary tightening continued since April 2013, taking the policy rate to 11.75 percent by December (up from 7.25 percent before the tightening cycle).
  - Fiscal performance deteriorated in 2014, with the primary balance slipping into deficit and policy lending edging back up, resulting in an increase in public debt in 2014.
- Staff view: Limited role for demand support given supply constraints and limited policy space; priority is to bolster policy credibility through front-loaded fiscal adjustment and monetary tightening to boost confidence and private demand over the medium term.

### Fiscal policy recommendations
- An ambitious and front-loaded fiscal adjustment, embedded in a realistic medium-term fiscal plan, is imperative to reduce public debt and bolster credibility.
- The announced fiscal target for 2015 of a primary surplus of 1.2 percent of GDP for the NFPS is appropriate.
  - Additional effort estimated at 1.2−1.4 percent of GDP (including to offset cyclical effects on revenue from the contraction in 2015) will be needed to meet the target.
  - Additional expenditure containment is expected to be included in the revised 2015 budget.
- Going beyond 2015:
  - The new government’s target of 2.0 percent of GDP for the primary surplus would begin to reduce public debt in the central macroeconomic scenario.
  - Increasing that target by ½ percent of GDP would help put public debt on a more firmly downward path by reducing the interest bill faster and increasing resilience to shocks and fiscal risks.
- Composition of adjustment:
  - Tilting the adjustment towards expenditure consolidation may help limit the drag on activity, while preserving and even increasing capital spending is important.
  - Given the size of the required adjustment, revenue measures are also necessary in the short run; consideration should be given to a fuller rollback of tax exemptions to enlarge the tax base, reduce distortions, and promote horizontal equity.
  - Addressing budget rigidities and ageing-related spending pressures is crucial to reduce debt and build fiscal space.
  - Structural fiscal measures adopted early (for example, linking benefits to minimum wages) could allow a more gradual adjustment, but absent such reforms, adherence to announced primary surplus objectives is key.
- Institutional reforms:
  - Anchor fiscal policies and targets in a medium-term framework to improve predictability.
  - Publish a debt-sustainability analysis.
  - Establish an independent fiscal council to support transparency and accountability.

### Specific fiscal and SOE-related measures
- Commitment to end policy lending to the development bank (BNDES) and to correct relative prices and reduce subsidies is welcome.
  - Decision to stop policy lending to BNDES starting this year will alleviate fiscal pressures and reduce financial distortions.
  - Discontinuation of general subsidies to electricity, underpinned by tariff increases, is positive for fiscal and economic efficiency.
  - Low international oil prices provide a window to recoup downstream losses incurred by Petrobras and later introduce formula-based mechanisms to adjust domestic prices in line with import parity benchmarks and reasonable domestic margins.
  - Adopting market-related pricing formulas for administered prices would help preserve SOE balance sheets and reduce future fiscal risks.
- Transparency and governance:
  - Improving transparency of fiscal accounts and reviewing governance frameworks in SOEs is critical.
  - Irregularities in Petrobras point to the need to review and strengthen internal and external oversight mechanisms in Petrobras and possibly other SOEs.
  - Recent appointment of a director for governance in Petrobras is a positive initial step.
  - Strong governance and close oversight of parastatals are key for containing fiscal risks.

### Monetary and financial sector recommendations
- Monetary policy:
  - Bringing inflation to target by 2016 likely requires further tightening in 2015.
  - Monetary policy should maintain a tightening bias to mitigate second-round effects from regulated price adjustments and currency depreciation.
  - Renewed emphasis in communication on the 4.5 percent inflation target and readiness to use policy instruments will bolster credibility.
  - Strengthen the inflation targeting framework by narrowing the tolerance band around the 4.5 percent target and giving a specific term of office to the central bank’s top management, as recommended by the 2002 and 2012 FSAPs.
- Subsidized lending and policy transmission:
  - Widespread subsidized lending weakens monetary policy transmission and distorts credit markets.
  - Introduce a direct link between the policy rate (SELIC) and the subsidized lending rate (TJLP) to increase policy effectiveness.
  - Reducing the gap between the SELIC and the TJLP—675 bps after the recent 50 bps TJLP hike—would lower the recurrent fiscal cost arising from the cumulative stock of policy lending by government.
- Exchange rate policy:
  - The exchange rate should remain the main shock absorber; intervention should be limited to dealing with excessive volatility.
  - The pre-announced intervention program helped reduce volatility and pre-empt pressures, but may have encouraged excessive private sector risk taking and slowed necessary exchange rate convergence.
  - Staff considers the reduction in size and duration of the intervention program announced in December 2014 positive.
  - Recommendation: refrain from extending the intervention program further and, as conditions permit, use the calendar of rollovers of maturing swaps to temper the stock of swaps outstanding to preserve policy space and support exchange rate convergence.
- Financial sector soundness:
  - Banking system soundness indicators are encouraging, but private sector leverage and rapid past expansion of public banks are potential stress sources requiring vigilance.
  - Central bank stress tests (with staff-constructed scenarios) show that in a high stress scenario some banks would become noncompliant with capital requirements, but the capital shortfall would be small, less than 0.5 percent of regulatory capital.
  - Note: The stress tests indicate that in an extreme scenario defaults peak at 5 percent, requiring a recapitalization less than 0.4 percent of regulatory capital in the system as of March 2016. The scenario assumes GDP growth, interest rate, foreign exchange rate, inflation, and unemployment would be -3.1 percent, 14.2 percent, R$3.35/U$, 11.6 percent, and [text cut in source].
  - Risks could arise from high private sector leverage and growing FX exposure in sustained low growth and possibly rising unemployment.
  - Increase in delinquencies of high-risk loans by public banks could generate demand for additional capital if defaults increase; underscores need for vigilance and monitoring of bank balance sheets.

### Structural reform priorities to boost productive potential
- Address infrastructure bottlenecks:
  - Implement the infrastructure concessions program more vigorously; assess factors impeding private sector participation.
  - Consider increasing the program’s scope and size while observing high standards of governance and program design (including transfer of risks) to minimize fiscal risks and attract private participation.
  - Tilt public expenditure composition away from current spending to free resources for public investment, including infrastructure.
- Tax reforms:
  - Simplify the State Tax on the Circulation of Goods and Services (ICMS) to reduce the cost of doing business.
  - Address complexity and burden of distortionary indirect taxes.
- Opening the economy:
  - Reduce applied MFN customs tariffs.
  - Continue trade facilitation efforts.
  - Lift domestic content requirements.
  - Pursue preferential trade agreements to increase competition and efficiency.

*Source: _cr15121 - 16.      Growth should gradually rise over the medium term, but its long term potential will (IMF staff extract).*

### 7.2 percent, respectively, during the 18 months between September 2014 and March 2016.

### _cr15121 - 7.2 percent, respectively, during the 18 months between September 2014 and March 2016.

### Fiscal policy, fiscal targets, and public finances
- Authorities’ announced primary fiscal targets:
  - 1.2 percent of GDP in 2015.
  - at least 2.0 percent of GDP in 2016 and 2017.
- Authorities’ intended approach:
  - Implement consolidation over two years, relying on both expenditure cuts and revenue measures.
  - Avoid cuts in key spending items (high-value capital and social spending) and increases in distortionary taxes.
  - No new policy lending by government to the development bank; end Treasury funding for public banks as policy lending.
  - Revise costly subsidies, notably to energy, where revisions are already being implemented.
- Staff assessment and recommendations:
  - The fiscal target of 1.2 percent of GDP for 2015 is appropriate, but further measures will be needed to meet this target.
  - Starting in 2016, aiming for a primary surplus above the minimum objective of 2.0 percent of GDP in 2016−17 would bolster fiscal sustainability.
  - An ambitious and front-loaded fiscal consolidation is required to reduce public debt and restore credibility.
  - Anchoring fiscal targets in an effective medium-term fiscal framework would improve predictability.
  - Improving transparency of public finances and full disclosure of the underlying fiscal position is critical.

### Growth, consumption, and macro outlook
- Authorities’ view:
  - Expect 2015 to be a difficult transition year with subdued activity in the first half and recovery in investment in the second half contingent on strengthened macroeconomic policy.
  - Anticipate consumption remaining subdued given drag from tighter fiscal and monetary policies.
  - Disagree with staff forecast that implicitly expects public consumption to decline by 6.9 percent in 2015; they note the worst decline in 1996–2013 was -1.8 percent in 1996.
  - Consider private consumption could show small positive growth due to projected real wage and credit growth.
- Staff appraisal:
  - The Brazilian economy faces serious challenges in the context of stalling growth and high inflation.
  - The new government must strengthen macro-financial policies and institutions and pursue structural reforms to boost potential growth.

### Monetary policy and inflation
- Authorities’ objectives and views:
  - Key monetary priority: ensure inflation convergence to the 4.5 percent target by the end of 2016.
  - Monetary policy stance has been adjusted over the past year-and-a-half to align with the evolving inflation outlook and support relative price adjustment.
  - Noted that headline inflation in 2014 was broadly stable but with decelerating inflation in freely determined prices offset by rising inflation of monitored prices.
  - TJLP gap relative to SELIC should narrow over time.
- Staff assessment and recommendations:
  - Monetary policy has been appropriately tightened, but bringing inflation to target within the next two years will likely require some further tightening in the near term.
  - If currency weakness or correction of regulated prices fuels inflation expectations, further tightening would be necessary.

### Foreign exchange intervention and external position
- Authorities’ view:
  - FX intervention program aimed at preserving financial stability and preventing capital outflows during episodes of high volatility.
  - Argued program had not encouraged overseas borrowing by corporates and that FX swaps reduced the cost of carrying international reserves; swaps are settled in local currency and do not compromise international reserves.
  - Notional value of hedging contracts outstanding is broadly in line with the economy’s hedging needs; latest extension on a reduced scale and shorter period consistent with this view.
  - Current account in 2014 was weaker than expected but mostly FDI-financed; deficit should narrow over the medium term due to relative price adjustments and increases in oil exports.
- Staff assessment:
  - Welcomes recent scale down of the foreign exchange intervention program.
  - Continuous operation of the program could delay convergence of the exchange rate to a more competitive value; consideration should be given to not renewing the program further.

### Financial sector, public banks, and prudential policy
- Authorities’ remarks:
  - Rapid expansion of public banks’ balance sheets has moderated significantly; NPL ratios in these institutions have remained low.
  - Asset quality deterioration concentrated in non-core segments; banks are well provisioned.
  - Phase-in of Basel III capital requirement started from October 2013.
  - Authorities’ estimates: full Basel III implementation would require additional capital for only a few banks and be equivalent to 0.3 percent of regulatory capital in the system until 2019.
  - Brazilian banks will be required to build 0.625 percent of regulatory capital as conservation buffers from 2016; required buffers will increase to 2.5 percent. The possibility of activation of countercyclical capital buffers, equivalent to the size of conservation buffers, will be available from 2016.
  - Progress since the 2013 Article IV consultation includes introduction of a new framework for Emergency Liquidity Assistance (ELA) and approval of updated bylaws of the deposit insurance fund (FGC).
- Staff recommendations:
  - Close monitoring and prudential measures to address latent risks in private sector balance sheets, especially commercial loans to SMEs and non-housing consumer loans.
  - Enhanced supervision and targeted microprudential measures; welcome enhanced on- and off-site supervision of public banks by the central bank.
  - Public banks should bolster capital positions, including by retained earnings.
  - Rising corporate leverage, including through overseas borrowing, should be carefully monitored and assessed for adequate hedging.

### Structural reforms, labor, and pensions
- Staff recommendations and concerns:
  - Reform pension system (beyond announced tightening of survivor benefits) to mitigate foreseeable fiscal pressures and boost savings for investment.
  - Revise indexation of certain benefits, including pensions, to the minimum wage to help raise public saving.
  - Revise minimum wage indexation formula so it better reflects productivity gains; reform is critical but will likely require extensive consultation and broad-based consensus.
  - Large and sustained rise in unit labor costs has contributed to erosion of competitiveness; trade-off between employment and high real wage growth may reassert in low-growth environment.
- Authorities’ views on reforms:
  - Do not see modifying the minimum wage indexation formula as a pressing need; current formula would imply modest increases in the real value of the minimum wage in the next few years and has been a factor of stability in the last two years.
  - See potential benefits from simplification of the ICMS but note it requires complex negotiations with state governments and the Senate.
  - Consider simplification of PIS/COFINS and potential expansion of SIMPLES to include some medium-sized enterprises.
  - Support promoting a more open economy and have introduced trade facilitation procedures, including in customs.
  - Stress that improvements in fiscal transfer programs (better targeting and reduction in abuses) can provide incentives for higher labor productivity equivalent to reforms.
- Infrastructure:
  - Authorities agree addressing infrastructure gaps is essential to boost potential growth; further domestic private sector participation needed given limited fiscal space.
  - Highlight recent success of infrastructure concession program in attracting investors for ports, roads, and airports.
  - Public banks expected to continue role in financing infrastructure; new options to mobilize private financing from capital markets under consideration.

### Key risks and governance
- Petrobras and governance:
  - Authorities stress investigation into Petrobras is proceeding within law and underscores institutional strength.
  - Petrobras new management (from February) works with independent auditor to resolve asset markdowns to permit issuance of audited accounts.
  - Staff welcomes ongoing investigation and encourages steps to limit economic fallout and prevent future procurement fraud and corruption.
- Risks highlighted by staff:
  - Risk of deterioration in bank asset quality in current low-growth environment.
  - Rising corporate leverage and overseas borrowing risks.
  - Continuous FX intervention could delay necessary exchange rate adjustment.
  - Fiscal slippage would undermine debt stabilization and credibility.

*Source: _cr15121 - 7.2 percent, respectively, during the 18 months between September 2014 and March 2016.*

### 46.      It is recommended that the next Article IV consultation takes place on the standard

### _cr15121 - 46. It is recommended that the next Article IV consultation takes place on the standard 12-month cycle.

### I. Social and Demographic Indicators
- Area (thousands of sq. km): 8,512
- Agricultural land (percent of land area): 31.2
- Population, Total (million) (est., 2013): 198.3
- Annual rate of growth (percent, 2013): 0.9
- Density (per sq. km.) (2012): 23.3
- Life expectancy at birth (years): 75
- Infant mortality (per thousand live births): 15
- Physician per 1000 people (2010): 1.8
- Hospital beds per 1000 people (2011): 2.3
- Access to safe water (2011): 97.2
- Adult illiteracy rate (2013): 9.7
- Unemployment rate (average, 2013): 5.4
- Net enrollment rates, percent in:
  - Primary education (2013): 93
  - Secondary education (2013): 54
- Poverty rate (in percent, 2013): 15.1
- Income distribution (2013):
  - By highest 10 percent of households: 41.6
  - By lowest 20 percent of households: 3.2
  - Gini coefficient (2013): 49.5
- GDP (2013) R$4,845 billion / US$2,246 billion
- GDP per capita (est., 2013) US$11,326

### II. Macroeconomic Performance and Projections (Selected series, annual percent change or percent of GDP as indicated)
- GDP at current prices (2011–2020 series shown): 9.9, 6.0, 10.3, 4.6, 6.6, 7.6, 7.8, 7.6, 7.7, 7.7
- GDP at constant prices (annual growth): 2.7, 1.0, 2.5, 0.0, -1.0, 0.9, 2.2, 2.3, 2.4, 2.5
- Consumption (annual percent change): 3.6, 3.2, 2.4, 1.9, -1.7, -0.2, 1.4, 1.5, 2.0, 2.1
- Investment (annual percent change): 3.1, -8.8, 7.8, -10.1, -0.6, 5.6, 4.3, 3.9, 4.0, 4.0
- Consumer prices (IPCA, end of period): 6.5, 5.8, 5.9, 6.4, 7.0, 5.4, 4.8, 4.6, 4.6, 4.5
- Gross domestic investment (percent of GDP): 19.7, 17.5, 18.1, 16.4, 16.5, 17.2, 17.5, 17.8, 18.0, 18.3
- Gross national savings (percent of GDP): 17.6, 15.1, 14.5, 12.2, 12.9, 13.6, 14.0, 14.4, 14.6, 14.8
- Current account (in percent of GDP): -2.1, -2.4, -3.6, -4.2, -3.6, -3.6, -3.5, -3.4, -3.4, -3.4
- GDP in billions of U.S. dollars (2011–2020): 2,475; 2,248; 2,246; 2,160; 2,040; 2,144; 2,257; 2,371; 2,491; 2,618

### III. Public Finances (Selected indicators, percent of GDP)
- Central government primary balance: 2.2, 1.7, 1.6, -0.4, 1.0, 1.5, 1.7, 2.0, 2.0, 2.0
- NFPS primary balance: 3.1, 2.1, 1.9, -0.6, 1.2, 2.0, 2.2, 2.5, 2.5, 2.5
- NFPS overall balance: -2.6, -2.8, -3.3, -6.8, -5.1, -4.3, -3.8, -3.2, -3.1, -3.1
- NFPS overall balance (including net policy lending): -3.6, -4.2, -3.9, -7.9, -5.1, -4.3, -3.8, -3.2, -3.1, -3.1
- Net public sector debt: 36.4, 35.3, 33.6, 37.2, 39.3, 38.9, 38.2, 38.1, 38.2, 37.6
- NFPS gross debt: 64.7, 68.2, 66.2, 71.0, 72.0, 71.4, 70.2, 69.8, 69.7, 68.8
- Net interest payments of the public sector (percent of GDP): 5.2, 5.7, 4.9, 5.1, 6.1, 6.3, 6.3, 6.1, 5.7, 5.6

### IV. Balance of Payments and External Sector (selected levels and flows)
- Trade balance (in billions of U.S. dollars, 2011–2020): 29.8, 19.4, 2.4, -3.9, 9.8, 11.1, 15.7, 22.8, 23.7, 25.0
- Exports (fob, in billions of U.S. dollars): 256.0, 242.6, 242.0, 225.1, 212.3, 221.1, 235.1, 252.0, 262.9, 274.5
- Imports (fob, in billions of U.S. dollars): -226.2, -223.2, -239.6, -229.0, -202.4, -210.0, -219.4, -229.2, -239.1, -249.6
- Current account (in billions of U.S. dollars): -52.5, -54.2, -81.1, -90.9, -73.5, -76.7, -79.2, -79.7, -85.9, -90.1
- Capital account and financial account (in billions of U.S. dollars): 112.4, 70.0, 74.2, 99.6, 73.5, 76.7, 79.7, 79.8, 85.9, 90.1
- Foreign direct investment (net, in billions of U.S. dollars): 67.7, 68.1, 67.5, 66.0, 53.9, 54.0, 52.6, 53.8, 55.3, 56.8
- Gross official reserves (eop, in billions of U.S. dollars): 352.0, 373.1, 358.8, 363.6, 358.3, 358.8, 359.6, 360.4, 361.2, 362.3
- Total external debt (in percent of GDP): 16.3, 19.6, 21.4, 25.7, 28.8, 29.5, 30.0, 30.5, 31.0, 31.5
- Memorandum – Current account (in percent of GDP): -2.1, -2.4, -3.6, -4.2, -3.6, -3.6, -3.5, -3.4, -3.4, -3.4

### V. Monetary and Financial Sector (selected aggregates and indicators)
- Base money (annual percent change series shown): 2/10.8, -13.6, 13.1, -4.5, 6.6, 7.6, 7.8, 7.6, 7.7, 7.7
- Broad money (annual percent change series shown): 3/18.5, 15.9, 8.9, 15.5, 14.8, 14.5, 14.2, 14.1, 14.0, 14.0
- Bank loans to the private sector (annual percent change): 20.2, 15.8, 15.3, 11.5, 11.6, 11.9, 12.4, 12.8, 13.1, 13.5
- Financial Soundness Indicators (Total banking system, selected):
  - Regulatory capital to risk-weighted assets (selected points): 18.7; 16.9; 16.3; 16.4; 16.1; 15.4; 15.5; 16.5
  - Nonperforming loans to total gross loans (selected): 4.2; 3.1; 3.5; 3.4; 2.9; 2.9; 2.9; 2.9
  - Return on assets (selected): 1.8; 1.9; 1.7; 1.4; 1.4; 1.4; 1.3; 1.3
  - Liquidity assets to short-term liabilities (selected): 252.1; 185.3; 178.6; 191.8; 158.0; 145.4; 149.2; 186.0

### VI. External Debt Sustainability Framework (2012–2020, selected)
- Baseline: External debt (percent of GDP, 2012–2020): 19.6, 21.4, 25.7, 28.8, 29.5, 30.0, 30.5, 31.0, 31.5
- Change in external debt (percent of GDP, selected): 3.3, 1.8, 4.2, 3.1, 0.7, 0.5, 0.5, 0.5, 0.5
- Identified external debt-creating flows (4+8+9): 1.5, 1.1, 3.3, 2.5, 1.4, 1.2, 0.9, 1.0, 1.0
- Current account deficit, excluding interest payments (percent of GDP): 1.6, 2.8, 3.4, 2.6, 2.6, 2.4, 2.2, 2.1, 2.1
- External debt-to-exports ratio (in percent): 156.0, 171.3, 208.4, 234.1, 241.8, 243.4, 242.7, 248.3, 254.0
- Gross external financing need (in billions of US dollars): 131.5, 158.0, 164.3, 173.5, 167.4, 178.4, 188.5, 205.4, 221.3
- Key macroeconomic assumptions underlying baseline (selected):
  - Real GDP growth (in percent): 1.0, 2.5, 0.0, -1.0, 0.9, 2.2, 2.3, 2.4, 2.5
  - Exchange rate appreciation (US dollar value of local currency, change in percent): -14.3, -9.4, -8.1, -11.4, -2.3, -2.4, -2.4, -2.4, -2.4
  - Nominal external interest rate (in percent): 4.4, 4.3, 3.8, 3.6, 3.6, 3.8, 4.2, 4.5, 4.5

### VII. Recent Economic Developments and Risks (textual findings from figures and notes)
- Brazil was in a technical recession during the first half of 2014 and growth was subdued in Q3.
- After four quarters of contraction, investment grew moderately in Q3 of 2014 while consumption continued to moderate.
- Activity has generally been more subdued on the industry side; after contracting in Q2, both industry and services posted moderate gains in Q3.
- Retail sales have shown tentative improvement, but consumer confidence continues to deteriorate.
- Industrial production is at very low levels and capacity utilization remains well-below historical averages.
- Deteriorating business confidence contributed to the contraction in investment.
- Inflation:
  - Inflation has risen since mid-2012 and is currently above the upper ceiling of the official target tolerance band.
  - Medium-term inflation expectations are drifting upwards.
  - Free-price inflation has begun to moderate from high levels while regulated-price inflation has begun to increase.
  - Non-tradable inflation has risen more strongly than tradable inflation since 2010.
- Labor and wages:
  - Inflation expectations hover above the target band for 2015 and well-above the official target mid-point over the medium term.
  - Wage growth remains strong.
- Financial sector:
  - Credit growth decelerated; downturn phase of a credit cycle continued in 2014.
  - Capitalization remains above regulatory minimums.
  - Ample liquidity provides a buffer to funding risks.
  - Nonperforming loans broadly stable around 3 percent, but public banks' NPLs have started to increase.
  - Leading indicators suggest NPLs will rise due to subdued activity and tighter financial conditions; the rise is expected to be gradual.
- External sector:
  - Amid high unit labor costs, manufacturing exports remain relatively weak.
  - Terms of trade have deteriorated but remain at a relatively high level.
  - The real effective exchange rate remains elevated, especially when calculated using unit labor costs.
  - The external current account worsened further in 2014 despite weak growth.
  - Net capital inflows were broadly stable in 2014 amid strong FDI and portfolio inflows.

### VIII. Policy and Fiscal Notes (textual and tabulated policy-relevant items)
- Fiscal stance:
  - The fiscal stance remained approximately neutral in 2013, but turned expansionary in 2014.
  - Gross debt has increased to above 70 percent of GDP.
  - Primary surpluses have repeatedly relied on exceptional revenue.
  - The overall fiscal balance remains negative and has deteriorated recently due to a reduction in the primary balance and increased interest bill.
- Monetary and macroprudential policy:
  - Since April 2013 the policy rate has been raised by 500 basis points.
  - Macroprudential policies have been tightened, though more recently slightly eased.

*Sources: Central Bank of Brazil; Ministry of Finance; IPEA; Ministry of Planning and the Budget; and Fund staff estimates and projections.*

### Appendix I. Brazil: External Sector Assessment 2014

### Appendix I. Brazil: External Sector Assessment 2014

### Overview
- Brazil’s external position is weaker than the level consistent with medium-term fundamentals and desirable policy settings.
- Reserves are adequate and FDI continues to cover a significant share of the current account deficit.
- Policy prescriptions highlighted:
  - Increase national saving, including by advancing with pension reform and shifting the structure of public spending away from consumption.
  - Foreign exchange intervention, including through the use of derivatives, can be appropriate to address bouts of excess volatility in the foreign exchange market arising from unstable capital flows, but should not be used to resist currency pressures that reflect changes in fundamentals.

### Current account: developments and drivers
- The current account turned into deficit over the past decade despite large terms of trade gains.
- Import volumes more than doubled since 2004, while export volumes have remained broadly constant.
- Illustration of terms-of-trade importance: were the terms of trade to return to their 2005 level, Brazil’s current account deficit would have reached 5.1 instead of 3.6 percent of GDP in 2013.
- Recent evolution:
  - Current account deficit reached 4.2 percent of GDP in 2014.
- Savings-investment perspective:
  - Both private and public savings are relatively low compared with other emerging economies.
  - Since 2004, consumption has accounted for almost all the growth in Brazil.
  - Increasing domestic savings would help prevent further deterioration in external balances and support an increase in investment.
  - Policies to bolster savings include pension reform and containing the rate of growth of public consumption.
- Staff estimates of norms and gaps (2014):
  - Current account norm range: -2.0 (EBA CA regression approach) to -1.2 percent of GDP (ES approach).
  - Staff’s assessed norm range: -0.5 to -2 percent of GDP.
  - Cyclically adjusted current account deficit: about 3.8 percent of GDP.
  - Current account gap in 2014: between -1.8 to -3.3 percent of GDP.
- Medium-term projection:
  - Current account is projected to fall to 3.4 percent of GDP by 2020.
  - Oil balance (oil and distillates exports net of direct oil and distillates imports) is expected to improve by around 1 percent of GDP by 2020.
- Key vulnerabilities:
  - Further declines in export commodity prices are a key vulnerability; iron ore, soybeans and oil alone account for one third of total exports.
  - Offshore oil exploration plans raise uncertainty; pressures on Petrobras’ balance sheet and international oil prices increase uncertainty.
  - Imports of machinery and intermediate goods for platform construction will partly offset the boost from oil.

### Exchange rate and relative prices
- CPI-based REER and trends:
  - REER has risen by more than 30 percent since end-2004, but depreciated some 20 percent between end-2010 and December 2014.
  - Following the Fed taper announcement, REER depreciated by 14 percent from April 2013 to August 2013, then appreciated by 6 percent until March 2014.
  - REER depreciated during the second half of 2014 and is broadly in line with its long-term (10-year) average level.
- Alternative competitiveness measures:
  - Unit labor costs (ULC) increased markedly in recent years.
  - Despite substantial nominal depreciation, the ULC-based real exchange rate did not depreciate since 2010, suggesting stagnating price competitiveness.
  - A direct measure of relative prices (prices on non-tradables vs tradables) indicates relative prices have risen by some 10 percent since 2010.
- Assessment of valuation (2014):
  - EBA REER approach suggests real was undervalued by some 3 percent.
  - Staff assesses REER approach less reliable for Brazil due to wide dispersion in REER measures.
  - Based on the current account gap of -1.8 to -3.3 percent, staff assesses the real was some 10 to 20 percent over-valued on average in 2014.
  - As of December 2014, the REER had depreciated by some 6 percent compared to its 2014 average.
  - Staff assessment: REER was approximately 5−15 percent above the level implied by fundamentals and desirable policies at end-2014.

### Capital account flows and policy toolkit
- Post-crisis capital inflows and reserve accumulation:
  - Financial account surplus averaged 4.1 percent of GDP between 2007 and 2014.
  - Reserve accumulation reached 1.9 percent of GDP per year over that period.
- FDI and composition:
  - Since 2012, FDI has been about 3 percent of GDP per year.
  - FDI financed more than 70 percent of the current account deficit in 2014.
  - Intercompany loans accounted for some 60 percent of total FDI in 2014.
  - About 60 percent of total intercompany loans are loans to Brazilian foreign investors extended by their own subsidiaries.
  - Offshore issuance by foreign-incorporated subsidiaries (largely in Cayman Islands and Netherlands) appears to return to Brazil as intercompany loans.
  - Industry composition of offshore issuance (1980-2013): Oil & Gas, 38%; Finance, 28%; Food & Beverage, 10%; Mining, 8%; Other, 15%.
  - Residence of subsidiaries for offshore issuance: Cayman Islands, 64%; Netherlands, 18%; Other, 18%.
- Exchange rate flexibility and interventions:
  - Brazil has a flexible exchange rate which remained the most important shock absorber, including during turbulence since May 2013.
  - Authorities have not conducted spot market interventions since 2012; they used foreign exchange swaps (conventional non-deliverable forwards settled in local currency) and Brazilian foreign exchange repos (conventional foreign exchange swaps) to contain volatility.
  - Intervention can be useful for episodes of excess volatility; the program initially reduced hedging costs after the Fed taper announcement.
  - Continued extension of the intervention program may have encouraged additional private sector risk taking and may have slowed convergence of the exchange rate to a more competitive value.

### International reserves, NIIP, and external debt
- International reserves:
  - Reserves remain above adequate levels and are considered more than adequate with respect to various metrics, including the IMF’s composite adequacy measure.
  - Brazil and other BRICS countries signed a treaty to establish the BRICS Contingent Reserve Arrangement (CRA) in July 2014.
  - CRA initial size: US$100 billion, with individual commitments of US$41 billion by China; US$18 billion by Brazil, Russia, and India; and US$5 billion by South Africa.
  - For Brazil, maximum access will equal the financial commitment to the CRA; up to 30 percent of a member’s maximum access will be available without conditionality and the remainder requires an on-track financial arrangement with the Fund.
- Net international investment position (NIIP):
  - NIIP strengthened from -48 percent of GDP in 2003 to -36 percent in 2014.
  - Gross assets and liabilities in 2014: assets 36 percent of GDP, liabilities 72 percent of GDP.
  - FDI liabilities account for about half of total liabilities.
  - Brazil’s NIIP is high relative to peers but compares reasonably well across emerging markets.
  - With persistent current account deficits, NIIP would worsen over the medium term (at a constant real exchange rate).
  - In the longer run, as “pre-salt” oil reserves come on line, added efforts to increase savings to strengthen NIIP would be appropriate.
- External debt and FX exposure:
  - External debt about 26 percent of GDP as of 2014.
  - Total foreign exchange exposure is low in international comparison and has decreased significantly over the past decade.
  - Corporate issuance in foreign exchange has increased recently, though largely hedged, partly offsetting reduced sovereign exposure.
  - Foreign holdings of domestic debt securities account for close to a fifth of outstanding public debt securities and some 8 percent of GDP.
  - As foreign investors hold more local debt, local yields may become more sensitive to global developments as those investors take on foreign exchange risk.

### Appendix II — Nonperforming loans of public banks: key findings
- General assessment:
  - NPL ratios at public banks have been around 2 percent in recent years, but banks face the risk of a gradual deterioration in loan quality.
  - Public banks historically focused on lower-risk segments: Caixa (housing loans), Banco do Brasil (rural credit), BNDES (exports, working capital for large firms, long-term infrastructure).
  - Caixa has expanded into higher-risk segments: non-payroll personal loans, credit card, and SME loans.
  - Delinquencies at public banks started to pick up in 2014, likely to continue especially in newer credit segments.
  - Credit growth deceleration in public banks in 2014 was most marked in these newer credit segments.
- Performance by business line:
  - BNDES’s NPL ratio has been under 0.3 percent over the past three years (including effects of OGX’s bankruptcy).
  - Banco do Brasil reduced the share of non-earmarked loans and replaced them with rural credits and real estate loans; its NPL by loan vintage has gradually decreased over the past three years.
  - Caixa maintained mortgage loan quality by applying loan-to-value caps at around 70 percent.
- Risks and outlook:
  - High-risk lines (credit cards, non-payroll personal loans, SME loans) have shown rapidly increasing delinquencies.
  - Continued economic deterioration would weaken repayment capacity of households and firms, requiring public banks to increase provisions and impair earnings.
  - Although current buffers (loan loss provisions and capital) guard against expected and unexpected losses and imply no immediate systemic risk, public banks will need to tighten lending standards to preserve asset quality.

*Source: IMF staff compilation from "Appendix I. Brazil: External Sector Assessment 2014" and "Appendix II. Nonperforming Loans of Public Banks" (prepared by Christian Saborowski and Heedon Kang).*

### Appendix III. Brazil: Risk Assessment Matrix

### _cr15121 - Appendix III. Brazil: Risk Assessment Matrix

### Domestic Risks
- Delays in the resolution of the Petrobras corruption probe
  - Likelihood: M
  - Expected impact: H. Firms under investigation, including Petrobras, could see their access to funding diminished and their investment programs at risk. The infrastructure concession program could be hampered by the ineligibility of construction companies. Pressure would rise to use public funds, possibly through public banks, to support Petrobras’ investment.
  - Policy responses:
    - Strengthen governance standards and anti-corruption safeguards in procurement procedures to ensure the success in attracting private sector participation in the infrastructure program.
    - Ease the requirement that Petrobras’ participate in all new oil developments, and domestic content requirements.

- Drought and power rationing
  - Likelihood: H
  - Expected impact: H. Growth slowdown from electricity rationing accompanied by inflationary pressures as consumers will have to bear the additional energy cost in the absence of energy subsidies. Water rationing could affect manufacturing as well as agriculture, including in Sao Paulo state.
  - Policy responses:
    - Keep policies tight to contain spillovers into inflation and refrain from introducing additional Treasury subsidies which will weaken the fiscal outturn.
    - Make sure that prices reflect scarcity to promote the efficient use of resources, while protecting basic level of access for vulnerable households.

- Falling short of the fiscal target
  - Likelihood: M
  - Expected impact: H. Fiscal balances would continue to disappoint and fail to stabilize debt. Further loss of confidence would result in lower investment and growth. Inflationary pressures would remain elevated. Brazil could lose its investment grade, which would further dampen confidence and growth, weakening the primary balance and increasing sovereign borrowing costs and public debt. Corporates could be vulnerable to capital flow reversals and exchange rate depreciation. The strains would worsen if banking system soundness deteriorated owing to an increase in NPLs.
  - Policy responses:
    - Additional fiscal consolidation measures should be identified to restore credibility in the fiscal framework and to ensure debt stabilizes.
    - Focus efforts on boosting competitiveness and productivity.
    - If the sovereign loses its investment grade, triggering economic side-effects, additional policy actions would be necessary, possibly including monetary policy tightening.

- Intensified inflationary pressures
  - Likelihood: M
  - Expected impact: H. Worsening inflation expectations and further erosion to the inflation targeting framework.
  - Policy responses:
    - Further monetary tightening to preserve the credibility of the inflation framework and ensure the convergence of inflation towards the target.

### External Risks
- Protracted period of low growth (global)
  - Likelihood: M
  - Expected impact: H. Employment destruction would lead to a deterioration of households’ balance sheet and income resulting in a rise in delinquencies on consumer loans. Increased financial vulnerabilities among banks with portfolio concentrated in consumer/housing loans. Potential knock on effects on public finances. For example, Caixa extends housing loans to low-income families with a government guarantee. Lower corporate profits may expose some highly leveraged corporates.
  - Policy responses:
    - Monitor for signs of emerging domestic financial and corporate vulnerabilities.
    - Take measures to strengthen the fiscal framework including public debt, and refrain from adding further demand stimulus.
    - Impose targeted prudential measures to reduce risks in weak financial institutions.
    - Smooth out the employment loss by relying on strategies such as reduced hours.
    - Accelerate efforts to improve the business environment and foster investment.

- Abrupt surges in global financial market volatility
  - Likelihood: H
  - Expected impact: H. Increasing Brazil’s risk premiums, pressures on the real and reversal of capital flows. Increasing yields in domestic bond markets. In particular corporates lacking FX hedging could be exposed.
  - Policy responses:
    - The flexible exchange rate remains an important capital flow shock absorber.
    - Recourse to FX intervention if FX volatility becomes excessive.
    - Provide FX liquidity and support individual banks if dollar shortages appear.
    - Increase policy rate to ensure adequate external financing.
    - May also need to tighten fiscal policy to further strengthen policy credibility and avoid sell-offs of Brazilian domestic bonds.

- Financial imbalances from protracted period of low global interest rates
  - Likelihood: M
  - Expected impact: M. Building-up vulnerabilities as some corporates may further increase leverage.
  - Policy responses:
    - Monitor highly leveraged corporate; consider CFMs to discourage shorter-term borrowing.
    - Tighten monetary policy further if financial risk taking becomes excessive.

- Protracted period of slower global growth in advanced and emerging economies
  - Likelihood: H
  - Expected impact: H. Worsening current account deficit and weaker growth. Highly indebted corporates could see their profits decline. A sharp decline in commodity prices would have a direct impact on the exporting sector.
  - Policy responses:
    - Use the exchange rate as first shock absorbers.
    - Limited room for monetary and/or fiscal policy stimulus to smooth shock. Instead, prioritize structural reforms to boost potential growth.

- Sharp rise in world oil prices
  - Likelihood: M
  - Expected impact: L. Mild negative impact on the trade balance in the short-term, but improving current account in the medium term, when Brazil is expected to become a net oil exporter. In the near term, an adverse impact on the finances of Petrobras if domestic fuel prices are not adjusted sufficiently.
  - Policy responses:
    - Domestic pricing policies should ensure Petrobras obtains an adequate return from commercialization of imported fuel.

*The Risk Assessment Matrix shows events that could materially alter the baseline path. Likelihood categories: “low” (probability below 10 percent), “medium” (between 10 and 30 percent), and “high” (between 30 and 50 percent).*

---

### Appendix IV. The Inflation Targeting Framework

### Key findings and diagnostics
- Inflation has been above the midpoint of the central bank’s tolerance band for several years, and longer-term inflation expectations have risen.
  - Estimates suggest that inflation expectations (1−3 years ahead) have risen due to both higher inflation outturns and perceptions of higher inflation in the medium term.
  - Model used: non-linear Kalman filter with time-varying parameters and state constraints; expectations modeled at horizon h as a weighted combination of current inflation and an unobserved medium-term inflation expectation with the weight restricted between 0 and 1.

- Central bank independence
  - Brazil's central bank has enjoyed ‘de facto’ independence since 1999, but it does not have statutory independence.
  - The central bank has ‘instrument independence’ but: (i) price stability is not enshrined in law as the ultimate objective; and (ii) the Governor and Deputy Governors do not have fixed-term contracts and can be dismissed by the president at any time.
  - A Bank of England survey notes Brazil is unique among inflation-targeting central banks for these two reasons.

- Inflation tolerance band and target specification
  - Brazil’s inflation tolerance band allows inflation to range between 2.5 percent and 6.5 percent.
  - The inflation target is specified in terms of 12-month inflation in December, which permits inflation to be outside the tolerance band for most months of the year and can erode credibility.

### Policy recommendations
- Strengthen the inflation-targeting framework to support central bank effectiveness and credibility:
  - Passage of legislation providing for the terms of the bank’s Board members.
  - Mandate the achievement of price stability as the monetary policy objective.
  - Narrow the inflation tolerance band.
  - Better clarify the medium-term inflation target.
  - Complement stronger autonomy with enhanced accountability and transparency.

### Comparative context
- Brazil’s tolerance band is relatively wide compared with other inflation-targeting regimes (chart shows cross-country comparison; band and target/mid-point measured in percent).

---

### Appendix V. Measurement of Gross Public Debt in Brazil

### Core issue
- The Fund’s GGGD (per GFSM 2001/2014) differs from Brazil’s Central Bank (BCB) GGGD mainly in the treatment of government bonds held by the BCB and not pledged as security in monetary policy operations:
  - Under GFSM standards, government bonds held by the central bank are counted as part of government gross debt.
  - Under the BCB’s post-2008 definition, securities in the BCB’s “outright ownership” (free securities) are excluded from the BCB’s published GGGD, while securities used as collateral in REPOs remain included.

### Institutional background and chronology
- Fiscal Responsibility Law (FRL) of 2000 prevents the BCB from issuing its own debt instruments and bans direct financing of the Treasury by the BCB.
- Between December 2000 and September 2003, the central government issued securities amounting to 7.8 percent of GDP which were included in the BCB’s restructured portfolio.
- Since 2008, a law authorized direct issuance of securities by the Treasury to the BCB without counter-payment; these direct issuances have the same terms and similar maturity structure as bonds in the hands of the public.
- The accumulation of government securities in the BCB’s balance sheet has reflected compensation for unrealized financial losses related to valuation of international reserves and, more recently, losses on FX swaps operations.
- The 2008 law foresees that the central bank can automatically roll over the Treasury securities; in practice the BCB always does so to keep an adequate amount of securities available for liquidity management (REPOs).
- An additional 2009 regulation stipulates the government will issue new paper to the BCB when its uncollateralized portfolio falls below R$20 billion.

### Equalização Cambial (EC) box — mechanics and historical figures
- Law 11803 (November 2008) established a swap operation between the BCB and the National Treasury regarding financial results of international reserves and derivatives operations.
- EC includes changes in valuation of reserves, carry cost of reserves, and result of operations with swaps and derivatives.
- Historical examples provided:
  - End-2008: holding gain of R$171.4 billion (effectively transferred to the single treasury account in March 2009).
  - End-2009: holding loss of R$52.2 billion, compensated by the central government through issuance of securities placed in the BCB’s portfolio.
  - End-2014: holding gain of R$65.2 billion.
- Profits are transferred semi-annually 10 days after the publication of the budget; recapitalization takes place with some delay.

### Conceptual and accounting implications
- Under GFSM 2001/2014:
  - The BCB is a financial corporation outside the government sector; gross transactions and stock positions between the BCB and the government are recorded accordingly.
  - When the government issues securities to the BCB, a financial claim on the government is created and recorded on the BCB’s balance sheet; a corresponding liability is incurred by the government and should be included in GGGD.
  - Securities pledged for REPOs remain on the original owner’s balance sheet; GFSM requires including Treasury securities held by the central bank in GGGD regardless of their use.
- In January 2008, Brazil changed its dissemination methodology to exclude free securities held by the BCB from the national GGGD measure while keeping repo-ed securities included.
  - Authorities’ reasons for excluding free securities: they consider free securities do not represent a claim on government revenue, do not affect market conditions, do not reflect financing needs, and do not give rise to refinancing risk.
  - Fund view: regardless of these practical considerations, such securities represent a government liability under GFSM 2001/2014 and thus should be counted in GGGD.
- Data point on securities and maturities:
  - The average maturity of securities held by the public was 4.4 years (average life was 6.1 years) at end-2014.

### Data visualization remark
- Figure 1 (BCB data) presents securities used by BCB for monetary policy purposes in billion Brazilian reais, distinguishing: BCB Securities, GG Securities (held by BCB), and GG Securities (repo-ed by BCB).

*Prepared by IMF staff (Appendices III–V from the IMF staff report)._

### 6.      The wedge between the national and GFSM definitions of gross debt (that is, the stock

### 6.      The wedge between the national and GFSM definitions of gross debt (that is, the stock of free securities held by the BCB)

### Evolution of the wedge and debt series
- The wedge between the national and GFSM definitions of gross debt (that is, the stock of free securities held by the BCB) has varied considerably over time.
- The evolution of the two indicators―GGGD with and without free securities―is plotted in Figure 2.
- Historical magnitudes:
  - The difference amounted to over 15 percent of GDP in the past.
  - The wedge narrowed through November 2014 to 3.2 percent of GDP.
  - The wedge increased to 6.1 percent of GDP in December 2014.
- The two series suggest somewhat different trends in public debt; the Fund measure shows a clearer declining trend in the pre-crisis years.

### Effect of central bank sterilization on authorities’ GGGD measure
- By excluding free securities, the authorities’ measure of GGGD is affected by central bank sterilization operations.
- Mechanism:
  - For a given stock of government securities in its portfolio, every time the central bank conducts REPO transactions, the authorities’ GGGD indicator will change in equal measure.
  - Thus, by this definition, public debt rises (falls) when the central bank mops up (injects) liquidity.
- Authorities’ view:
  - The authorities find this a useful feature of the indicator as it induces lower monthly variation of the GGGD series (because the BCB sterilizes the short-term impact of government operations on market liquidity), even if the same smoothing effect is not observed at a yearly frequency.
- Neither the Fund’s nor authorities’ gross debt concept is simply explained by the trajectory of the general government deficit in the last several years owing to the accumulation of government debt issued in favor of public banks (policy lending).
- Changes in net debt are closer to the government’s net lending, as both the Treasury Single Account and claims on public banks are netted out.

### Refinancing risk and gross financing needs
- The negligible refinancing risk of public debt held by the central bank is acknowledged in the discussion of risks in staff’s Debt Sustainability Analysis for Brazil.
- While there is no legal obligation for the BCB to roll over its holdings of government debt indefinitely, the BCB has always done it, meaning that amortization of this debt does not create a need for financing from capital markets.
- Implication for gross financing needs:
  - Actual gross financing needs from the market are lower than those measured by the amortization of total government debt (as measured by GFSM2001/2014).
  - Specific magnitudes: about 14 of GDP in public debt will be rolled over in 2015, of which 10.3 percent of GDP in the market.

*Source: _cr15121 - 6.      The wedge between the national and GFSM definitions of gross debt (that is, the stock of free securities held by the BCB)_*

### 4. Brazil Skills and Jobs - Economic and Sector Work (ESW)Apr-15

### 4. Brazil Skills and Jobs - Economic and Sector Work (ESW)Apr-15

### Relations with the Inter-American Development Bank (IDB)
- The IDB’s Country Strategy with Brazil was approved on May 9, 2012, established for the period 2012−14 and comprised 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.
- A new Country Strategy with Brazil for the period 2015−18 is under preparation and expected to be approved in the second semester of the current year.

### IDB Lending and Approvals (2014–2015 projections)
- For 2015, total loan approvals are projected to reach US$1,856.0 million.
  - Loans with sovereign guarantee projected at US$1,609.0 million.
  - Operations with the private sector expected to total US$247 million.
- IDB program estimates approvals of US$4.8 million in grants for Technical Cooperation for the period.
- In 2014, the IDB approved 30 loans amounting to US$2,947.8 million, including 21 sovereign guarantee operations for US$2,240.8 million.
- Lending allocation in 2014 (percentages reported):
  - Productivity and infrastructure: 50 percent.
  - Stimulate social and productive inclusion: 22 percent.
  - Institutional strengthening and modernization of the state: 20 percent.
- Lending to subnational governments corresponded to 71 percent of total lending to Brazil.
- Major operations approved in 2014 highlighted in the source:
  - São Paulo State Road Investment Program Phase II (US$480.1 million).
  - Strengthening the Unified Health System in Salvador (US$200 million).
  - Road Program for Logistic and Integration Ceará Phase IV (US$200 million).
  - Program of Environmental Sanitation of CAESB (US$170.8 million).

### Loans Approved by the IDB in 2014 — Summary Table (values in million USD)
- Stimulate social and productive inclusion: Subnational Gov. 482; Total 482.
- Improve the condition of the country's infrastructure: Subnational Gov. 1,104; Total 1,104.
- Promote the development of sustainable cities: Subnational Gov. 171; Total 171.
- Improve the institutional capacity of public entities: Subnational Gov. 285; Central Gov. 150; Total 435.
- Increase the sustainable management of natural resource: Total 0.
- Promote development through the private sector: Subnational Gov. 48; Total 755 (Private sector 707).
- Total value of loans: Subnational Gov. 2,091; Central Gov. 150; Private sector 707; Total 2,948.
- Total number of loans: Subnational Gov. 20; Central Gov. 1; Private sector 9; Total 30.

### IDB Portfolio and Outstanding Debt (end-2014 / as of January 8, 2015)
- Active portfolio: 123 loans to the public sector (US$11,382 million) and 8 loans to the private sector (US$734.5 million).
- Brazil’s outstanding debt with the IDB amounts to US$14,531 million (as of end of December 2014).
- From the current portfolio US$8,932.7 million have not been disbursed yet (as of January 8, 2015).

### Statistical Issues — Assessment of Data Adequacy for Surveillance (As of January 30, 2015)
- General: Quality of macroeconomic statistics has improved significantly; data provision is adequate for surveillance.
- National Accounts:
  - Estimates compiled based on the 1993 System of National Accounts.
  - Availability of annual and quarterly supply and use tables supports consistent national accounts estimates.
  - IBGE is in the process of changing the base year and implementing the System of National Accounts 2008.
  - Participation in G-20 Data Gaps Initiative recommendation 15 to develop balance sheet approach, flow of funds, and sectoral data on a quarterly and annual basis.
- Price Statistics:
  - Since July 1999, 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 the 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 government finance statistics using GFSM 2001 presentation.
  - Reported statistics include statement of government operations and financial balance sheet for the consolidated central government and financing operations for general government.
  - Reported data are compiled by converting nationally published data, which 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, complicating international comparisons.
  - Migration plan for full implementation of GFSM 2001 developed in 2009; plan comprises introduction of IPSAS-based accounting framework merging budgetary and accrual approaches; 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 regularly reports quarterly FSIs to the IMF; currently reports all core and 18 encouraged FSIs, with data beginning in Q1 2005; plans underway to compile remaining encouraged FSIs.
- External Sector Statistics:
  - Brazil disseminates quarterly balance of payments and international investment position data compiled according to BPM5.
  - BCB supplementing registry of the foreign exchange system with surveys on transportation, insurance, and other services.
  - Compilation of reinvested earnings and undistributed branch profits in the current account and reinvested earnings in the financial account could be improved.
  - 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.
  - Authorities in process of revising external sector statistics in line with BPM6; revised BOP data expected to be published in April 2015, revised external debt data expected in June.
  - As part of conversion: foreign holdings of domestic debt securities will be included in external debt statistics, and its income will be recorded separately rather than jointly with principal outflows.
- Data Standards and Quality:
  - Subscriber to the Fund’s Special Data Dissemination Standard (SDDS) since 2001; uses SDDS flexibility options on timeliness of general government operations and depository corporations survey.
  - Implementing G-20 DGI recommendations with further progress to 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.

### Table of Common Indicators Required for Surveillance (As of January 30, 2015) — Selected entries and dates
- Exchange Rates: Latest observation 1/29/15; Date received 1/30/15; Frequency of Data/Reporting/Publication: D D D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Latest observation 1/28/15; Date received 1/30/15; Frequency D D D.
- Reserve/Base Money: Nov 14; Date received 1/30/15; Frequency M M M.
- Broad Money: Nov 14; Date received 1/30/15; Frequency M M M.
- Central Bank Balance Sheet: Nov 14; Date received 1/30/15; Frequency M M M.
- Consolidated Balance Sheet of the Banking System: Nov 14; Date received 1/30/15; Frequency M M M.
- Interest Rates: Latest observation 1/30/15; Date received 1/30/15; Frequency D D D.
- Consumer Price Index: December 14; Date received 1/09/15; Frequency M M M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: December 13; Date received 9/30/14; Frequency M M M.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: December 14; Date received 1/30/15; Frequency M M M.
- Stocks of Central Government and Central Government-Guaranteed Debt: December 14; Date received 1/30/15; Frequency M M M.
- External Current Account Balance: Dec. 14; Date received 1/23/15; Frequency M M M.
- Exports and Imports of Goods and Services: Dec. 14; Date received 1/5/15; Frequency M M M.
- GDP/GNP: Q3 2014; Date received 11/28/14; Frequency Q Q Q.
- Gross External Debt: Dec 14; Date received 1/23/15; Frequency M M M.
- International Investment Position: Q4 14; Date received 1/23/15; Frequency Q Q Q.

### Public Debt Sustainability Analysis (DSA) — Key Findings and Baseline
- Analysis based on the framework developed for market access countries (Staff Guidance Note for Public Debt Sustainability Analysis in Market Access Countries, IMF, May 2013).
- Gross debt of the nonfinancial public sector (NFPS) reached 71 percent of GDP in 2014.
- Net debt declined by 13 percentage points of GDP in the last decade to 37.6 percent of GDP in 2014.
- Public sector assets amounted to 39.1 percent of GDP in 2014, including 19.4 percent of GDP in international reserves.
- Non-financial public sector assets amount to 32.5 percent of GDP (see Box).
- Primary surpluses around 1.6 percent of GDP (excluding interest revenue) are needed to keep gross debt from growing as a ratio to GDP; larger primary balances will be needed to put gross debt-to-GDP on a downward path.
- Baseline scenario consistent with government’s announced targets for 2015−17 projects gross debt decreases by 2.2 percentage points to 68.8 percent of GDP by 2020.
- The trajectory of gross debt is sensitive to growth and fiscal policy underperformance given pressure from high borrowing costs.

### Public Debt Composition and Profile (2014)
- Debt coverage: NFPS excludes Petrobras and Eletrobras and consolidates the Sovereign Wealth Fund.
- NFPS gross debt includes Treasury securities on the central bank's balance sheet, including those not used under repurchase agreements.
- At end-2014, gross debt amounted to 71 percent of GDP.
- National definition of gross debt includes Treasury securities used for monetary policy by the central bank (pledged as security in reverse repo operations) but excludes other government securities held by the central bank; under national definition, gross debt of the general government amounted to 64.2 percent of GDP at end-2014.
- Debt profile:
  - Federal government domestic tradable securities account for 92 percent of total NFPS gross debt in 2014.
  - About 2/3 of those securities were held by the public.
  - Average maturity of tradable instruments about 4.4 years in 2014, up from less than 3 years in 2008.
  - Nearly 25 percent of total domestic tradable securities matures within 1 year.
  - Government objective: raise average maturity to 5.5 years and bring total short term debt down toward 20 percent of all debt.
  - Zero-coupon bonds with original maturities over one year constitute slightly more than half of FG domestic tradable securities held by the public, or 21.7 percent of GDP.
  - Foreign holding of domestic debt amounted to 17 percent of total at end-2014.
  - Foreign currency denominated debt of the NFPS accounted for 5 percent of the total in 2014, representing slightly more than 4 percent of GDP.
  - Gross financing needs have tended to be high, above 15 percent of GDP; this overstates rollover risk as about 20 percent of GDP of federal government debt is held by the central bank which follows automatic rollover policy.

### Box — Non-Financial Public Sector Debt and Asset (Summary)
- Gross NFPS debt remained high over past decade while net debt has mostly declined.
- Improvements include longer maturities, lower foreign exposure, and higher share of fixed-rate instruments.
- Drivers of widening wedge between gross and net debt:
  - Lending through development banks (countercyclical policy during global crisis).
  - Sterilization of large foreign inflows leading to increased international reserves and corresponding Treasury cash holdings at the central bank (TSA).
  - TSA balances reached 11.9 percent of GDP in 2014 (compared to 7.1 percent in 2003).
  - Credit to public financial institutions, mainly BNDES, increased over the period (details in source box).

*Prepared by the Staff of the International Monetary Fund (March 4, 2015).*

### 0.5 percent of GDP before the global crisis to 10.8 percent of GDP in 2014. In addition, a large share of

### _cr15121 - 0.5 percent of GDP before the global crisis to 10.8 percent of GDP in 2014. In addition, a large share of

### NFPS assets: composition, liquidity, and economic value
- Assets of the Workers’ Assistance Fund (FAT) now amount to 4 percent of GDP and are mainly invested in the BNDES because at least 40 percent of FAT’s annual revenues must be transferred to BNDES by its constitution.
- Other assets:
  - hybrid instruments of capital and debt: 1.1 percent of GDP
  - investment in funds and programs: 2.8 percent of GDP
  - remaining share: tax float, pension fund assets, and sight deposits of subnational governments (broadly stable over the period)
- Treasury single account (TSA) balances: no risk associated and high liquidity; TSA is remunerated at an average rate equal to interest paid by federal government securities in the central bank’s portfolio, about 10−11 percent during the same period.
- Loans to BNDES:
  - liquidity: low (not in the form of a negotiable security)
  - risk: low
  - economic value: below book value because government borrows at the SELIC rate and earns the TJLP on loans to BNDES
  - implicit grant element in government loans to BNDES: about 52 percent
  - NPV of the stock of credit to BNDES (discounted at government’s borrowing cost): below 4 percent of GDP at end-2014, less than half its nominal value
- At original maturity, short-term debt is very small, amounting to some 2 percent of total NFPS debt.

### BNDES lending profile and terms
- BNDES direct credit: about one third of its resources to large and highly competitive foreign and domestic companies, mainly in infrastructure, industry, and services, subject to stringent eligibility criteria.
- BNDES on-lends government resources through other major public and private banks, which channel credit and bear the risk.
- Repayment profile:
  - loan terms: as long as 40 years
  - grace periods: up to 20 years for principal repayment and 5 years for interest
- Interest rate linkage: BNDES loans are linked to the long-term interest rate (the TJLP), set by the National Monetary Council, which has been around 5−6 percent since 2009.
- Historical portfolio performance:
  - historical default rates on BNDES loans: below 3 percent
  - NPLs have more recently been near 0
- Regulatory: BNDES is subject to Basel III requirements as other financial institutions in Brazil.

### Fiscal balance between gross debt and assets; policy implications
- Because assets have low liquidity or value (loans to BNDES) or must be maintained at reasonable precautionary levels (cash), gross debt remains the most useful indicator.
- Policy objectives and expectations:
  - lowering the gross debt ratio is an important policy objective
  - transfers from the Federal Government to BNDES are expected to stop starting 2015, though BNDES will remain involved in funding investment by recycling funds and fostering capital market development including through guarantees
  - a sustained decline in gross debt will have to be based on ambitious primary surpluses

### Baseline scenario: macroeconomic and fiscal projections (projections assume policy lending stops from 2015)
- Macroeconomic assumptions:
  - real GDP contraction in 2015: -1 percent
  - slight recovery in 2016
  - gradual return to potential growth of 2.5 percent by the end of the projection horizon
- Fiscal adjustment: primary balance brought to 2.5 percent of GDP by 2018, implying an improvement of 3.1 percentage points of GDP during 2015−18
- Interest and financing:
  - nominal interest rates on new borrowing over 2015−20: between 11 and 13 percent
  - effective interest rate on average: below 12 percent
- TSA balances: assumed constant at 11.9 percent of GDP throughout the projection period
- Assumed policy actions: policy strengthening and implementation of the infrastructure concessions program; otherwise limited structural reforms and a modest world output recovery
- Baseline debt path:
  - gross debt increases to 72 percent of GDP in 2015 before declining to 68.8 percent of GDP in 2020
  - gross financing needs projected to remain above the high risk threshold of 15 percent of GDP on average over the medium term
- Primary balance required to stabilize debt in the baseline (excluding interest revenue): 1.6 percent of GDP
- Past forecast errors and realism:
  - median forecast error for GDP growth and the primary balance is below 1 percent
  - projected fiscal adjustment (improvement of about 3 percentage points in the cyclically-adjusted primary balance/GDP over the medium term) is ambitious but appears achievable
  - the 3‐year adjustment in cyclically-adjusted primary balance is at the 20 percentile among all surveillance countries

### Shocks and stress tests: scenarios and impacts
- Growth shock (1 standard deviation = 2.6 percent):
  - over 2016-17 real GDP growth rates become negative
  - inflation declines by 150 bps in each year of the shock
  - primary balance worsens before recovering in 2018
  - interest rates increase by 55 bps for each percentage point decline in output growth
  - debt path: gross debt increases above 81.5 percent of GDP by 2019 and stabilizes at 81.1 percent in 2020
  - gross financing needs reach almost 23 percent of GDP
- Primary balance shock:
  - consolidation delayed by one year
  - impact on debt and gross financing needs is modest, pushing up debt-to-GDP by 2 percentage points above the baseline in 2020
- Real interest rate shock:
  - borrowing costs increase by 200 bps in the first projection year and remain the same over the medium term
  - similar modest impact as primary balance shock (about 2 percentage points higher debt-to-GDP in 2020)
- Combined macro-fiscal shock and contingent liabilities shock:
  - macro-fiscal shock combines growth and interest rate shocks, primary balance shock, and real exchange rate shock (consistent with maximum past 10-year movement and pass-through coefficient of 0.25)
  - contingent liability shock: simulates a loss of 10 percent of banking system assets and assumption of contingent liabilities by the public sector
  - results in a primary deficit of ‐3.6 percent of GDP in 2016 and a 1 standard deviation shock to GDP growth in 2016 and 2017
  - effect on debt ratios and gross financing needs is large; debt-to-GDP reaches about 85 percent by 2020 in both shocks
- Heat map and vulnerabilities:
  - premium asked by the market on government borrowing, reliance on external financing, and share of short-term debt are all high, pointing to risks to the debt profile
  - gross financing need indicator overstates actual rollover risk because of Central Bank policy of continuous rollover and its holding of a significant amount of FG bonds

### Selected numeric indicators and projections (as presented)
- TSA balances assumed constant at 11.9 percent of GDP
- FAT assets: 4 percent of GDP
- Implicit grant element in government loans to BNDES: about 52 percent
- NPV of credit to BNDES: below 4 percent of GDP at end-2014
- Short-term debt at original maturity: some 2 percent of total NFPS debt
- Baseline projections:
  - gross debt: 72 percent of GDP in 2015; 68.8 percent of GDP in 2020
  - gross financing needs: projected to remain above 15 percent of GDP on average over the medium term
  - primary balance (baseline target): 2.5 percent of GDP by 2018
  - primary balance required to stabilize debt (excluding interest revenue): 1.6 percent of GDP
- Stress test outcomes:
  - growth shock: gross debt above 81.5 percent of GDP by 2019; 81.1 percent in 2020; gross financing needs almost 23 percent of GDP
  - combined shocks and contingent liabilities: debt-to-GDP reaches about 85 percent by 2020

*Source: IMF staff (as of January 23, 2015; Press Release No. 15/167, April 10, 2015).*

### References to GDP (including ratios to GDP) do not reflect the revised national accounts issued by IBGE in March

### _cr15121 - References to GDP (including ratios to GDP) do not reflect the revised national accounts issued by IBGE in March

### Inflation, monetary policy, and exchange rate
- Headline and core inflation have been near the upper-edge of the inflation tolerance band in recent years, reflecting sustained wage cost pressures, lingering indexation practices, and the ongoing drought.
- Longer-term inflation expectations rose since 2011, but have edged down since end-2014.
- Modest increases in regulated energy and fuel prices helped hold back overall inflation for some time; overdue adjustments in regulated prices are now underway.
- Inflation in market-determined prices is moderating, reflecting tighter financial conditions and subdued economic activity.
- New inflation pressures are emerging from the Real’s nominal depreciation.
- The central bank raised the monetary policy rate by 375 basis points to 11 percent between April 2013 and April 2014; policy tightening paused from May through September 2014.
- Between October 2014 and March 2015, the rate was increased by a cumulative 175 basis points to prevent second round effects from currency depreciation and anticipated increases in regulated prices.
- Directors generally agreed monetary policy should remain tight and recommended further efforts to improve monetary policy transmission and the inflation targeting framework over time.

### External sector, reserves, and competitiveness
- Despite weakening domestic demand, the current account deficit reached 4.2 percent of GDP in 2014, up from 2.4 percent of GDP in 2012.
- Deterioration drivers: worsening terms of trade, a drop in exports to Argentina, and increased fuel imports necessitated by the drought.
- Recent depreciation against the U.S. dollar has not translated one-for-one into gains against competitors in global markets; persistently high unit labor costs continue to damp competitiveness.
- The external position is assessed as weaker than desirable, with the real still overvalued at end-2014.
- Gross international reserves (cash concept) are about US$362 billion and are well above the IMF’s reserve adequacy metric and other standard benchmarks.
- FDI financed more than 70 percent of the current account deficit in 2014; portfolio inflows have been buoyant.
- Directors welcomed the recent scale-down of the foreign exchange intervention program and recommended its use remain limited to smoothing excessive volatility to allow further depreciation in line with fundamentals.

### Fiscal position, policy measures, and public debt
- In 2013, the non-financial public sector (NFPS) primary balance declined to 1.9 percent of GDP, undershooting its 2.3 percent target.
- NFPS primary balance moved to -0.6 percent of GDP in 2014 despite one-off measures of about ½ percent of GDP.
- Policy lending to public banks edged back up; NFPS gross debt increased to 71 percent of GDP.
- In 2013, the NFPS primary balance and debt dynamics contributed to a downgrade of Brazil’s sovereign credit rating: Standard & Poor’s cut Brazil to BBB- in March 2014; Moody’s revised the outlook to negative in September 2014.
- Since January 2015, the government introduced measures to strengthen macroeconomic policies: target primary surplus of 1.2 percent of GDP in 2015 and at least 2 percent of GDP in 2016 and 2017 to stabilize and then reduce NFPS gross debt.
- Fund staff cautioned that achieving budget targets requires ambitious, front-loaded measures and recommended continued fiscal reforms to reduce budget rigidities, simplify the tax system, and address structural fiscal pressures including the pension and wage indexation systems.
- The authorities announced they would not provide new policy lending for public banks as part of the strategy to stabilize and reduce gross public debt to GDP.

### Growth outlook and risks
- Fund staff projects negative output growth of 1 percent in 2015, with drag from tighter fiscal and monetary policies and cuts in investment by Petrobras adding to downward momentum from 2014.
- Staff expects return to positive growth in 2016 if fiscal adjustment strategy is successfully implemented and other policy actions restore confidence and reinvigorate investment.
- The outlook is subject to significant downward risks, including drought-induced rationing of energy and water, possible fallout from the Petrobras case, and a more adverse international environment.
- The authorities dispute staff’s growth forecasts for 2015 and 2016 as overly pessimistic; central bank survey medians cited by authorities are -0.78 percent and 1.3 percent for GDP growth in 2015 and 2016, respectively.
- Authorities argue some staff assumptions (e.g., weight on water/energy rationing and Petrobras investment reduction) are exaggerated; note Petrobras registered production of 2.67 Mbpd in 2014, with new pre-salt areas accounting for about ¼ of total output.

### Executive Board and Directors’ recommendations
- Directors underlined Brazil’s success in reducing unemployment, poverty, and inequality but noted stalling growth, high inflation, and deteriorating public finances.
- Key recommendations and priorities from Directors:
  - Further strengthen policy credibility and market confidence.
  - Boost investment and competitiveness; reinforce the foundation for strong, balanced, and sustainable growth.
  - Achieve announced fiscal targets via ambitious, front-loaded measures; focus on cuts in current expenditures and tax exemptions to make room for priority spending on investment and social programs.
  - Consider targeting a higher primary surplus over the next two years (some Directors), while others cautioned about growth impacts.
  - Strengthen governance frameworks in state-owned enterprises; address problems at the state-owned oil company as an immediate priority.
  - Maintain a flexible exchange rate as the main shock absorber and limit foreign exchange intervention to smoothing excessive volatility.
  - Monitor banks’ balance sheets and corporate leverage; enhance bank supervision (including for public banks) and consider targeted microprudential measures.
  - Pursue supply-side reforms with priority on infrastructure investment, tax efficiency, improving the business climate, and fostering international trade; prioritize reforms and increase private sector participation.

### Key statistics and projections (selected exact figures from the source)
- Monetary policy rate: increased by 375 basis points to 11 percent between April 2013 and April 2014; further increased by 175 basis points between October 2014 and March 2015.
- Current account deficit: 4.2 percent of GDP in 2014; 2.4 percent of GDP in 2012.
- Gross international reserves (cash concept): about US$362 billion.
- FDI financed more than 70 percent of the current account deficit in 2014.
- NFPS primary balance: 1.9 percent of GDP in 2013; -0.6 percent of GDP in 2014.
- One-off measures in 2014: about ½ percent of GDP.
- NFPS gross debt: 71 percent of GDP (2014).
- Government fiscal targets: primary surplus of 1.2 percent of GDP in 2015; at least 2 percent of GDP in 2016 and 2017.
- Fund staff growth projection: negative output growth of 1 percent in 2015.
- Central bank survey medians cited by authorities: -0.78 percent (2015) and 1.3 percent (2016) for GDP growth.
- Petrobras production in 2014: 2.67 Mbpd; pre-salt production share: about ¼ of total output.
- Reversal of payroll tax cuts estimated yield: 0.4 percent of GDP savings per year (measure under consideration).

*International Monetary Fund — _cr15121 (Statement and selected excerpts) *

### 12.      Staff estimates that the gross public debt to GDP ratio will rise slightly in 2015 and

### _cr15121 - 12.      Staff estimates that the gross public debt to GDP ratio will rise slightly in 2015 and

### Gross public debt: definitions and implications
- Staff estimates that the gross public debt to GDP ratio will rise slightly in 2015 and gradually decline as of 2016 (table 3).
- There is a significant difference between the Fund’s and the authorities’ definitions of gross public debt:
  - Fund’s definition: includes all treasury securities held by the Central Bank of Brazil (BCB).
  - Authorities’ definition: excludes treasury securities held by the BCB and only accounts for those held by the public – including as collateral for BCB’s liquidity-mopping repos.
- Market and rating agency practice:
  - The authorities’ definition is widely used by financial markets, including major international banks, and by the three largest rating agencies in their debt sustainability analyses.
- Quantified divergence:
  - Under the Fund’s approach, the ratio of gross public debt to GDP was nearly 7 percentage points higher in 2014 (table 3).
- Methodological implications:
  - The Fund’s methodology leads to an overestimation of gross financing needs because the rollover risk of securities held by the BCB is insignificant — a point staff now recognizes.
  - Despite this recognition, the debt sustainability analysis is entirely based on the Fund’s definition of gross public debt.

### Monetary policy and FX swaps
- Inflation objective:
  - The BCB is determined to bring inflation back to the 4.5 percent midpoint of the target range by the end of 2016.
- Policy rate actions:
  - From April 2013 to April 2014 the policy rate was raised by 375 basis points.
  - In October (prior year) the BCB resumed tightening, increasing the policy rate by a further 175 basis points, totaling a 550-basis-point increase.
- Price adjustments addressed:
  - The tightening aims to cope with second-order inflation effects from: i) realignment of tradables prices vis-à-vis non-tradables; and ii) realignment of administered vis-à-vis market-based prices.
- Exchange rate regime and FX swaps:
  - Authorities stress that the floating exchange rate regime remains the first line of defense; the exchange rate has moved in response to fundamentals and external shocks.
  - A FX swap program was put in place in August 2013 to mitigate financial risks from U.S. monetary normalization and to allow economic agents to hedge foreign exchange positions.
  - FX swaps are settled in local currency and therefore do not compromise or commit international reserves.
  - The BCB considers the notional value of FX swap contracts outstanding to be broadly in line with private-sector hedging needs.
  - The latest extension of the FX swap program on a reduced scale and for a shorter period is consistent with the BCB’s view.
- Assessment of swap program effects:
  - Staff’s argument that the swap program, by lowering the cost of hedging, encouraged excessive risk taking is described as debatable.
  - Counterpoint: lower hedging costs facilitate access to hedging and therefore a reduction and better distribution of risks.

### Financial sector: liquidity, provisioning, supervision
- System health and oversight:
  - Data in table 6 indicate the Brazilian financial system has ample liquidity, is well-provisioned and holds adequate capital levels.
  - Financial sector regulation and supervision are recognized to be strong, both in terms of on-site and off-site monitoring.
- Credit expansion and balance-sheet risk:
  - The BCB is confident recent credit expansion did not create fragilities in the banking system.
  - Staff’s assessment of risk of deterioration of banks’ balance sheets in a low-growth scenario is characterized as exaggerated.
  - Stress tests conducted by the central bank with extreme scenarios proposed by staff pointed to some — yet limited — need for additional capital.
- Supervisory tools:
  - The BCB’s credit registry system tracks 99 percent of banking credit, allowing early identification of asset quality deterioration — a factor staff should have taken into account.
- Non-performing loans (NPLs):
  - The ratio of NPLs to total loans has been stable at less than 3 percent since 2013.
  - At 2.1 percent as of September 2014, the NPL ratio of public banks continues to be significantly lower than that of private banks (table 6).

### External sector
- Current account:
  - The current account deficit widened and is expected to have reached 4.2 percent of GDP in 2014, compared to 3.6 percent in 2013.
  - Note: part of the increase in the current account deficit as a proportion of GDP reflects the impact of exchange rate depreciation on GDP expressed in dollar terms.
- Foreign direct investment (FDI):
  - FDI in 2014 surpassed USD 60 billion, enough to cover more than ¾ of the current account deficit.
  - Brazil accounted for 4.4 percent of global FDI inflows and ranked among the top five FDI host economies in UNCTAD’s 2014 World Investment Report.
  - The BCB expects FDI flows to remain broadly stable in 2015, around USD 65 billion.
- Drivers and outlook:
  - The rise in the current account deficit is in part due to exogenous factors: worsening terms of trade and reduced demand from important trading partners.
  - Ongoing realignment of the exchange rate, with further real effective exchange rate depreciation in late 2014 and early 2015, will help reduce the current account deficit.
  - Authorities expect U.S. recovery to have a positive impact on Brazilian exports.
- Reserves and external buffers:
  - Reserves closed 2014 at USD 364 billion.
  - Reserves equivalent of 377 percent of short-term debt at residual maturity and more than 15 months of prospective imports of goods and non factor services (table 5).
  - The high level of reserves is highlighted as a main strength but is noted as not taken into account in staff’s analysis of external risks and not mentioned in the report’s Risk Assessment Matrix (Appendix III).

### Investment program
- Three key areas:
  - (i) Removal of regulatory obstacles to investment, especially infrastructure investment.
  - (ii) Adoption of coordinated policy measures for increasing competitiveness.
  - (iii) Improvement of labor force skills and promotion of innovation to boost productivity and lift potential growth.
- Specific measures:
  - Infrastructure investment package of USD 40 billion in the form of concessions and public-private partnerships already negotiated, and projects in the pipeline totaling USD 110 billion.
  - A new regulatory framework for small and medium enterprises to reduce red tape and improve access to capital markets and export credit.
  - Trade facilitation through integration of foreign trade procedures under a new single window system.
  - Implementation of the National Education Plan and the National Program of Knowledge Platforms.
- New instruments:
  - Infrastructure debentures (fixed-income securities linked to infrastructure projects) to facilitate private sector participation.
  - As of December 2014, the outstanding volume of these debentures surpassed 15 billion reais, with maturities ranging from 5 to 17 years.

### Social programs and outcomes
- Objectives and instruments:
  - Social programs aim for universal coverage of social protection through well-defined criteria; economic inclusion of the poorest; and reduction of income, gender, color, and regional inequality.
  - Bolsa Família (BF) is the main instrument; created in 2003.
  - Brasil Sem Miséria was created in 2011 to more directly address extreme poverty.
- Program implementation and monitoring:
  - BF reaches 54 million people or 14 million families.
  - BF’s budget is around 0.5 percent of GDP; administrative costs represent less than 5 percent of the total.
  - Around 1.3 million people were excluded from BF in 2014 for reasons including failure to update data biannually, noncompliance with conditionalities, or no longer meeting the revenue criterion (monitored through cross-checking with other official databases).
  - Participation of all states and municipalities supports the Single Registry of Social Programs of the Federal Government.
  - The Single Registry supported initiatives under Brasil sem Miséria: enrollment of 1.8 million people in Pronatec and formalization of 1.2 million micro-entrepreneurs; expansion of day care to 700 thousand children registered in BF; and initiatives for water and energy supply and child health prevention and treatment.
- Poverty outcomes:
  - The rate of chronic poverty fell from 1.8 percent of the population in 2011 to 1.1 percent in 2014.
  - Brazil has left the map of world hunger of the Food and Agriculture Organization of the United Nations.

*Source: _cr15121 - 12.      Staff estimates that the gross public debt to GDP ratio will rise slightly in 2015 and (PDF chapter).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15121.pdf_