## _cr16348

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### External position and financial sector health
- External position assessed as "moderately weaker than the level consistent with fundamentals" reflecting reversal of exchange rate depreciation in 2015.
- Banking sector:
  - System wide capital ratios fell in 2015 but "remain well above the regulatory minima".
  - Liquidity risk increased in 2015; "the overall funding profile of the system remained strong".
  - External funding exposures are low (around 12 percent of total funding) and foreign exchange risks are "largely hedged".
  - Profitability declined due to a spike in provisions for loan losses and higher funding costs.
  - Non-performing loans (NPLs) "have gradually increased, but remain moderate at 4.1 percent" (3.6 percent in July 2016 excluding restructured loans; 4.1 percent if restructured loans are added).
  - Loan loss reserves cover 150 percent of NPLs.
  - Nonfinancial corporates are leveraged and vulnerable.

### Fiscal outcomes, policy measures, and reforms
- Fiscal outcomes:
  - 2015: NFPS primary deficit reached 1.9 percent of GDP; overall deficit was 10.4 percent of GDP.
  - 2016 (expected): primary deficit projected to reach 2.7 percent of GDP; overall balance close to 2015 level.
- Government measures since May 2016:
  - Constitutional amendment sent to Congress to limit growth in federal noninterest spending to "the rate of consumer price inflation of the previous year for the next 20 years".
  - Announced reform of the social security system described as "needed in its own right and also necessary to make the expenditure limit viable".
- Staff assumptions and conditionality:
  - Staff project output growth of -3.3 percent in 2016 and about ½ percent in 2017, conditional on approval of the fiscal spending cap and social security reform and meeting fiscal targets for 2016 and 2017.
- Policy recommendations (staff and Directors):
  - Rebuild credibility and regain long-term fiscal sustainability through reforms addressing unsustainable expenditure mandates, including social security reform.
  - Merit in additional actions to achieve a more frontloaded fiscal consolidation given large public gross financing needs.
  - Complement expenditure restraint with revenue measures if collections disappoint.
  - Consider stepping up structural reforms in tax policy, labor markets, infrastructure, and trade to raise potential growth and competitiveness.
  - Strengthen reporting of fiscal statistics for SOEs, public banks, and states; monitor and enforce subnational fiscal rules.

### Outlook, scenarios and risks
- Staff baseline expectations:
  - Activity to start to recover gradually but remain weak for a prolonged period; investment projected to recover with fiscal improvements and declining uncertainty.
  - Baseline medium-term fiscal projection: consolidation proceeds at a gradual pace; gross debt stabilizes only past the standard 5-year projection period.
- Baseline scenario (selected years):
  - 2016: Growth %: -3.3; Inflation (GDP deflator) %: 8.0; Primary Balance % GDP: -2.7; Gross Debt % GDP: 78.4
  - 2017: Growth %: 0.5; Inflation (GDP deflator) %: 6.1; Primary Balance % GDP: -2.3; Gross Debt % GDP: 82.9
  - 2018: Growth %: 1.5; Inflation (GDP deflator) %: 5.3; Primary Balance % GDP: -1.3; Gross Debt % GDP: 85.7
  - 2019: Growth %: 2.0; Inflation (GDP deflator) %: 5.1; Primary Balance % GDP: -0.5; Gross Debt % GDP: 88.2
  - 2020: Growth %: 2.0; Inflation (GDP deflator) %: 5.0; Primary Balance % GDP: 0.1; Gross Debt % GDP: 90.9
  - 2021: Growth %: 2.0; Inflation (GDP deflator) %: 5.0; Primary Balance % GDP: 0.8; Gross Debt % GDP: 93.5
- IMF "Debt Reduction Begins by 2021" recommended path (selected):
  - Primary Balance, % GDP (IMF Recommended Path): 2016: -1.8; 2017: -0.6; 2018: 0.7; 2019: 2.0; 2020: 3.0
  - Measures Required, % GDP (total): 2018: 0.7; 2019: 1.2; 2020: 1.9; 2021: 2.2
  - Measures Required — Revenues, % GDP: 2018: 0.5; 2019: 0.8; 2020: 1.0; 2021: 1.0
  - Measures Required — Expenditures, % GDP: 2018: 0.2; 2019: 0.4; 2020: 0.9; 2021: 1.2
- Key downside risks:
  - Domestic: failure to deliver fiscal consolidation; re-intensification of political uncertainties (e.g., corruption probe developments); "sudden stop" of capital inflows; sharp asset price adjustment; widening credit spreads; banking losses and recapitalization needs.
  - External: protracted slower growth in advanced and emerging economies (especially China); further declines in commodity prices; tighter global financial conditions.
- Stress-test outcomes:
  - 1 standard deviation growth shock (3.4 percent) could raise gross debt to 112 percent of GDP by 2021 and gross financing needs to 39 percent of GDP.
  - Combined macro-fiscal and contingent liability shocks could raise debt-to-GDP to about 109−119 percent by 2021.
  - No reform scenario could see debt reach 106 percent of GDP by 2021.

### Labor market, unemployment, and social impacts (Box 1)
- Youth unemployment (18–24) rose from 14.1 percent in 2014Q4 to 24.5 percent in 2016Q2.
- Since the start of the recession, Brazil lost 2.7 million formal jobs; bulk (about 1.8 million) from industry and construction.
- Under staff Real GDP forecast, cumulative formal job destruction may reach 3.1 million between 2014Q1 and 2017Q4 (methodology: regression using 1999Q3–2016Q1 data and IMF Staff forecasts).
- Real average earnings dropped by more than 4 percent year-over-year in 2016Q2 while real minimum wage increased, likely pricing younger workers out of the labor market.

### Growth drivers and investment (Box 2 summary)
- Investment fell by around 25 percent since the beginning of 2014; fixed capital formation has fallen further behind other emerging economies.
- Mid-term (3-year ahead) growth expectations:
  - Averaged around 4 percent between 2002 and 2012; fell to about 2 percent by end-2015.
  - As of 2016Q2, change in current conditions explains roughly one quarter of the recent decrease; remainder due to autonomous reassessment of medium-term potential.
- Factors hampering investment: rise in costs (e.g., almost 18 percent regulated-price rise in 2015), falling terms of trade, tighter financial conditions, political uncertainty, governance issues at Petrobras.
- Policy levers to revive investment: stabilization of regulated-price inflation, terms of trade, equity prices, real interest rates, and reduction in political uncertainty.

### Inflation, monetary policy, and exchange rate
- 2015: headline IPCA spiked to 10.7 percent (e.o.p.); two sharp relative-price realignments in 2015 (regulated prices up almost 18 percent; REER depreciation around 20 percent in real effective terms).
- Monetary policy actions:
  - SELIC hiked by 250 basis points to 14.25 percent between January 2015 and July 2015.
  - TJLP increased by 250 basis points to 7.5 percent between late 2014 and early 2016.
  - Central bank narrowed inflation tolerance range for 2017 from 2.5–6.5 percent to 3–6 percent.
- Policy guidance:
  - Monetary policy should remain tight until inflation expectations converge closer to the center of the tolerance band.
  - Exchange rate should remain the main external adjustment variable; gradual reduction in the stock of FX swaps should continue; interventions limited to fending off market dysfunction.
  - Reserve buffers should be preserved.

### Banking sector resilience and macroprudential policy
- Banking system: capital and liquidity broadly above regulatory minima, but profitability and asset quality weakened during recession.
- Recommendations to bolster resilience:
  - Strengthen procedures for use of deposit insurance fund and secure adequate funding.
  - Enhance central bank emergency liquidity assistance.
  - Modernize resolution regime and mandate a macro-prudential oversight committee including all financial regulators, the Deposit Guarantee Fund, and Ministry of Finance.
  - Mandate a separate crisis coordination entity and periodically test crisis response capacity.
  - Strengthen private insolvency frameworks to expedite bankruptcy and reduce creditor losses.
- Macroprudential actions taken: central bank relaxed reserve requirements for small- and medium-sized banks to support liquidity and targeted lending.

### Subnational fiscal stress and Rio de Janeiro case
- Many states faced sharp revenue falls in 2015−16; mandatory spending (salaries, pensions) consumed large shares of revenue.
- Rio de Janeiro (Box 4) highlights:
  - Declared "state of calamity" in July 2016; received R$2.9 billion transfer for Olympic security.
  - By August 2016, a 4-month delay in transferring payroll-withheld amounts to banks; monthly payments of salaries and pensions consumed 90 percent of monthly revenues.
  - 2016 gap for Rio de Janeiro estimated at R$16 billion (2.4 percent of the state's GDP and ¼ percent of Brazil's GDP).
- Policy implications: structural fiscal reforms required, including public employment rules and national pension reform; consider new recurrent revenue sources for stressed states.

### External sector, reserves, and capital flows
- Current account deficit narrowed from 4.3 percent of GDP in 2014 to 3.3 percent in 2015; NIIP improved to -27 percent of GDP in 2015.
- Gross official reserves around US$363.6–369.3 billion series reported; reserves assessed as above IMF adequacy metric.
- Central Bank reduced net notional value of FX swaps from about US$110 billion to about US$32 billion by issuing reverse swaps and not rolling over swaps.
- Net direct investment fully financed the current account deficit in both 2015 and 2016.

### Public debt, debt dynamics, and DSA key points
- NFPS gross debt: 2014: 63.3; 2015: 73.7; 2016 (Proj.): 78.4; 2017 (Proj.): 82.9; 2018: 85.7; 2019: 88.2; 2020: 90.9; 2021: 93.5 (percent of GDP).
- Net public sector debt: 2014: 33.1; 2015: 36.2; 2016 (Proj.): 45.9; 2017 (Proj.): 50.9; 2018: 54.1; 2019: 56.8; 2020: 59.7; 2021: 62.5 (percent of GDP).
- Gross financing needs have tended to be high, above 15 percent of GDP; baseline projects gross debt reaching 93.5 percent of GDP by 2021.
- Baseline macro assumptions: real GDP contraction of -3.3 percent in 2016; ½ percent growth in 2017; nominal interest rates on new borrowing between 12 and 15 percent over 2016−21; effective interest rate about 12 percent on average.
- Debt-stabilizing primary balance by end-horizon estimated at about 3.3 percent of GDP (excluding interest revenue) under baseline.

### Structural reforms and growth policy recommendations
- Priority reforms to boost medium-term potential growth:
  - Alleviate infrastructure bottlenecks via the concessions program and improved regulatory framework.
  - Tax reform: simplify PIS/COFINS and ICMS to reduce cost of doing business.
  - Open the economy: reduce tariffs and non-tariff barriers, revise domestic content rules, pursue free-trade negotiations outside Mercosur.
  - Review credit earmarking and distortions to ensure efficient allocation of savings.
  - Labor reform: facilitate productive employment and reduce incentives for informality; moderate minimum wage indexation.
- Fiscal transparency:
  - Publish a full balance sheet for general government and fiscal statistics for the entire nonfinancial public sector and public sector including BNDES, Caixa, and Banco do Brasil.
  - Strengthen states’ fiscal reporting and enforce subnational fiscal rules.
- Transparency and anti-corruption measures:
  - Make public procurement data open by default; implement conflict-of-interest legislation; strengthen whistleblowing; improve AML/CFT supervision and enforcement.

### Selected key indicators (exact figures preserved)
- Area (thousands of sq. km): 8,512
- Population Total (million) (est., 2015): 204.5
- Annual rate of growth (percent, 2015): 0.8
- Unemployment rate (average, 2016): 11.6
- Life expectancy at birth (years): 75
- GDP (2015): R$5,904 billion; US$1,773 billion
- GDP per capita (est., 2015): US$8,668
- GDP at constant prices (annual percent change): 2014: 0.1; 2015: -3.8; 2016 (Proj.): -3.3; 2017 (Proj.): 0.5; 2018: 1.5; 2019: 2.0; 2020: 2.0; 2021: 2.0
- Consumer price index (IPCA, end of period): 2014: 6.4; 2015: 10.7; 2016 (Proj.): 7.2; 2017 (Proj.): 5.0
- Trade balance (in billion US$): 2014: -6.6; 2015: 17.7; 2016 (Proj.): 48.5
- Exports (in billion US$): 2015: 190.1; 2016 (Proj.): 197.6
- Imports (in billion US$): 2015: 172.4; 2016 (Proj.): 149.1
- Gross official reserves (eop, in billions of US$): 2014: 363.6; 2015: 356.5; 2016 (Proj.): 369.3
- Total external debt (percent of GDP): 2014: 29.5; 2015: 37.5; 2016 (Proj.): 38.4; 2017 (Proj.): 35.3

### Governance, anti-corruption, and institutional developments
- Recent corruption investigations have increased transparency but added to political and economic uncertainty.
- Authorities have implemented oversight mechanisms including the Federal Court of Accounts, Federal Public Prosecutors Office, Financial Intelligence Unit, and ENCCLA.
- Revisions to the AML Law in 2012 and the 2013 AC law provided additional investigative and prosecutorial tools.
- Staff and Directors encourage further strengthening of anti-corruption, AML/CFT measures, and transparency in public procurement and SOE governance.

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

*Source: IMF Staff Report for the 2016 Article IV Consultation (selected extracts).*

### 3.3 percent in 2015. Brazil’s external position remained, however, moderately weaker than the

### _cr16348 - 3.3 percent in 2015. Brazil’s external position remained, however, moderately weaker than the

### External position and financial sector health
- External position "moderately weaker than the level consistent with fundamentals" reflecting the reversal of exchange rate depreciation that occurred in 2015.
- Banking sector:
  - System wide capital ratios fell in 2015 but "remain well above the regulatory minima".
  - Liquidity risk increased in 2015, but "the overall funding profile of the system remained strong".
  - External funding exposures are low and foreign exchange risks are "largely hedged".
  - Profitability declined owing to a spike in provisions for loan losses and higher funding costs.
  - Non-performing loans (NPLs) "have gradually increased, but remain moderate at 4.1 percent".
  - Loan loss reserves cover 150 percent of NPLs.
  - Nonfinancial corporates are leveraged and vulnerable.

### Fiscal outcomes, policy measures, and reforms
- Fiscal outcomes:
  - In 2015 the non-financial public sector (NFPS) primary deficit reached 1.9 percent of GDP and the overall deficit was 10.4 percent of GDP.
  - The primary deficit in 2016 is expected to reach 2.7 percent of GDP, and the overall balance would be close to that observed in 2015.
- Government measures since May 2016:
  - Constitutional amendment sent to Congress limiting growth in federal noninterest spending to "the rate of consumer price inflation of the previous year for the next 20 years".
  - Announced reform of the social security system deemed "needed in its own right and also necessary to make the expenditure limit viable".
- Staff assumptions and conditionality:
  - Staff project output growth of -3.3 percent in 2016 and about ½ percent in 2017.
  - Projection predicated on approval of the fiscal spending cap and social security reform in a "reasonable timeframe", and the government meeting proposed fiscal targets for 2016 and 2017.
- Policy recommendations:
  - Focus on rebuilding credibility and regaining long-term fiscal sustainability through reforms addressing unsustainable expenditure mandates, including social security reform, reducing the fiscal deficit, and boosting potential growth.
  - Merit in additional actions to achieve a more frontloaded fiscal consolidation given large public gross financing needs for a considerable period.
  - Monetary policy should remain tight until inflation expectations converge closer to the center of the tolerance band.
  - The exchange rate should remain the main external adjustment variable; gradual reduction in the stock of FX swaps should continue, consistent with market circumstances; further intervention only to fend off market dysfunction.
  - Bolster banking sector resilience through enhanced monitoring and improved financial safety nets.

### Outlook and risks
- Staff expectations:
  - Activity to start to recover gradually, but remain weak for a prolonged period.
  - With fiscal improvements and declining uncertainty, investment is projected to recover, supporting a gradual return to positive sequential growth beginning in late 2016.
- Key downside risks:
  - Re-intensification of political uncertainties (e.g., developments in the corruption probe).
  - Protracted period of slower growth in advanced and emerging economies, especially China.
  - Further declines in export commodity prices.
  - Tighter financial conditions.
- Baseline medium-term fiscal projection note:
  - In the baseline scenario, fiscal consolidation proceeds at a gradual pace, and gross debt only stabilizes past the end of the standard 5-year projection period.
- Short summary from "KEY ISSUES":
  - Growth projected to resume gradually but remain weak for a prolonged period.
  - Failure to implement ambitious structural fiscal reforms is "the most immediate risk" and would jeopardize debt sustainability.

### Executive Board assessment and Directors' views
- Diagnosis:
  - Brazil’s difficult economic situation resulted from several factors, including "past policy missteps, policy uncertainty, and external shocks".
  - The recession lowered growth, raised unemployment, and undermined public and private balance sheets.
- Directors' priorities:
  - Strong emphasis on fiscal consolidation to ensure macroeconomic stability and comprehensive structural reforms to raise potential growth.
  - Welcomed authorities’ announced fiscal strategy and its positive effects on confidence and market sentiment.
  - Supported focus on controlling expenditure growth, including the proposed federal spending cap, while noting expenditure restraint may need to be complemented with revenue measures if collections disappoint.
  - Some Directors cautioned against more front-loaded measures until growth is on a strong recovery path.
  - Underlined need for reform of social security schemes including civil servants' schemes at all government levels; emphasized centrality of this reform to the viability of the federal spending cap.
  - Expressed concern over subnational finances and encouraged durable solutions in coordination with the states.
  - Monetary policy: noted it had been appropriately calibrated; recommended policy remain relatively tight until more tangible progress in fiscal adjustment and reforms and until inflation expectations move closer to the central bank’s inflation target.
  - Welcomed intention to strengthen inflation targeting framework by enhancing central bank autonomy and communications.
  - Underscored preserving floating exchange rate system and reserve buffers; welcomed reduction in foreign exchange intervention and recommended limiting intervention to smoothing excessive volatility.
  - Financial system: encouraged enhancing the financial safety net and close monitoring of corporate sector links to banks.
  - Strong recommendation to step up structural reforms in tax policy, labor markets, and infrastructure; underscored importance of trade reforms to increase competitiveness and efficiency.
  - Commended Brazil for effective implementation of AML/CFT measures and encouraged further reforms.
  - Noted need for strengthened reporting of fiscal statistics of SOEs, public banks, and states’ finances, and monitoring and enforcement of subnational fiscal rules.

### Selected key economic and social indicators (selected exact figures from the source)
- Social and demographic:
  - Area (thousands of sq. km): 8,512
  - Population Total (million) (est., 2015): 204.5
  - Annual rate of growth (percent, 2015): 0.8
  - Density (per sq. km.) (2012): 24.0
  - Unemployment rate (average, 2016): 11.6
  - Life expectancy at birth (years): 75
  - Infant mortality (per thousand live births): 15
  - Access to safe water (2015): 98.1
  - Physician per 1000 people (2013): 1.9
  - Hospital beds per 1000 people (2012): 2.3
  - Adult illiteracy rate (2014): 8.3
  - Net enrollment rates (2014): Primary education 99; Secondary education 84
  - Poverty rate (in percent, 2013): 15.1
  - GDP (2015): R$5,904 billion; US$1,773 billion
  - GDP per capita (est., 2015): US$8 billion
  - Gini coefficient (2014): 51.8
- National accounts and prices (annual percent change):
  - GDP at current prices: 2014: 7.0; 2015: 3.8; 2016 (Proj.): 4.4; 2017 (Proj.): 6.6; 2018: 6.9; 2019: 7.2; 2020: 7.1; 2021: 7.1
  - GDP at constant prices: 2014: 0.1; 2015: -3.8; 2016 (Proj.): -3.3; 2017 (Proj.): 0.5; 2018: 1.5; 2019: 2.0; 2020: 2.0; 2021: 2.0
  - Consumption: 2014: 1.3; 2015: -3.4; 2016 (Proj.): -4.1; 2017 (Proj.): -0.4; 2018: 0.6; 2019: 0.8; 2020: 1.0; 2021: 1.1
  - Investment: 2014: -5.6; 2015: -22.6; 2016 (Proj.): -11.3; 2017 (Proj.): 4.6; 2018: 5.1; 2019: 7.1; 2020: 6.1; 2021: 5.5
  - Consumer price index (IPCA, end of period): 2014: 6.4; 2015: 10.7; 2016 (Proj.): 7.2; 2017 (Proj.): 5.0; 2018: 4.8; 2019: 4.5; 2020: 4.5; 2021: 4.5
- Public sector finances (percent of GDP):
  - Gross domestic investment: 2014: 21.0; 2015: 19.2; 2016 (Proj.): 18.4; 2017 (Proj.): 18.9; 2018: 19.4; 2019: 20.1; 2020: 20.7; 2021: 21.3
  - Gross national savings: 2014: 16.7; 2015: 15.9; 2016 (Proj.): 17.6; 2017 (Proj.): 17.4; 2018: 17.7; 2019: 18.3; 2020: 19.0; 2021: 19.5
  - Private sector savings: 2014: 20.2; 2015: 24.1; 2016 (Proj.): 26.5; 2017 (Proj.): 25.3; 2018: 24.2; 2019: 23.9; 2020: 23.8; 2021: 23.7
  - Public sector savings: 2014: -3.5; 2015: -8.2; 2016 (Proj.): -8.9; 2017 (Proj.): -7.8; 2018: -6.5; 2019: -5.6; 2020: -4.8; 2021: -4.2
  - Central government primary balance (1/): 2014: -0.4; 2015: -2.0; 2016 (Proj.): -2.7; 2017 (Proj.): -2.4; 2018: -1.7; 2019: -0.9; 2020: -0.2; 2021: 0.4
  - NFPS primary balance: 2014: -0.6; 2015: -1.9; 2016 (Proj.): -2.7; 2017 (Proj.): -2.3; 2018: -1.3; 2019: -0.5; 2020: 0.1; 2021: 0.8
  - NFPS overall balance: 2014: -1.5; 2015: -1.7; 2016 (Proj.): -1.6; 2017 (Proj.): -1.4; 2018: -0.8; 2019: -0.3; 2020: 0.1; 2021: 0.8
  - NFPS overall balance (incl. net policy lending): 2014: -7.0; 2015: -10.4; 2016 (Proj.): -10.5; 2017 (Proj.): -9.5; 2018: -8.2; 2019: -7.2; 2020: -6.2; 2021: -5.9
  - Net public sector debt: 2014: 33.1; 2015: 36.2; 2016 (Proj.): 45.9; 2017 (Proj.): 50.9; 2018: 54.1; 2019: 56.8; 2020: 59.7; 2021: 62.5
  - NFPS gross debt: 2014: 63.3; 2015: 73.7; 2016 (Proj.): 78.4; 2017 (Proj.): 82.9; 2018: 85.7; 2019: 88.2; 2020: 90.9; 2021: 93.5
  - Of which: Foreign currency linked: 2014: 3.4; 2015: 4.6; 2016 (Proj.): 3.8; 2017 (Proj.): 3.7; 2018: 3.7; 2019: 3.6; 2020: 3.6; 2021: 3.5
- Money and credit (annual percent change):
  - Base money (2/): 2014: -4.5; 2015: 8.4; 2016 (Proj.): 4.5; 2017 (Proj.): 6.7; 2018: 6.9; 2019: 7.2; 2020: 7.1; 2021: 7.1
  - Broad money (3/): 2014: 13.5; 2015: 9.8; 2016 (Proj.): 5.8; 2017 (Proj.): 9.6; 2018: 10.0; 2019: 10.6; 2020: 13.6; 2021: 14.4
  - Bank loans to the private sector: 2014: 10.9; 2015: 3.6; 2016 (Proj.): 1.2; 2017 (Proj.): 5.6; 2018: 9.3; 2019: 11.4; 2020: 12.0; 2021: 12.6
- Balance of payments (in billion of U.S. dollars):
  - Trade balance: 2014: -6.6; 2015: 17.7; 2016 (Proj.): 48.5; 2017 (Proj.): 48.6; 2018: 47.3; 2019: 46.5; 2020: 49.2; 2021: 51.9
  - Exports: 2014: 224.1; 2015: 190.1; 2016 (Proj.): 197.6; 2017 (Proj.): 206.7; 2018: 210.9; 2019: 215.7; 2020: 224.8; 2021: 233.6
  - Imports: 2014: 230.7; 2015: 172.4; 2016 (Proj.): 149.1; 2017 (Proj.): 158.1; 2018: 163.6; 2019: 169.2; 2020: 175.7; 2021: 181.8
  - Current account: 2014: -104.2; 2015: -58.9; 2016 (Proj.): -14.7; 2017 (Proj.): -29.5; 2018: -34.9; 2019: -38.6; 2020: -39.9; 2021: -41.2
  - Capital account and financial account: 2014: 100.8; 2015: 55.2; 2016 (Proj.): 14.7; 2017 (Proj.): 29.5; 2018: 34.9; 2019: 38.6; 2020: 39.9; 2021: 41.2
  - Foreign direct investment (net): 2014: 70.9; 2015: 61.6; 2016 (Proj.): 61.8; 2017 (Proj.): 56.7; 2018: 53.1; 2019: 50.8; 2020: 49.2; 2021: 47.7
  - Terms of trade (percentage change): 2014: -3.4; 2015: -11.0; 2016 (Proj.): 3.2; 2017 (Proj.): -2.5; 2018: -2.9; 2019: -2.4; 2020: -0.7; 2021: -0.5
  - Merchandise exports (in US$, annual pct. change): 2014: -7.2; 2015: -15.2; 2016 (Proj.): 3.9; 2017 (Proj.): 4.6; 2018: 2.0; 2019: 4.4; 2020: 6.6; 2021: 3.9
  - Merchandise imports (in US$, annual pct. change): 2014: -4.3; 2015: -25.3; 2016 (Proj.): -13.5; 2017 (Proj.): 6.0; 2018: 3.5; 2019: 7.0; 2020: 7.4; 2021: 3.5
  - Total external debt (in percent of GDP): 2014: 29.5; 2015: 37.5; 2016 (Proj.): 38.4; 2017 (Proj.): 35.3; 2018: 34.4; 2019: 33.1; 2020: 31.7; 2021: 30.2
- Memorandum items:
  - Current account (in percent of GDP): 2014: -4.3; 2015: -3.3; 2016 (Proj.): -0.8; 2017 (Proj.): -1.5; 2018: -1.7; 2019: -1.8; 2020: -1.8; 2021: -1.8
  - Gross official reserves: 2014: 363.6; 2015: 356.5; 2016 (Proj.): 369.3; 2017 (Proj.): 369.3; 2018: 369.3; 2019: 369.3; 2020: 369.3; 2021: 369.3
  - REER (annual avg., in pct. change; appreciation +): 2014: -1.0; 2015: -15.8

*Source: IMF Staff Report for the 2016 Article IV Consultation (selected extracts).*

### Box 1. Brazilian Unemployment in a Recessionary Environment (Continued)

### Box 1. Brazilian Unemployment in a Recessionary Environment (Continued)

### Youth and adult unemployment dynamics
- Youth unemployment (18 to 24 years old) climbed from 14.1 percent in 2014Q4 to 24.5 percent in 2016Q2.
- Nearly 1 in every 4 Brazilian youngsters (18 to 24 years old) was unemployed as of 2016Q2.
- Adult cohort defined as 25 to 59 years old:
  - Labor force has been growing at a steady pace.
  - Since end-2014, decline in employment growth led to an increase in adult unemployment.
- Youth labor force dynamics since early 2015:
  - Youth labor force, which had been declining, has been rising again.
  - Youth employment has collapsed, causing youth unemployment rates to increase by more than 10 percent.
- The effects on youth employment are exacerbated by a high minimum wage:
  - Youth employment is significantly more sensitive to increases in the minimum wage (holding the average wage constant) than adult unemployment.
  - Real average earnings dropped by more than 4 percent year-over-year in 2016Q2, while the real minimum wage increased, likely pricing younger workers out of the labor market.

### Formal job losses and projections
- Since the beginning of the recession the Brazilian economy lost 2.7 million formal jobs.
- The bulk of formal job destruction (about 1.8 million) has come from industry and construction.
- Formal job destruction is likely to continue for a few more quarters.
- Under Staff’s forecast for Real GDP, cumulative formal job destruction during the recession can amount to as much as 3.1 million jobs between 2014Q1 and 2017Q4.
  - Note on methodology: regression of quarterly net formal job creation numbers (1999Q3‒2016Q1) on year-on-year percent changes of real GDP (contemporaneous and two lags) and two lags of formal job creation; IMF Staff forecasts used to derive predicted values cumulated from 2014Q1.

### Drivers of the deterioration in growth
- Domestic factors largely explain the deterioration in growth, although terms of trade changes and weak global demand also played an important role.
- Activity contracted in 7 out of the 10 quarters through 2016Q2.
- Specific drivers:
  - Investment contracted severely, reflecting:
    - sustained period of deteriorating competitiveness;
    - tighter financial conditions (retreat in real private credit during 2015−16);
    - rising unit labor costs;
    - worsening terms of trade;
    - reassessment of Brazil’s future growth prospects (Box 2).
  - Cuts in expansion plans by Petrobras and other large companies due to reassessment of export price prospects and legacy governance and debt problems.
  - Infrastructure concessions program has had difficulties making progress.
  - Consumption contracted owing to deteriorating labor market conditions and a tightening of credit conditions.
  - Net exports began to support growth due to:
    - demand-related contraction in imports;
    - strong exports following real depreciation in 2015;
    - commodity export volumes expanded owing to capacity increases from investment initiated during the boom years.
    - Caveat: currency appreciation since March 2016 raises doubts about momentum of net exports going forward.
  - Sharp realignment of regulated prices and monetary policy tightening represented a drag on growth in 2015.
  - Fiscal policy was broadly neutral over 2015‒16 (not counting reduction in quasi-fiscal activity) despite cuts in discretionary spending introduced in early 2015; momentum was not sustained and some policies were at times expansionary.
  - Additional factors: uncertainty surrounding the political situation and the corruption probe at Petrobras; the probe broadened to include more firms and high-ranking politicians, complicating disentanglement from economic factors.

### Investment and growth expectations (Box 2 summary)
- Investment fell by around 25 percent since the beginning of 2014.
- Fixed capital formation in Brazil has fallen further behind other emerging economies.
- Mid-term (3-year ahead) growth expectations:
  - Between 2002 and 2012 averaged around 4 percent.
  - Fell to about 2 percent by end-2015.
  - As of 2016Q2, change in current conditions explains roughly one quarter of the recent decrease in medium-term growth expectations; the remainder is due to other, ‘non-current’ factors representing an autonomous reassessment of Brazil’s medium-term growth potential.
- Factors hampering investment include:
  - a rise in costs (chiefly sharp increase in regulated prices, such as energy prices);
  - falling terms of trade;
  - tighter financial conditions (higher real interest rates and lower equity prices).
- The autonomous part of the deterioration in the medium-term outlook reduced investment by more than 10 percent since beginning of 2014.
- Implications for the future:
  - Stabilization of regulated-price inflation, terms of trade, equity prices, and real interest rates should improve investment growth and growth expectations.
  - The large tariff increases of 2015 corrected past policy mistakes and need not be repeated; subsequent increases can be more moderate.
  - Interest rates are expected to be eased as disinflation allows.
  - Return to investment growth depends crucially on alleviation of other weaknesses: reduction in political uncertainty, improvements in policy credibility, and addressing impediments to potential output.
  - If medium-term growth expectations remain subdued, the recovery in investment may be incomplete.

### Inflation, monetary policy, and relative price realignment
- Monetary policy action:
  - Policy rate (SELIC) was hiked by 250 basis points to 14.25 percent between January 2015 and July 2015.
  - Interest rate on subsidized loans (TJLP) was increased by 250 basis points to 7.5 percent between late 2014 and early 2016.
  - Central bank’s inflation tolerance range was reduced from 2.5 percent to 6.5 percent to 3 percent to 6 percent for 2017.
- Inflation developments:
  - Headline and core inflation have been above the central target and around the upper limit of the tolerance range for several years.
  - 2015 inflation spiked to 10.7 percent (e.o.p.), largely because of relative-price adjustments.
  - In 2016, some price increases began to moderate and 12-month inflation fell back to single digits; disinflation proceeded slowly due to inflation expectations higher than target and rising food prices (owing in part to drought in the Northeast).
- Relative-price realignment (Box 3 summary):
  - Two sharp relative-price realignments occurred in 2015, contributing to the 10.7 percent headline inflation in December 2015.
  - Regulated prices rose by almost 18 percent over the year.
  - The exchange rate depreciated by around 20 percent in real effective terms, adding pressure on tradables’ prices.
  - These adjustments were deemed necessary to correct past distortions (e.g., subsidized electricity prices, Petrobras fuel pricing).
  - Regulated prices have a significant weight in Brazil’s CPI (around 25 percent of the basket), making direct effects on inflation particularly large; exchange rate effects are smaller but still significant.
  - Second-round effects via regulated goods as inputs and price- and wage-indexation broadened the inflationary impact.

### Fiscal outcomes
- 2015 fiscal outcomes:
  - Non-financial public sector primary deficit reached 1.9 percent of GDP (original target was a surplus of 1.2 percent of GDP).
  - Overall deficit was 10.4 percent of GDP.
  - Key driver: fall of 4.8 percent in real revenue collection, partially offset by a decline in real expenditures.
  - Interest payments increased substantially, including FX swap program losses of 1.5 percent of GDP.
- 2016 fiscal targets and developments:
  - Targets for the 2016 primary balance were repeatedly revised, with a final large downward revision mid-year.
  - New government reduced the 2016 federal primary balance target to -170 billion reais, or some -2.7 percent of GDP, reflecting growth in items indexed to past inflation and the minimum wage and continuing revenue weakness.
  - As of September 2016, meeting this target appeared feasible, but outcome may depend on the yield of the repatriation tax.
  - Strengthening of the currency generated profits on the FX swaps in 2016, helping avoid an increase in the overall deficit.
  - Financing large deficits and falling maturities became significantly more expensive throughout 2015, with the rise in borrowing costs starting ahead of the loss of investment grade between September and December 2015.

*Source: IMF staff estimates and analysis as presented in the box.*

### 2015. But no difficulties arose in the placement of new debt, in part owing to the favorable

### _cr16348 - 2015. But no difficulties arose in the placement of new debt, in part owing to the favorable

### Debt markets and borrowing costs
- Borrowing costs have fallen significantly in the course of 2016 with the change in government and the prospects of fiscal reforms.
- Yield on the 5-year bond fell from 16.5 percent at end-December 2015 to 11.7 percent at end-September 2016.
- Settlement of irregular obligations to public banks carried over from 2014 (the so-called “pedaladas”) contributed to market developments.

### Subnational fiscal stress and the Rio de Janeiro crisis
- Many subnational governments faced sharp revenue falls in 2015−16, making mandatory spending (chiefly on salaries and retirement pensions) increasingly difficult to finance.
- Responses by states included raising tax rates and selling assets; since late 2015 several states have been paying salaries late and/or using third-party funds held in escrow to make ends meet.
- Federal government measures and state negotiations:
  - The federal government agreed to a temporary standstill in the servicing of federal loans.
  - Many states are lobbying the federal government for additional support.
- Box 4 — Key facts for Rio de Janeiro:
  - In July 2016, Rio de Janeiro declared a “state of calamity” and received a R$2.9 billion transfer from the federal government to guarantee payment of security forces during the Olympic Games.
  - At the end of 2015, Rio Grande do Sul had breached the debt limit established by the Fiscal Responsibility Law (at 200 percent of net current revenues); Rio de Janeiro and Minas Gerais were rapidly approaching the limit.
  - In 2015, 24 states accumulated R$15.4 billion (0.3 percent of Brazil’s GDP) in DEAs (an increase of 44 percent from 2014); Rio de Janeiro was the state with the largest increase (185 percent).
  - By August 2016, Rio de Janeiro accumulated a 4-month delay in transferring payroll-withheld amounts to commercial banks for employees’ personal loans; banks stopped payroll loans to state government employees in Rio de Janeiro.
  - In 2016 monthly payments of both salaries and pensions consumed 90 percent of monthly revenues in Rio de Janeiro.
  - Despite savings from the federal debt rescheduling program (equivalent to R$2.5 billion) and ad-hoc measures, the state faced a gap of R$16 billion in 2016 (2.4 percent of the state’s GDP and ¼ percent of Brazil’s GDP).
- Policy implications from Box 4:
  - Structural fiscal reforms are required, including reform of public employment rules and a pension reform at the national level.
  - Consideration of new sources of recurrent revenue for Rio de Janeiro and possibly other states.

### Financial markets, reserves, and external position
- Financial market volatility has been driven by political and policy shocks (successive loosening of fiscal targets and the impeachment of President Rousseff).
- Exchange rate and asset movements:
  - The real depreciated by around 50 percent against the U.S. dollar over the year to December 2015, and by around 20 percent in real effective terms.
  - Stock prices lost 10 percent of their value and domestic government bond yields rose by more than 300 basis points over the same period.
  - Indicators regained ground in 2016 amid expectations of improved policies and reduced risk aversion; a sharp reversal in the FCI occurred in 2016Q2.
- Central bank FX interventions and swaps:
  - Intervention in 2015 was limited to containing short-term excessive volatility and relied on FX swaps and, to a lesser extent, FX repos.
  - The central bank lowered the net notional value of outstanding FX swaps to about US$32 billion (from a high of about US$110 billion) by issuing reverse swaps and not rolling over maturing swaps.
- External balances and reserves:
  - The current account deficit narrowed from 4.3 percent of GDP in 2014 to 3.3 percent in 2015.
  - At US$365 billion, international reserves are above the IMF’s adequacy metric.
  - Over 2015-2016, equity liability flows (direct investment and portfolio) remained strong; debt liability flows fell sharply, especially in 2015.
  - Net direct investment fully financed the current account deficit in both 2015 and 2016.
  - The share of intercompany loans in direct investment liability flows fell to about 25 percent in 2015.
  - Net portfolio debt liabilities fell to close to zero in 2015 from 1 percent of GDP in previous years.

### Financial cycle, credit conditions, and macroprudential policy
- Brazil is in the downturn phase of the financial cycle, warranting enhanced monitoring.
- Credit and bank funding dynamics:
  - Corporates are significantly bank dependent; years of expanding bank credit contributed to rising leveraging among firms.
  - Nominal credit growth was negative (-0.6 percent year over year) in August 2016, the first time since 2002.
  - Contributing factors: decline in demand, tighter underwriting standards, and authorities’ decision to reduce the rate of expansion of public banks.
  - Caixa Economica reduced mortgage supply in 2015 by tightening LTV requirements; LTVs were reversed in 2016 as Caixa compensated lower deposits with alternative, more expensive funding.
- Macro-prudential actions:
  - The central bank relaxed reserve requirements on deposits for small- and medium-sized banks to support liquidity and bolster housing, agricultural and infrastructure lending.
  - This move was consistent with macro-prudential principles, softening the declining credit cycle and alleviating liquidity risks.

### Banking sector health and nonfinancial corporate vulnerabilities
- Banking sector developments (2015 and first half of 2016):
  - Solvency:
    - System-wide capital ratios fell in 2015 but increased thereafter and are well above regulatory minima.
    - Capital ratios of public banks remained much lower than private banks and continued to drop due to higher Basel III deductions from capital.
    - Two largest public banks cut dividends and planned asset sales, including IPOs of parts of operations.
    - Decrease in capital in 2015 reflected higher unrealized losses on fixed income securities, balance sheet expansion from exchange rate depreciation, and a significant increase in deferred tax assets following a tax rate increase.
    - Increase in private banks’ capital ratios in 2016 driven by balance sheet reduction and higher unrealized gains on fixed income securities as government yields plunged.
  - Liquidity:
    - Liquidity risk increased in 2015 due to withdrawals of funding, especially saving deposits.
    - Overall funding profile improved in the first half of 2016 as banks increased holdings of liquid assets.
    - External funding exposures are low (at around 12 percent of total funding); foreign exchange risks are largely hedged.
  - Profitability:
    - Net income after taxes increased in 2015 reflecting higher tax credits and higher deferred tax assets; net income before taxes dropped significantly in 2015 due to higher provisions and funding costs after the sovereign downgrade.
    - Net incomes after taxes fell in the first half of 2016, pushing profitability indicators below 2015 levels; profits before taxes surged in H1-2016 due to higher spreads from higher credit risk.
    - Poor performance of stocks, especially Petrobras, impacted BNDES’ equity portfolio (damage recognized in mid-2016 income statement).
  - Asset quality:
    - Non-performing loans (NPLs) gradually increased over 2015 and reached 3.6 percent of total loans in July 2016 (4.1 percent if restructured loans are added).
    - Loan loss reserves cover 150 percent of NPLs.
- Nonfinancial corporates:
  - Brazilian firms display high leverage and interest servicing burdens relative to the region, with pronounced declines in profitability.
  - Depreciation of the real increased leverage; impact on profitability and capital has been mitigated by widespread hedging and recent appreciation of the real.
  - Corruption scandal at Petrobras and credit ratings downgrades hampered access to foreign credit, motivating deleveraging strategies by some large firms.
  - Market access improved for some firms in 2016, but many corporations remain under pressure; increase in bankruptcy protection applications and a rising share of larger firms in these processes.
  - Example: Oi filed for bankruptcy protection on US$19 billion of debt in June, contributing to a spike in provisioning.

### Household indebtedness
- Household debt dynamics in 2016:
  - Household debt-to-disposable income has fallen over the course of 2016.
  - The share of mortgage debt has increased to one third.
  - Underwriting standards, including mortgage LTVs, have tightened.
  - Household debt service-to-income ratio has been broadly stable at 22 percent for more than a year, with rising interest costs largely offsetting lower principal payments as a share of income.

### Policy changes and reform agenda
- Fiscal policy and fiscal rule:
  - The government proposed a constitutional amendment limiting the growth in federal noninterest spending to the rate of consumer price inflation of the previous year for the next 20 years, with an opportunity for revision in the tenth year.
  - The government accepted a large primary deficit in 2016 and proposed a primary balance target for 2017 aligned with the expenditure ceiling.
  - The proposed 2017 budget includes some ½ percent of GDP in one-off revenues from auctioning of concessions and asset sales.
  - Under these policies, significant real spending growth could still occur in 2017 (if inflation falls); the harder part of adjustment would start in 2018 once inflation stabilizes.
  - The government announced a reform of the social security system to make the expenditure limit viable.
- Central bank policy and institutional changes:
  - The Central Bank prioritized return of inflation to the central target by end-2017 and indicated easing could be considered once visible progress in fiscal reforms is secured.
  - The BCB stepped up communication practices.
  - The new government announced intent to grant the central bank operational autonomy through a constitutional amendment that would provide immunity to board members from lower-court prosecution and remove the ministerial status of the BCB governor.
- Infrastructure and concessions:
  - The infrastructure concessions program faced difficulties in an environment of uncertainty, low growth, and tight financing conditions, especially for large construction companies implicated in the Petrobras corruption scandal.
  - A newly announced institutional framework and forthcoming changes in regulatory agencies may stimulate a pick-up in private sector participation.

*International Monetary Fund, Brazil staff report content provided in the source document.*

### 16.      While recent corruption investigations signal a welcome move towards greater

### _cr16348 - 16.      While recent corruption investigations signal a welcome move towards greater

### Recent anti-corruption efforts and political/economic uncertainty
- Recent corruption investigations have increased transparency but added to political and economic uncertainty.
- Authorities have implemented strong oversight mechanisms to oversee public expenditure and recover losses via:
  - Federal Court of Accounts
  - Federal Public Prosecutors Office
  - Financial Intelligence Unit
  - ENCCLA (Estratégia Nacional de Combate à Corrupção e à Lavagem de Dinheiro)
- Revisions to the AML Law in 2012 and the 2013 AC law provided additional tools to investigate and prosecute corruption.
- High-level enforcement actions have added uncertainty to the existing negative impact that large-scale corruption has on investment, growth, and political stability.

### Outlook and risks — Returning to growth
- Near-term recovery is expected to start in the second half of 2016, conditional on diminished political uncertainty and the fading of other downward shocks (2015 administered-price adjustments; major investment cuts by Petrobras).
- Constraints on a sharper recovery include excess leverage and slack among firms, weakened household incomes and balance sheets, relatively tight monetary policy, and projected further fall in credit growth as a share of GDP in 2017.
- Largest banks have enough capital to absorb possible losses (see Selected Issues Paper).
- Baseline assumes proposed fiscal target for 2016 is met and authorities’ structural expenditure reforms are approved and implemented.
- Medium-term: inflation expected to slowly converge toward the target midpoint as output reaches potential rate of 2 percent; current account deficit expected to stabilize around 2 percent of GDP; credit to recover with a lag (credit to GDP ratio begins to edge up in 2018); BNDES to prioritize lending for infrastructure; government spending to continue growing in real terms at reduced rates consistent with expenditure ceiling.

- Scenario: Baseline (listed by year)
  - 2016
    - Growth, %: -3.3
    - Inflation (GDP deflator), %: 8.0
    - Primary Balance, % GDP: -2.7
    - Gross Debt, % GDP: 78.4
  - 2017
    - Growth, %: 0.5
    - Inflation (GDP deflator), %: 6.1
    - Primary Balance, % GDP: -2.3
    - Gross Debt, % GDP: 82.9
  - 2018
    - Growth, %: 1.5
    - Inflation (GDP deflator), %: 5.3
    - Primary Balance, % GDP: -1.3
    - Gross Debt, % GDP: 85.7
  - 2019
    - Growth, %: 2.0
    - Inflation (GDP deflator), %: 5.1
    - Primary Balance, % GDP: -0.5
    - Gross Debt, % GDP: 88.2
  - 2020
    - Growth, %: 2.0
    - Inflation (GDP deflator), %: 5.0
    - Primary Balance, % GDP: 0.1
    - Gross Debt, % GDP: 90.9
  - 2021
    - Growth, %: 2.0
    - Inflation (GDP deflator), %: 5.0
    - Primary Balance, % GDP: 0.8
    - Gross Debt, % GDP: 93.5

- Key downside risks
  - Domestic: failure to deliver fiscal consolidation, re-intensification of political uncertainties (e.g., corruption probe developments) leading to “sudden stop” of capital inflows, sharp asset price adjustment, widening credit spreads, defensive monetary tightening, losses on fixed income securities for banks, “double dip” recession causing larger loan losses and capital shortfalls, recapitalization costs and realization of deferred tax credits. Petrobras’ balance sheet may face unfunded contingent liabilities (similar risk for other SOEs like Eletrobras and Caixa Economica).
  - External: protracted slower growth in advanced and emerging economies (especially China), further declines in commodity prices, tighter global financial conditions.
- Upside risks
  - Policy pronouncements boosting confidence and asset prices could foster sharper turnaround in investment and growth.
  - Faster progress on fiscal reform approval could spark a stronger recovery in sentiment and foreign interest, although surges in capital flows may pose challenges for sectors benefiting from recent currency depreciation.

### Policy responsiveness and prior staff recommendations
- Authorities have tightened monetary policy in 2015.
- National Monetary Council narrowed the inflation tolerance range from 4.5 percent +/- 2 percent to 4.5 percent +/- 1.5 percent for 2017.
- Long-term lending rate (TJLP) raised from 5.5 to 7.5 percent over the past year and a half.
- Net FX swaps position lowered significantly.
- Government announced plans to pursue social security reform.

### Policy discussions — Restoring credibility through fiscal sustainability
- Unsustainable fiscal dynamics driven by unfunded and increasingly onerous mandates on expenditure side; these raise financing needs, borrowing costs, and slow growth, worsening public debt dynamics.
- Approval and steadfast implementation of the spending cap could improve long-term public spending trajectory and permit stabilization and eventual reduction of public debt as a share of GDP.
- Draft budget law before Congress contains one-off revenues from concessions and asset sales; together with revenue projections, yields a primary balance target (floor) of -2.1 percent of GDP for 2017.

- Main areas for reform to restore sustainability and increase allocation flexibility:
  - Social security
    - Pension and other benefits represent nearly one half of federal noninterest spending and at least 13 percent of states’ noninterest spending.
    - Reform should address retirement age, replacement rates at retirement, post-retirement benefit growth, duplication of benefits.
    - Targeted social assistance programs should be ready to step in as retirement system is reformed.
    - Bringing civil servants’ pension schemes closer to private sector schemes is advised.
  - Ending revenue earmarking
    - Eliminate earmarking to create allocation flexibility required by the expenditure cap.
    - Expenditure cap legislation aims to remove obligation to dedicate increasing share of net federal revenues to education and health; this needs supplementation with measures to control growth of spending per capita on public health.
  - Containing payroll growth
    - Payrolls are a large share of spending, especially subnational; reforms to enable exit from civil service and rationalize automatic career progression needed.
  - Subnational governments
    - Strengthen institutional relationships across government levels; enact legislation enabling states to make difficult expenditure adjustments.
    - Apply social security and payroll control recommendations to states; increase transparency.
  - Minimum wage and indexation
    - Current formula for minimum wage revisions affects growth in pension and other benefits; sever automatic link between benefit payments and minimum wage is advisable.
    - Limit minimum wage increases to cost of living adjustments.
  - Spending efficiency and composition
    - Expenditure cap will require better use of resources to prevent decline in service quality.
    - Preserve programs with positive impact on growth (including investment) and social safety nets.

- Fiscal dynamics and timing
  - As designed, the expenditure cap would allow one and possibly two more years of positive real spending growth before freezing real spending when inflation stabilizes.
  - Under staff’s baseline (full implementation of cap plus one-off revenues collected each year), overall deficit remains high for many years; public debt (GFSM definition) would reach 93.5 percent of GDP in 2021 and peak around two years later before declining.

- Staff recommendation: frontloaded adjustment to regenerate fiscal space
  - Gradually raise the primary balance to about 3 percent of GDP by 2021; with this, public debt would start declining from a peak of 86 percent of GDP in that year (see DSA).
  - Additional adjustment requires undershooting the spending cap and mobilizing quick-acting revenue gains, over-performing on government primary balance targets by 0.3 percent of GDP in 2017 and 2018 and larger margins subsequently.
  - Suggested temporary revenue measures (while debt rising): asset sales, increases in fuels taxes (CIDE) and federal turnover taxes (PIS/COFINS), increase in IOF tax on new loans, rollback of payroll tax cuts and other tax expenditures (including SIMPLES).
  - Expenditure measures: extend spending cap to subnational entities, reduce inefficient discretionary expenditures.
  - Timing: proceed with measures as economic growth firms up.

- Scenario: Debt Reduction Begins by 2021 (listed by year and series)
  - Growth
    - 2016: -3.3
    - 2017: 0.2
    - 2018: 1.5
    - 2019: 2.2
    - 2020: 2.5
    - 2021: 2.2
  - Inflation (GDP deflator), %:
    - 2016: 8
    - 2017: 6.1
    - 2018: 5.3
    - 2019: 5.1
    - 2020: 5
    - 2021: 5
  - Primary Balance, % GDP (Authorities’ Target):
    - 2016: -2.6
    - 2017: -2.1
    - 2018: -0.9
    - 2019: 0.2
    - 2020: ... 
    - 2021: ...
  - Primary Balance, % GDP (IMF Baseline):
    - 2016: -2.7
    - 2017: -2.3
    - 2018: -1.3
    - 2019: -0.5
    - 2020: 0.1
    - 2021: 0.8
  - Primary Balance, % GDP (IMF Recommended Path):
    - 2016: -1.8
    - 2017: -0.6
    - 2018: 0.7
    - 2019: 2.0
    - 2020: 3.0
  - Measures Required, % GDP:
    - 2017: ...0.5
    - 2018: 0.7
    - 2019: 1.2
    - 2020: 1.9
    - 2021: 2.2
  - Measures Required — Revenues, % GDP:
    - 2017: ...0.3
    - 2018: 0.5
    - 2019: 0.8
    - 2020: 1.0
    - 2021: 1.0
  - Measures Required — Expenditures, % GDP:
    - 2017: ...0.2
    - 2018: 0.2
    - 2019: 0.4
    - 2020: 0.9
    - 2021: 1.2
  - Gross Debt, % GDP:
    - 2016: 78.4
    - 2017: 82.8
    - 2018: 84.7
    - 2019: 85.7
    - 2020: 85.8
    - 2021: 85.5

### Monetary and financial stability policy
- Monetary policy stance
  - Should remain unchanged until inflation more certainly converges to central target.
  - Maintain current settings given uncertainty about output gap, reform approval, and exchange rate movements.
  - Spike in inflation from 2015 regulated-price and exchange-rate adjustments and drought-related food price shock expected to wane; weak demand and exchange rate appreciation expected to put downward pressure on inflation, allowing an easing cycle to begin in 2017.
  - Risk of second-round effects creating greater inflation persistence; monetary policy should remain tight until inflation expectations settle closer to midpoint of tolerance range.
  - Strengthening inflation-targeting framework via enhanced central bank autonomy and improved communication is welcome.

- Exchange rate and reserves
  - Exchange rate should remain key external adjustment variable; intervention limited to episodes of disorderly market conditions.
  - Reserve buffers should be preserved; resist using them for ad-hoc purposes or to defend the currency in sustained outflows.
  - Continue gradually reducing net notional value of FX swaps, including issuance of reverse FX swaps.
  - If large capital inflows cause unwarranted appreciation, policy options include tightening fiscal policy, issuing more reverse FX swaps (some fiscal cost), further reserve accumulation (higher sterilization costs), and easing policy rate while raising the TJLP (tradeoffs with disinflation).

- Banking sector resilience
  - Banking system health remains largely sound but recession affected profitability and asset quality.
  - Mission welcomes moderation in credit growth by public banks, plans to reduce direct financing of large corporations with market access, and intentions of two largest public banks to strengthen capital.
  - Recommendations to bolster resilience:
    - Strengthen procedures for use of deposit insurance fund and secure adequate funding for the fund.
    - Enhance central bank emergency liquidity assistance.
    - Modernize resolution regime.
    - Create explicit mandate and committee for macro-prudential oversight including all financial regulators, the Deposit Guarantee Fund, and Ministry of Finance.
    - Mandate a separate entity to set up coordination framework for crisis decision-making and periodically test crisis response capacity.
    - Follow through on plans to strengthen private insolvency frameworks to expedite bankruptcy and reduce creditor default losses.
  - Continued vigilance and close monitoring of corporate sector health and links to banking sector due to high private sector leverage.

### Policies to boost potential growth
- Greater progress on medium-term structural issues—particularly the fiscal framework at national and subnational levels—is essential to restore policy credibility and boost confidence for strong, inclusive, sustainable growth.
- Early implementation of key measures would moderate inflation expectations and facilitate monetary easing.
- Given current environment and risks, bolster banking sector resilience and scale up efforts to boost infrastructure investment.

*International Monetary Fund — Brazil, Article IV consultation (excerpt).*

### 27.      Structural reforms targeted at reducing costs of doing business, enhancing efficiency,

### _cr16348 - 27.      Structural reforms targeted at reducing costs of doing business, enhancing efficiency,

### Structural reforms to boost medium-term growth
- Structural reforms are essential to strengthen growth over the medium term and would hasten a return to growth and bolster it beyond the current projection of 2 percent over the medium term, although quantifying the precise impact on growth is difficult.
- Key areas to consider:
  - Infrastructure bottlenecks
    - The infrastructure concessions program is critical to alleviating supply-side constraints and boosting competitiveness.
    - Following through on recently announced enhancements and regulatory reforms would help make the program more attractive to investors, while maintaining high standards of governance and program design.
  - Tax reform
    - Brazil’s tax system is complex and burdensome.
    - One important way to reduce the cost of doing business would be to simplify the federal PIS/COFINS and the State Tax on the Circulation of Goods and Services (ICMS).
    - Note: The PIS/COFINS is an indirect levy earmarked for the funding of social security, and is thus considered a “contribution” instead of a tax.
  - Opening the economy
    - Tariffs and nontariff-barrier reductions, a revision of the policy on domestic content requirements, and pursuing free-trade negotiations outside Mercosur would help increase competition and efficiency.
  - Efficient allocation of savings
    - A review of credit earmarking rules and other distortions would be advisable to ensure that national savings go to their most productive uses.
  - Labor reform
    - Reforms aimed at facilitating productive employment and reducing incentives for informality would promote job-creation, investment, and growth.
    - Reforms should be mindful of first-time entrants in the labor market, largely young people and relatively sensitive to cyclical fluctuations.
    - The moderation of the minimum wage indexation rule, proposed earlier on fiscal grounds, would also contribute to restoring youth employment.

### Fiscal statistics and transparency
- Fiscal statistics should be made more comprehensive:
  - A full balance sheet for general government should be published. The published balance sheet for general government currently includes only debt and financial assets; missing items include accounts payable, including floating debt (restos a pagar), and liabilities related to civil servants’ pensions.
  - Given the importance of state-owned enterprises and public banks, the government should publish fiscal statistics for the entire nonfinancial public sector (including Eletrobras and Petrobras) and for the entire public sector (including BNDES, Caixa Econômica Federal, and Banco do Brasil). These entities should not be included in the calculation of fiscal targets.
  - Strengthening fiscal transparency in states’ fiscal reporting (including by adopting standard accounting practices) and timely monitoring and enforcement of fiscal rules are key challenges.

### Transparency, anti-corruption, and AML/CFT measures
- Effective implementation would enhance predictability for businesses and perception of fairness.
- Recommended actions:
  - Make data on public procurement open by default.
  - Implement recent legislation on conflict of interest and strengthen whistleblowing mechanisms.
  - Eliminate regulations that provide opportunities for bribes.
  - Improve access to and sharing of banking and fiscal information, and prevent abuse of appeal provisions and statutes of limitations in legal proceedings, in line with Supreme Court jurisprudence.
  - Strengthen provisional measures and confiscation, pursue a larger number of significant corruption, money laundering and illicit enrichment cases, and enhance AML/CFT supervision of banks’ obligations regarding politically exposed persons.

### Authorities’ views and planned measures
- Recent activity and growth expectations
  - Authorities see evidence that economic activity has stabilized recently and indicated growth is likely to turn positive in the fourth quarter of this year, driven by rising confidence and a recovery in investment.
  - Ministry of Finance projects GDP growth of 1.6 percent in 2017 and 2.5 in 2018, and considers there is potential for upside surprises.
- Structural reform sequencing and priorities
  - Authorities view the revamped infrastructure concession framework and regulatory changes as facilitating private sector participation and raising potential growth.
  - Their agenda includes tax simplification, labor reform, and negotiation of new international trade agreements, with many legal reforms expected to wait until after key fiscal reforms are secured.
- Fiscal strategy
  - Regaining control of public expenditure is front and center of the fiscal reform strategy.
  - The proposed constitutional amendment to cap expenditure growth is seen as having a high probability of approval and as a commitment device to support other fiscal reforms, including social security reform.
  - The government aims to accelerate reduction of gross debt through asset sales and other operations, including negotiation of an early repayment of debt by BNDES amounting to R$100 billion over three years.
  - Additional measures, including rolling back tax exemptions, could be considered once the expenditure ceiling is approved, social security reform is well advanced, and the recovery in economic activity has started.
- Social security reform
  - Authorities concur that pension and social benefits reforms are urgent and view the current juncture as a historical opportunity to stabilize the finances of social security for the next three decades or so.
  - They expect reforms to cover various key parameters and reach a variety of participants, respecting constitutional constraints and rights; final form and transitional clauses will reflect ongoing discussions with stakeholders and Congress.
- Subnational finances
  - Authorities are concerned with fiscal problems in many subnational governments and plan to include states in key structural reforms and promote national reforms to enable states to address employment and remuneration problems.
  - Greater transparency in state government finances is necessary; the National Treasury is organizing missions to states experiencing severe strains.
- Monetary and exchange rate policy
  - The central bank prioritizes ensuring convergence of inflation to the target in the relevant horizon for monetary policy (including 2017).
  - Disinflation is ongoing but its pace is uncertain; start of an easing cycle depends on factors including limited persistence of food-price shocks, appropriate pace of disinflation of components sensitive to monetary policy, and reduced uncertainty regarding fiscal reforms.
  - Views on foreign exchange interventions are broadly consistent with staff: the exchange rate has acted as a good shock absorber; interventions through FX swaps and repos have smoothed excess volatility while preserving market-determined movements; FX swaps also have a macro-prudential component sheltering corporates and creditors.
  - Authorities did not rule out future interventions using different instruments if needed and when market conditions allow, and noted there will be less room to reduce the stock of FX swaps as the benign period for emerging market economies approaches.
- Banking sector
  - Authorities emphasized resilience of the banking system and effectiveness of risk monitoring and management tools.
  - Banks remain well capitalized and have significantly increased provisions for corporate exposures.
  - Authorities maintain a comprehensive and timely stress testing framework and plan enhancements, including “bottom-up” approaches.
  - A new resolution framework consistent with the FSB’s key attributes will include a backstop for the deposit insurance fund from the central bank and will be implemented in 2017.
  - Authorities agreed that clear mandates for macro-prudential oversight and crisis management would enhance policy implementation and preparedness.

### Staff appraisal and policy recommendations
- Overall assessment
  - Brazil must revamp its policy framework to restore fiscal sustainability, rein in inflation, and open up the economy amid an uncertain recovery from a prolonged recession.
  - Policymaking in recent years failed to tackle long-standing structural problems, contributing to erosion of credibility and a large contraction of output; fiscal sustainability is at risk.
- Fiscal policy
  - Capping growth of fiscal spending and reforming social security are well founded to restore fiscal sustainability, but more is required to address budgetary rigidities.
  - Approval and steadfast implementation of the spending cap would help improve the long-term trajectory of public spending and permit stabilization and eventual reduction of public debt as a share of GDP.
  - Credibility of reforms will be bolstered by attention to the link between minimum wage indexation and benefit payments, revenue earmarking, and rigidities and lack of transparency in subnational budgets.
  - Consider merit in a more frontloaded consolidation strategy once growth has firmed up, combining expenditure and revenue measures to contain growth in public debt and reverse its trajectory earlier; some revenue measures can begin once growth is underway and some should be temporary.
- Monetary and FX policy
  - Monetary policy should remain on hold until inflation expectations converge more clearly toward the central target; current settings are broadly appropriate.
  - Tangible progress on restoring sustainability of public finances would create room for easing monetary policy earlier than envisaged.
  - Staff welcomes use of the exchange rate as the first line of defense; FX interventions should remain limited to episodes of disorderly market conditions and reserve buffers should be preserved.
  - Staff sees merit in continuation of the central bank’s policy to reduce the net notional value of FX swaps.
- Financial sector resilience
  - The resilience of the banking sector should be bolstered despite sound fundamentals.
  - Strengthen financial safety nets by improving procedures for use of the deposit insurance fund, enhancing central bank emergency liquidity assistance, and modernizing the resolution regime.
  - Improve private insolvency frameworks and frameworks to identify, prepare for, and respond to future risks.
  - Staff welcomes ongoing work to strengthen the central bank’s stress testing framework.
- Structural reforms
  - Well-designed and properly sequenced structural reforms can hasten the return to growth and strengthen it over the medium term.
  - Staff encourages follow-through on plans to strengthen the supply side, increase efficiency and productivity, and implement transparency, anti-corruption and AML measures; without these reforms, potential growth is likely to remain underwhelming.

*Source: _cr16348 - 27.*

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

### _cr16348 - 47.      It is recommended that the next Article IV consultation takes place on the standard

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

### Key economic indicators (selected)
- Area (thousands of sq. km): 8,512
- Agricultural land (percent of land area): 31.2
- Total population (million) (est., 2015): 204.5
- Annual rate of growth (percent, 2015): 0.8
- Density (per sq. km.) (2012): 24.0
- Life expectancy at birth (years): 75
- Infant mortality (per thousand live births): 14
- Access to safe water (2015): 98.1
- Physician per 1000 people (2013): 1.9
- Hospital beds per 1000 people (2012): 2.3
- Adult illiteracy rate (2014): 8.3
- Net enrollment rates, percent in Primary education (2014): 99; Secondary education (2014): 84
- Poverty rate (in percent, 2013): 15.1
- Income distribution (2014) — By highest 10 percent of households: 40.9; By lowest 20 percent of households: 3.6; Gini coefficient (2014): 51.8
- GDP, local currency (2015): R$5,904 billion
- GDP, dollars (2015): US$1,773 billion
- GDP per capita (est., 2015): US$8,668

### Recent macro developments and projections (selected series)
- GDP at current prices (2014–2021): 7.0, 3.8, 4.4, 6.6, 6.9, 7.2, 7.1, 7.1
- GDP at constant prices (annual percent change, 2014–2021): 0.1, -3.8, -3.3, 0.5, 1.5, 2.0, 2.0, 2.0
- Consumption (2014–2021): 1.3, -3.4, -4.1, -0.4, 0.6, 0.8, 1.0, 1.1
- Investment (2014–2021): -5.6, -22.6, -11.3, 4.6, 5.1, 7.1, 6.1, 5.5
- Consumer prices (IPCA, end of period, 2014–2021): 6.4, 10.7, 7.2, 5.0, 4.8, 4.5, 4.5, 4.5
- Gross domestic investment (percent of GDP, 2014–2021): 21.0, 19.2, 18.4, 18.9, 19.4, 20.1, 20.7, 21.3
- Gross national savings (percent of GDP, 2014–2021): 16.7, 15.9, 17.6, 17.4, 17.7, 18.3, 19.0, 19.5

### Public sector finances (selected)
- Central government primary balance (2014–2021): 1/ -0.4, -2.0, -2.7, -2.4, -1.7, -0.9, -0.2, 0.4
- NFPS primary balance (2014–2021): -0.6, -1.9, -2.7, -2.3, -1.3, -0.5, 0.1, 0.8
- NFPS cyclically adjusted primary balance (2014–2021): -1.5, -1.7, -1.6, -1.4, -0.8, -0.3, 0.1, 0.8
- NFPS overall balance (including net policy lending, 2014–2021): -7.0, -10.4, -10.5, -9.5, -8.2, -7.2, -6.2, -5.9
- Net public sector debt (percent of GDP, 2014–2021): 33.1, 36.2, 45.9, 50.9, 54.1, 56.8, 59.7, 62.5
- NFPS gross debt (2014–2021): 63.3, 73.7, 78.4, 82.9, 85.7, 88.2, 90.9, 93.5
- Public sector net interest expenditure (percent of GDP): 5.5, 8.5, 7.8, 7.2, 6.9, 6.7, 6.3, 6.7
- Nominal GDP (million Brazilian reais, 2014–2021): 5,687,310; 5,904,332; 6,166,126; 6,575,681; 7,028,792; 7,533,815; 8,066,764; 8,640,597

### Balance of payments and external sector (selected)
- Current account (2014–2021, in billions of US$): -104.2, -58.9, -14.7, -29.5, -34.9, -38.6, -39.9, -41.2
- Trade balance (2014–2021): -6.6, 17.7, 48.5, 48.6, 47.3, 46.5, 49.2, 51.9
- Exports (fob, 2014–2021): 224.1, 190.1, 197.6, 206.7, 210.9, 215.7, 224.8, 233.6
- Imports (fob, 2014–2021): 230.7, 172.4, 149.1, 158.1, 163.6, 169.2, 175.7, 181.8
- Capital and financial account (2014–2021): 100.8, 55.2, 14.7, 29.5, 34.9, 38.6, 39.9, 41.2
- Foreign direct investment (net, 2014–2021): 70.9, 61.6, 61.8, 56.7, 53.1, 50.8, 49.2, 47.7
- Gross official reserves (eop, in billions of US$): 363.6, 356.5, 369.3, 369.3, 369.3, 369.3, 369.3, 369.3
- Net international reserves (eop, in billions of US$): 363.6, 357.7, 370.6, 370.6, 370.6, 370.6, 370.6, 370.6
- Current account (in percent of GDP, 2014–2021): -4.3, -3.3, -0.8, -1.5, -1.7, -1.8, -1.8, -1.8
- Total external debt (percent of GDP, 2014–2021): 29.5, 37.5, 38.4, 35.3, 34.4, 33.1, 31.7, 30.2

### Medium-term macroeconomic framework and external debt (selected)
- GDP growth at constant prices (2014–2021): 0.1, -3.8, -3.3, 0.5, 1.5, 2.0, 2.0, 2.0
- Consumer prices (IPCA, end of period, 2014–2021): 6.4, 10.7, 7.2, 5.0, 4.8, 4.5, 4.5, 4.5
- Public sector net debt (percent of GDP, 2014–2021): 33.1, 36.2, 45.9, 50.9, 54.1, 56.8, 59.7, 62.5
- Total external debt (in billions of US$, 2014–2021): 712.7, 665.1, 680.1, 691.0, 698.3, 702.7, 703.3, 700.0
- Medium- and long-term external debt service (2014–2021): 88.3, 115.8, 115.1, 104.5, 108.3, 111.2, 113.2, 114.6
- Gross reserves (eop, in billions of US$): 363.6, 356.5, 369.3, 369.3, 369.3, 369.3, 369.3, 369.3

### External vulnerability (selected)
- Exports of GNFS (12-month percent change, US$): 29.1, 26.1, -3.9, -0.5, -5.6, -15.2, 3.9
- Imports of GNFS (12-month percent change, US$): 39.8, 24.0, 0.6, 7.1, -2.1, -23.7, -12.9
- Terms of trade (12-month percent change): 16.0, 7.8, -5.8, -2.0, -3.4, -11.0, 3.2
- Current account (in percent of GDP, 2010–2016): -3.4, -2.9, -3.0, -3.0, -4.3, -3.3, -0.8
- Gross reserves (in months of prospective GNFS imports): 15.2, 18.8, 18.6, 18.7, 25.3, 28.7, 28.0
- In percent of short-term external debt (residual maturity): 502.6, 875.4, 1,142.5, 1,096.1, 629.2, 697.0, 728.8

### Fiscal structure and main fiscal aggregates (selected)
- Federal government nonfinancial revenue (2014–2021): 21.5, 20.8, 20.2, 21.0, 21.4, 21.7, 21.9, 21.9
- Total primary expenditure (federal government, percent of GDP, 2014–2021): 21.8, 22.8, 22.9, 23.4, 23.1, 22.6, 22.1, 21.5
- Pension benefits (federal government, percent of GDP, 2014–2021): 6.9, 7.4, 8.5, 8.7, 8.9, 9.1, 9.4, 9.6
- Capital expenditures (federal government, percent of GDP, 2014–2021): 1.4, 1.0, 0.7, 0.8, 0.9, 0.9, 1.0, 1.0
- Expenditure reforms to meet Spending Cap Rule: -0.2, -0.5, -1.0, -1.6 (timing implied across projection years)
- Nonfinancial public sector (NFPS) structural primary balance (2014–2021): -1.3, -1.4, -1.6, -1.4, -0.9, -0.4, -0.1, 0.6
- NFPS overall balance including policy lending (2014–2021): -7.0, -10.4, -10.5, -9.5, -8.2, -7.2, -6.2, -5.9

### Monetary and financial sector indicators (selected)
- Policy rate (SELIC) raised to 14.25 percent and has stayed for over a year (text note).
- Central Bank FX swaps: stock of FX swaps was significantly reduced in 2016 (text note).
- Base money (annual percent change series shown): -4.5, 8.4, 4.5, 6.7, 6.9, 7.2, 7.1, 7.1
- Broad money (annual percent change series shown): 13.5, 9.8, 5.8, 9.6, 10.0, 10.6, 13.6, 14.4
- Bank loans to the private sector (annual percent change): 10.9, 3.6, 1.2, 5.6, 9.3, 11.4, 12.0, 12.6
- Financial soundness indicators (total banking system, selected):
  - Regulatory capital to risk-weighted assets (2010–2016q1): 16.9, 16.3, 16.4, 16.1, 16.7, 16.4, 16.2
  - Nonperforming loans to total gross loans (total banking system): 3.1, 3.5, 3.4, 2.9, 2.9, 3.3, 3.6
  - Return on assets (total banking system): 1.9, 1.7, 1.4, 1.4, 1.3, 1.5, 1.4
  - Liquidity assets to short-term liabilities (total banking system): 185.3, 178.6, 191.8, 158.0, 202.2, 190.0, 195.2

### Fiscal risks, debt dynamics, and stress scenarios (selected)
- Total external debt-to-GDP (2013–2021 baseline): 25.2, 29.5, 37.5, 38.4, 35.3, 34.4, 33.1, 31.7, 30.2
- Change in external debt (2013–2021): 2.0, 4.3, 8.0, 0.9, -3.1, -0.9, -1.2, -1.4, -1.5
- Identified external debt-creating flows (2013–2021): 1.5, 2.5, 8.5, -0.9, -1.2, -1.2, -1.2, -1.2, -1.3
- Gross external financing need (in billions of US$, 2013–2021): 167.2, 207.7, 213.8, 162.0, 167.0, 175.4, 181.4, 184.2, 186.4
- Debt-stabilizing non-interest current account (long-run): -3.1 (presented in table context)

### Main qualitative findings from figures and charts (text captions)
- Brazil is in a deep recession: activity contracted in 8 out of the past 10 quarters; investment and private consumption particularly weak; net exports have begun boosting growth.
- Contraction is broad-based across industries; retail sales continue to contract.
- Deteriorating business confidence has contributed to dramatic decline in investment; industrial production is very much below capacity despite recent pickup.
- Inflation spiked to 10.7 percent in December 2015; non-tradable inflation has risen more strongly than tradable inflation since 2010; regulated-price inflation rose sharply in 2015 largely due to energy prices and exchange rate depreciation.
- After peaking at end-2015, inflation expectations began to moderate, with mid-term expectations converging to the inflation target mid-point by end-2018.
- Real average wage contracting while minimum wage increased in real terms.
- Policy rate increased to 14.25 percent and held; central bank reduced FX swaps in 2016 as demand for dollar hedge declined.
- Fiscal stance mildly expansionary in 2016; primary deficit continued to widen partly due to repayment of arrears amounting to around 1 percent of GDP.
- Overall balance deteriorated due to widening primary balance and larger interest bill; gross and net debt have risen.
- Current account improved over 2015 with trade balances moving into surplus; terms of trade deteriorated to levels last seen in 2009.
- Net capital inflows edged up with strong direct investment and portfolio flows; real effective exchange rate depreciated sharply in 2015.
- Reduction in unit labor costs and currency depreciation contributed to rise in exports of manufactured goods.
- Credit growth decelerated reflecting weak loan demand and conservative supply; nonperforming loans increasing gradually since 2014; bank profits increased despite higher allowances and funding costs.
- Capital and liquidity remain above regulatory minima; under stress scenarios some banks might need recapitalization driven by higher funding costs and corporate loan losses.

*Sources: Central Bank of Brazil; Ministry of Finance; IPEA; Ministry of Planning and the Budget; Haver Analytics; IBGE; Bloomberg; and Fund staff estimates.*

### Appendix I. Risk Assessment Matrix

### Appendix I. Risk Assessment Matrix

### Major Risks, Likelihood, Expected Impact, and Policy Responses
- Risk: Fiscal balances continue to disappoint and fail to stabilize debt.
  - Likelihood: M
  - Expected impact on economy: H. "Further loss of confidence would lower investment and growth. Inflationary pressures would remain elevated. Corporates could be vulnerable to capital flow reversals, exchange rate depreciation and higher funding costs. The strains would worsen if banking system soundness deteriorated owing to an increase in NPLs and funding costs and losses on government bonds' holdings."
  - Policy responses: "Strong fiscal adjustment to restore credibility in the fiscal framework and to ensure debt stabilizes. Focus efforts on boosting competitiveness and productivity."

- Risk: Prolonged political and policy uncertainty (broadening of the corruption scandal / failing to pass spending cap measures).
  - Likelihood: M
  - Expected impact on economy: H. "Prolonged uncertainty would further hamper investment, confidence and growth. A more persistent increase in unemployment increases the threat of social unrest. And there is further damage to the credibility of the policy framework."
  - Policy responses: "Greater efforts to ensure policy credibility. Monetary policy should ensure inflation expectations remain firmly within the tolerance range and exchange rate intervention should be limited to clear cases of market disruption. Fiscal policy should forge ahead with efforts to ensure medium-term debt sustainability."

- Risk: Continued employment destruction and domestic demand collapse.
  - Likelihood: M
  - Expected impact on economy: M. "Continuous employment destruction leading to a deterioration of households’ balance sheet and income resulting in a rise in delinquencies on consumer loans. Lower corporate profits may expose some highly leveraged corporates. Increased financial vulnerabilities among banks with portfolio concentrated in households and corporate loans. Potential knock on effects on public finances. For example, Caixa extends housing loans to low-income families with a government guarantee."
  - Policy responses: "Monitor for signs of emerging domestic financial and corporate vulnerabilities and strengthen safety nets. Smooth out the employment loss by relying on strategies such as reduced hours."

- Risk: Sharp rise in risk premia with flight to safety and capital flow reversal.
  - Likelihood: M
  - Expected impact on economy: H. "Increasing Brazil’s risk premiums, pressures on the real and reversal of capital flows. Increasing yields in domestic bond markets and higher funding costs for corporates and banks. In particular corporates lacking FX hedging could be exposed."
  - Policy responses: "The flexible exchange rate remains an important shock absorber. Recourse to FX intervention if FX volatility becomes excessive. Provide FX liquidity and support individual banks if dollar shortages appear. May also need to tighten fiscal policy to further strengthen policy credibility and avoid sell-offs of Brazilian domestic bonds. Capital flow management measures could be envisaged on a temporary basis but only in crisis type circumstances."

- Risk: Protracted period of low global growth and/or worsening commodity prices.
  - Likelihood: H/M
  - Expected impact on economy: H/M. "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."

- Risk: Persistently lower oil prices and Petrobras exposure.
  - Likelihood: L
  - Expected impact on economy: M. "Mild favorable impact on the trade balance in the short-term, but worsening current account in the medium term, when Brazil is expected to become a net oil exporter. Petrobras could see a decline in the value of its assets and face an increase in borrowing costs, causing delays in on-going investment plans and affecting plans to develop new fields. Banks could face losses on exposures to oil sector."
  - Policy responses: "The requirement for Petrobras’s participating in new oil developments should be eased. Domestic pricing policies should ensure Petrobras obtains an adequate return. Tighten governance in the company and enforce strict criteria on capital projects to avoid unnecessary losses."

### Nature and Sources of External Risks (selected)
- Sharp rise in risk premia with flight to safety: Investors reassess risks in large economies or respond to unanticipated Fed tightening; safe haven currencies—especially the US dollar—surge and create balance sheet strains for FX debtors.
- Structurally weak growth in key advanced and emerging economies: "Weak demand, low productivity growth, and persistently low inflation" leading to lower medium-term potential growth (the Euro area, Japan, and the United States) and exacerbated legacy financial imbalances (high likelihood for some sources; medium likelihood for emerging market effects).
- Persistently lower energy prices: Triggered by supply factors reversing more gradually than expected.
- Protracted period of low growth.

### External Sector Assessment — Key Facts and Findings
- NIIP: "Brazil’s NIIP improved to -27 percent of GDP in 2015 reflecting in part the real’s depreciation. It is projected to remain broadly unchanged over the medium term."
- DI (direct investment) composition: "DI accounts for close to half of liabilities (which are 69.7 percent of GDP)."
- External debt: "Of concern is the rise in external debt since the global financial crisis (to some 350 percent of exports)."
- Overall external position 2015: "moderately weaker than the level consistent with medium-term fundamentals and desirable policy settings."
- REER: "Staff’s assessment is that the real was on average some 5−15 percent above the level implied by fundamentals and desirable policy settings in 2015."
- Current account:
  - Background: "The current account deficit adjusted sharply in 2015 owing to the real’s depreciation and the drop in domestic demand." The deficit "fell from 4.3 percent of GDP in 2014 to 3.3 percent in 2015."
  - Staff estimates: "the CA norm is consistent with fundamentals and desirable policy settings range from 0.25 to -1.5 percent of GDP."
  - Cyclically adjusted CA: "-2.8 percent" and "the 2015 CA gap ranged between -1.3 and -3.1 percent of GDP."
- Trade and terms of trade: "Brazil’s ToT are expected to weaken further under the baseline and remain a downside risk."
- Capital and financial accounts:
  - "Equity liability flows remained strong while debt liability flows fell sharply."
  - "Net DI fully financed the CA deficit (DI liabilities totaled 4.3 percent of GDP)."
  - "Net portfolio debt liabilities ... fell to close to zero."
  - Assessment: "While the composition of flows has a favorable risk profile, there is a risk that outflows may increase amid the prolonged recession and growing domestic risks."

### FX Intervention and Reserves
- Exchange rate regime and reserves:
  - "Brazil has a floating exchange rate."
  - Gross reserves: "$358 billion" in 2015, "some 20 percent of GDP and 200 percent of short term debt at remaining maturity."
  - Net forward position: "some $62 billion as of early June" (related to FX swap adjustments in March–June 2016).
- Assessment: "The flexible exchange rate has been an important shock absorber. Reserves are adequate relative to various criteria including the IMF’s composite reserve adequacy metric (185 percent)."
- Policy guidance: "Staff would advise only punctually alleviating disorderly market conditions as needed" and "the authorities should aim to retain these buffers and their net creditor position in foreign exchange."

### Technical Background Notes — Selected Numeric Points
- Import volumes: "Import volumes fell by 15 percent in 2015."
- Export volumes: "Export volumes rose by 8 percent."
- China: "At 19 percent of the total, China remains Brazil’s most important export destination and accounts for the bulk of Brazil’s major commodity exports."
- Current account norm assessments: EBA approach "-2.7 percent" and NIIP-stabilizing approach "-1.2 percent"; staff CA norm range "0.25 to -1.5 percent."
- IMF composite reserve adequacy metric: "185 percent."

*Appendix I. Risk Assessment Matrix — extracted from the IMF mission documents provided in the source PDF.*

### 4. The government has created a Council of the Investment Partnership Program

### 4. The government has created a Council of the Investment Partnership Program (CIPP)

### CIPP and Infrastructure Support Fund
- The CIPP is located in the Presidency and is in charge of monitoring implementation of the PPI program, formulating policy recommendations and providing guidance to agencies, entities and the federal public administration.
- Members with voting rights include:
  - the Executive Secretary of the Secretariat of the Investment Partnership Program of the Presidency (who will also act as Executive Secretary of the Council);
  - the Chief Minister of the Civil House;
  - Ministers of Finance, Planning, Development and Management, Transport, Ports and Civil Aviation and the Environment;
  - President of the National Bank for Economic and Social Development (BNDES);
  - the President of Caixa Economica Federal.
- An infrastructure fund will support infrastructure partnerships and will be managed by the BNDES, which will provide specialized professional services for structuring investment partnerships and privatization contracts.

### Institutional and Regulatory Framework Changes
- Proposed changes (pending congressional approval) aim to:
  - strengthen the autonomy of regulatory agencies;
  - standardize aspects of management, organization, governance and social control.
- Key institutional reforms:
  - Regulatory agencies will have an independent budget.
  - Selection of nominees to compose management boards will be more rigorous to shield agencies from political interference and other forms of capture.
  - Deadlines will be set for appointment of new directors to avoid prolonged vacancies.

### Balance Sheet Analysis (BSA) — purpose and construction
- The Balance Sheet Analysis (BSA) is used to assess macro-financial linkages by carrying information on stocks and vulnerabilities of corporates, households and government.
- Sectoral balance sheet matrices show aggregate exposures, exposures to other sectors, and to the rest of the world, revealing interconnectedness important for shock propagation.
- The BSA matrix is constructed using several data sources including the MFS, the IIP, and the GFSM among others.
- Government sector grouping: the central government, the state governments and the budgetary public companies (excluding Petrobras and Eletrobras) are grouped into the government sector.
- NFCs (Nonfinancial corporates) typically considered “the Private Sector”, include also some nonfinancial corporates in the Public Sector.
- BSA matrices for 2007 and 2014 are used for comparison with the last “pre-crisis” year.

### BSA findings and systemic developments
- System depth and connectedness:
  - Gross assets of all sectors at end-2014 amounted to 416 percent of GDP, against 341 percent of GDP in 2007.
  - Other financial institutions (OFIs) increased in importance in size and connectedness.
  - Almost two thirds of the growth of total assets could be ascribed to the expansion of ODCs’ assets against the private nonfinancial sector.
  - ODCs and NFCs are the largest issuers of gross liabilities in the system.
  - The government’s net liability position remains the most dominant, though it declined somewhat since 2007.
- Foreign currency and external exposure:
  - Foreign currency exposure of NFCs increased due to higher external borrowing.
  - The Central Bank held government bonds worth 20 percent of GDP in 2014, while the government deposits at the central bank totaled 12 percent of GDP.
  - ODCs’ gross foreign currency liabilities to Nonresidents increased but net currency exposures remain modest.
  - The highest foreign currency exposure is in the NFC sector, where foreign bond issuance picked up in recent years.
  - The oil company Petrobras alone had about US$130 million alone in foreign debt at end-2014.
- Exposure to Nonresidents increased:
  - The government became more reliant on financing from abroad.
  - NFCs’ net liabilities to Nonresidents appear to have increased too.
  - External borrowing growth may be understated where offshore bond issuances by foreign incorporated subsidiaries are not repatriated through intercompany loans.
- Changes in net liability positions since 2007:
  - Net liability position of ODCs and NFCs improved.
  - Net position of Other financial corporations (OFCs) and Households (HHs) worsened.
  - Net liability position of the Public Sector (the government and the Central Bank) improved albeit marginally.
- Financial deepening and policy effects:
  - Government issuance of securities in 2010 increased government liabilities to the Central Bank.
  - Growth of Central Bank liabilities to ODCs reflects the increasing role of repo operations in liquidity management.
  - Post-crisis transfers of securities to public banks supported countercyclical fiscal stimulus, increasing banks’ holdings of government paper and enabling increased lending.
  - Caixa stepped up mortgage lending to HHs, while the BNDES increased lending to businesses.
  - ODCs (excluding BNDES) fund lending mainly through domestic deposits (64.4 percent of GDP), with loan to deposit ratio amounting to over 99 percent in 2014.
  - Strong liquidity up to 2014 was supported by increased NFCs cash holdings, the counterparty of which is higher company debt.

### Data limitations and caveats in the BSA
- Main limitations due to data gaps:
  - No data are available for the relationship between Nonfinancial corporate (NFC) sector and Households (HH) sectors.
  - No information about the maturity structure of assets and liabilities.
  - The BSA focuses on aggregate sectoral exposures and thus ignores within-sector risks and specific linkages among sectors (for example, banks specializing in mortgage lending to lower-income segments may face higher risk during slowdowns).
  - The BSA matrix does not include insurance companies or asset managers, which are large players in Brazil.
- Complementary tools:
  - The network map provides a graphical representation of the size and direction of sectoral interlinkages, with nodes representing total size of sector liability exposure and links outlining direction and size of gross exposures (example: NFCs liabilities to Nonresidents were 51 percent of GDP in 2014 as represented in the BSA).

*Source: IMF staff analysis in the provided document.*

### 15. Developments in 2015 altered the size of some intersectoral exposures in the BSA

### 15. Developments in 2015 altered the size of some intersectoral exposures in the BSA

### Changes in 2015 to sectoral balance-sheet exposures
- Government liabilities increased by 10 percentage points of GDP, reflecting a high overall deficit.
- About 16 percent of gross debt was held by non-residents and 25 percent by financial institutions.
- Central Bank foreign assets increased by 3 percentage points to 24 percent of GDP, driven by the steep depreciation of the real.
- Total net liabilities of Other Depository Corporations (ODCs) improved by 2 percentage points of GDP.
- ODCs’ net exposure to Nonfinancial Corporates (NFCs) increased by almost 6 percentage points of GDP.
- ODCs’ net liabilities to the Public sector decreased by almost 6 percentage points of GDP due to higher holdings of government securities.
- Net liabilities to Nonresidents remained broadly unchanged.
- Issuances of debt instruments by the NFC sector foreign slowed down because of weak demand and amounted to 2.5 percent of GDP (of which 2 percent of GDP were domestic).
- The direction of overall net sectoral interlinkages in the BSA remained unchanged.

### Selected table highlights (Change 2007‒14, percent of GDP)
- Total change (aggregate row in the table): 10.3 4.8 5.5 10.6 9.3 1.3 32.7 24.2 8.5 -10.7 -1.5 -9.1 13.3 6.5 6.8 5.3 9.6 -4.3 1.9 10.6 -8.7
- Government (Total row fragment): 6.3 2.1 4.2 -5.6 9.4 -15.0 -1.0 -1.1 0.1 0.0 0.0 0.0 0.0 0.0 4.5 -0.1 4.6
- Central Bank (Total row fragment): 2.1 6.3 -4.2 8.2 0.0 8.2 0.0 0.0 0.0 -0.2 0.0 -0.2 0.0 0.0 0.0 -0.9 4.3 -5.2
- Other Depository Corporations (Total row fragment): 9.4 -5.6 15.0 0.0 8.2 -8.2 -4.0 1.2 -5.2 8.8 17.9 -9.1 6.7 9.8 -3.1 3.4 1.2 2.1
- Other Financial Corporations (Total row fragment): -1.1 -1.0 -0.1 0.0 0.0 0.0 1.2 -4.0 5.2 -0.3 -5.6 5.3 -1.4 -0.2 -1.1 0.0 0.1 -0.1
- NFCs (Total row fragment): 0.0 0.0 0.0 0.0 -0.2 0.2 17.9 8.8 9.1 -5.6 -0.3 -5.3 -5.8 5.0 -10.8
- Households (Total row fragment): 0.0 0.0 0.0 0.0 0.0 0.0 9.8 6.7 3.1 -0.2 -1.4 1.1 0.0 0.0 0.0
- External (Total row fragment): -0.1 5.1 -5.2 4.3 -0.9 5.2 1.2 3.4 -2.1 0.1 0.0 0.0 1.5 0.0 -5.8 10.8 0.0 0.0 0.0
- Currency breakdowns are provided in the table (In domestic currency / In foreign currency) with sectoral detail.

### Data sources and methodological notes (selected)
- Standard data sources: Central Bank of Brazil; Ministry of Industry, Commerce and Tourism, Secretariat of Foreign Commerce (SECEX); Brazilian Institute of Statistics and Geography (IBGE).
- Central Bank: data based on a standardized report form (SRF) from July 2007, aligned with MFSM (2000) concepts; departures from MFSM methodology are explained in the source.
- Securities lending backed by securities is treated as a transaction and included in Other Items (Net) rather than recorded off-balance sheet.
- Loans to financial corporations in liquidation are valued at market price rather than nominal value.
- Some foreign assets are partly calculated using balance of payments data rather than entirely from the Central Bank balance sheet.
- Beginning December 2006, Central/General Government Gross Debt excludes Central Government securities under Central Bank outright ownership; the financial asset "currency and deposits" was corrected by the same amount.

### Composition of Direct Investment (DI) liabilities and offshore issuance
- Net DI (flows) amounted to some 3 percent on average since 2010 while DI liabilities reached about 4 percent of GDP.
- Current account deficit over the same period was some 3.3 percent.
- The share of intercompany loans in total DI liabilities increased significantly during the post-2008 period, amounting to around half of DI liabilities in 2013/14.
- Loans by foreign incorporated subsidiaries to Brazilian parent companies (example: Petrobras) drove the uptick.
- Intercompany loans from the subsidiary to the parent may have a risk profile more similar to portfolio debt flows because they reflect proceeds from offshore bond issuances by foreign incorporated subsidiaries.
- Outstanding stock of offshore issuances by foreign incorporated subsidiaries increased dramatically in recent years (to some 7 percent of GDP in 2014) in several emerging markets including Brazil.
- In Brazil, parent companies appear to have repatriated the bulk of proceeds, as indicated by a close correlation between issuances and the relevant DI component.
- The dramatic decline of both series in 2015, reflecting largely Petrobras’ temporary loss of market access, illustrates the risk profile of such flows, distinguishing them from other, less risky types of DI liabilities.

### Trade response to Real Effective Exchange Rate (REER) changes
- A structural VAR analysis (first differenced quarterly data since 1990) including the REER, trade volumes and terms of trade finds:
  - Imports respond strongly to real depreciations within the same year, with an immediate and sizable response of about 0.45.
  - There is no evidence that a change in the REER affects import volumes later than 4 quarters out.
  - Exports respond with a delay of one to two years.
  - The elasticity of manufacturing exports to a REER change is -0.45, with the bulk of the response materializing one year after the price change.
  - Semi-manufactured and basic products show smaller elasticities operating with longer lags.
- The aggregate export elasticity has fallen over time as the share of manufacturing in total exports declined from 59 percent in 2000 to 38 percent in 2015.
- The current aggregate elasticity is about 0.4 and would have been closer to 0.5 in 2000.
- Staff’s trade projections use the estimated trade elasticities; import decline in 2015 following the dramatic REER depreciation in the same year is sizeable, while exports show a delayed response that fully materializes with the estimated lags.

*Source: _cr16348 - 15. Developments in 2015 altered the size of some intersectoral exposures in the BSA*

### 2017. The total effect of movements in

### _cr16348 - 2017. The total effect of movements in

### Trade and REER effects (2013–2020)
- The total effect of movements in the REER between 2013 and 2020 is projected to amount to 35 billion US dollars, about evenly split between exports and imports.
- Using the estimated trade elasticities, the analysis indicates that staff’s trade balance forecast would have remained closer to zero throughout the medium term in the absence of the currency depreciation, all else constant.

### Fund relations — membership and accounts (as of September 16, 2016)
- Membership Status: Joined January 14, 1946; Article VIII.
- General Resources Account (SDR Million / Percent Quota):
  - Quota                                                                                            10,042.00 100.00
  - Fund holdings of currency (Exchange Rate) 10,116.84 92.07
  - Reserve Tranche Position 875.17 8.71
  - Lending to the Fund: New Arrangement to Borrow 783.12
- SDR Department (SDR Million / Percent of Allocation):
  - Net cumulative allocation 2,887.08 100.00
  - Holdings 2,596.22 89.93
- Outstanding Purchases and Loans: None

### Financial arrangements (historical Stand-by and SRF)
- Stand-by 09/06/2002–03/31/2005: Amount Approved 27,375.12; Amount Drawn 17,199.64 (SDR Million).
  - Of which: SRF 09/06/2002–09/05/2003: 7,609.69 drawn 7,609.69 (SDR Million).
- Stand-by 09/14/2001–09/05/2002: Amount Approved 12,144.40; Amount Drawn 11,385.37 (SDR Million).
  - Of which: SRF 09/14/2001–09/05/2002: 9,950.87 drawn 9,950.87 (SDR Million).
- Stand-by 12/02/1998–09/14/2001: Amount Approved 13,024.80; Amount Drawn 9,470.75 (SDR Million).
  - Of which: SRF 12/02/1998–12/01/1999: 9,117.36 approved; drawn 6,512.40 (SDR Million).

### Projected payments to the Fund (SDR million; based on existing use of resources and present holdings of SDRs)
- Forthcoming 2016 2017 2018 2019 2020 — Principal: 0.00 0.00 0.00 0.00 0.00
- Charges/interest: 0.07 0.25 0.25 0.25 0.25
- Total: 0.07 0.25 0.25 0.25 0.25

### Safeguards, exchange regime, and IOF
- Safeguards Assessments: A safeguards assessment of the Banco Central do Brasil (BCB) was completed in June 2002 and updated in March 2005.
- Exchange Rate Arrangement: Since January 18, 1999, Brazil’s de facto and de jure foreign exchange regime has been classified as floating.
- Article VIII obligations: Brazil accepted the obligations of Article VIII, Sections 2(a), 3, and 4, effective November 30, 1999.
- IOF on exchange transactions:
  - The tax on financial transactions (Imposto sobre Operações Financeiras, IOF) of 6.38 percent on exchange transactions carried out by credit card, debit card, and traveler's checks (including cash withdrawals) gives rise to multiple currency practices (MCP) subject to Fund jurisdiction under Article VIII, Sections 2(a) and 3.
  - Timeline: January 2008, IOF for these exchange transactions was raised to 2.38 percent; March 2011, further increased to 6.38 percent.
  - December 2013: Scope of operations expanded to other foreign exchange transactions than with credit cards.

### Article IV consultations and resident representation
- Last Article IV Consultation: Concluded by the Executive Board on March 16, 2015. Brazil is on the 12-month cycle.
- FSAP: Joint Fund/World Bank missions visited Brazil in 2002 for the FSAP; discussed by the Board in December 2002. A FSAP Update mission took place in March 2012.
- Resident Representative: The Fund maintains a resident representative office in Brasilia. The Resident Representative is Mr. Fabian Bornhorst, who assumed the post in April 2014.

### Technical assistance highlights
- Fiscal Affairs Department (FAD) support:
  - Fiscal Transparency Evaluation organized by the Inter-American Development Bank: two visits (methodology explanation; delivery of assessment).
  - TA to São Paulo on implementation of a public service cost system: prepared a cost manual; defined IFMIS reforms to calculate costs automatically; defined procedures to calculate costs of secretaries of penitentiary administration, health, and education.

### Relations with the World Bank — strategy and diagnostics
- World Bank Country Partnership Framework (CPF) builds on FY 2012–15 Country Strategy with four strategic objectives:
  - (i) increasing the efficiency of public and private investment;
  - (ii) enhancing service provision to poorer segments of the population;
  - (iii) reducing regional economic disparities;
  - (iv) improving sustainable natural resource management and climate resilience.
- Systematic Country Diagnostics (SCD) identifies five main challenges:
  - (i) lack of fiscal space and a large transfer of resources to the non-poor (particularly pensions);
  - (ii) weaknesses of public sector governance and institutional fragmentation which hamper effective long-term policy design, planning and implementation;
  - (iii) segmentation of financial markets, lack of long term credit and high interest rates;
  - (iv) insufficient competition and poor business environment;
  - (v) weaknesses in the management of Brazil’s natural resources and insufficient resilience against climate risks.

### World Bank Group financial engagement and instruments
- IBRD lending program:
  - US$550 million for FY 15, and US$758 million for FY 16.
  - Strategy for FY 17: start rebuilding the lending pipeline for FY 18; FY 17 new lending deliveries should be close to US$300 million.
- Principles guiding Bank engagement: Flexibility, Selectivity, Innovation, Leveraging.
- IFC:
  - Investment portfolio stands at US$4.05 billion, including US$1.3 billion from syndications.
  - IFC new commitments reached US$1.3 billion by the end of FY 16; US$1.018 million from IFC’s own account and US$309.38 million from mobilization.
  - Key sectors: Financial Markets, Health, Education, Agribusiness, Infrastructure.
- MIGA:
  - Processed in FY 15 its first exposure transaction in Brazil since FY 09.
  - Example: São Paulo Sustainable Transport Project — MIGA’s NHSFO guarantee approved by Executive Directors in April 2014 and by the Brazilian Senate on September 2, 2014.
  - Brazil will gain about US$100 million in additional IBRD lending headroom through an exchange of existing IBRD exposure to Brazil for MIGA exposure to Panama.

### Provisional timing of missions / Investment Project Financing (example)
- Recife Municipal PforR — Expected approval/delivery date: 06/30/2017

*Source: _cr16348 - 2017. The total effect of movements in*

### 2.     Salvador PForR

### 2.     Salvador PForR

### Program for Results
- Fortaleza Municipal IPF — 02/15/2017

### Advisory Services and Analytics (Technical Assistance)
- Energy effic. recommendations for CESAN — 08/22/16
- Infrastructure Regulatory Frameworks — 09/30/16
- BR Online retail and urban logististics — 09/30/16
- Rio de Janeiro Education Studies — 10/28/16
- BR Transport and Gender Mainstreaming — 10/31/16
- Innovation in DRM Decision Making in BR — 11/28/16
- Agriculture Drought Preparedness ENSO — 12/12/16
- Post-COP21 Environmental Research Agenda — 12/30/16
- Conferences, workshops and other events — 05/10/17
- On Efficiency of Pub.Inv. for Productiv. — 05/31/17
- Studies on Innovation Impacts and Policies — 05/31/17
- Studies on Invest. and Trade Facilitation — 05/31/17
- Logistics Support to SEP/PR, SECEX, SEAE — 05/31/17
- Comp Advoc Support SEAE, SMPE, MPOG, MOC — 05/31/17
- Cross Policy Synergies — 05/31/17
- BR NLTA DEFRA CERRADO Climate Change — 06/08/17
- Participat. Governance Citizen Security — 06/30/17
- Review of Costs of Violence — 06/30/17
- Municipal Diagnostics of C&V — 06/30/17
- Briefs to Inform City Strategies — 06/30/17
- Assessment of the Bank’s engagement — 06/30/17
- Capacity building based on interventions — 06/30/17

### Economic Sector Work (ESW)
- BR financial sector credit allocation — 08/25/16
- Infrastructure Efficiency for Growth — 09/30/16
- Brazil Governance in Infrastructure — 09/30/16
- Mobility in Cities Study — 09/30/16
- BR Subnational Governance Monitoring — 10/31/16
- Expenditure Review of Education — 12/16/16
- Analysis of INDC Land Use Targets — 01/31/17
- Knowledge Products on Social Assistance — 05/08/17
- Exploring Forest Bonds — 05/31/17
- Typology of Cities — 05/31/17
- Brazil expenditure review — 06/30/17

### Programmatic Approach (PA)
- BR WWP Learning Initiative (SoD Hub) — 05/25/17
- Productivity for Shared Prosperity — 05/31/17
- Violence Prevention in Brazil — 06/30/17

### Relations with the Inter-American Development Bank (IDB)
- IDB Country Strategy with Brazil approved on March 30, 2016 for period 2016−18; three strategic areas: (1) increase productivity and competitiveness; (2) reduce inequity and improve public services; (3) strengthen institutions at the three levels of government; crosscutting issues: gender, diversity, integration, and climate change.
- Portfolio (strategy 2012‒14): 84 operations totaling US$8.35 billion; 68 sovereign guarantee (SG) operations totaling US$7.4 billion; 16 non-sovereign guarantee (NSG) operations totaling US$950.7 million.
- Of SG operations, 62 were with Brazilian states, state-owned enterprises, or municipals (91 percent of approved operations).
- Regional focus of SG operations (by number): 45 percent in the North (19 percent) and Northeast (26 percent).
- Technical cooperation: 45 operations approved for a total of US$40.9 million focusing on social and productive inclusion, and environmental and rural management and climate change.
- IDB approvals in 2015: seven loans totaling US$382.5 million — one SG operation for US$56 million and six NSG operations for US$326.5 million. Lending composition: 85 percent to promote development through the private sector; 15 percent to promote the development of sustainable cities. Lending to subnational governments corresponded to 15 percent of total lending to Brazil.
- Highlighted 2015 operations: Program for Integrated Urban Development of the Municipality of Campo Grande (US$56 million); Banco Coorporativo Sicredi Financing for Rural Credit and Low Carbon Agriculture (US$50 million); Mind Lab Increasing Access to Innovative Education Methodologies in Brazil (US$4.6 million); Itau Unibanco Women-Owned MSME Partnership (US$100 million).
- 2016 projected total loan approvals: US$1,457.4 million. Sovereign guarantee approvals projected at US$1,250.0 million; private sector operations expected to total US$207.4 million.
- IDB program estimates approvals of US$43.9 million in grants for Technical Cooperation.
- Current active portfolio: 118 loans to the public sector (US$11,315.8 million) and 50 loans to the private sector (US$974.2 million). Brazil’s outstanding debt with the IDB: US$14,588 million (as of end of February 2016). Undisbursed from the current portfolio: US$7,253.2 million (as of march 22, 2016).

### Statistical Issues — Assessment of Data Adequacy for Surveillance (As of September 23, 2016)
- General: quality of macroeconomic statistics has improved significantly; data provision is adequate for surveillance.
- National Accounts: since 2015, estimates follow 2008 System of National Accounts; availability of annual and quarterly supply and use tables; series available on IBGE and in International Financial Statistics (IFS); participation in G-20 Data Gaps Initiative (recommendation 15) to promote compilation/dissemination of balance sheet approach, flow of funds, and sectoral data on quarterly and annual basis.
- Price Statistics: since July 1999, IPCA is the price index reference for monetary policy compiled by IBGE; IPCA covers households earning between one and forty times the minimum wage in 11 metropolitan areas and two municipalities; FGV and IBGE compile producer price indices IPA and IPP since 2010.
- Government Finance Statistics: Ministry of Finance and BCB compile using GFSM 2001 presentation; reported statistics include statement of government operations and financial balance sheet for consolidated central government and financing operations and financial balance sheet for general government; reported data compiled by converting nationally published data that broadly follow GFSM 1986; data reflect single treasury account movements and are on a cash basis except for interest; gross debt indicator excludes government securities under central bank’s outright ownership.
- Migration plan (2009) for full implementation of GFSM 2001 includes introducing accounting framework based on IPSAS, merging budgetary approach, accrual accounting, and internal controls into a single system.
- Monetary and Financial Statistics: BCB compiles/publishes broadly MFSM 2000-aligned statistics; 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.
- Financial Soundness Indicators (FSIs): BCB reports quarterly FSIs to IMF beginning Q1 2005; currently reports all core and 18 encouraged FSIs; plans to compile the rest of encouraged FSIs.
- External Sector Statistics: Brazil disseminates monthly balance of payments and quarterly international investment position compiled per the sixth edition of the Balance of Payments Manual; BCB supplementing foreign exchange registry 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 International Reserves and Foreign Currency Liquidity daily with a lag of one day; Brazil reports quarterly total external debt position data with a three-month lag to the World Bank’s Quarterly External Debt Statistics database.
- Data Standards and Quality: Subscriber to 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 needed 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 October 6, 2016) — selected entries and dates preserved as presented:
  - Exchange Rates — Date of Latest Observation: 10/6/16; Date Received: 10/6/16; Frequency of Data: D; Frequency of Reporting: D; Frequency of Publication: D
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities — Date of Latest Observation: 10/5/16; Date Received: 10/6/16; Frequency of Data: D; Frequency of Reporting: D; Frequency of Publication: D
  - Reserve/Base Money — Aug. 16; Date Received: 9/28/16; Frequency: M (Data/Reporting/Publication)
  - Broad Money — Aug. 16; Date Received: 9/28/16; Frequency: M (Data/Reporting/Publication)
  - Central Bank Balance Sheet — Aug. 16; Date Received: 9/28/16; Frequency: M (Data/Reporting/Publication)
  - Consolidated Balance Sheet of the Banking System — Aug. 16; Date Received: 9/28/16; Frequency: M (Data/Reporting/Publication)
  - Interest Rates — Date of Latest Observation: 10/6/16; Date Received: 10/6/16; Frequency: D (Data/Reporting/Publication)
  - Consumer Price Index — Aug. 16; Date Received: 9/9/16; Frequency: M (Data/Reporting/Publication)
  - Revenue, Expenditure, Balance and Composition of Financing – General Government — Aug. 16; Date Received: 9/30/16; Frequency: M (Data/Reporting/Publication)
  - Revenue, Expenditure, Balance and Composition of Financing – Central Government — Aug. 16; Date Received: 9/30/16; Frequency: M (Data/Reporting/Publication)
  - Stocks of Central Government and Central Government-Guaranteed Debt — Aug. 16; Date Received: 9/30/16; Frequency: M (Data/Reporting/Publication)
  - External Current Account Balance — Aug. 16; Date Received: 9/26/16; Frequency: M (Data/Reporting/Publication)
  - Exports and Imports of Goods and Services — Aug. 16; Date Received: 9/26/16; Frequency: M (Data/Reporting/Publication)
  - GDP/GNP — Q2 2016; Date Received: 8/31/16; Frequency: Q (Data/Reporting/Publication)
  - Gross External Debt — Aug. 16; Date Received: 9/26/16; Frequency: M (Data/Reporting/Publication)
  - International Investment Position — Q2 2016; Date Received: 8/23/16; Frequency: Q (Data/Reporting/Publication)

### Public Debt Sustainability Analysis (DSA) — Key Findings and Baseline
- 2015 developments:
  - Gross debt of the nonfinancial public sector (NFPS) increased by 10½ percentage points of GDP in 2015, reaching 73.7 percent of GDP.
  - Net debt of the public sector rose by 3 percentage points of GDP in 2015 owing to valuation gains on gross international reserves.
  - Net interest on NFPS debt picked up significantly in 2015 due to more elevated borrowing costs and large losses on the FX swaps (recorded in the interest bill).
- Debt dynamics and projections:
  - Primary surpluses above 3 percent of GDP (excluding interest revenue) would be needed to keep gross debt from growing as a ratio to GDP beyond the projection horizon.
  - In the baseline scenario, fiscal consolidation based on the government’s proposed reforms on the government expenditure side, if fully implemented, would restore the sustainability of debt, but debt ratios would stabilize after the end of the 5-year projection period, with gross debt reaching 93.5 percent of GDP in 2021.
  - The trajectory of gross debt is highly sensitive to fiscal policy performance because of modest GDP growth and high borrowing costs; failure to implement proposed fiscal reforms would jeopardize debt sustainability.
- Coverage and measurement:
  - Debt coverage: NFPS excludes Petrobras and Eletrobras and consolidates the Sovereign Wealth Fund. In line with GFSM 2014, NFPS debt includes all Treasury securities on the Central Bank's balance sheet, including those not used under repurchase agreements. At end-2015, gross debt amounted to 73.7 percent of GDP.
  - Government-reported net debt corresponds to the public sector, defined to include the Central Bank.
  - Consolidated public sector assets amounted to 42 percent of GDP in 2015, including 24.1 percent of GDP in international reserves. Non-financial public sector assets amounted to 34.3 percent of GDP.
  - Brazil’s debt is reported at nominal value. The nominal value is calculated as the PDV of future interest and principal payments at the security’s contractual interest rate(s).
- Debt profile and management:
  - Federal government (FG) domestic tradable securities accounted for 90 percent of total NFPS gross debt in 2015, of which 2/3 were held by the public.
  - Nearly 22 percent of total (domestic tradable securities) will mature in 2016.
  - Objectives: raise average maturity to 5.5 years and bring total short-term debt (on both original and residual maturity basis) down toward 20 percent of all debt over the medium term.
  - Average maturity of outstanding tradable instruments about 4.6 years on average (up from less than 3 years in 2008).
  - A greater share of newly issued securities was linked to the policy rate (Selic) in 2015. Zero-coupon bonds with original maturities over one year constitute slightly more than half of FG domestic tradable securities held by the public.

*Source: _cr16348 - 2.     Salvador PForR (IMF staff report excerpts and annexes as provided in the source content).*

### 21.7 percent of GDP. Foreign holding of domestic

### _cr16348 - 21.7 percent of GDP. Foreign holding of domestic

### Debt composition and foreign holdings
- Foreign holding of domestic securities was stable at 18 percent of total at end-2015.
- Foreign currency denominated tradeable securities accounted for only 6.7 percent of the total in 2015, representing slightly below 5 percent of GDP.
- Other NFPS debt includes liabilities issued by SOEs and subnational governments, as well as direct bank lending.
- Gross financing needs have tended to be high, above 15 percent of GDP.
- Interest charged on new issuances has increased by 250 bps since end-2014.
- A large fraction of federal government debt (about 21 percent of GDP) is held by the Central Bank, which follows a policy of automatic rollover of its holdings of government securities.
- Short-term debt at original maturity is very small, amounting some 2 percent of total NFPS debt.

### Box 1 — Impact of swaps and valuation changes on interest and debt in 2015
- The Central Bank of Brazil (BCB) most frequently uses the Brazilian FX swap (the swap), a non-deliverable future settled in local currency.
- At end-December 2015, the notional value of the outstanding stock of swaps was about US$110 billion, equivalent to 30 percent of gross international reserves or 7.3 percent of GDP.
- EC (“Equalização Cambial”) reported by the BCB includes results of swap operations and derivatives, changes in the valuation of reserves (net external debt) and the carry cost of reserves.
- Treatment of EC:
  - EC is considered in the compilation of the General Government (GG) net debt (a positive result decreases net debt; a negative result increases net debt), but not in compiling gross debt.
  - A positive EC result gives rise to a transfer from the BCB to the Treasury Single Account (TSA).
  - To cover a negative EC result the government issues debt to the BCB.
- Because over 2/3 of reserves are in U.S. dollars, EC movements are strongly affected by changes in the real/U.S. dollar exchange rate.
- Example: the dollar value of reserves increased from 17.8 percent of GDP in 2014 to 24.1 percent of GDP at end-December 2015, on account of a 49 percent depreciation of the Brazilian real during the year; EC was 1.9 percent of GDP.
- Interest on EC, which includes the interest on swaps, is accounted together with interest on public debt and accrues interest at the same rates applied to the FG deposits in the TSA.
- The part of the interest bill related to swaps reached 1.5 percent of GDP in 2015, pushing up the implied interest on net debt.

### Baseline scenario and macro assumptions
- Real GDP contraction of -3.3 percent in 2016; ½ percent output growth in 2017; gradual return to potential growth of 2 percent by 2019.
- Assumed fiscal adjustment brings the primary balance to 0.8 percent of GDP by 2021, implying an improvement of about 3 percentage points of GDP during 2017−21.
- Nominal interest rates on new borrowing are between 12 and 15 percent over 2016−21, bringing the effective interest rate to about 12 percent on average.
- Baseline assumes limited structural reforms and a modest world output recovery.
- Under the baseline, gross debt reaches 93.5 percent of GDP by 2021 and gross financing needs are projected to remain above the high-risk threshold of 15 percent of GDP on average over the medium term.
- By end of projection horizon, the primary balance required to stabilize debt in the baseline scenario is 3.3 percent of GDP (excluding interest revenue).
- The baseline does not include early repayment of BNDES credit to the government (proposed schedule: repayment on R$100 billion in three installments starting in 2016; estimated savings on interest from this transaction amount to about R$7 billion per year).

### Heat map and financing-risk nuance
- Heat map indicates stock of debt and gross financing needs are high; market premium on government borrowing and reliance on external financing are elevated.
- Gross financing needs overstate rollover risk because the Central Bank continuously rollovers a significant amount of FG bonds.
- Excluding rollover of Central Bank held bonds, gross financing needs would amount to about 15 percent of GDP in 2016, still at the threshold level for high risk.

### Realism and past forecast errors
- No evidence of systematic projection bias in baseline assumptions for GDP growth, primary balance and inflation.
- Median forecast error for GDP growth, the primary balance and inflation are below 2 percent and in line with other countries’ forecast errors.
- Brazil’s projected fiscal adjustment (an improvement of about 2½ percentage points in the cyclically-adjusted primary balance/GDP over the medium term) is in line with other countries’ experiences; a 3-year adjustment in cyclically-adjusted primary balance is at the 23 percentile among all surveillance countries.

### Shocks and stress tests — scenarios and impacts
- Growth shock:
  - 1 standard deviation shock (3.4 percent) to real GDP growth.
  - Over 2017−18, real GDP growth rates become negative while inflation declines by 200 bps in each year.
  - Primary balance worsens before recovering in 2019; interest rates increase by 55 bps for each percentage point decline in output growth.
  - Gross debt increases to 112 percent of GDP by 2021; gross financing needs reach 39 percent of GDP.
- Primary balance and real interest rate shocks:
  - Primary balance shock delays consolidation by one year.
  - Interest rate shock: borrowing costs increase by 200 bps in the first projection year and remain the same over the medium term.
  - These shocks push up debt-to-GDP by 3 percentage points above the baseline in 2021 (impact described as modest).
- Combined macro-fiscal shock and contingent liabilities shocks:
  - Macro-fiscal shock combines growth and interest rate shock, a primary balance shock, and a real exchange rate shock consistent with maximum movement over past 10 years 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, resulting in a primary deficit of -5.5 percent of GDP in 2017 and a 1 standard deviation shock to GDP growth in 2017 and 2018.
  - Debt-to-GDP reaches about 109−119 percent by 2021 in the two shocks.
- No reform scenario:
  - Government fails to implement proposed fiscal reforms; primary deficits persist through projection period.
  - Currency depreciates by 5 percent in 2016 and by another 20 percent in 2017.
  - Spreads on domestic securities pick up by 500 bps in 2016 and 2017 and remain elevated thereafter.
  - Growth recovery weaker and depreciation steeper; debt reaches 106 percent of GDP by 2021.
- Debt Reduction Begins by 2021 (“IMF recommended scenario”):
  - Assumes more aggressive fiscal consolidation so the primary balance reaches the debt-stabilizing level within the 5-year projection period.
  - Faster disinflation and higher confidence lower interest rates relative to the baseline, supporting growth in outer years; gross financing needs are lower and gross debt is put on a declining trajectory by 2021.

*Statement by the IMF Staff Representative on Brazil — October 31, 2016*

### 1. This note reports on information that has become available since the staff report

### _cr16348 - 1. This note reports on information that has become available since the staff report

### Updates since the staff report
- The constitutional amendment that limits the annual growth of federal primary spending to inflation in the previous year has passed by a wide margin the first and second votes in the lower house of Congress; it will now go to the Senate, where it must be voted twice.
- High-frequency data suggest economic activity continued to contract in the third quarter: the central bank’s monthly activity index fell 0.9 percent m/m in August, driven by a sharp drop in retail sales, industrial output, and services activity.
- Headline 12-month inflation decelerated to 8.3 percent in mid-October (compared to 8.8 percent in mid-September), with a print of 0.19 percent m/m.
- The median market forecast for annual inflation in 2017 fell to 5 percent on October 21, and is now 0.5 percentage points above the central bank’s target of 4.5 percent.
- The central bank lowered the policy rate by 25 bps to 14 percent in its October Monetary Policy meeting, citing declines since the last policy meeting in inflation, inflation expectations, and the central bank’s own inflation forecasts in the constant-policy-rate scenario; it signaled that further easing would be gradual and moderate.
- Petrobras announced a new pricing policy for gasoline and diesel at the refinery gate, lowered these prices slightly, and will update fuel prices monthly based on changes in international prices, exchange rates, transportation margins, and domestic market conditions; prices will not be allowed to fall below import parity.
- Moody's upgraded all ratings of Petrobras from B3 to B2, including the company's senior unsecured debt and corporate family rating, citing lower liquidity risk and improved prospects for operational performance in the medium term.

*Statement by Alexandre Tombini, Executive Director for Brazil — October 31, 2016*

### Recent economic developments
- Brazil entered its worst recorded recession in mid-2014, accumulating a GDP contraction of 8 percent in the nine quarters through the second quarter of 2016.
- Contributing factors: external shocks to commodity prices, policy missteps (particularly fiscal), political uncertainty, and the shrinking of Petrobras; investment fell dramatically in the last two years.
- The collapse in aggregate demand led to extensive job losses and a steep rise in unemployment.
- The new administration (interim since May, confirmed in September) has shown strong commitment to sound macroeconomic policies and has galvanized broad support in Congress.
- Current signs: activity is stabilizing tentatively; short-term indicators are uneven; business and consumer confidence have rebounded.
- Labor market: expected continued softening in the coming quarters before stabilizing in 2017.
- Market GDP forecast for 2017 revised upwards to 1.2 percent, compared to 0.3 percent six months ago.

### Economic policy priorities and fiscal measures
- Overarching goal: restore confidence by stabilizing gross public debt and subsequently reducing it.
- Fiscal consolidation strategy: initially curb the real growth of public spending and then promote a parametric reform of the pension system.
- Expected benefits: reestablish fiscal credibility, help inflation converge to target, enable rebalancing of the policy mix, lower real interest rates, reduced uncertainty, and reignited investment.
- Recent progress and measures:
  - Constitutional amendment approved in August to de-earmark a larger share of the budget, encompassing subnational entities and facilitating fiscal adjustment.
  - Constitutional amendment freezing federal spending in real terms approved by an overwhelming majority in the lower house; proceeding to the Senate.
  - Court of Accounts expected to rule soon on legality of the early repayment of BNDES loans from the Treasury; agreement may reduce gross public debt by R$100 billion (about 1.6 percent of GDP) in the next three years.
  - Tax revenues from the new law for repatriation of undeclared assets are expected to reach R$50 billion (the exact figure will be known in the next few days).
  - A constitutional amendment establishing new parameters for the social security system is set to be sent to Congress by the end of this year.
- Authorities view the spending cap and social security reform as “game changers” to restore debt sustainability and confidence; Congress is signaling willingness to approve these measures.
- Monetary policy: Copom cut the Selic rate by 25 basis points on October 19th; monetary policy remains tight with high real interest rates. Future easing will depend on confidence in the convergence of inflation, incoming data (especially items responsive to monetary policy), and the pace of reform implementation.
- The government is considering ways to strengthen the de jure autonomy of the monetary authority; the BCB has undertaken measures to sharpen transparency and policy communication.

### Structural reforms
- Sustainable growth requires robust structural reforms beyond cyclical rebound.
- Key initiatives:
  - Changes in the framework for privatization and concessions to make them more appealing, balancing fiscal accounts and boosting productivity.
  - Petrobras streamlining activities and exempted from mandatory participation in all pre-salt projects.
  - New framework for sanitation companies to facilitate private participation in public services.
  - Infraero no longer required to be a mandatory partner in airport concessions.
- Microeconomic reforms to improve business climate and stimulate investment:
  - Enhance governance in SOEs.
  - Increase autonomy of regulatory agencies.
  - Prioritize evaluation of results over procedures.
  - Update the bankruptcy law.
  - Encourage BNDES to focus on infrastructure investment.
- Recent corruption probes expected to lay groundwork for a more transparent government–private sector relationship and potential efficiency gains.

### Financial system soundness and the external sector
- The financial system underwent a real-life stress test and remained resilient with no systemic event.
- Adverse factors faced: decline in growth, sharp depreciation of the BRL, hike in domestic interest rates, fall in real household income.
- Banks are well provisioned and capitalized; regulatory and supervisory framework proved robust.
- BCB’s FX swap program (non-deliverable future instruments settled in BRL) provided valuable additional hedge, allowing exchange rate flexibility without disruptive financial distress.
- Fiscal impact of the FX swap program: large profits in the first ten months of 2016 made up for more than 80 percent of the losses incurred in 2015.
- High international reserves were important in maintaining confidence; no episodes of capital flight and foreign direct investment remained reliable.
- Exchange rate flexibility and a sound financial system are deemed vital for sustainable growth; authorities foresee healthier current account performance as the economy recovers.

### Fiscal situation of States and Municipalities
- Subnational public finances were adversely affected, especially where revenues depend more on commodity prices.
- All levels of government reduced spending to partially accommodate falling fiscal revenues; budget rigidities constrained adjustment and achieving sustainability remains challenging for states.
- Temporary federal relief provided space for adjustment; the federal social security reform should help states tackle rising pension expenditures.
- Recommended/supporting actions:
  - Strengthen controls and closer monitoring by the National Treasury.
  - Fully enforce the Fiscal Responsibility Law.
  - Improve efficiency in public spending and enhance fiscal transparency.
- Growth will be decisive for restoring fiscal sustainability, particularly for states whose revenues are more responsive to the economic cycle.

*Statement by Alexandre Tombini, Executive Director for Brazil — October 31, 2016*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16348.pdf_