## 1. Interest Payments and Real Interest Rate

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### Introduction
- Under the Collor Plan (1990), Brazil’s public sector primary balance recorded a surplus of 2.9 percent during 1991–94.
- Under the Real Plan (June 1994), the public sector primary balance averaged a deficit of -0.2 percent of GDP during 1995–98.
- Following the 1998 external and fiscal crisis and a Stand-By Arrangement with the IMF (1999–2001, extended to end-2002), the public sector recorded an average primary surplus of 3.5 percent of GDP during 1999–2002.
- Authorities shifted to operating under a floor for the consolidated primary surplus during Cardoso’s second term.
- The official primary surplus target for 2002 was raised from 2.7 percent of GDP to 3.9 percent of GDP because of higher projected interest payments after interest rate increases in 2001–2002.

### Overview of Public Sector Borrowing Requirements (PSBR), 1995–2002
- Fiscal performance split into two sub-periods: 1995–98 (deterioration) and 1999–2002 (adjustment).
- 1994 atypical: primary surplus in 1994 was 5.2 percent of GDP.
- Four aggregate facts:
  - Federal government nominal deficit progressively deteriorated until 1998.
  - All three government levels showed similar primary-balance deterioration in 1995–98, then improvement in 1999–2002.
  - Interest payments averaged 7.2 percent of GDP throughout 1995–2002.
  - A balance sheet adjustment variable (beginning in 1995–98) produced below-the-line changes modifying public sector debt.
- Key statistics:
  - Primary balance: 5.2 in 1994; 0.3 in 1995–98; 3.5 in 1999–2002.
  - Interest payments: averaged 7.2 percent of GDP during 1995–2002.
  - Nominal deficit (average): 5.5 percent of GDP during 1995–2002.
  - Accumulated change in public sector debt due to balance sheet adjustment: 19 percentage points of GDP between 1994 and 2002.

### Interest Payments and Real Interest Rate
- High real interest burden despite relatively small public debt in early Real Plan years due to need to attract external financing after Asian and Russian crises.
- SELIC gross real interest rate (using IPCA deflator) averaged 22 percent during 1995–98.
- SELIC gross real interest rate averaged 10 percent during 1999–2002.
- Lower real rates after 1999 applied to a much higher public sector debt and, combined with exchange rate effects, resulted in continued large interest payments.

### Sources of Fiscal Adjustment (focus on primary balance)
- Interest payments did not drive nominal deficit decline because they remained high throughout 1995–2002.
- Federal-level adjustment driven by a significant increase in fiscal tax revenues; federal non-financial expenditure grew continuously.
- States and municipal levels improved gradually after 1997 due to maturation and institutional changes.
- Public sector enterprises’ primary balances improved since 1999, largely due to Petrobras.

### Federal primary balance and fiscal aggregates
- Total federal revenues rose from under 19 percent of GDP in 1994 to over 24 percent of GDP in 2002.
- Gross federal government revenues increased from an average of 16.5 percent of GDP in 1991–94 to 22.6 percent of GDP in 1999–2002.
- Federal government non-financial expenditure grew considerably; all major categories contributed.
- Federal fiscal adjustment in 1999–2002 achieved principally through increased revenues while federal primary public expenditure rose in real terms during the eight years of the two administrations.
- Time series (1994–2002, percent of GDP):
  - Total revenues: 18.9, 18.3, 17.5, 18.4, 20.1, 21.7, 21.5, 22.7, 24.4.
  - Transfers to states and municipalities: 2.6, 2.8, 2.7, 2.8, 3.0, 3.6, 3.7, 3.9, 4.3.
  - Net revenues: 16.4, 15.5, 14.7, 15.6, 17.2, 18.1, 17.8, 18.8, 20.1.
  - Non-financial expenditures: 13.9, 14.8, 14.5, 15.4, 16.6, 16.0, 15.9, 17.1, 17.9.
  - Payroll expenses: 5.1, 5.6, 5.2, 4.8, 5.0, 5.1, 5.0, 5.4, 5.6.
  - Social security benefits: 4.8, 5.0, 5.3, 5.4, 5.8, 6.0, 6.0, 6.3, 6.7.
  - Other costs and capital expenses (OCC): 4.0, 4.2, 4.0, 5.3, 5.7, 4.9, 4.9, 5.4, 5.6.
  - Statistical discrepancy: 0.8, -0.1, 0.2, -0.5, 0.0, 0.2, -0.1, 0.1, 0.2.
  - Primary balance: 3.3, 0.5, 0.4, -0.3, 0.6, 2.3, 1.9, 1.8, 2.4.
  - Federal gov. and central bank primary balance: 3.1, 0.5, 0.5, 0.0, 1.4, 3.3, 2.8, 2.9, 3.7.
  - Social security primary balance: 0.2, 0.0, -0.1, -0.3, -0.8, -1.0, -0.9, -1.1, -1.3.

- Period averages (1991–94, 1995–98, 1999–2002, percent of GDP):
  - Total revenues: 16.5, 18.6, 22.6.
  - Transfers to states and municipalities: 2.7, 2.8, 3.9.
  - Net revenues: 13.8, 15.8, 18.7.
  - Non-financial expenditures: 12.4, 15.3, 16.7.
  - Personnel: 4.4, 5.2, 5.3.
  - Social security benefits: 4.4, 5.4, 6.3.
  - OCC: 3.7, 4.8, 5.2.
  - Statistical discrepancy: 0.2, -0.1, 0.1.
  - Primary balance (period averages): 1.6, 0.3, 2.1.
  - Federal gov. and central bank: 1.0, 0.6, 3.2.
  - Social security: 0.6, -0.3, -1.1.

### Federal revenues — composition and changes
- Total federal revenues (period averages, percent of GDP): 11.9 (1991-94), 13.2 (1995-98), 16.6 (1999-2002).
- Select revenue items (period averages, percent of GDP):
  - Import tax: 0.4, 0.7, 0.7.
  - Industrial Products Tax (IPI): 2.3, 2.0, 1.6.
  - Income tax total: 3.7, 4.5, 5.6.
    - Individuals: 0.2, 0.3, 0.3.
    - Corporations: 1.1, 1.5, 1.7.
    - Labor: 1.3, 1.5, 1.7.
  - Capital yields: 0.7, 0.8, 1.2.
  - Financial Transaction Tax (IPMF/CPMF): 0.3, 0.4, 1.3.
  - Tax on Financial Operations (IOF): 0.7, 0.4, 0.3.
  - Social Security Financing Contribution (Cofins): 1.5, 2.2, 3.7.
  - Social Integration Program Contribution (PIS/PASEP): 1.1, 0.9, 1.0.
  - Contribution on net profits: 0.7, 0.9, 0.8.
  - Civil service social security contribution: 0.1, 0.3, 0.3.
  - Other: 1.2, 0.9, 1.3.
- Memorandum:
  - Tax burden: 25.7, 28.8, 32.8 (percent of GDP).
  - State Value Added Tax (ICMS): 6.7, 7.0, 7.6 (percent of GDP).
- Observations:
  - CPMF/IPMF and Cofins together explain about two thirds of revenue change between 1991–94 and 1999–2002.
  - Gross revenue jumped by 1.6 percent of GDP in 1999 versus 1998, with 1.3 percent of GDP attributable to Cofins.
  - IPI revenues declined continuously over the period.

### Payroll expenses and retirees
- Federal government payroll expenses rose in nominal terms from R$18.5 billion in 1995 to R$33.2 billion in 2001.
- Structure of payroll (1995 vs 2002, percent of total payroll; real growth):
  - Total: 100, 100; Real growth 2.3.
  - Active duty: 55, 52; Real growth 2.1.
  - Retirees: 45, 48; Real growth 2.5.
  - Civilian: 75, 71; Active 44, 42; Retirees 31, 29; Real growth for civilians 1.5.
  - Military: 25, 29; Active 12, 12; Retirees 13, 17; Real growth for military 4.5.
- GDP growth (memorandum): 2.1 (Year average).
- Drivers:
  - Payroll rose despite salary ‘freezes’ due to career revisions, promotions, and salary-curve adjustments.
  - Spending on retired military personnel increased markedly; military allowances represented 45 percent of expenditure on retired military personnel in August 2000 versus 32 percent for civilian pensions.
  - Spending on retired military personnel share of total federal retired employees rose from 30 percent in 1995 to 37 percent in 2002.

### Social security benefits — indexation, composition, and growth
- Determinants of social security expenditure growth:
  - a) adjustment in pensions benefits by more than inflation;
  - b) faster growth in more expensive pension benefits; and
  - c) increase in the number of beneficiaries.
- Per-capita social security benefits (as of December 2002, percent of minimum legal wage):
  - Total benefits: 164; Social security: 172; Pension: 187; Old age: 113; Urban: 150; Rural: 100; Length-of-service: 360; Disability: 135; Allowances: 130; Other: 224; Aid support: 114.
- Social security benefits growth (annual average, percent):
  - Total benefits: 4.2 (1994-1998), 3.5 (1998-2002).
  - Social security: 3.7, 3.4.
  - Pension: 4.1, 2.9.
  - Old age: 1.9, 3.4.
  - Urban: 4.9, 2.6.
  - Rural: 0.9, 3.7.
  - Length-of-service: 11.5, 2.2.
  - Disability: 1.0, 2.5.
  - Allowances: 3.8, 3.0.
  - Other: -3.0, 12.6.
  - Aid support: 7.3, 4.5.
- Observations:
  - Length-of-service pension benefits grew rapidly at 11.5 percent a year in 1995–98.
  - Welfare reform reduced retirement applications; assistance component contributed to rising social security expenditure-to-GDP ratio.
  - Minimum salary adjustments increased social security expenditure by 0.7 percent of GDP between 2000 and 2002.

### Other costs and capital expenses (OCC) — rigidity and composition
- OCC increases not solely due to ‘Inverse Tanzi effect’; major increases occurred after 1996.
- OCC series (percent of GDP and nondiscretionary share):
  - 1999: 1.0 percent of GDP; nondiscretionary share 20 percent.
  - 2000: 2.6 percent of GDP; nondiscretionary share 52 percent.
  - 2001: 2.9 percent of GDP; nondiscretionary share 54 percent.
  - 2002: 3.3 percent of GDP; nondiscretionary share 62 percent.
- Budget 2002 OCC composition (percent of total OCC):
  - Health: 28%; Employment-insurance: 8%; Fund for Fighting Poverty: 7%; Other obligatory expenses: 14%; Noncommitted expenditure: 43%.
- Principal nondiscretionary items:
  - Health spending set as a fixed percentage of GDP by constitutional provision (2000).
  - Fund for Fighting Poverty set as a real value by constitutional provision (2000), full effect in 2002.
- Consequence: nondiscretionary commitments limited short-run fiscal management; nondiscretionary OCC share rose from 20 percent in 1999 to 60 percent in 2002.

### Real growth of non-financial expenditure (averages)
- Real growth rates (average percent):
  - Non-financial expenditure: 7.0 (1994-1998), 4.6 (1998-2002), 5.8 (1994-2002).
  - Payroll expenses: 2.0, 4.2, 3.1.
  - Social security benefits: 7.4, 5.0, 6.2.
  - Transfers to states and municipalities: 6.6, 11.0, 8.8.
  - Other costs and capital expenditure: 12.3, 0.7, 6.3.
- Memorandum:
  - GDP growth (implicit deflator): 2.6, 2.1, 2.1 (average percent).
- Aggregate: Overall non-financial expenditure grew by 7.0 percent a year in real terms during the first Cardoso administration and by 4.6 percent a year during the second.

### States and municipalities — fiscal evolution and reforms
- States and municipalities primary balance (1994–2002, percent of GDP):
  - Total balance: 0.8, -0.2, -0.5, -0.7, -0.2, 0.2, 0.5, 0.9, 0.8.
- Institutional measures:
  - Bilateral refinancing agreements (Law 9,496 of 1997 basis) with 30-year repayments and real interest rates of 6 percent per year; agreements signed May 1997–October 1999 (states) and July 1999–May 2000 (municipalities).
  - Refinancing collateralized with participation fund resources; default would trigger suspension of transfers.
  - Fiscal Responsibility Law (FRL) in 2000 banned future refinancing of states’ debts.
- Revenue improvements:
  - ICMS revenue rose from 6.7 percent to 7.9 percent of GDP between 1998 and 2002.
  - Transfers to states and municipalities rose from 3.0 percent to 4.3 percent of GDP.
  - Revenues of states and municipalities rose by 2.5 percent of GDP during 1999–2002, explaining most improvement in their primary balance.
- Drivers: improved fiscal administration, legislative changes (e.g., “Kandir Law”), and political shifts toward fiscal discipline.

### Public Sector Enterprises
- Primary balance of public sector enterprises improved since 1999.
- Petrobras drove improvement due to higher international oil prices in 1999.
- 2001–2002 average aggregate primary surplus for federal enterprises, including Itaipu Binacional, was approximately 0.5 percent of GDP:
  - Petrobras surplus: 0.4 percent of GDP.
  - Itaipu: 0.2 percent of GDP.
  - Eletrobrás group primary deficit: 0.1 percent of GDP.
  - Other federal companies: virtually zero primary result.
- State and municipal enterprises’ primary balance shifted from a deficit of 0.5 percent of GDP in 1995 to a surplus of 0.3 percent of GDP during 2001–2002.

### Temporary Sources of Revenues
- Temporary revenues peaked at over 3 percent of GDP in 1999 and averaged 2.5 percent of GDP in 2000–2002.
- Time series (Total temporary revenues, percent of GDP): 1995: 0.5; 1996: 0.5; 1997: 1.4; 1998: 2.8; 1999: 3.2; 2000: 2.3; 2001: 2.3; 2002: 2.9.
- CPMF/IPMF and concessions significant contributors:
  - IPMF/CPMF: 1997: 0.8; 1998: 0.9; 1999: 0.8; 2000: 1.3; 2001: 1.5; 2002: 1.5.
  - Concessions (includes Telebras receipts): 1997: 0.2; 1998: 1.0; 1999: 0.9; 2000: 0.5; 2001: 0.4; 2002: 0.3.
  - Fiscal stability fund (FEF): 1995: 0.5; 1996: 0.5; 1997: 0.4; 1998: 0.3; 1999: 0.3; 2000: 0.0; 2001: 0.0; 2002: 0.0.
  - Collection of arrears: 1999: 0.2; 2000: 0.6; 2001: 0.1; 2002: 0.7.
- Policy implication: phasing out temporary revenues will require cuts in expenditure, phasing-down temporary revenues, and possibly transforming some temporary revenues into permanent ones.

### Public Debt Growth and Hidden Liabilities
- Public debt-to-GDP fell from 56 percent in 1984 to 30 percent in 1994; rose sharply 1994–1998 due to persistent deficits.
- Net public debt (percent of GDP) time series:
  - Total public debt: 1994: 30.0; 1995: 30.6; 1996: 33.3; 1997: 34.3; 1998: 41.7; 1999: 48.7; 2000: 48.8; 2001: 52.6; 2002: 55.5.
  - Federal government: 1994: 13.0; 1995: 13.3; 1996: 16.0; 1997: 18.6; 1998: 24.9; 1999: 29.8; 2000: 30.6; 2001: 32.7; 2002: 35.3.
  - Domestic public debt: 1994: 21.5; 1995: 25.1; 1996: 29.4; 1997: 30.0; 1998: 35.5; 1999: 38.4; 2000: 39.2; 2001: 42.2; 2002: 41.2.
  - Debt in U.S. dollars (percent of GDP): 1994: 9.5; 1995: 6.3; 1996: 5.9; 1997: 8.7; 1998: 13.5; 1999: 19.6; 2000: 19.6; 2001: 25.0; 2002: 28.9.
  - Debt in U.S. dollars (percent of total debt): 1994: 31.7; 1995: 20.6; 1996: 17.7; 1997: 25.4; 1998: 32.4; 1999: 40.2; 2000: 40.2; 2001: 47.5; 2002: 52.1.
- After 1999, total public debt increased despite primary adjustment due to devaluation impact on foreign and dollar-denominated domestic debt.
  - At devaluation, foreign-denominated public debt was 14 percent of GDP (30 percent of total public debt).
  - By end-2002, U.S. dollar–denominated debt reached 29 percent of GDP (50 percent of total public debt).
- Balance sheet adjustments (1996–2002):
  - Accumulated increase from recognition of old debts and exchange rate variations: 23 percent of GDP.
  - Privatization reduced debt by 4 percent of GDP.
  - Net effect: 19 percent of GDP increase in public sector debt; net effect between 1998 and 2002: 18 percent of GDP.

### Cardoso’s Fiscal Reforms
- Five major structural reforms: changes affecting states and municipalities; privatization; social welfare changes; financial system reform; revision of budget procedures.
- Measures for states/municipalities:
  - Privatization of state-owned banks; restrictions on budget-advance mechanisms; blocking misuse of judicial credits; refinancing of subnational debt with 30-year terms and ceilings; FRL (Complementary Law No. 101, May 4, 2000).
- Privatization:
  - Sales (e.g., telecommunications, Vale do Rio Doce) could have allowed public debt reduction but did not fully materialize due to borrowing needs.
  - Sale of loss-making enterprises reduced permanent fiscal pressure.
- Social security reforms:
  - 1998 Constitutional Amendment introduced minimum retirement age and progressive increases; new hires under general regime without special privileges.
  - Social welfare factor: “average salary” = real average of 80 percent of highest contributing salaries since June 1994; welfare factor between 0.70 and 1.75.
  - Example: a 53-year-old man who began work at 18 could retire on 35 years of contributions with a discount of 30 percent relative to the average of the 80 percent of highest contributing salaries.
  - Reform contained social security deficit, though minimum salary increases in 2001–2002 raised social security outlays by 0.7 percent of GDP between 2000 and 2002.
- Financial system reforms:
  - Proer (Resolution 2,208 of November 3, 1995) intervened in troubled banks and increased government assets with assisted banks; generated a loss about 1 percent of GDP due to mismatch between liabilities and assets.
- Budget procedure revisions:
  - FRL changed LDO process: LDO must include federal primary target for OGU and targets for following two years, creating embryonic medium-term framework.

### The Authorities’ New Fiscal Attitude
- Prior to 1998 authorities showed weaker rigor; spending under direct control expanded during first Cardoso administration.
- 1998–99 crisis (foreign currency reserve outflow US$1 billion per day) strengthened case for austerity and tighter fiscal policies.
- President Cardoso supported higher taxes and spending cuts as conditions for IMF support.
- Some argue the change was in financing concern rather than attitude; reforms during 1995–98 were important but short-term fiscal flows were relaxed by a benign external environment.

### Challenges ahead and Policy Recommendations
- Two main challenges to preserve adjustment:
  - Offset gradual phasing out of temporary revenues (examples: CPMF, Petrobras windfalls).
  - Cut public expenditure across all budget components and reduce committed revenues for nondiscretionary expenses.
- Institutional recommendations:
  - Embed austere fiscal attitude permanently into fiscal institutions.
  - Consider a “Fiscal Solvency Law” to establish medium-term rules (e.g., ceiling on borrowing requirements or floor on primary surplus).
  - Success depends on policymakers valuing fiscal sustainability as necessary for growth and lower interest rates.

### Institutional improvements in fiscal data and monitoring (since 1995)
- Improvements:
  - 1995: breakdown of public sector enterprises’ results into federal, state and municipal companies.
  - 1996: monthly fiscal statistics published regularly in Central Bank Press Notes.
  - 1997: incorporation of social security data into National Treasury, producing consolidated federal statistics.
  - 1998: breakdown of balances for states and municipalities.
  - August 2000: reduction in lag between end of month and release of official fiscal data by the Central Bank to 25 days.
- Effect: capacity to identify causes of fiscal deterioration with a lag of less than a month.

### Public debt sustainability testing (appendix summary)
- Method: ADF unit-root tests on discounted public debt (Wilcox (1989), Luporini (2000) approach).
- Main conclusion: hypothesis of a unit root is not rejected for all sample periods — fiscal policy was not tight enough to make public debt sustainable during January 1999–December 2002.
- Appendix Table 1 (selected ADF results):
  - Jan 1995–Dec 2002: ADF test stat.: 0.176510; Null of unit root: Not rejected at 10 percent level.
  - Jan 1995–Dec 1998: ADF test stat.: -3.048911; Null: Not rejected at 10 percent level.
  - Jan 1999–Dec 2002: ADF test stat.: -1.880546; Null: Not rejected at 10 percent level.
  - Test critical values (Jan 1995–Dec 2002): 1%: -4.045236; 5%: -3.451959; 10%: -3.151440.
  - Number of lags: 626; Number of observations: 964 (Jan 1995–Dec 2002), 484 (Jan 1995–Dec 1998), 480 (Jan 1999–Dec 2002).

### Additional quantitative and contextual notes
- Acceptable growth context suggested: with economic growth of 4–4.5 percent per year, public spending can rise in absolute terms while expenditure-to-GDP may fall if expenses grow slower than GDP.
- Political timing:
  - President Cardoso’s pre-election speech (10 days before 1998 elections) emphasized ensuring “that the state lives within its means,” and generating primary surpluses to prevent public sector debt from growing faster than GDP.
- Empirical charts referenced (figures not reproduced here): Fig. 1 and Fig. 2 on Net Total Public Debt (Jan-95 to Jul-02).

*Source: IMF staff analysis as presented in the chapter "1. Interest Payments and Real Interest Rate" from the supplied PDF content.*

### 1. Interest Payments and Real Interest Rate.......................................................................9

### 1. Interest Payments and Real Interest Rate

### Introduction
- Under the Collor Plan (1990), Brazil’s public sector primary balance recorded a surplus of 2.9 percent during 1991–94.
- Under the Real Plan (June 1994), the public sector primary balance averaged a deficit of -0.2 percent of GDP during 1995–98.
- Following the 1998 external and fiscal crisis and a Stand-By Arrangement with the IMF (1999–2001, extended to end-2002), the public sector recorded an average primary surplus of 3.5 percent of GDP during 1999–2002.
- The authorities’ shift to operating under a floor for the consolidated primary surplus during Cardoso’s second term represented a major institutional change in the management of Brazilian public finances.
- The initial official primary surplus target for 2002 of 2.7 percent of GDP was raised by 1.2 percent of GDP to 3.9 percent of GDP because of higher projected interest payments after interest rate increases in 2001–2002.

### Overview of Public Sector Borrowing Requirements (PSBR), 1995–2002
- Fiscal performance divides into two sub-periods: 1995–98 (deterioration) and 1999–2002 (adjustment).
- Atypical features of 1994 complicate comparisons: the primary surplus in 1994 was 5.2 percent of GDP, higher than preceding years, reflecting the end of inflationary erosion and a short-term economic boom.
- Four major aggregate facts highlighted:
  - Federal government nominal deficit progressively deteriorated until 1998, partly due to assumed state debts and differential impact of tight monetary policy.
  - All three levels of government showed similar deterioration of the primary balance in 1995–98, followed by marked improvement in 1999–2002.
  - Interest payments averaged 7.2 percent of GDP throughout 1995–2002, contributing substantially to the high average nominal deficit of 5.5 percent of GDP during the same period.
  - The emergence of a “balance sheet adjustment” variable in fiscal accounts (beginning in 1995–98) produced below-the-line changes that modified the public sector debt stock.
- The balance sheet adjustment and related effects generated an accumulated change in the public sector debt of 19 percentage points of GDP between 1994 and 2002.

Key statistics from the overview (preserve numeric values exactly as in the source):
- Primary balance: 5.2 in 1994; 0.3 in 1995–98 (average -0.2 reported elsewhere); 3.5 in 1999–2002.
- Interest payments: averaged 7.2 percent of GDP during 1995–2002.
- Nominal deficit (average): 5.5 percent of GDP during 1995–2002.
- Accumulated change in public sector debt due to balance sheet adjustment: 19 percentage points of GDP between 1994 and 2002.

### Interest Payments and Real Interest Rate
- High real interest burden despite relatively small public debt in the early Real Plan years because of:
  - Elevated real interest rates reflecting risk and need to attract external financing after the Asian and Russian crises.
  - SELIC gross real interest rate (using IPCA deflator) averaged 22 percent during 1995–98.
  - SELIC gross real interest rate averaged 10 percent during 1999–2002.
- Lower real rates after 1999 applied to a much higher public sector debt and, combined with exchange rate effects, resulted in continued large interest payments.
- Figure summary (textual):
  - Interest payments (left scale) and Real rate of interest (SELIC, right scale) show interest payments in percent of GDP and real interest rate in percent a year for 1995–2002.

### Sources of Fiscal Adjustment (focus on primary balance)
- Interest payments did not account for the nominal deficit decline because they remained high throughout 1995–2002.
- Federal-level adjustment was driven by a significant increase in fiscal tax revenues while federal non-financial expenditure grew continuously.
- States and municipal levels improved gradually after 1997 due to maturation and institutional changes.
- Public sector enterprises’ primary balances improved since 1999, largely due to state oil company results (Petrobras).

Federal government specifics and trends (preserve numeric values exactly):
- Total federal revenues rose from under 19 percent of GDP in 1994 to over 24 percent of GDP in 2002.
- Gross federal government revenues increased from an average of 16.5 percent of GDP in 1991–94 to 22.6 percent of GDP in 1999–2002.
- At the same time, federal government non-financial expenditure grew considerably; all major categories contributed to expenditure growth.
- The fiscal adjustment in 1999–2002 was achieved principally through increased revenues, while federal primary public expenditure rose in real terms during the eight years of the two administrations.

### Policy-relevant messages and institutional implications
- The principal cause of the fiscal deterioration in the first Cardoso administration (1995–98) was deterioration in the primary balance rather than rising interest payments.
- The fiscal adjustment in the second Cardoso administration (1999–2002) was driven by revenue increases rather than cuts in federal non-financial expenditure.
- Key to achieving fiscal sustainability is embedding the authorities’ austere fiscal attitude permanently into fiscal institutions.

*Source: IMF staff analysis as presented in the chapter "1. Interest Payments and Real Interest Rate" from the supplied PDF content.*

### 1.5 percentage points of GDP. In addition, transfers to states and municipalities grew

### _wp04156 - 1.5 percentage points of GDP. In addition, transfers to states and municipalities grew

### Federal primary balance and fiscal aggregates
- Total revenues (1994–2002 annual series): 18.9, 18.3, 17.5, 18.4, 20.1, 21.7, 21.5, 22.7, 24.4 (In percent of GDP).
- Transfers to states and municipalities (1994–2002): 2.6, 2.8, 2.7, 2.8, 3.0, 3.6, 3.7, 3.9, 4.3 (In percent of GDP).
- Net revenues (1994–2002): 16.4, 15.5, 14.7, 15.6, 17.2, 18.1, 17.8, 18.8, 20.1 (In percent of GDP).
- Non-financial expenditures (1994–2002): 13.9, 14.8, 14.5, 15.4, 16.6, 16.0, 15.9, 17.1, 17.9 (In percent of GDP).
- Payroll expenses (1994–2002): 5.1, 5.6, 5.2, 4.8, 5.0, 5.1, 5.0, 5.4, 5.6 (In percent of GDP).
- Social security benefits (1994–2002): 4.8, 5.0, 5.3, 5.4, 5.8, 6.0, 6.0, 6.3, 6.7 (In percent of GDP).
- Other costs and capital expenses (OCC) (1994–2002): 4.0, 4.2, 4.0, 5.3, 5.7, 4.9, 4.9, 5.4, 5.6 (In percent of GDP).
- Statistical discrepancy (1994–2002): 0.8, -0.1, 0.2, -0.5, 0.0, 0.2, -0.1, 0.1, 0.2 (A positive figure indicates an increase in the primary balance surplus).
- Primary balance (1994–2002): 3.3, 0.5, 0.4, -0.3, 0.6, 2.3, 1.9, 1.8, 2.4 (In percent of GDP, surplus "+").
- Federal gov. and central bank primary balance (1994–2002): 3.1, 0.5, 0.5, 0.0, 1.4, 3.3, 2.8, 2.9, 3.7 (In percent of GDP).
- Social security primary balance (1994–2002): 0.2, 0.0, -0.1, -0.3, -0.8, -1.0, -0.9, -1.1, -1.3 (In percent of GDP).

### Period averages (1991–2002) — Federal primary balance
- Total revenues (1991-94, 1995-98, 1999-2002): 16.5, 18.6, 22.6 (In percent of GDP).
- Transfers to states and municipalities (period averages): 2.7, 2.8, 3.9 (In percent of GDP).
- Net revenues: 13.8, 15.8, 18.7 (In percent of GDP).
- Non-financial expenditures: 12.4, 15.3, 16.7 (In percent of GDP).
- Personnel: 4.4, 5.2, 5.3 (In percent of GDP).
- Social security benefits: 4.4, 5.4, 6.3 (In percent of GDP).
- Other costs and capital expenses (OCC) 1/: 3.7, 4.8, 5.2 (In percent of GDP).
- Statistical discrepancy 2/: 0.2, -0.1, 0.1 (In percent of GDP).
- Primary balance (period averages): 1.6, 0.3, 2.1 (In percent of GDP).
- Federal gov. and central bank (period averages): 1.0, 0.6, 3.2 (In percent of GDP).
- Social security (period averages): 0.6, -0.3, -1.1 (In percent of GDP).
- Note: 1/ Includes central bank's primary balance. 2/ A positive figure indicates an increase in the primary balance surplus.

### Federal revenues — composition and changes
- Total federal revenues (period averages, percent of GDP): 11.9 (1991-94), 13.2 (1995-98), 16.6 (1999-2002).
- Select revenue items (period averages, percent of GDP):
  - Import tax: 0.4, 0.7, 0.7
  - Industrial Products Tax (IPI): 2.3, 2.0, 1.6
  - Income tax total: 3.7, 4.5, 5.6
    - Individuals: 0.2, 0.3, 0.3
    - Corporations: 1.1, 1.5, 1.7
    - Labor: 1.3, 1.5, 1.7
  - Capital yields: 0.7, 0.8, 1.2
  - Financial Transaction Tax (IPMF/CPMF): 0.3, 0.4, 1.3
  - Tax on Financial Operations (IOF): 0.7, 0.4, 0.3
  - Social Security Financing Contribution (Cofins): 1.5, 2.2, 3.7
  - Social Integration Program Contribution (PIS/PASEP): 1.1, 0.9, 1.0
  - Contribution on net profits: 0.7, 0.9, 0.8
  - Civil service social security contribution: 0.1, 0.3, 0.3
  - Other: 1.2, 0.9, 1.3
- Memorandum item:
  - Tax burden: 25.7, 28.8, 32.8 (In percent of GDP).
  - State Value Added Tax (ICMS): 6.7, 7.0, 7.6 (In percent of GDP).
- Observations:
  - The Provisional Contribution on Financial Transactions (CPMF/IPMF) and the Social Security Financing Contribution (Cofins) together explain about two thirds of the revenue change between 1991–94 and 1999–2002.
  - Gross revenue jumped by 1.6 percent of GDP in 1999 versus 1998, with 1.3 percent of GDP attributable to Cofins.
  - IPI revenues declined continuously over the period.

### Payroll expenses and retirees
- Federal government payroll expenses rose in nominal terms from R$18.5 billion in 1995 to R$33.2 billion in 2001.
- Structure of payroll (1995 vs 2002, percent of total payroll):
  - Total: 100, 100; Real growth (deflated) 2.3
  - Active duty: 55, 52; Real growth 2.1
  - Retirees: 45, 48; Real growth 2.5
  - Civilian (active/retiree split): 75, 71; Active 44, 42; Retirees 31, 29; Real growth for civilians 1.5
  - Military (active/retiree split): 25, 29; Active 12, 12; Retirees 13, 17; Real growth for military 4.5
- GDP growth (memorandum): 2.1 (Year average).
- Key drivers and facts:
  - Despite salary ‘freezes’, payroll rose because of career revisions, promotions, and adjustments to salary curves.
  - Spending on retired military personnel increased markedly due to generous pension rules and allowances (e.g., allowances to unmarried daughters).
  - Military allowances represented 45 percent of expenditure on retired military personnel in August 2000, versus 32 percent for civilian pensions (Central Bank of Brazil (2000)).
  - Spending on retired military personnel as a share of total federal retired employees rose from 30 percent in 1995 to 37 percent in 2002.
  - Federal payroll expenditure growth was mainly associated with retirees and pensioners.

### Social security benefits — indexation, composition, and growth
- Determinants of social security expenditure growth:
  - a) adjustment in pensions benefits by more than inflation;
  - b) faster growth in more expensive pension benefits; and
  - c) increase in the number of beneficiaries.
- Social security benefit index: Base June 1994 = 100; index rose over time until 1998, contained in 1999, resumed growth in 2000–2001 due to real increases in minimum salary.
- Per-capita social security benefits (as of December 2002, percent of minimum legal wage):
  - Total benefits: 164
  - Social security: 172
  - Pension: 187
  - Old age: 113
  - Urban: 150
  - Rural: 100
  - Length-of-service: 360
  - Disability: 135
  - Allowances: 130
  - Other: 224
  - Aid support: 114
- Social security benefits growth (annual average, percent):
  - Total benefits: 4.2 (1994-1998), 3.5 (1998-2002)
  - Social security: 3.7, 3.4
  - Pension: 4.1, 2.9
  - Old age: 1.9, 3.4
  - Urban: 4.9, 2.6
  - Rural: 0.9, 3.7
  - Length-of-service: 11.5, 2.2
  - Disability: 1.0, 2.5
  - Allowances: 3.8, 3.0
  - Other: -3.0, 12.6
  - Aid support: 7.3, 4.5
- Observations:
  - Length-of-service pension benefits were particularly expensive and grew rapidly (11.5 percent a year in 1995–98).
  - Welfare reform reduced applications for retirement and altered recent trends.
  - Number of beneficiaries grew faster than GDP, increasing social security expenditure-to-GDP ratio; assistance component (minimum-salary beneficiaries without prior contributions) contributed to this.

### Other costs and capital expenses (OCC) — rigidity and composition
- OCC increase was not solely due to the ‘Inverse Tanzi effect’; major OCC increases occurred after 1996.
- OCC series (percent of GDP and share of OCC that was nondiscretionary):
  - 1999: 1.0 percent of GDP; nondiscretionary share 20 percent.
  - 2000: 2.6 percent of GDP; nondiscretionary share 52 percent.
  - 2001: 2.9 percent of GDP; nondiscretionary share 54 percent.
  - 2002: 3.3 percent of GDP; nondiscretionary share 62 percent.
- Budget 2002 composition of OCC (in percent of total):
  - Health: 28%
  - Employment-insurance: 8%
  - Fund for Fighting Poverty: 7%
  - Other obligatory expenses: 14%
  - Noncommitted expenditure: 43%
- Principal nondiscretionary OCC items:
  - Health spending set as a fixed percentage of GDP by constitutional provision established in 2000.
  - Fund for Fighting Poverty set as a real value by constitutional provision established in 2000 (implemented months after approval; full effect in 2002).
- Consequences:
  - Nondiscretionary commitments limit day-to-day fiscal management and made OCC expenditures increasingly rigid.
  - Nondiscretionary OCC share rose from 20 percent in 1999 to 60 percent in 2002.

### Real growth of non-financial expenditure (averages)
- Non-financial expenditure real growth (1994-1998, 1998-2002, 1994-2002):
  - Non-financial expenditure: 7.0, 4.6, 5.8 (Average percent).
  - Payroll expenses: 2.0, 4.2, 3.1 (Average percent).
  - Social security benefits: 7.4, 5.0, 6.2 (Average percent).
  - Transfers to states and municipalities: 6.6, 11.0, 8.8 (Average percent).
  - Other costs and capital expenditure 2/: 12.3, 0.7, 6.3 (Average percent).
- Memorandum item:
  - GDP growth (implicit deflator): 2.6, 2.1, 2.1 (Average percent).
- Note: 2/ Includes central bank's primary balance.
- Aggregate: Overall non-financial expenditure, including transfers to states and municipalities and the Central Bank deficit, grew by 7.0 percent a year in real terms during the first Cardoso administration and by 4.6 percent a year during the second.

### States and municipalities — fiscal evolution and reforms
- States and municipalities primary balance (1994–2002, percent of GDP, surplus "+"):
  - Total balance: 0.8, -0.2, -0.5, -0.7, -0.2, 0.2, 0.5, 0.9, 0.8
  - States: (series shows deterioration then improvement) -0.4, 0.2, 0.4, 0.6, 0.6 (selected latter years)
  - Municipalities: 0.2, 0.1, 0.1, 0.3, 0.2 (selected latter years)
- Institutional measures and outcomes:
  - Bilateral refinancing agreements (Law 9,496 of 1997 basis) between federal government and states/municipalities established monthly repayments over 30 years and real interest rates of 6 percent per year; agreements signed May 1997–October 1999 for states and July 1999–May 2000 for municipalities.
  - Refinancing collateralized with resources from participation funds; default would trigger suspension of transfers.
  - Fiscal Responsibility Law (FRL) in 2000 banned future refinancing of states’ debts, introducing market discipline and limiting new loans to states and municipalities.
  - Bilateral agreements and FRL prompted states to generate primary surpluses to meet debt obligations.
- Revenue improvements for subnational governments:
  - ICMS revenue rose from 6.7 percent to 7.9 percent of GDP between 1998 and 2002.
  - Transfers to states and municipalities rose from 3.0 percent to 4.3 percent of GDP.
  - Revenues of states and municipalities rose by 2.5 percent of GDP during 1999–2002, explaining most of the improvement in their primary balance.
- Contextual factors:
  - Improved fiscal administration by governors elected in 1998.
  - Changes to legislation (notably the “Kandir Law”) and compensation arrangements raised transfers.
  - Change in political attitudes toward fiscal discipline contributed to improvements in state and municipal finances.

*Source: Secretary of Economic Policy, Ministry of Finance; Social Security; Central Bank of Brazil; Ministry of Planning; IPEA; authors' estimates.*

### 1.6 percent of GDP.

### _wp04156 - 1.6 percent of GDP.

### Public Sector Enterprises
- Primary balance of public sector enterprises improved since 1999 (Table 12).
- Improvement in federal enterprises’ primary balance mainly due to Petrobras benefiting from the increase in international oil prices in 1999.
- Petrobras’s balance improved substantially because pass through of international market prices affected only part of Petrobras’s costs (most oil products sold derive from domestic production).
- Petrobras improvement created margin for increased investments by public sector enterprises without affecting the PSBR.
- 2001–2002 average aggregate primary surplus for federal enterprises, including Itaipu Binacional, was approximately 0.5 percent of GDP.
  - Break down: surplus of 0.4 percent of GDP for Petrobras; 0.2 percent of GDP for Itaipu; primary deficit of 0.1 percent for the Eletrobrás group.
  - Other federal companies generated a virtually zero primary result.
- State and municipal enterprises’ primary balance shifted from a deficit of 0.5 percent of GDP in 1995 to a surplus of 0.3 percent of GDP during 2001–2002.
- Drivers of state and municipal improvement:
  - Change in fiscal attitude by state and municipal authorities.
  - Privatization of loss-making enterprises.
  - Appointment of managers committed to efficiency and stricter performance demands.

### Temporary Sources of Revenues
- Temporary revenues contributed significantly to the fiscal adjustment after 1999.
- Extraordinary revenues peaked at over 3 percent of GDP in 1999, and averaged 2.5 percent of GDP in 2000–2002 (Table 13).
- Temporary revenues comprised strictly temporary measures or revenues that would tend to disappear absent legislative changes.
- Examples and magnitudes (In percent of GDP, Table 13):
  - Total: 1995: 0.5; 1996: 0.5; 1997: 1.4; 1998: 2.8; 1999: 3.2; 2000: 2.3; 2001: 2.3; 2002: 2.9.
  - Financial Transaction Tax (IPMF/CPMF): 1997: 0.8; 1998: 0.9; 1999: 0.8; 2000: 1.3; 2001: 1.5; 2002: 1.5.
  - Concessions (includes Telebras privatization receipts): 1997: 0.2; 1998: 1.0; 1999: 0.9; 2000: 0.5; 2001: 0.4; 2002: 0.3.
  - Fiscal stability fund (FEF): 1995: 0.5; 1996: 0.5; 1997: 0.4; 1998: 0.3; 1999: 0.3; 2000: 0.0; 2001: 0.0; 2002: 0.0.
  - Collection of arrears: 1999: 0.2; 2000: 0.6; 2001: 0.1; 2002: 0.7.
- Policy implications noted:
  - Making up for gradual loss of temporary revenues will require a combination of cuts in expenditure, phasing out temporary revenues at declining rates, and possibly transforming some temporary revenues into permanent ones (example: possible definitive adoption of a 2.5 percentage point surcharge on income tax for higher salary brackets).
- Historical context of temporary measures:
  - IPMF approved end-1993, abolished 1994; reintroduced as CPMF in 1997 and extended.
  - FSE created in 1994, renewed and renamed FEF, abolished in December 1999.
  - Telebras privatization receipts counted as tax revenues for public sector deficit purposes.

### Public Debt Growth and Hidden Liabilities
- Public debt-to-GDP ratio, including the monetary base, fell from 56 percent in 1984 to 30 percent in 1994, driven by high seigniorage, low operational deficits in early 1990s, correction of debt’s face value by less than inflation, and accumulated economic growth of 32 percent over 1985–94.
- Between 1994 and 1998, public debt-to-GDP rose sharply mainly due to persistent public deficits; by end-1998 financing mechanisms were exhausted.
- Table 14 highlights (Net public debt, In percent of GDP):
  - Total public debt: 1994: 30.0; 1995: 30.6; 1996: 33.3; 1997: 34.3; 1998: 41.7; 1999: 48.7; 2000: 48.8; 2001: 52.6; 2002: 55.5.
  - Federal government: 1994: 13.0; 1995: 13.3; 1996: 16.0; 1997: 18.6; 1998: 24.9; 1999: 29.8; 2000: 30.6; 2001: 32.7; 2002: 35.3.
  - Domestic public debt: 1994: 21.5; 1995: 25.1; 1996: 29.4; 1997: 30.0; 1998: 35.5; 1999: 38.4; 2000: 39.2; 2001: 42.2; 2002: 41.2.
  - Debt in U.S. dollars (percent of GDP): 1994: 9.5; 1995: 6.3; 1996: 5.9; 1997: 8.7; 1998: 13.5; 1999: 19.6; 2000: 19.6; 2001: 25.0; 2002: 28.9.
  - Debt in U.S. dollars (percent of total debt): 1994: 31.7; 1995: 20.6; 1996: 17.7; 1997: 25.4; 1998: 32.4; 1999: 40.2; 2000: 40.2; 2001: 47.5; 2002: 52.1.
- After 1999, total public debt increased despite primary balance adjustment due to devaluation impact on foreign public debt and domestic public debt denominated in U.S. dollars.
  - At time of devaluation public debt denominated in U.S. dollars was 14 percent of GDP (30 percent of total public debt).
  - By end-2002, U.S. dollar–denominated debt reached 29 percent of GDP (50 percent of total public debt).
- Balance sheet adjustments were central to debt evolution since mid-1990s, arising from:
  - Recognition of previously unrecorded old debts (“skeletons”).
  - Variations in value of debt due to exchange rate fluctuations.
  - Privatization receipts used to reduce public sector debt.
- Aggregate effect 1996–2002:
  - Accumulated increase from the first two factors: 23 percent of GDP.
  - Privatization reduced debt by 4 percent of GDP.
  - Net effect: 19 percent of GDP increase in public sector debt; net effect between 1998 and 2002: 18 percent of GDP.
- Note on balance sheet/exchange rate channel: exchange rate has a double impact—foreign public debt increases and dollar-denominated domestic debt appreciates in local currency—particularly strong in 1999, 2001 and 2002.

### Cardoso’s Fiscal Reforms
- Five important structural reforms carried out during the Cardoso administrations:
  - Changes affecting states and municipalities.
  - Privatization.
  - Changes affecting social welfare.
  - Reform of the financial system.
  - Revision of budget procedures.
- States and municipalities reforms and measures:
  - Privatization of majority of banks owned by state governments, closing a financing window for state treasuries.
  - Rigid restrictions on advancing budgetary resources (mechanisms for borrowing from financial institutions).
  - Blocking of mechanisms for issuing judicial credits (precatórios) that had been misused.
  - Refinancing of state and municipal debts via federalization of debt securities, repayment over 30 years subject to ceiling of 30 percent of revenues in most cases, with penalties including withholding transfers or appropriating part of ICMS revenues.
  - Fiscal Responsibility Law (FRL) (Complementary Law No. 101, May 4, 2000) introduced:
    - Defined sub-ceilings for payroll expenses.
    - Defined sub-ceilings for payroll by branch of government (executive, legislature, judiciary).
    - Fixed strict limits on official actions, including certain restrictions in election years.
    - Promoted transparency rules for reporting public sector accounts.
    - Prohibited new refinancing of sub-national debt by federal authorities.
- Privatization effects:
  - Sale of telecommunications companies and Vale do Rio Doce could have permitted significant reduction in public sector debt (practically did not materialize due to ongoing high borrowing needs).
  - Privatization removed potential pressure on public sector spending associated with high levels of public enterprise investments.
  - Sale of loss-making enterprises reduced permanent sources of fiscal pressure.
- Social security reforms:
  - Constitutional Amendment to social security scheme in 1998 allowed:
    - Introduction of a minimum retirement age for public sector employees and progressive increase in retirement age for those with shorter service.
    - Hiring of new public employees under general social security regime without public-employee pension privileges and setting up complementary pension funds for new employees.
  - General social security regime reform removed constitutionally fixed formula for calculating retirement benefits; enacted the ‘social welfare factor’ law during 1999–2002:
    - “Average salary” equals real average of 80 percent of all highest contributing salaries earned since June 1994.
    - “Welfare factor” between 0.70 and 1.75; less than unity for early retirement, increases with retirement age and time of contribution.
  - Example: a 53-year-old man who began work at 18 could retire on 35 years of contributions with a discount of 30 percent relative to the average of the 80 percent of highest contributing salaries; discount diminishes if retirement is delayed.
  - Reform helped contain social security deficit; note that social security deficit was contained in 2000 but rose as proportion of GDP in 2001 and 2002 due to large adjustments in the minimum salary, which increased social security expenditure by 0.7 percent of GDP between 2000 and 2002.
- Financial system reforms:
  - Approval of Program for the Restructuring and Strengthening of the National Financial System (Proer).
  - Privatization of various state banks (sometimes after federalization).
  - Greater opening to foreign capital, increasing competition.
  - Central Bank required banks to adopt more rigid credit-granting criteria.
  - Proer (Resolution 2,208 of November 3, 1995) provided legal instruments to intervene in troubled banks and increased government assets in form of credits with assisted banks, financed by increasing public sector debt; generated a loss about 1 percent of GDP due to mismatch between liabilities and additional assets.
- Revision of budget procedures:
  - FRL changed the Law of Budget Guidelines (LDO) process: LDO must include federal government’s primary result target for the OGU and targets for the following two years, creating an embryonic medium-term budget framework to limit total expenditure and constrain additional expenditures to available resources.

### The Authorities’ New Fiscal Attitude
- Prior to 1998 authorities displayed less rigor in controlling public sector accounts; spending amenable to direct control expanded vigorously during the first Cardoso administration.
- Brazil experienced a situation of “weak budgetary restriction” with tendencies toward adjustment via higher inflation (if monetary policy accommodative) or higher public sector debt (if monetary policy rigid).
- The 1998–99 crisis changed the stance, allowing advocates of tighter fiscal policy to implement fiscal adjustment.
  - Fiscal adjustment was imposed by circumstances to avoid internal debt moratorium.
  - President Cardoso supported higher taxes and spending cuts as conditions for IMF support and led negotiations with Congress for approval.
- Qualification: some argue the change was greater concern with financing public expenditure adequately rather than an attitude shift; reforms during 1995–98 (including constitutional amendments) were important and may have led to a temporary relaxation in short-term fiscal flows financed by a benign external environment.

*Source: _wp04156 - 1.6 percent of GDP.*

### 2000. Some critics argued that it was ‘easier’ to make adjustments by boosting revenues than

### _wp04156 - 2000. Some critics argued that it was ‘easier’ to make adjustments by boosting revenues than

### Context and background
- Debate during the first Cardoso administration polarized between:
  - Opponents of “structural reforms” (welfare reform, privatization of public enterprises).
  - Proponents who argued fiscal imbalance was due to failure to approve reforms quickly enough.
- Both positions are judged incorrect in the source:
  - Rejection of reforms ignored structural weaknesses: state-owned banks financing treasuries, loss-making public enterprises, early retirement and generous benefits, benefits to high-income groups without actuarial justification, dual social welfare regime creating privileges for some public sector employees.
  - Attributing all fiscal problems to missing reforms ignored that main pressures on public accounts during 1995–1998 could have been controlled but were not fully addressed.

### Fiscal dynamics and empirical findings (1994–2002)
- Primary expenditure under greater federal control (excluding transfers to states and municipalities, payroll and welfare benefits):
  - Real cumulative increase of 59 percent over 1995–98.
  - GDP growth over same period: 11 percent.
  - Resulted in increase in primary expenditure of 1.7 percent of GDP in the same period.
- Social welfare benefit index, June 1994 to July 1998:
  - Accumulated change: 99 percent.
  - Accumulated inflation (IPCA) for the period: 71 percent.
  - Real increase (superindexation): 16 percent.
  - Expenditure impact: approximately 0.8 percentage points of GDP.
- States and municipalities:
  - States and municipalities’ primary balance deteriorated by 1.3 percent of GDP between 1994 and 1996.
  - Good fiscal performance from 1999 partly due to structural measures approved earlier and reinforced by the FRL.
- Public sector debt and credibility:
  - Public sector debt rose from 30 percent to 42 percent of GDP between 1994 and 1998.
  - Public sector debt reported as over 50 percent of GDP (context: credibility concerns through to 1994 and primary balance deterioration 1994–98).
- External crisis 1998–99:
  - Outflow of foreign currency reserves reached US$1 billion per day.
  - Crisis strengthened case for austerity and tighter fiscal policies.
- Real terms spending behavior:
  - Adjustment after 1998 was based on increased revenues; overall public sector spending was not reduced in real terms.
  - Primary expenditure by the federal government (including transfers and small Central Bank deficit) increased in real terms every year of the eight-year Cardoso administration.

### Challenges ahead and policy recommendations
- Preserve and improve fiscal adjustment achieved after 1999; two main challenges:
  - Offset gradual phasing out of temporary revenues (examples cited in text: CPMF and Petrobras’s additional earnings due to fuel price increases):
    - Options include transforming part of these temporary revenues into permanent revenues.
  - Cut public expenditure across all components of the budget.
  - Reduce the degree of committed revenues for nondiscretionary expenses to give authorities more short-run adjustment room.
- Institutional recommendations:
  - Embed austere fiscal attitude permanently into fiscal institutions.
  - Possible complementary measure to the Fiscal Responsibility Law (LRF):
    - Introduce a “Fiscal Solvency Law” to establish clear and permanent rules to ensure public debt sustainability over the medium term, for example by defining a ceiling on borrowing requirements or a floor on the primary surplus.
    - Purpose: address fiscal consequences of political fragmentation and pressures for more social spending; improve trade-off between fiscal adjustment and economic growth by strengthening credibility and allowing lower interest rates.
  - Caveat: success of legal reform depends on policymakers’ and politicians’ understanding that fiscal sustainability is a valuable public good and necessary for economic growth.

### Institutional improvements in fiscal data and monitoring (since 1995)
- Five noted improvements:
  - From 1995: breakdown of public sector enterprises’ results into federal, state and municipal companies.
  - From 1996: publication of monthly fiscal statistics regularly in Central Bank Press Notes.
  - From 1997: incorporation of social security data into the National Treasury, producing consolidated federal government statistics by “above the line” criteria, published monthly in National Treasury Press Notes.
  - From 1998: breakdown of balances for states and municipalities.
  - From August 2000: reduction in lag between end of month and release of official fiscal data by the Central Bank to only 25 days.
- Effect: capacity to know causes of fiscal deterioration with a lag of less than a month and respond more rapidly than in the past.

### Public debt sustainability testing (Appendix summary)
- Methodology:
  - Test follows Wilcox (1989) and Luporini (2000): test for stationarity (unit roots) of discounted public debt using Augmented Dickey-Fuller (ADF) tests.
  - Data: monthly consolidated net public debt at par value, nominal debt divided by general price index (IGP). Real discount factors = SELIC interest rate divided by IGP.
- Main conclusion:
  - The hypothesis of a unit root is not rejected for all sample periods: fiscal policy was not tight enough to make public debt sustainable during January 1999–December 2002.
- Appendix Table 1 (testing for stationarity of the discounted net public debt):
  - Sample period: Jan 1995–Dec. 2002
    - Null Hypothesis of unit root: Not ejected at 10 percent level
    - Augmented Dickey-Fuller test stat.: 0.176510
    - (Probability): (-0.9976)
  - Sample period: Jan. 1995–Dec. 1998
    - Null Hypothesis of unit root: Not ejected at 10 percent level
    - Augmented Dickey-Fuller test stat.: -3.048911
    - (Probability): (0.1281)
  - Sample period: Jan 1999–Dec. 2002
    - Null Hypothesis of unit root: Not ejected at 10 percent level
    - Augmented Dickey-Fuller test stat.: -1.880546
    - (Probability): (0.6522)
  - Test critical values:
    - 1 percent level: -4.045236 (Jan 1995–Dec 2002), -4.118444 (other subperiods)
    - 5 percent level: -3.451959 (Jan 1995–Dec 2002), -3.486509 (other subperiods)
    - 10 percent level: -3.151440 (Jan 1995–Dec 2002), -3.171541 (other subperiods)
  - Number of lags: 626
  - Number of observations: 964 (Jan 1995–Dec 2002), 484 (Jan 1995–Dec 1998), 480 (Jan 1999–Dec 2002)

### Additional quantitative and contextual notes
- Suggested acceptable growth context: in the presence of economic growth of 4–4.5 percent per year, public spending can rise in absolute terms while the ratio of expenditure to GDP may fall if expenses grow at a lower rate than GDP expansion.
- Timing and political economy:
  - President Cardoso’s pre-election (10 days before 1998 elections) speech emphasized ensuring “that the state lives within its means,” and generating primary surpluses to prevent public sector debt from growing faster than GDP.
  - The crisis created political conditions favoring austerity and legal measures to address structural fiscal imbalances.
- Empirical charts referenced (figures not reproduced here):
  - Fig. 1: Brazil: Net Total Public Debt (In percentage of GDP), Jan-95 to Jul-02 (Central Bank of Brazil).
  - Fig. 2: Brazil: Net Total Public Debt (In millions of Reais of December 2002), Jan-95 to Jul-02 (Public debt and Discounted public debt; Central Bank of Brazil).

*Source: _wp04156 - 2000. Some critics argued that it was ‘easier’ to make adjustments by boosting revenues than*

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