Brazil and the IMF

Press Release: IMF Approves US$15.58 Billion Stand-By Credit for Brazil

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Brazil—Letter of Intent

Brasília, August 23, 2001

The following item is a Letter of Intent of the government of Brazil, which describes the policies that Brazil intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Brazil, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Mr. Horst Köhler
Managing Director
International Monetary Fund

Dear Mr. Köhler:

The attached memorandum describes the economic policies and objectives of the Government of Brazil for the remainder of 2001 and for 2002, in support of which the Government requests a Stand-By Arrangement for a period of 15 months with the Fund, in the amount of SDR 12,144.4 million (equivalent to some US$15,650 million). We also request the cancellation of Brazil's existing 36-month Stand-By Arrangement that was approved by the Executive Board in December 1998 and was scheduled to expire on December 1, 2001.

The Government believes that the policies described in the memorandum will promote sustainable and equitable long-term growth of output and employment with continued low inflation and external viability, despite the current difficult environment. The Government stands ready to take additional policy measures as appropriate to ensure the attainment of these objectives.

During the period of the arrangement, the authorities of Brazil will maintain the usual close policy dialogue with the Fund.

Pedro Sampaio Malan
Minister of Finance
Armínio Fraga Neto
Central Bank of Brazil


Brazil—Memorandum of Economic Policies

1.  Brazil has successfully completed seven reviews of the three-year Stand-By Arrangement (SBA) with the International Monetary Fund (the Fund) approved by the Fund's Executive Board on December 2, 1998. Continued successful implementation of the government's program has helped maintain economic stability, invigorate economic growth, foster improvements in social indicators and strengthen the social safety net.

2.  However, since the completion of the last review of the program on March 28, 2001, the Brazilian economy has been subjected to temporary external and domestic shocks, in particular a deterioration of the external environment and a domestic energy crisis, that are expected to adversely affect economic activity and the balance of payments in the remainder of the year. These have triggered a series of strong policy responses by the government, including a tightening of monetary policy to address the inflationary implications of these shocks and a more proactive stance of the central bank in the foreign exchange market; and a significant tightening of the fiscal policy stance in 2001 and 2002 and over the medium term. In addition, the energy crisis led the government to implement a domestic energy saving program and a package of measures to accelerate investments in the energy sector. To support these policy initiatives, the government has decided to cancel the existing Stand-By Arrangement, and to request a new stand-by arrangement to run through December 2002.

I.  Recent Performance of the Brazilian Economy

3.  The economy continued to perform strongly at the beginning of 2001, but the most recent indicators have shown a deceleration of economic activity. Economic growth averaged 4.5 percent in the 12 months through March 2001, led by industry, which expanded by 4.9 percent in the period. Investment demand was strong in the first half of 2001, when capital goods production increased by 17 percent compared to the same period of 2000. However, increased uncertainties regarding the external and domestic environment and the required tightening of monetary policy took a toll on economic activity in the second quarter. Monthly industrial production fell by a cumulative 5.3 percent on a seasonally-adjusted basis during March–June, and retail sales decreased significantly in May and June from their levels during the first four months of the year.

4.  Labor market conditions have continued to improve. Employment creation has continued, although there are signs of a slowdown. Average employment in January–June 2001 was 1.5 percent higher than in the same period of 2000 in the six metropolitan areas surveyed by the Brazilian Statistical Institute (IBGE). Formal-sector employment in June was 3.9 percent higher than a year earlier, as 293 thousand new jobs were created. The reduction in unemployment has continued, albeit at a slower pace, with the unemployment rate falling by 1 percentage point in the 12 months to June 2001, to 6.4 percent of the economically active population, compared to a drop of 1.9 percentage points in the 12 months to January 2001.

5.  The energy crisis was precipitated by record low rainfall that adversely affected the output of hydroelectric power plants—which account for approximately 90 percent of Brazil's energy supply—and by a regulatory framework that did not provide sufficient incentives for private investment in the past. In response to the crisis, the government has announced a series of measures to address the short-term imbalance by reducing demand and increasing supply on an emergency basis, and to raise generating capacity over the medium term. The energy saving plan, which started in June 2001, is the main demand-side measure. It aims at reducing the demand for electricity through a mixture of price incentives and penalties for overconsumption. The plan has been successful so far, having received the broad-based support of households and businesses: energy saving in June met the 20 percent target, which reduces the likelihood of blackouts in the short run. On the supply side, the government is fostering market mechanisms for buying and selling energy consumption quotas between companies, which will allow for a more rational allocation of electricity, and should reduce the adverse impact of the energy crisis on economic activity. To boost energy supply in the short run, the government is also contemplating the leasing of mobile thermoelectric power generators. To increase supply on a permanent basis, the government has announced plans for 2001–03 that will accelerate investment in hydroelectric and thermoelectric plants, co-generation facilities, and wind energy. The plan calls for more than two-thirds of a total investment of R$31 billion to be made by the private sector. The current steps to improve the regulatory framework are expected to facilitate this investment.

6.  Inflation has been higher than expected in 2001, largely reflecting the impact of increases in food and administered prices, as well as the passthrough to prices of the exchange rate depreciation. In June, the 12-month rate of consumer price inflation (IPCA) stood at 7.3 percent, slightly above the 6.9 percent trigger point for informal consultation on inflation with IMF staff under the existing stand-by arrangement. Cumulative consumer price inflation in the six months through June amounted to 3.0 percent, compared to the government's target ceiling of 6.0 percent for the year; about 24 percent of the increase (0.7 percentage point) reflected adjustments in administered prices (including electricity, telecommunication, and transport tariffs, and prices of petroleum products). About 38 percent of the increase (1.11 percentage points) is due to pass through to both administered and other prices from the more depreciated exchange rate.

7.  The government has continued to adjust administered prices. As of July 6, wholesale petroleum product prices were increased in line with the formula for quarterly price adjustments, which is based on changes in the exchange rate and in international oil prices. This has reinforced transparency and predictability, and strengthened the credibility of the adjustment mechanism.

8.  Broadly in line with expectations, the current account posted a deficit of US$13.4 billion during January–June 2001, compared to US$11.2 billion during the same period of 2000, owing to a less favorable trade balance as well as higher interest payments and remittances of profits and dividends. The deterioration in the trade balance occurred notwithstanding strong export performance. Merchandise exports grew by 12 percent in volume terms during January–June 2001 compared to the same period in 2000, but imports rose by 18 percent over the same period, reflecting in part strong growth of capital goods imports. The trade balance up to July 2001 showed a surplus of less than US$0.1 billion, down from a surplus of US$0.9 billion for the first seven months of 2000.

9.  The capital account of the balance of payments performed well, notwithstanding a decline in foreign direct investment (FDI). Net FDI amounted to US$12 billion during January–June 2001 (compared with US$13 billion over the same period last year), covering 90 percent of the current account deficit. Net portfolio investment was lower than in the same period of 2000. However, Brazil has continued to enjoy good access to the international sovereign bond market, which it tapped six times in the year to date for a total of US$6.7 billion, most recently in late July through a Yen-denominated issue equivalent to US$1.6 billion that was completed with an average spread of 358 basis points over yen LIBOR. This compares to a total external amortization burden of the central government of US$4.1 billion this year.

10.  The government has continued to maintain frequent and constructive contacts with the international investor community. A wide range of economic information is made available—in a user-friendly format—over the Internet as well as through regular bulletins issued by several units of the Finance Ministry and the Central Bank. This includes daily updates on international reserves and central bank foreign exchange market interventions, monthly details of fiscal results (including data on debt management), and monthly reports on the balance of payments. In addition, the government has organized on a regular basis a series of road shows, conference calls and other types of communication with market participants, both deal-related and non-deal-related. A Central Bank Investors Relations Group (IRG), established within the Central Bank, has been operating since April 1999 to improve the channels of communication with market participants and increase transparency in policies, in particular Central Bank policies. Its reports are distributed via electronic mail to an estimated 13,400 recipients in more than 60 countries. The IRG is in charge of providing Brazilian sovereign bondholders with detailed information on the economy, in order to comply with disclosure requirements of various countries. The Group also conducts regular meetings with investors, both in Brazil and abroad. The Central Bank has also created a unit in charge of relations with rating agencies. Its goals are to facilitate the agencies' access to information and analyses of the Brazilian economy. This is done through frequent contacts between staffs of the BCB and the agencies, as well as through the organization of meetings of agency analysts with key policy makers, politicians, and other observers of the economic and political scene in Brazil.

11.  In light of the adverse external environment, the government announced in June initiatives to strengthen balance of payments financing prospects for the remainder of the year through additional resources. The initiatives involve the sale of government shares in public and privately-controlled enterprises for an estimated US$3.8 billion (some US$650 million was raised in July through sales of shares of Petrobrás, the petroleum company that is majority-owned by the government), additional bond issues by the republic and BNDES, liability management operations, and a US$2 billion drawing made on June 28 under the stand-by arrangement approved in December 1998.

12.  Gross international reserves, which stood at US$34.4 billion at end-March, increased to US$35.6 billion as of end-July. Also at end-July 2001, net international reserves, as measured under the program, stood at US$32.1 billion, US$7.1 billion above the floor established in the existing stand-by arrangement.

13.  At end-May, total external debt amounted to US$239 billion (41.7 percent of estimated GDP), broadly unchanged from end-2000, and its public sector component also remained stable, at US$92 billion. The short-term component of the external debt, measured on an original maturity basis, decreased to US$29 billion at end-May from US$30 billion at end-2000. The short-term external debt is mainly trade-related, and essentially owed by the private sector.

14.  Brazil continues to perform strongly in the fiscal area, having complied with the program targets for the primary budget balance of the consolidated public sector under the existing stand-by arrangement for the eleventh consecutive quarter in June 2001. The accumulated primary surplus of the consolidated public sector reached R$30.4 billion in June, R$8.9 billion (about 0.8 percent of estimated annual GDP) higher than the program target for end-June. However, reflecting primarily the more depreciated exchange rate, the accumulated public sector borrowing requirement reached 4.9 percent of period GDP (R$28.8 billion) in June, relative to 3.1 percent of GDP in the same period of 2000. In line with the increase in the public sector borrowing requirement, the net public debt ratio rose to 51.3 percent of GDP at end-June from 49.3 percent of GDP at end-2000. As a result of the more depreciated exchange rate, the indicative targets for the net public debt at end-March and end-June were missed by small margins.

15.  Fiscal performance has been strong at all levels of government. For January–June 2001 the central government primary surplus reached 3.2 percent of period GDP, reflecting continued expenditure restraint. The states and municipalities posted a primary surplus of 1.1 percent of period GDP in January–June 2001 (municipalities accounted for 0.4 percent of period GDP) in compliance with the Fiscal Responsibility Law and the debt rescheduling agreements with the Treasury. At 0.7 percent of period GDP in January–June 2001, the primary surplus of the public enterprises reflects not only the favorable impact of the more depreciated exchange rate on the profits of Petrobrás, the federal oil company, and Itaipú (the binational hydroelectric power plant) but also the strong performance of other public enterprises at all levels of government.

16.  The government's debt management activities continued to lengthen maturities and increase duration. The average maturity of competitively-placed outstanding securitized federal debt rose from 15.8 months at end-2000 to 22.0 months at end-June 2001 (from 29.9 months to 35.2 months for all securitized federal debt), while average duration grew from 6.3 to 9.7 months over the same period. However, in light of increased market volatilities, the government was unable to further reduce the share of its outstanding foreign-exchange indexed debt or to increase the share of its fixed-return instruments. By end-June, the share of foreign-exchange indexed debt had increased to 26.4 percent of total securitized federal debt outstanding, up from 21.6 percent in January, while the share of fixed-return instruments had declined to 10.9 percent from 16.0 percent in January.

17.  In response to higher-than-expected inflation, the central bank (BCB) undertook a series of measures aimed at avoiding the second round effects on prices of the shocks and therefore ensuring that inflation will return to its target path. In particular, the BCB tightened monetary policies by gradually increasing the annualized overnight interest rate (SELIC) by 375 basis points during March–July. In addition, the BCB adopted a more proactive policy stance in the foreign exchange market. To this end, in early July the BCB announced its intention to make regular periodic small sales of U.S. dollars in the spot market until the end of the year, totaling US$6 billion. The BCB will limit to extraordinary circumstances any increases in the outstanding stocks of U.S. dollar-indexed bonds. In support of these measures, the government also announced that the Treasury was temporarily suspending its regular monthly spot foreign exchange market purchases of US$100 million.

18.  As a result of the tightening of monetary policy, average annualized bank lending rates increased from 51 percent in December 2000 to 55 percent in June 2001 (though rates fell from 45 percent to 38 percent for enterprises), reflecting both an increase in the cost of credit to banks and wider average bank lending spreads. The BCB will continue to work toward the reduction of lending spreads. However, marked declines in these spreads will also depend on strengthening bankruptcy procedures as well as on the voting into law of the provisional measures that have recently introduced more efficient credit instruments to facilitate collateralization of loans. Credit continued to expand, albeit at a slower pace than at the start of the year, driven in part by the increase in bank lending rates, which particularly dampened the growth of freely allocated credit. Total outstanding bank loans rose by 16 percent in the 12 months to May 2001, driven largely by credit to households. Monthly growth rates for freely allocated credit have declined sharply since the beginning of the year.

19.  Prudential indicators remained broadly stable. The share of loans overdue for more than 180 days remained broadly stable at 5.4 percent in May 2001. Total bank provisions at end-May 2001 amounted to over R$23.2 billion, fully meeting minimum provisioning requirements.

20.  The government continued to make major progress in strengthening Brazil's financial system. Following global consolidated inspections by the BCB of the four main federal banks—Banco do Brasil (BB), Caixa Econômica Federal (CEF), Banco do Nordeste do Brasil (BNB), and Banco da Amazônia (BASA)—the government announced in late June a comprehensive restructuring plan for these institutions. The plan involves a recapitalization of these banks through a set of measures including an exchange of illiquid and subpar value assets for liquid and marketable government securities, explicit capitalization of all banks (except BB), and the exchange of Brazilian Brady bonds from BB's portfolio for domestic government bonds. The exchange of securities will have no immediate impact on the public sector net debt, but the capitalization of CEF (R$9.3 billion), BNB (R$2.1 billion) and BASA (R$1.1 billion) will increase the public sector net debt by R$12.5 billion (1 percent of GDP). The restructuring is expected to be completed by end-2001 and will have no impact on the central government primary surplus, but the increase in the net public sector debt will increase government interest expenditures. There could also be limited future fiscal costs to the extent that there are problems in recovering the full value of the assets transferred from the banks. To increase fiscal transparency and prevent a build-up of quasi-fiscal liabilities in the future, implicit subsidies embedded in new directed lending operations of these banks—largely to high social return projects in the areas of housing, sanitation, and agriculture—will henceforth be recorded in the federal government budget. Taken together, these measures will allow the federal banks to comply with the new Basel capital adequacy criteria and the more stringent prudential requirements that were recently introduced by the BCB. A series of measures to improve governance of the federal banks is being introduced, most of which involve subjecting these banks to the stricter regulations that already apply to private banks. In addition, the BCB will monitor closely the implementation of internal controls in federal banks.

21.  In another financial operation geared toward increasing transparency, Congress approved a law setting the terms for financing a R$40 billion recapitalization of the severance payments fund (FGTS), due to a court ruling which found that the inflation indexation adjustments of individual FGTS balances during two pre-1994 stabilization plans were not adequate. Expenditures will be phased in between 2002 and 2007. Employers will contribute R$16 billion to the recapitalization effort, the FGTS itself R$14 billion, employees R$4 billion, and the Treasury R$6 billion.

22.  Notwithstanding the adverse economic environment, the government continued to implement important structural reforms. In April, Congress approved two of the remaining three pieces of legislation for the complementary pension funds. These clarified the regulatory framework of the funds, and the fiduciary relationship between the various levels of government and the pension funds for their respective employees. An important result was to make pension contributions of private sector workers portable between funds. The government also continued to implement its privatization program, and successfully auctioned various oil prospecting licenses and concessions for hydroelectric power plants, as well as the concessions for two of the three mobile phone bands to be sold this year. Moreover, in July the BCB auctioned the petrochemical company Copene for R$785 million as part of the liquidation process for a failed private bank.

II.  Policies and Prospects for The Remainder of 2001 and 2002

23.  The government's policy framework for 2001 and 2002 continues to promote sustainable economic growth and employment in a context of low inflation, with the aim of improving living standards, especially for lower income groups. In an international environment fraught with significant uncertainty and prone to adverse shocks, the pursuit of these objectives requires firm but flexible management of macroeconomic policies, and a continued commitment to structural and institutional reform. This, in turn, should facilitate a strengthening of market confidence, and a smooth financing of the current account deficit.

24.  Further tightening of the fiscal policy stance is being undertaken to make sure that the debt dynamics will remain under control, with the target for the primary balance of the consolidated public sector rising to 3.35 percent of GDP in 2001 (from an original 3 percent) and to 3.5 percent in 2002 (from an original 2.7 percent). In addition, the indicative primary surplus targets for 2003 and 2004 have been raised to 3.5 percent of GDP, compared to a declining trend of original targets starting with 2.5 percent of GDP in 2003. The changes in the central government fiscal targets consistent with these revised targets for 2002–2004 will be implemented via an amendment to the Budget Guidelines Law. Achievement of these primary surpluses for 2001–2004 should allow for a gradual decline of the net public debt in relation to GDP.

25.  In the context of the floating exchange rate regime, monetary policy will aim to reduce the rate of consumer price inflation (IPCA) in line with the targets for 2001–2003. The structural reform agenda will continue to focus on carrying out the remaining fiscal reforms, strengthening monetary and financial institutions, improving corporate governance, and enhancing the regulatory framework for private investment. The government will also continue to implement its privatization program and to strengthen targeted social programs.

26.  These policies will facilitate achieving projected real GDP growth in the range of 2.22.7 percent this year, lower than the 4.5 percent projected earlier this year, due to the adverse international environment and the domestic energy crisis.1 Economic growth in 2001 is projected to be led by agriculture, and, notwithstanding an expected slowdown in the second half of the year, by industrial activity, and to be supported by the maintenance of a good performance of the service sector. Growth is expected to accelerate somewhat next year, reaching around 3½ percent. Productivity gains in both years should permit continued moderation of unit labor costs, while still leaving scope for a further recovery of real wages.

27.  Notwithstanding more subdued foreign demand, export volumes are projected to grow by 9.6 percent due in part to the depreciation of the real. Exporters are projected to score gains in market share, as a result of further improvements in competitiveness and continued efforts to increase Brazilian enterprises' access to foreign markets. Import volumes are expected to continue to rise in 2001 (by about 11.0 percent), albeit at a slower pace during the second half of the year, reflecting a slowdown in economic activity and the currency depreciation. The terms of trade are projected to improve moderately, reflecting a decline in import prices. On the whole, the trade balance may show a modest deficit in U.S. dollar terms in 2001, similar to that of 2000. The current account deficit is likely to widen from US$24.6 billion in 2000 to around US$26 billion in 2001. Despite an expected decline associated with the slowdown in the world economy and domestic shocks, FDI is projected to cover more than 80 percent of the current account deficit.

28.  Other net capital flows are expected to remain positive, with net portfolio investment inflows and net borrowing from multilateral organizations more than offsetting net short-term capital outflows. The overall balance of payments is expected to show a small deficit of around US$1.8 billion in 2001, which will be financed by a reduction in net international reserves (NIR). NIR are, however, projected to be about US$28 billion, above the proposed US$20 billion program floor established in the attached Technical Memorandum of Understanding (TMU).

29.  For 2002 the current account deficit is expected to decline to US$ 24.5 billion due mainly to an improvement in the trade balance, as the recent real depreciation in the exchange rate continues to take effect. The trade balance is expected to be in surplus by about US$2 billion compared with a modest deficit in 2001. The volume of exports is expected to grow by 10 percent, about the same as in 2001. The volume of imports is expected to grow by less than 7 percent, well below the level of 2001, reflecting the effects of the depreciation of the real. The terms of trade are expected to improve slightly due to an increase in the price of exports. Foreign direct investment is expected to decline slightly, but to remain well within the long-term trend, covering about 70 percent of the current account deficit. Portfolio investment and other capital flows are expected to be slightly positive and broadly in line with those of 2001. The overall balance of payments is expected to show a small deficit of around US$1.4 billion leading to a slight decline in NIR to around US$27 billion

30.  Achieving the revised fiscal targets for the central government in 2001 and 2002 will require continued expenditure restraint, although spending on priority social programs will be protected. Fiscal policy will be conducted within the framework of the Fiscal Responsibility Law and the Budgetary Guidelines Law. The government will continue to monitor closely the evolution of revenues and the performance of enterprises and regional governments during the year, and will be ready to adjust spending ceilings so as to safeguard the revised primary surplus of the consolidated public sector of at least 3.35 percent of GDP for 2001 and 3.50 percent of GDP for 2002.

31.  The states and municipalities are also expected to continue consolidating their finances in 2001 and 2002 in line with the requirements of the fiscal responsibility law and the debt rescheduling agreements with the Treasury, registering a primary surplus of around 0.8 percent of GDP this year and 0.6 percent of GDP next year. Some states are also expected to make further progress in the privatization of their enterprises. The primary surplus of the public enterprises is expected to reach 0.7 percent of GDP this year, with the additional capital outlays on energy generation capacity and lower electricity revenues being offset mainly by higher revenues of Petrobrás and Itaipú, due primarily to the more depreciated exchange rate. Domestic petroleum product prices are expected to be adjusted to reflect changes in international prices and in the exchange rate in the remainder of 2001 as established in existing regulations, in anticipation of the full liberalization of the domestic petroleum products market in 2002. For 2002, the public enterprises are projected to achieve a primary surplus of 0.6 percent of GDP.

32.  On the whole, on current policies, the PSBR is projected to rise this year to around 6.0 percent of GDP compared with 4.5 percent in 2000, and the net public debt to increase this year to some 54 percent of GDP, after allowance for privatization revenues and the planned securitization of unrecorded liabilities, as set out in the attached TMU. For 2002, the PSBR is projected to decline to 3.7 percent of GDP, and the net public debt is projected to decline slightly to just under 54 percent of GDP.

33.  The government will continue its efforts to increase further the share of fixed-rate instruments in the securitized domestic federal debt, and to raise average maturities. It will also endeavor to improve further the structure of its external debt, by extending duration, smoothing the amortization profile, and diversifying the currency mix. Quarterly indicative targets on the net debt of the consolidated public sector are set out in the attached TMU.

34.  The government remains committed to progress in fiscal reforms during 2001 and beyond. It will continue to work toward congressional approval of the remaining piece of legislation in the reform of pension funds, and the introduction of a social security contribution for retired civil servants. It will also seek to move forward on the reform of indirect taxation through constitutional amendments establishing unified legislation for the states' value added tax (ICMS) and an explicit system of taxation for domestic oil products to replace the implicit taxes embodied in the oil account in the budget by early 2002, when the domestic oil market is expected to be fully liberalized. In addition, the government has introduced legislation to reform the tax refund system for the indirect taxes of PIS and COFINS with a view to reducing their cascading effect and eliminating their implicit bias against exports. The government has sent to Congress a proposed constitutional amendment to extend the financial transaction tax (CPMF) from June 2002, when it was scheduled to expire, through the end of 2004. It also continues to study ways to avoid or mitigate the negative impact of the CPMF on capital markets. Legislation defining the jurisdictional control over the municipal water and sanitation companies will pave the way for investment in the sector and for the privatization of some enterprises. Finally, the government intends to request technical assistance from the Fiscal Affairs Department of the IMF to consider reforms to the indirect tax system that could improve efficiency while maintaining the sustainability of the fiscal accounts in the medium term. A ROSC mission on fiscal transparency is scheduled to take place next September.

35.  Monetary policy will continue to be conducted within the inflation-targeting framework. Given the various shocks that have led to higher-than-projected inflation this year, the midpoint for the program's inflation consultation mechanism for September has been fixed at 6.0 percent (with a range from 4.0 to 8.0 percent), compared to the 4.1 percent midpoint for September under the existing stand-by arrangement. For end-2001, the midpoint under the program has been set at 5.8 percent, within the outer tolerance bands around the central target of 4 percent established under the inflation targeting framework. Quarterly bands for end-March, end-June and end-September 2002 are spelled out in the attached TMU. These bands are consistent with an end-2002 central inflation target of 3.5 percent, as established by the government in the current inflation targeting framework. In addition, the midpoints of the consultation bands have been established in a forward-looking manner, incorporating information about expected developments in administered prices as well as seasonal effects. Inflation prospects will be among the aspects considered during quarterly reviews of the program. In addition, the BCB will continue its regular exchange of views with the Fund staff about the evolution of monetary policy. To help guide inflation expectations over the medium-term, and in line with regulations in effect, in June the government set the 2003 inflation target at 3.25 percent within a +/– 2 percentage point band.

36.  The government is working on draft legislation to strengthen capital markets supervision by unifying and strengthening various regulatory agencies active in this area. It will also continue to work closely with Congress toward the passage of the pending draft law on publicly-traded companies, which aims to improve transparency and governance in these enterprises, and of a new bankruptcy law. The BCB is planning additional steps (detailed in the attached TMU) to enhance the regulatory framework for banks, and its off-site supervision systems. Reforms to the system of housing finance are also being considered that would provide better protection to homebuyers. In addition, the government intends to participate in the Financial Sector Assessment Program (FSAP), building on the previous assessment of the observance of Basel core principles that was carried out with the assistance of the IMF and the World Bank. The government is also working on measures that gradually would eliminate remaining differences between internationally-accepted accounting standards and those currently in use in Brazil.

37.  Promoting further regional integration and policy coordination within Mercosur remains high on the government's policy agenda. The government continues its efforts to resolve the recent difficulties among Mercosur member-countries concerning the common external tariff. Brazil also remains committed to multilateral trade liberalization in the context of broad-based negotiations to include trade in agricultural products. The government believes that greater access for Brazilian exporters to international markets is key to increasing net exports and strengthening the current account.

38.  Brazil has made substantial progress in improving its statistical database, and since March 14, 2001 subscribes to the SDDS, the first country to subscribe after the expiration of the transition period in December 1998. Further progress is expected in the second half of 2001, particularly in preparing quarterly national accounts for aggregate demand components, developing a producer price index, and defining monetary aggregates that are more in line with common international practice, as outlined in the attached TMU.

39.  In summary, Brazil's successful performance under the stand-by arrangement has contributed to enhanced economic stability, stronger growth, and continued improvements in the well being of the Brazilian population. To protect and further these gains in the face of the unsettled external environment, the government is committed to a program of further significant fiscal consolidation and structural reform, assisted by further support from the Fund. In addition to the measures described in this MEP, the government stands ready to adjust policy as needed to ensure the achievement of the objectives of the program, and looks forward to a continued close and constructive dialogue with the Fund.

1The economic program was originally developed with a projected growth rate of 2.7 percent in 2001. Following the release of the preliminary second quarter GDP results by the statistical authorities, the growth forecast was changed to the range of 2.2–2.7 percent. The lower bound of the projection is in line with market expectations as shown by the survey carried out by the BCB on August 20, 2001.


Brazil—Technical Memorandum of Understanding

1.  This Technical Memorandum of Understanding (TMU) sets out the specific performance criteria (PCs), indicative targets (ITs), structural benchmarks (SBs) and assumptions that will be applied under the SBA during 2001 and 2002.

I.  Phasing of Purchases and Reviews

2.  The general phasing of purchases and reviews for 2001 and 2002 is shown in Table 1 below.

Table 1. Brazil: Phasing of Purchases and Reviews

Amounts Available
(In millions of SDRs)
and Sources
 Earliest Availability Dates  Conditions and Remarks

358.625 from CT
3316.958 from SRF
September 14, 2001 Approval of the stand-by arrangement.
358.625 from CT December 15, 2001 Completion of the first review, and observance of the relevant PCs under the arrangement (end-September, 2001).
358.625 from CT
3316.958 from SRF
March 29, 2002 Completion of the second review and observance of the relevant PCs under the arrangement (end-December, 2001).
358.625 from CT
3316.958 from SRF
June 14, 2002 Completion of the third review and observance of the relevant PCs under the arrangement (end-March, 2002).
379.513 from CT August 30, 2002 Completion of the fourth review and observance of the relevant PCs under the arrangement (end-June, 2002).
379.513 from CT November 29, 2002 Observance of the relevant PCs under the arrangement (end-September, 2002).

II.  Quantitative Targets

A.  Fiscal Targets

(i) Performance criterion for the primary balance of the consolidated public sector1

(In billions of R$)

Cumulative fiscal year primary balance of the consolidated public sector
January 1, 2001–June 30, 2001 (preliminary) 30.4
January 1, 2001–September 30, 2001 (performance criterion) 34.4
January 1, 2001–December 31, 2001 (performance criterion) 40.2
January 1, 2002–March 31, 2002 (performance criterion) 11.4
January 1, 2002–June 30, 2002 (indicative target) 25.0
January 1, 2002–September 30, 2002 (indicative target) 34.1

1As defined below.
2Minimum cumulative primary surplus of the consolidated public sector.

3.  The cumulative primary balance of the consolidated public sector is defined as the sum of the cumulative primary balances of the various entities that make up the public sector. The public sector is defined to comprise the central government, state and municipal governments, and the public enterprises (including federal, state and municipal enterprises); the central government includes the federal government, the social security system, and the Central Bank of Brazil (BCB).

4.  For any given month, the primary balance of the consolidated public sector is measured, in Brazilian reais (R$), as the total net interest (i.e., net interest accrued on the consolidated net domestic debt of the public sector, plus the net interest due (competência contratual) on the net external debt of the public sector) minus the borrowing requirement of the consolidated public sector, where the public sector is defined as above. For foreign-exchange indexed government securities, the interest rate is the accumulated rate of change of the U.S. dollar vis-à-vis the R$, plus the fixed coupon rate. The fixed coupon rate applies to the nominal value of the security revalued by the rate of change of the U.S. dollar vis-à-vis the R$ from the issuance date to the relevant date. For any given month, the borrowing requirement of the consolidated public sector is defined as the change in the nominal outstanding net domestic debt plus the change in the net external debt, converted into R$ at the actual period average R$/US$ exchange rate.1 The stock of the U.S. dollar-indexed domestic debt is revalued at the end of a given month to reflect any change in the value of the real vis-à-vis the U.S. dollar that has taken place during the month. The proceeds from privatization during that period are added to these results; amounts representing the recognition of unregistered liabilities during that period are subtracted from these results. The cumulative primary balance from January 1 of a given year to the relevant date of the same year is the sum of the monthly primary balances of the consolidated public sector for that period.

(ii) Indicative target on the net debt of the consolidated public sector 1

(In billions of R$)

Total net debt outstanding of the consolidated public sector
End-September, 2001 (indicative target) 680.0
End-December 2001 (indicative target) 700.0
End-March 2002 (indicative target) 720.0
End-June 2002 (indicative target) 730.0
End-September 2002 (indicative target) 750.0

1The public sector is defined as above; the net debt includes the monetary base.
2Maximum stock outstanding of total net debt of the consolidated public sector.

5.  Total net debt outstanding of the consolidated public sector (dívida líquida total) equals the public sector's gross debt (including the monetary base), net of its financial assets; it is defined as the sum of the registered net domestic and net external debt (all valued in R$), of the central government, state and municipal governments, and the public enterprises (including federal, state and municipal enterprises); the central government is defined as above.

6.  Total net debt outstanding of the consolidated public sector is measured on an accrual basis (including accrued interest) for the domestic debt component, and on an interest-due basis (competência contratual) for the external debt component. The stock of external debt and of foreign-exchange indexed domestic debt is valued at the actual R$/US$ exchange rate prevailing at the end of each period.

7.  The central government will continue to incorporate into its registered debt various unregistered liabilities that are currently outstanding. The above ceilings for the total net debt outstanding of the consolidated public sector are predicated on the paths for privatization receipts (defined here to exclude concession revenue) and the recognition of unregistered liabilities that are shown in Table 2 below. These ceilings will be adjusted downward (adjusted upward) to the extent that privatization receipts exceed (fall short of) the amounts implied by Table 2 below; they will be adjusted upward (adjusted downward) to the extent that the recognition of unregistered liabilities exceeds (falls short of) the amounts implied by Table 2 below.

B. External Sector Targets

(i) Performance criterion on external debt of the nonfinancial public sector1

(In billions of US$)

Stock of total external debt of the nonfinancial public sector at
End-September 2001 (performance criterion) 95.0
End-December 2001 (performance criterion) 94.8
End-March 2002 (performance criterion) 96.4
End-June 2002 (performance criterion) 96.5
End-September 2002 (performance criterion) 97.6

1The data in this table apply to all external debt of the nonfinancial public sector that is disbursed and outstanding. The nonfinancial public sector includes the federal, state, and municipal governments, the public enterprises, and the social security system. Excluded from measured debt stocks are any liabilities vis-à-vis the Fund.

8. For any given quarter, the stock of debt2 disbursed and outstanding is defined as the stock of debt disbursed and outstanding at the end of the previous quarter, plus gross disbursements that take place during the quarter in question, less the gross amortization payments made during the quarter in question.

9. The above limits will be adjusted upward to accommodate new external borrowing that is made in order to undertake a voluntary early or advance repurchase to the Fund.

(ii) Performance criterion on publicly guaranteed external debt of the private sector1

(In billions of US$)

Stock of publicly guaranteed external debt outstanding  
End-September, 2001 (performance criterion) 1.6
End-December 2001 1.6
End-March 2002 (performance criterion) 1.6
End-June 2002 (performance criterion) 1.6
End-September 2002 (performance criterion) 1.6

1The limit applies to all private external debt guaranteed by the public sector. The public sector includes the nonfinancial public sector (as defined above), the BCB and the financial public sector
2These ceilings will be adjusted upward for publicly guaranteed external debt that is actually transferred to or assumed by the private sector in the context of the privatization of public enterprises.

10.  For any given quarter, the stock of external debt guaranteed by the public sector is defined as the stock of external debt guaranteed by the public sector that is outstanding at the end of the previous quarter, plus the net addition to external debt guaranteed by the public sector during the quarter in question.

(iii) Performance criterion on nonfinancial public sector short-term external debt1

(In billions of US$)

Stock of total short-term external debt of the
  nonfinancial public sector as of
End-September 2001 (performance criterion) 3.5
End-December 2001 (performance criterion) 3.5
End-March 2002 (performance criterion) 3.5
End-June 2002 (performance criterion) 3.5
End-September 2002 (performance criterion) 3.5

1The data in this table apply to all external debt (disbursed and outstanding) of the nonfinancial public sector with original maturities of strictly less than one year. The nonfinancial public sector includes the federal, state, and municipal governments, the public enterprises, and the social security system. Excluded are any liabilities incurred vis-à-vis the Fund.

11.  Short-term debt3 is defined as all debt with an original maturity of strictly less than one year. For any given quarter, the stock of short-term external debt (disbursed and outstanding) is defined as the stock of short-term external debt (disbursed and outstanding) at the end of the previous quarter, plus the net flows associated with the disbursements and amortizations of short-term debt that take place during the quarter in question.

12.  The above limits will be adjusted upward to accommodate new external borrowing that is made in order to undertake a voluntary early or advance repurchase from the Fund.

(iv) Performance criterion on net international reserves (NIR) in the BCB1

(In billions of US$)

Stock net international reserves in the BCB as of July 31, 20012 32.2
End-September 2001 (performance criterion) 20.0
End-October 2001 (performance criterion) 20.0
End-November 2001 (performance criterion) 20.0
End-December 2001 (performance criterion) 20.0
End-January 2002 (performance criterion) 20.0
End-February 2002 (performance criterion) 20.0
End-March 2002 (performance criterion) 20.0
End-April 2002 (performance criterion) 20.0
End-May 2002 (performance criterion) 20.0
End-June 2002 (performance criterion) 20.0
End-July 2002 (performance criterion) 20.0
End-August 2002 (performance criterion) 20.0
End-September 2002 (performance criterion) 20.0
End-October 2002 (performance criterion) 20.0
End-November 2002 (performance criterion) 20.0

1NIR are measured as defined below.
2Measured at constant cross exchange rates and gold prices as specified in EBS/01/36.

13.  The NIR in the BCB are equal to the balance-of-payments concept of net international reserves in the BCB (reservas internacionais líquidas ajustadas) and include gross official reserves minus gross official liabilities.

14.  Gross official reserves are defined as liquid foreign currency denominated claims in the BCB. Gross official reserves include (i) monetary claims, (ii) free gold, (iii) holdings of SDRs, (iv) the reserve position in the IMF, and (v) holdings of fixed income instruments. Items (i) through (iv) will be valued at the end-period prices shown in Table 3 below. Item (v) will be valued marked to market. Gross official reserves will exclude participation in international financial institutions, the holdings of nonconvertible currencies, and the holdings of precious metals other than gold.

15.  Gross official liabilities in foreign currencies include (i) foreign currency liabilities with original maturity of one year or less, (ii) the use of Fund resources, and (iii) any forward foreign exchange (FX) liabilities on a net basis—defined as the long position (posição vendida) minus the short position (posição comprada)—directly undertaken by the BCB or by other financial institutions on behalf of the BCB. Items (i) through (iii), will be valued at the prices shown in Table 3 below. Any increases in foreign currency-denominated claims (both spot and forward) against residents, or against foreign branches or subsidiaries of Brazilian institutions, do not count toward NIR in the BCB.

(v) Performance criterion on the BCB's exposure in FX futures markets

16.  The BCB will continue to refrain from entering into FX futures contracts, either directly or through any institution it uses as its financial agent. This constitutes a performance criterion under the arrangement.

(vi) Performance criterion on the BCB's exposure in FX forward markets

17.  The BCB will continue to refrain from entering into FX forward contracts, either directly or through any institution it uses as its financial agent. This constitutes a performance criterion under the arrangement.

C.  Monetary Targets

(i) Consultation mechanism on the 12-month rate of inflation

18.  The quarterly consultation bands for the 12-month rate of inflation in consumer prices (as measured by the Indice de preços ao consumidor ampliado (IPCA)) are specified as follows:

Consultation bands for the 12-month rate of change of the IPCA (in percent)


Outer band (upper limit) 8.0 7.8 7.8 7.3 6.2
  Inner band (upper limit) 7.0 6.8 6.8 6.3 5.2
    Central point 6.0 5.8 5.8 5.3 4.2
  Inner band (lower limit) 5.0 4.8 4.8 4.3 3.2
Outer band (lower limit) 4.0 3.8 3.8 3.3 2.2

19.  Inflation prospects will be an important part of each review under the arrangement. In addition, the BCB will discuss with the Fund staff the appropriate policy response should the 12-month rate of IPCA inflation exceed the upper limit of the inner band specified in the table above. Should the 12-month rate of IPCA inflation exceed the upper limit of the outer band specified above, the authorities will complete a consultation with the Executive Board of the IMF (henceforth the Board) on their proposed policy response.

III.  Structural and Statistical Benchmarks

A.  Structural Benchmarks

By end-September 2001

  • Completion of a revision and upgrade to international standards of the plan of accounts for financial institutions, the rules for recording and evaluating assets and liabilities of these institutions, and the reporting to the BCB and the public of the financial statements of financial institutions.

  • Further progress in preparing for the privatization of the federalized state banks.

By end-December 2001

  • The central bank to begin putting in place the framework to develop a rating system for banks on the basis of a private consultant's report.

  • Design of the new off-site banking supervision system to be completed.

  • Presentation of enabling legislation to introduce explicit taxation of oil products after enactment of the relevant constitutional amendment.

  • Progress in the auctioning of the federalized state banks.

Additional structural benchmarks may be agreed at the time of the first review under the SBA.

B.  Statistical Benchmarks

By end-September 2001

  • Begin publication of broad monetary aggregates as redefined on an internationally comparable basis.

  • Begin regular publication of quarterly GDP data by expenditure categories at current and constant prices. The publication lag should be no longer than three months.

IV.  Disclosure of Specific Information

20.  Specific data to continue to be provided by the authorities to the Fund staff include the following (at the indicated frequencies, and lags):

  • Composition of gross international reserves under the cash concept (posição de caixa) and the liquidity concept (posição liquidez internacional) (weekly, the following week);

  • The levels of gross international reserves and of net international reserves as defined under the NIR concept (daily, the next business day);

  • The BCB's position in FX futures, including notional amounts of open-interest contracts, both bought and sold, in each contract for the next four months (daily, the next business day if this position should exceed zero);

  • Outstanding stocks of US$-indexed federal debt by instrument, showing auction values (preço de lastro) and updated nominal values (valor nominal atualizado), as well as information on rollovers of these instruments, showing the face value of the amounts falling due, and new placements of this debt (following each auction, with a one-day lag);

  • Quantitative results of the monitoring of the external credit lines of financial institutions (two business days after the deadline at which these institutions have to comply), and of external medium- and long-term bank claims on Brazilian nonbank debtors (once a week for the previous week).

V.  Program Assumptions for Selected Variables

The following Tables 2 and 3 set out program assumptions for selected variables.

Table 2. Baseline Assumptions for Selected Variables
(In millions of R$)

  Sep. Dec.   Mar. Jun. Sep. Dec.

Privatization receipts (cumulative/year)1 2,010 12,288   0 3,732 6,182 6,182
Recognition of previous liabilities and PROES (cumulative/year) 19,679 26,331   2,534 5,068 7,602 10,136

1 Excluding concession revenues.


Table 3. Assumption on Accounting Exchange Rates and Gold Prices1

  Program Assumptions
Third Quarter 2001

SDR (US$/SDR, end-period)
Gold price (US$/ounce, end-period)

1Currencies not shown here will first be converted using the official rate used by the Fund's Treasury Department as of August 31, 2001.


1Foreign currency debt denominated in currencies other than the US$ is first converted into US$ at actual average exchange rates for the period.
2The term "debt" has the meaning set forth in point No. 9 of the IMF's Guidelines on Performance Criteria with Respect to External Debt (Decision No. 12274-(00/85) of August 24, 2000).
3The term "debt" has the meaning set forth in point No. 9 of the IMF's Guidelines on Performance Criteria with Respect to External Debt (Decision No. 12274-(00/85) of August 24, 2000).