Fiscal Discipline Critical to Restoring Growth in Brazil

IMF News, November 15, 2016

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Brazil appears to be exiting from a deep recession.
A gradual recovery is expected to start in the second half of 2016, assuming that reforms continue, political uncertainty diminishes, and that other economic shocks run their course.
IMF projected output growth of -3.3 percent in 2016 and 0.5 percent in 2017.
Since the beginning of 2015, the unemployment rate has doubled to more than 11 percent and 2.7 million formal jobs have been lost.
Key risks to the outlook:
- Domestic: the new government fails to deliver on its fiscal consolidation strategy and provide a lasting boost to confidence.
- External: an extended period of slower growth in advanced and emerging economies, especially China, further declines in export commodity prices, and tighter financial conditions.
- Upside: faster-than-expected progress on the reform agenda could spark a more vigorous recovery in investment and boost foreign interest.

Restoring long-term fiscal sustainability is central to restoring growth and credibility.
The report welcomes the new government’s focus to control fiscal spending growth by imposing a cap on spending in real terms and reforming the social security system.
Approval and successful implementation of the spending cap would be a game-changer for Brazil.
Other measures to contain spending include:
- improving the allocation of public funds,
- ending revenue earmarking,
- containing payroll growth.
An emerging priority is expenditure control at the regional level.
The spending cap by itself would take several years to stabilize and begin to reduce public debt; given the risks associated with such a prolonged period of fiscal adjustment, the IMF called for more measures to speed up fiscal consolidation and for greater efforts to boost potential output growth over the medium term.

Inflation has been above the central bank’s target for the past several years.
Given uncertainty about the output gap, approval of key reforms, and related movements in the exchange rate, the IMF argued that maintaining current monetary policy settings would be broadly appropriate.
Tangible progress on fiscal consolidation would allow more room for monetary easing to support the recovery and help moderate inflation.
The IMF welcomed the government’s intention to strengthen the inflation targeting framework by enhancing the independence of the central bank and improving central bank communication.
The report also welcomed the use of exchange rate flexibility as the first line of defense against shocks; intervention in foreign exchange markets should remain limited to episodes of disorderly market conditions, and reserve buffers should be preserved.

The Brazilian banking system remains largely sound, but its resilience should be reinforced.
The IMF welcomed:
- the moderation in the growth rate of credit by public banks,
- the plans to reduce direct financing of large corporations with market access,
- the intention of the two largest public banks to strengthen their capital position.
Enhanced monitoring and improved financial safety nets would also help strengthen the banking sector.

International Monetary Fund — Fiscal Discipline Critical to Restoring Growth in Brazil (November 15, 2016).