Brazil: Staff Concluding Statement of the 2020 Article IV Mission

IMF News, October 5, 2020

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Brazil: Staff Concluding Statement of the 2020 Article IV Mission

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• Published: October 5, 2020

Pre-Covid: Macroeconomic context and structural reforms

• Brazil experienced the slowest recovery on record after the 2015-16 recession, with GDP growth during 2017-19 described as "disappointingly low" and among the 10 percent weakest recoveries around the world in the last 50 years.
• Key reforms and policy developments before 2020:
  • Pension reform passed in October 2019 that "stabilized pension spending as a share of GDP."
  • Draft legislations submitted to control government spending, improve tax efficiency, and decentralize fiscal resources.
  • Adoption of the constitutional expenditure ceiling in 2016.
  • Core inflation below target enabled the Central Bank (BCB) to cut the policy rate to a record low of 4.25 percent by early 2020.
  • Structural transformation of financial markets and deepening capital markets with new retail investors.

The Covid-19 shock: impact on health, labor, and financial markets

• Health and labor impact:
  • "More than140,000 Brazilians have died and 4.8 million have been infected."
  • Economic activity contracted by 7 percent in the first half of 2020, "the largest contraction in 30 years."
  • Almost 12 million jobs were lost between February and July, of which over 7 million were from the informal sector.
  • Unemployment rate rose by about 2 percentage points to 13.8 percent; 11 million workers (over 10 percent of the workforce) left the labor force altogether.
  • Households at the lowest income decile lost 30.2 percent of their monthly income.
  • Women experienced a decline in hours worked of 36.2 percent versus 27 percent for men.
• Financial flows and external sector:
  • Portfolio outflows amounted to US$32 billion in March and April; outflows over 2015-19 totaled around US$47 billion.
  • The Real weakened significantly; international reserves recovered to end-2019 levels but non-resident portfolio outflows have not yet reversed.
• Policy response and stabilization measures:
  • Congress declared a state of public calamity enabling fiscal/quasi-fiscal measures amounting to 18 percent of GDP.
  • Primary fiscal deficit rose to 12 percent of GDP.
  • Emergency Aid (Auxílio Emergencial):
  • Lifted the income of an estimated 23 million individuals—10 percent of the total population—above the extreme poverty line.
  • Extended to 67.7 million individuals; average fiscal costs for nine months expected to reach around 4.6 percent of GDP.
  • Noted as "close to 10 times the annual cost of the well regarded Bolsa Familia program."
  • Employment retention scheme subsidized temporary reductions in hours and is estimated to have saved up to 10 million jobs at a cost of around 0.4 percent of GDP between April and September.
  • Government-backed credit lines to SMEs helped save 2 million jobs.
  • BCB actions:
  • Cut policy rate by 225 bps in quick succession to 2 percent.
  • Sold US$38 billion in the spot and derivatives market during March and April.
  • Announced extensive liquidity and capital relief measures.
  • Congress passed legislation allowing the BCB to purchase public and private assets for financial stability purposes while a state of public calamity is in force (option not yet used).

Outlook and macroeconomic risks

• Growth and current account projections:
  • Economy projected to shrink by 5.8 percent in 2020, followed by partial recovery to 2.8 percent in 2021.
  • Current account projected to post a small surplus of 0.3 percent of GDP in 2020 and to balance in 2021.
• Fiscal and debt projections:
  • Gross public debt projected to jump to around 100 percent of GDP in 2020 and remain high over the medium-term.
  • Gross financing needs of 29 percent of GDP in 2020 are being met through domestic issuances and use of liquid assets (Treasury deposits at the BCB).
  • Record low SELIC and shorter average debt maturities have reduced borrowing costs to historically low levels (5 percent relative to a high of close to 15 percent in late 2016).
  • Brazil faces a "very steep local currency yield curve," signalling market concerns over fiscal sustainability.
• Key risks and strengths:
  • Downside risks: second wave of the pandemic, long-term scarring from a protracted recession, vulnerability to confidence shocks given high public debt.
  • Upside potential: recession could be less severe or recovery more robust than projected.
  • Strengths: "sizable international reserves, a resilient banking system, and a low share of public FX debt."
  • International reserves are "about 150 percent of the IMF’s benchmark (ARA) metric and 250 percent of external debt."

Near-term policy priorities: saving lives and livelihoods

• Fiscal anchor and consolidation:
  • "Authorities’ steadfast commitment to the expenditure ceiling is welcome."
  • Preserving the constitutional expenditure ceiling is essential to support market confidence and keep the sovereign risk premium contained.
  • Substantial fiscal consolidation required to close the primary deficit; mission projects consolidation as necessary to stabilize public debt over the medium-term.
• Conditional additional support:
  • Authorities should be prepared to provide additional fiscal support if health, economic, and social conditions worsen.
• Structural reforms to lock in medium-term consolidation—recommended focuses:
  • Reducing mandatory spending and budget rigidities:
  • Discretionary spending currently limited to less than 7 percent of the Federal Budget (1.5 percent of GDP).
  • Suggested measures: overhaul civil service career structures to reduce wages and pensions burden; reduce earmarking; de-link social benefits from minimum wage increases.
  • These measures "could at a minimum release one percent of GDP annually for discretionary spending."
  • Reform subnational pension schemes in line with federal provisions and reduce state personnel spending to comply with Fiscal Responsibility Law limits.
  • Strengthening the social safety net:
  • Holistic review to eliminate inefficient and regressive programs.
  • Expected savings of at least 0.3 percent of GDP under the expenditure ceiling to fund an expanded Bolsa Familia program on a permanent basis while preserving efficient targeting.
  • Revamping the tax system:
  • Simplify indirect taxes, reduce payroll costs and tax expenditures, and adopt more progressive labor and capital income taxation.
  • Implicit and explicit fiscal incentives are approaching 5 percent of GDP and could be a source of revenues to improve the primary balance and reduce debt.
• Monetary and financial policy role in 2021:
  • With withdrawal of fiscal stimulus, monetary policy "carries the burden of supporting the economy."
  • Current policy rate of 2 percent corresponds to a negative real rate and is "strongly expansionary."
  • Room to cut the policy rate further if inflation and inflation expectations remain below target, while monitoring capital outflows and financial stability.
  • Use of forward guidance conditional on a sound fiscal regime recommended.
  • Temporary reduction in the reserve requirement ratio could be made permanent to reduce banks’ liquidity costs.
  • If conventional monetary policy is exhausted, BCB has the option to use QE.
  • Approval of formal Central Bank independence would further strengthen the monetary framework.
• Banking system resilience and supervisory recommendations:
  • Solvency stress tests suggest banking system will remain resilient; banks have increased provisions.
  • Use regulatory flexibility to weather short-term impact without diluting prudential standards.
  • If needed, banks should draw down capital conservation buffers; allow liquidity coverage ratio to fall below 100 percent in system-wide liquidity stress and BCB could expand collateral base of lending facilities.
• Structural agenda to raise potential growth:
  • Urgent need for reforms to make the economy more competitive and attractive to investment.
  • Support for the BCB's BC# Agenda to improve market efficiency and reduce the cost of credit.
  • Calls for renewed push to pass comprehensive tax reform, finalize trade agreements with the EU and others, conclude the GPA with the WTO, and accelerate concessions and privatizations.
  • Newly approved sanitation and sewage bill is welcomed and expected to spur infrastructure projects and investments.
• Anti-corruption and AML/CFT priorities:
  • Authorities should continue to prioritize the fight against corruption and money laundering and prevent legal and institutional setbacks.
  • Preparations for FATF/GAFILAT AML/CFT assessment underway (national risk assessment and AML/CFT risk-based financial supervision).
  • Legislative initiative to amend AML/CFT law should involve all stakeholders to ensure FATF compliance.
  • Additional measures recommended: enhance sharing of beneficial ownership information, and strengthen frameworks for asset disclosures, lobbying, and whistleblower protection.

Key statistics and selected indicators (as presented)

• Area (thousands of sq. km): 8,512
• Agricultural land (percent of land area): 28.7
• Physician per 1000 people (2018): 2.1
• Hospital beds per 1000 people (2018): 2.0
• Population, Total (million) (est., 2019): 210.1
• Annual rate of growth (percent, 2018): 0.8
• Density (per sq. km.) (2018): 24.7
• Access to safe water (2015): 98.1
• Adult illiteracy rate (2016): 7.2
• Unemployment rate (2019): 11.9
• Net enrollment rates, Primary education (2017): 99
• Net enrollment rates, Secondary education (2015): 84
• Life expectancy at birth (years): 76
• Infant mortality (per thousand live births): 13
• Poverty rate (in percent, 2017) 1/: 25.4
• Ratio between average income of top 10 percent of earners over bottom 40 percent (2017): 12.4
• GDP, local currency (2019): R$7,257 billion
• GDP, dollars (2019): US$1,839 billion
• GDP per capita (2019): US$8,751
• Gini coefficient (2017): 54.9
• Main export products: airplanes, metallurgical products, soybeans, automobiles, electronic products, iron ore, coffee, and oil.

Selected projections (Percentage change unless noted)

• GDP at current prices: 2017 5.0; 2018 4.6; 2019 5.3; 2020 -2.6; 2021 6.3; 2022 6.5; 2023 6.2
• GDP at constant prices: 2017 1.3; 2018 1.1; 2019 -5.8; 2020 2.8; 2021 2.3; 2022 2.2
• Consumption: 2017 1.4; 2018 1.7; 2019 -6.4; 2020 2.9; 2021 1.5
• Investment: 2017 2.4; 2018 3.1; 2019 3.6; 2020 -10.8; 2021 6.6; 2022 5.6; 2023 6.1
• Consumer prices (IPCA, end of period): 2017 3.7; 2018 4.3; 2019 3.2; 2020 3.3
• Gross domestic investment, Private sector (percent of GDP): 2017 12.3; 2018 12.7; 2019 13.1; 2020 12.9; 2021 13.5; 2022 14.0; 2023 14.5
• Gross national savings (percent of GDP): 2017 20.4; 2018 18.6; 2019 17.2; 2020 30.6; 2021 20.3; 2022 19.6; 2023 19.8; 2024 20.2; 2025 20.5
• Central government primary balance 2/: 2017 -1.9; 2018 -1.8; 2019 -1.3; 2020 -11.7; 2021 -3.0; 2022 -2.0; 2023 -0.6; 2024 -0.1
• NFPS primary balance: 2017 -1.7; 2018 -1.0; 2019 -12.0; 2020 -3.1
• NFPS overall balance: 2017 -7.9; 2018 -7.2; 2019 -16.8; 2020 -5.6; 2021 -5.9
• Net public sector debt (percent of GDP): 2017 51.4; 2018 53.6; 2019 55.7; 2020 68.5; 2021 74.0; 2022 76.9; 2023 79.1; 2024 81.2; 2025 82.8
• General Government gross debt, Authorities’ definition: 2017 73.7; 2018 76.5; 2019 75.8; 2020 99.0; 2021 100.0; 2022 100.5; 2023 100.6
• NFPS gross debt: 2017 83.7; 2018 87.1; 2019 89.5; 2020 101.4; 2021 102.8; 2022 103.5; 2023 103.8; 2024 104.2; 2025 104.4
• Of which: Foreign currency linked: 2017 4.1; 2018 4.7; 2019 4.5; 2020 4.4
• Base money (annual percentage change): 2017 9.6; 2018 1.6; 2019 9.9
• Broad money (annual percentage change): 2017 8.1; 2018 9.1; 2019 10.2; 2020 8.3; 2021 8.0
• Bank loans to the private sector (annual percentage change): 2017 7.7; 2018 5.5; 2019 10.0; 2020 12.0; 2021 9.0; 2022 8.5
• Trade balance (billions of U.S. dollars): 2017 64.0; 2018 53.0; 2019 40.5; 2020 62.8; 2021 62.9; 2022 71.1; 2023 73.0
• Exports (billions of U.S. dollars): 2017 218.1; 2018 239.5; 2019 225.8; 2020 221.1; 2021 238.7; 2022 248.3; 2023 258.9; 2024 270.6; 2025 282.7
• Imports (billions of U.S. dollars): 2017 154.1; 2018 186.5; 2019 185.3; 2020 158.3; 2021 175.8; 2022 179.7; 2023 187.8; 2024 197.6; 2025 209.1
• Current account (billions of U.S. dollars): 2017 -15.0; 2018 -41.5; 2019 -50.9; 2020 0.2; 2021 -4.1; 2022 -8.3; 2023 -13.6
• Total external debt (percent of GDP): 2017 32.3; 2018 35.3; 2019 37.0; 2020 48.3; 2021 45.2; 2022 41.0; 2023 38.4; 2024 36.0; 2025 34.2
• Foreign direct investment (net inflows, billions of U.S. dollars): 2017 47.5; 2018 76.1; 2019 50.7; 2020 68.1; 2021 37.4; 2022 31.4; 2023 27.6; 2024 26.8
• Terms of trade (percentage change): 2017 5.8; 2018 0.9; 2019 -0.9; 2020 -1.2
• Merchandise exports (in US$, annual percentage change): 2017 18.3; 2018 9.8; 2019 -5.7; 2020 7.9; 2021 4.0
• Merchandise imports (in US$, annual percentage change): 2017 21.0; 2018 -14.6; 2019 11.0; 2020 5.2
• Memorandum items:
  • Current account (in percent of GDP): 2017 -2.2; 2018 -2.8; 2019 0.3; 2020 -0.5
  • Unemployment rate: 2017 12.8; 2018 13.4; 2019 14.1; 2020 13.3; 2021 12.5; 2022 11.6; 2023 10.8
  • Gross official reserves: 2017 374; 2018 375; 2019 357
  • REER (annual average in percent; appreciation +): 2017 -10.4

Source: IMF staff concluding statement, "Brazil: Staff Concluding Statement of the 2020 Article IV Mission", October 5, 2020.

References

• Brazil and the IMF
• IMF Policy Advice -- A Factsheet
• The IMF and Good Governance -- A Factsheet
• Mission Concluding Statements
• PRESS CENTER
• https://www.imf.org/en/home