Public Information Notice: IMF Concludes 2003 Article IV Consultation with Brazil

IMF News, March 24, 2003

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Public Information Notice: IMF Concludes 2003 Article IV Consultation with Brazil

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• Published: March 24, 2003

Background: 2002 macroeconomic developments

• External environment and concerns about policy continuity after the change in government led to:
  • Sharp decline in external capital flows, depreciation of the real, and drop in rollover rates on domestic debt.
• Trade and current account:
  • Trade balance rose to US$13.1 billion, five-times the level recorded the previous year.
  • Current account deficit fell to US$7.8 billion, from more than US$23 billion in 2001.
• Output and inflation:
  • Real GDP growth for 2002: 1.5 percent.
  • Consumer price inflation for the year: 12.5 percent, driven largely by tradable goods prices and administered prices.
• Capital flows and reserves:
  • Foreign direct investment in 2002: about US$16.6 billion (US$6 billion below the previous year's total).
  • Net foreign portfolio flows dropped by about US$4 billion from their previous year's level.
  • Net international reserves (as defined under the Stand-By Arrangement): US$14.2 billion at end-year (US$9.2 billion above the program floor).
  • Gross international reserves: US$37.8 billion.
• Financial market volatility in 2002:
  • Between April and October: currency depreciated by 60 percent; sovereign risk spreads reached 2,400 basis points.
  • By mid-March (2003): exchange rate had recovered more than 10 percent of its value relative to last October and risk spreads had fallen by more than half.
• Fiscal and monetary developments:
  • 12-month accumulated primary surplus of the consolidated public sector: 3.9 percent of GDP in December (in line with the program target).
  • Net public debt: 56 percent of GDP at end-December 2002 (from 52.6 percent of GDP at end-2001), reflecting primarily the depreciation of the real.
  • Central bank policy: tightened aggressively—overnight interest rate raised by 700 basis points during the fourth quarter of 2002 and an additional 150 basis points so far in 2003.
  • Inflation expectations for 2003 remain above 12 percent, compared to the central bank's operational target of 8.5 percent for the year.
• Structural reform progress in 2002:
  • Legislation approved initiating conversion of domestic turnover taxes into a value added type tax.
  • Measures introduced to improve bank supervision.
  • Delays on pension reform and the new central bank law, owing in part to election-related congressional recesses.

Executive Board Assessment: vulnerabilities, responses, and priorities

• Overall view:
  • Brazil has made considerable progress in addressing economic imbalances and improving social indicators, while maintaining disciplined fiscal and monetary policies.
  • Events in 2002 demonstrated Brazil's vulnerability to shifts in investor sentiment; sources of vulnerability include the size and structure of the public debt, the external borrowing requirement, and slow economic growth.
• Commendations and market impact:
  • Directors commended the new government's decisive actions and commitment to policy discipline and structural reforms, noting improvement in market sentiment, declining risk spreads, and a strengthening currency.
• Fiscal stance and medium-term objectives:
  • Welcomed decision to raise the primary fiscal surplus target for 2003 to 4¼ percent of GDP.
  • Encouraged operationalizing medium-term surplus targets to keep public debt on a sustainable path; attainment would provide greater insurance against shocks and could lower risk spreads and interest rates, speed output growth, and further reduce the debt ratio.
• Pension, tax, and budget reforms:
  • Commended efforts to build consensus for pension and tax reform, noting agreement with all 27 state governors.
  • Pension reform viewed as key to maintaining medium-term primary surpluses and narrowing differences between public and private systems, with attention to compatibility with short- and medium-term fiscal objectives.
  • Noted rigid budget structure limits fiscal policy responsiveness and shifts adjustment burden onto investment spending; welcomed commitment to increase budget flexibility and limit earmarking in the context of a broad tax reform to be submitted to Congress in June 2003.
  • Agreed that tax reform objective should be to streamline and simplify the tax system to reduce distortions and administrative costs and make the system more transparent and equitable.
  • Welcomed intention to continue reducing the degree of indexation of the public debt stock to the exchange rate and to interest rates, as market conditions allow.
• Monetary and inflation policy:
  • Observed depreciation-led increase in traded goods prices spilled over into nontraded goods' prices; inflation expectations risked becoming entrenched.
  • Supported authorities' policy response and advised vigilance and readiness to act as needed.
  • Welcomed authorities' commitment to formalize the operational autonomy of the central bank.
• Structural reforms to boost growth and reduce poverty:
  • Sustained structural reform implementation, complementing sound fiscal and monetary policies, is important for growth and poverty reduction.
  • Important reforms include tax and pension reforms, measures to improve governance, transparency, the investment climate, and to boost trade.
  • Welcomed intention to seek reductions in trade barriers at bilateral, regional and multilateral levels to boost medium-term investment and growth and reduce external vulnerabilities.
  • Noted that addressing the poorest' needs requires economic growth plus more effective targeting of social spending; commended authorities' initiatives in this area.
  • Welcomed moves to reduce very high banking spreads through reforms of the bankruptcy law and encouraged continued labor market reforms.
  • Observed significant progress in establishing a comprehensive anti-money laundering institutional framework and commitment to ratify and implement main anti-terrorism and anti-money laundering agreements.

Policy recommendations and expected follow-up

• Fiscal policy:
  • Maintain primary surpluses over the medium term at levels sufficient to keep public debt on a sustainable path.
  • Set ambitious medium-term fiscal targets to provide insurance against shocks.
  • Increase budget flexibility and limit earmarking through broad tax reform.
  • Streamline and simplify the tax system to reduce distortions, administrative costs, and improve equity and transparency.
• Monetary policy and central bank governance:
  • Remain vigilant on inflation and be prepared to tighten policy if needed.
  • Formalize the operational autonomy of the central bank.
• Structural reforms:
  • Implement pension reform compatible with short- and medium-term fiscal objectives.
  • Improve governance, transparency, and the investment climate.
  • Pursue reductions in trade barriers to increase outward orientation.
  • Target social spending more effectively to assist the poorest.
  • Continue reforms to reduce banking spreads (including bankruptcy law reform) and press on with labor market reforms.
  • Ratify and implement key anti-terrorism and anti-money laundering agreements.

Brazil: Selected Economic Indicators (as reported)

• Domestic economy (in percent)
  • Change in real GDP: 1998: 0.1; 1999: 0.8; 2000: 4.4; 2001: 1.4; 2002: 1.5
  • Unemployment rate: 1998: 7.6; 1999: 7.1; 2000: 6.2; 2001: 7. 1; 2002: (not listed)
  • Inflation (IPCA, end-year): 1998: 1.7; 1999: 8.9; 2000: 6.0; 2001: 7.7; 2002: 12.5
• External economy (in billions of U.S. dollars)
  • Exports, f.o.b.: 1998: 51.1; 1999: 48.0; 2000: 55.1; 2001: 58.2; 2002: 60.4
  • Imports, f.o.b.: 1998: 57.7; 1999: 49.2; 2000: 55.8; 2001: 55.6; 2002: 47.2
  • Current account balance: 1998: -33.4; 1999: -25. 3; 2000: -24.2; 2001: -23.2; 2002: -7.8
  • Capital account balance: 1998: 29.7; 1999: 17.3; 2000: 19.3; 2001: 27.9; 2002: 12.0
  • o/w Foreign direct investment: 1998: 28.9; 1999: 28.6; 2000: 32.8; 2001: 22.5; 2002: 16.6
  • Gross official reserves: 1998: 44.6; 1999: 36.3; 2000: 33.0; 2001: 35.9; 2002: 37.8
  • Current account balance (in percent of GDP): 1998: -4.2; 1999: -4.7; 2000: -4.0; 2001: -4.5; 2002: -1.7
• Financial variables (in percent of GDP or percent)
  • Public sector borrowing requirement 1/: ... ; 1999: 5.8; 2000: 3.6; 2001: 4.6
  • Public sector primary balance: -- ; 1999: 3.2; 2000: 3.5; 2001: 3.9
  • Gross external public debt: 1998: 12.4; 1999: 17.1; 2000: 15.9; 2001: 17.7; 2002: 24.7
  • Change in broad money (in percent): 1998: 9.8; 1999: 14.6; 2000: 11.3; 2001: 13.1; 2002: 24.0
  • Average overnight interest rate (in percent): 1998: 31.2; 1999: 25.6; 2000: 17.4; 2001: 19.1; 2002: (not listed)
• Source of indicators: Brazilian authorities and IMF staff estimates.
• Footnote 1/: Harmonized public sector borrowing requirement (excluding the impact on the debt stock of exchange rate movements occurred during the reference period that will not be paid until the bond matures).

Public Information Notice: IMF Concludes 2003 Article IV Consultation with Brazil — March 24, 2003. Executive Board concluded the Article IV consultation on March 14, 2003.

References

• Brazil and the IMF
• Public Information Notices
• Article IV
• https://www.imf.org/en/home