## Brazil: Staff Concluding Statement of the 2016 Article IV Mission

_IMF News, September 29, 2016_

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**Canonical URL:** [Brazil: Staff Concluding Statement of the 2016 Article IV Mission](https://www.imf.org/en/news/articles/2016/09/29/ms092916-brazil-staff-concluding-statement-of-the-2016-article-iv-mission)

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## Bibliographic details
- Published: September 29, 2016

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### I. Context and Recent Developments
- Brazil is in a deep recession with multiple causes: policy failures on long-standing structural problems; declining terms of trade; tight financing conditions; steep increases in electricity tariffs; a corruption scandal; and a political crisis leading to heightened uncertainty.
- The recession has caused a large contraction of output, a massive toll on employment, and slowed progress on reducing social inequalities.
- Inflation has exceeded the top end of the target band since 2015, with disinflation proceeding slowly despite a large output gap.
- Fiscal sustainability is at risk:
  - Fiscal position, including at the subnational level, is at its worst level in over two decades.
  - Decline in potential growth and persistently high real interest rates have worsened debt dynamics.
- Government policy actions and reforms:
  - Proposed cap on the growth in federal noninterest spending at the rate of consumer-price inflation in the previous year.
  - Announced plans for social security reform.
  - Regulatory reforms to support concessions and privatization program; strengthened governance for state-owned enterprises.
  - Major public enterprises and banks, notably Petrobras and BNDES, placed under new management.
  - Markets have responded positively to decreasing uncertainty and improved sentiment toward emerging economies.

### II. Outlook
- Growth projections:
  - Output growth projected at -3.3 percent in 2016.
  - Output growth projected at about ½ percent in 2017.
  - Projection contingent on approval of the fiscal spending cap and social security reform in a reasonable timeframe and meeting proposed fiscal targets for 2016 and 2017.
- Recovery dynamics:
  - Investment projected to recover if uncertainty continues to decline, supporting gradual return to positive sequential growth beginning in late 2016.
  - Recovery impeded by excess corporate leverage, high unemployment, and weak household balance sheets.
  - Inflation expected to gradually converge toward the midpoint of the target band.
- Risks to the outlook:
  - Downside risks dominate: failure to deliver core fiscal consolidation; reforms watered down or stalled in Congress; re-intensification of political uncertainties; protracted slow growth externally (especially China); further commodity price declines; tighter external financial conditions.
  - Upside risks: recent policy pronouncements boosting confidence and asset prices; faster-than-expected approval of spending cap and social security reform could reduce risk premia and trigger stronger investment and growth (including via M&A activity).

### III. Policy Recommendations — Fiscal
- Core recommendation:
  - Controlling the growth of fiscal spending is imperative; approval and steadfast implementation of the spending cap could be a game changer for long-term public spending trajectory and permit stabilization and eventual reduction of public debt as a share of GDP.
- Address structural drivers of public expenditure growth — key areas:
  - Social security:
    - Move expeditiously on broad-based reform covering retirement age rules, replacement rates, access to benefits, duplication of benefits, annual growth of payments, and regimes for public sector employees at all levels.
    - Include provisions to protect the most vulnerable given high inequality.
  - Subnational governments:
    - Contain upward expenditure trajectories in many states through adoption of a rule similar to the federal proposal.
    - Enact enabling legislation for states to make difficult expenditure adjustments; increase transparency in expenditure reporting.
  - Fiscal framework:
    - Strengthen the medium-term fiscal framework; reduce budgetary rigidities (including tax earmarking); increase flexibility in composition of spending.
    - Recommended consolidation of Petrobras and Eletrobras into non-financial public sector statistics (without including them in fiscal targets calculation) to improve transparency and fiscal risk management.
  - Minimum wage and indexation:
    - Revise the formula for minimum wage revisions and the link between social benefits and the minimum wage to address medium-term fiscal pressures; revise the minimum wage formula to better reflect productivity improvements.
  - Spending efficiency:
    - The spending cap will require government agencies to make better use of resources to prevent declines in service quality.

- Fiscal consolidation timing and composition:
  - Consolidation based solely on the spending cap would take several years to stabilize public debt and carries risks: public sector debt as a ratio of GDP would continue to grow for a number of years before peaking and declining gradually; overall deficit would remain high for an extended period, crowding out private agents.
  - Merit in a more frontloaded consolidation:
    - Possible objective: reach a primary balance of around 3½ percent of GDP over the next 5 years, which would stabilize debt by 2021.
    - Consider a combination of expenditure and revenue measures; measures could be designed to take effect once economic growth has firmed up to mitigate short-run output costs.

### IV. Policy Recommendations — Monetary, Exchange Rate, Financial Sector
- Monetary policy:
  - Should remain tight until inflation expectations converge more clearly toward the center of the target band.
  - Current monetary policy settings considered broadly appropriate given inflation expectations.
  - Tangible progress on public finance sustainability would allow more room for monetary easing to support recovery.
- Exchange rate and FX intervention:
  - Exchange rate should remain the first line of defense against shocks.
  - Foreign exchange intervention should be limited to episodes of clear market disruption and high volatility; reserve buffers should be preserved.
  - Support continuation of central bank policy of reducing the net notional value of FX swaps; use of reverse FX swaps is a useful supplementary tool.
- Banking sector resilience and safety nets:
  - Banking system largely sound but profitability and asset quality affected by recession.
  - Mission welcomes moderation in growth of credit by public banks; plans to reduce direct financing of large corporations with market access; intentions of largest public banks to strengthen capital positions.
  - Recommendations:
    - Improve financial safety nets: strengthen procedures for use of the deposit insurance fund; enhance central bank emergency liquidity assistance; modernize the resolution regime.
    - Put in place frameworks for identifying, preparing for, and responding to future risks involving all financial regulators.
    - Strengthen private insolvency frameworks to expedite bankruptcy and reduce default losses for banks.

### V. Policy Recommendations — Structural Reforms and Governance
- Structural reforms to hasten and strengthen recovery:
  - Infrastructure bottlenecks:
    - Implement announced enhancements and regulatory reforms to make concessions program more attractive while maintaining governance and program design standards.
  - Opening of the economy:
    - Reduce tariffs and nontariff barriers, revise domestic content requirements, and pursue free-trade negotiations outside Mercosur to boost competition, efficiency, and growth.
  - Efficient allocation of savings:
    - Review credit earmarking rules and other distortions to channel national savings to their most productive uses.
  - Labor reform:
    - Facilitate productive employment and reduce incentives for informality to promote job creation, investment, and growth.
  - Tax reform:
    - Simplify the State Tax on the Circulation of Goods and Services (ICMS).
    - Consolidate PIS/CONFIS and IPI and replace them with a true federal VAT to reduce cost of doing business.
- Transparency, anti-corruption and anti-money laundering:
  - Effective implementation of these measures would enhance predictability for businesses and perceptions of fairness.
  - Government commitments cited:
    - Make public procurement data open by default.
    - Implement recent legislation on conflict of interest.
    - Strengthen whistleblowing mechanisms.

*IMF Staff Concluding Statement, September 29, 2016.*

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## References

- [Brazil and the IMF](http://www.imf.org/external/country/BRA/index.htm)
- [Mission Concluding Statements](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2016/09/29/ms092916-brazil-staff-concluding-statement-of-the-2016-article-iv-mission_