IMF Executive Board Concludes 2016 Article IV Consultation with Brazil

IMF News, November 15, 2016

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Brazil is poised to emerge from a deep recession that involved marked contractions in 2015 and 2016 driven mainly by long-standing domestic issues, with terms of trade changes and weak global demand also important.
Key factors behind the recession: tighter financial conditions, slowing credit, political uncertainty, declining investment and consumption, rising unemployment, sharp realignment of regulated prices, and monetary policy tightening.
Government measures since May 2016:
- Sent to Congress a constitutional amendment limiting the growth in federal noninterest spending to the rate of consumer price inflation of the previous year for the next 20 years.
- Announced a reform of the social security system.
IMF staff view: a strong push to implement proposed expenditure-side measures would help restore policy credibility, market confidence, investment, and growth; early implementation would also help moderate inflation expectations and facilitate monetary policy easing.

Staff project output growth of -3.3 percent in 2016 and about ½ percent in 2017 (projection assumes approval of the fiscal spending cap and social security reform in a reasonable timeframe and meeting proposed fiscal targets for 2016 and 2017).
Headline and core inflation have been above the central target and around the upper limit of the central bank’s tolerance range for several years.
In 2016 some price increases began to moderate, but disinflation proceeded slowly due to above-target, albeit declining, inflation expectations and rising food prices.
Monetary policy remained at a tight stance for over a year; Directors recommended monetary policy should remain relatively tight until more tangible progress in fiscal adjustment and reforms is made and inflation expectations move closer to the central bank’s inflation target.
Central bank foreign exchange operations:
- Lowered the net notional value of outstanding FX swaps to about US$35 billion (from a high of about US$110 billion) by issuing reverse swaps and failing to roll over maturing swaps.
- International reserves are above most IMF adequacy and other standard indicators.

Current account deficit narrowed from 4.3 percent of GDP in 2014 to 3.3 percent in 2015.
FDI fully financed the current account deficit in 2015.
External position remained moderately weaker than the level consistent with fundamentals, reflecting the reversal of exchange rate depreciation in 2015.
Balance of payments (selected items, in billion of U.S. dollars where provided):
- Exports: 224.1 (2014), 190.1 (2015), 197.6 (2016 proj.), 206.7 (2017 proj.)
- Imports: 230.7 (2014), 172.4 (2015), 149.1 (2016 proj.), 158.1 (2017 proj.)
- Current account: -104.2 (2014), -58.9 (2015), -14.7 (2016 proj.), -29.5 (2017 proj.)
- Foreign direct investment (net): 70.9 (2014), 61.6 (2015), 61.8 (2016 proj.), 56.7 (2017 proj.)

Fiscal outcomes:
- Non-financial public sector primary deficit: 1.9 percent of GDP in 2015; expected to reach 2.7 percent of GDP in 2016.
- Overall deficit: 10.4 percent of GDP in 2015; overall balance in 2016 expected to be close to that observed in 2015.
Staff and Directors emphasized the need for fiscal consolidation to ensure macroeconomic stability and debt sustainability.
Public debt indicators (selected):
- Net public sector debt: 33.1 (2014), 36.2 (2015), 45.9 (2016 proj.), 50.9 (2017 proj.), 54.1 (2018 proj.), 56.8 (2019 proj.), 59.7 (2020 proj.), 62.5 (2021 proj.)
- NFPS gross debt: 63.3 (2014), 73.7 (2015), 78.4 (2016 proj.), 82.9 (2017 proj.), 85.7 (2018 proj.), 88.2 (2019 proj.), 90.9 (2020 proj.), 93.5 (2021 proj.)

Banking sector: health deteriorated somewhat but remains solid.
- System-wide capital ratios fell in 2015 but remain well above regulatory minima.
- Liquidity risk increased in 2015, but overall funding profile remained strong.
- External funding exposures are low and foreign exchange risks are largely hedged.
- Profitability declined due to a spike in provisions for loan losses and higher funding costs.
- Non-performing loans (NPLs) at 4.1 percent; loan loss reserves cover 150 percent of NPLs.
Directors recommended enhancing the financial safety net, continued vigilance, and close monitoring of corporate sector vulnerabilities and links to banks.

Directors strongly recommended stepping up structural reform efforts to raise long-term growth, including in:
- Tax policy
- Labor markets
- Infrastructure
Directors also underscored the importance of trade reforms to increase competitiveness and efficiency.
Social security reform was emphasized as central to fiscal viability and to making the federal spending cap workable; reforms are needed for civil servant schemes at all levels of government.
Directors urged strengthened reporting of fiscal statistics for SOEs, public banks, and states’ finances, and encouraged monitoring and enforcement of subnational fiscal rules.
Directors commended Brazil for effective implementation of AML/CFT measures and encouraged pursuit of further reforms.

Staff expect activity to start to recover gradually but remain weak for a prolonged period.
Outlook contingent on: approval of fiscal spending cap and social security reform in reasonable timeframe, and meeting proposed fiscal targets for 2016 and 2017.
Downside risks include:
- Re-intensification of political uncertainties (e.g., developments in the corruption probe).
- Protracted slower growth in advanced and emerging economies, especially China.
- Further declines in export commodity prices.
- Tighter global financial conditions.

Population total (million) (est., 2015): 204.5
Annual rate of growth (percent, 2015): 0.8
GDP (2015): R$5,904 billion; US$1,773 billion
GDP per capita (est., 2015): US$8 billion
Unemployment rate (average, 2016): 11.6
Consumer price index (IPCA, end of period): 6.4 (2014), 10.7 (2015), 5.0 (2016 proj.), 4.8 (2017 proj.), 4.5 (2018 proj.)
Gross domestic investment (percent of GDP): 21.0 (2014), 19.2 (2015), 18.4 (2016 proj.), 18.9 (2017 proj.), 19.4 (2018 proj.), 20.1 (2019 proj.), 20.7 (2020 proj.), 21.3 (2021 proj.)
Gross official reserves (billion of U.S. dollars): 363.6 (2014), 356.5 (2015), 369.3 (2016 proj.)

Press Release No. 16/507 — IMF Executive Board Concludes 2016 Article IV Consultation with Brazil.

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