May 25, 2018
PRESS OFFICER: Raphael Anspach
Phone: +1 202 623-7100Email: MEDIA@IMF.org
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’). This mission was undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
A mild recovery supported by accommodative monetary and fiscal policies is underway. But the output gap is large, public debt is high and increasing, and, more importantly, medium-term growth prospects remain uninspiring, absent further reforms. Against the backdrop of tightening global financial conditions, placing Brazil on a path of strong, balanced and durable growth requires an earnest pursuit of fiscal consolidation, ambitious structural reforms, and a strengthening of the financial sector architecture. This will require strong leadership and resolve. Recent measures, notably the ceiling on federal expenditures, and reforms of the labor and subsidized credit markets are welcome and should help boost confidence, but much more is needed. Over the near term, since inflation is below target and expectations are anchored, monetary policy should remain accommodative to facilitate a durable recovery, while fiscal consolidation should accelerate. The exchange rate should remain flexible to absorb external shocks.
A mild recovery is underway supported by accommodative policies . Monetary policy remains accommodative in the context of a large output gap and historically low inflation. The fiscal stance is also supportive with the primary deficit projected to widen from 1.7 to 2.4 percent of GDP in 2018, as implied by the budget. GDP growth is projected to accelerate from 1 percent in 2017 to about 2 percent in 2018, driven by private consumption and investment.
The financial sector has proven to be resilient, yet bank credit recovery is lagging . Despite the severity of the 2015-16 recession, banks remain well capitalized, profitable, and liquidity indicators are good. Public banks are reducing lending after the big expansion during the crisis, but private banks and capital markets are taking up the slack. Bank credit is increasing for households but continues contracting for nonfinancial corporates, which have lower profitability and liquidity than before the crisis. Though nonfinancial corporates remain vulnerable to shocks, banks have sufficient buffers to absorb possible losses.
The government has undertaken key policy actions to boost confidence and increase potential growth . The ceiling on federal primary expenditures provides a basis for fiscal adjustment over the next few years. The introduction of the market-based long-term interest rate (TLP) and the government-mandated reduction of BNDES’s balance sheets are reducing distortions in the credit market. The labor market reform has lowered ligation costs and increased flexibility.
External buffers are substantial . At over USD 370bn, reserves are large. The current account deficit declined to ½ percent of GDP in 2017, largely because of import contraction, and is projected to widen modestly to around 2 percent of GDP in the medium term and financed comfortably by sustained foreign direct investment. Public debt is predominantly denominated in reais, and external rollover needs for private and public debt are low, at about 8 percent of GDP per year. These factors, together with a flexible exchange rate, buttress Brazil’s resilience to external shocks.
The crisis had severe social costs . After falling for years, inequality and poverty increased during the crisis. Unemployment has fallen from its peak but is still above 12 percent, and the number of discouraged workers is very high. Jobless rates are significantly higher among the young, women, and Afro-Brazilians. As the recovery of formal employment is slow, many are seeking informal jobs or self-employment, without adequate social protection.
Downside risks prevail. The recovery is still fragile and shocks could weigh on growth. Failure to proceed expeditiously with fiscal consolidation and pass urgent reforms could undermine confidence, causing a sudden tightening of financial conditions and an attendant contraction in growth. The repeated failure to pass a strong pension reform, which is key for ensuring fiscal sustainability, remains a key risk. The rapid depreciation of some emerging market currencies is a reminder that external conditions can change swiftly, compounding the effect of domestic political uncertainty.
A more equitable, sustainable, and pro-growth fiscal policy
Fiscal consolidation should be strengthened . Under staff’s baseline scenario, which assumes that reforms to comply with the expenditure ceiling are implemented, the primary balance improves from a deficit of 2.4 percent of GDP in 2018 to a surplus of 0.5 percent of GDP in 2023. Over this period, public debt is projected to grow from 84 percent of GDP in 2017 to above 90 percent of GDP. To secure sustainability and rebuild buffers, the government should pursue a faster pace of consolidation and avoid a widening of the primary deficit in 2018. This is especially important given the debt dynamics and tightening global financial conditions.
Pension reform is essential for securing fiscal sustainability and to ensure fairness. At almost 60 percent of the federal primary spending, social security expenditure is very high, increasing, and unsustainable—Brazil is a clear outlier across most emerging market economies, including in Latin America. A comprehensive reform should aim at increasing the retirement age, delinking the minimum pension from the minimum wage, and moderating the undue generosity of pensions for some segments of the populations, notably public employees. Such reform will improve equity and subnational government finances.
Additional expenditure measures are needed to comply with the ceiling. The 2019 revision of the minimum wage adjustment formula provides an opportunity to contain mandatory spending. Moreover, reforms of public sector employment and compensation are needed to make the wage bill sustainable, reduce labor market distortions, and alleviate income inequality. Spending efficiency should be increased to create fiscal space, even as expenditures for effective social programs, including Bolsa Familia, and public investment are protected and, if possible, increased.
Tax measures aimed at improving efficiency and bolstering revenues should be prioritized . In particular, consideration should be given to eliminating tax expenditures, which cost about 4 percent of GDP, expediting plans to simplify the tax system, including the PIS/CONFINS reforms, and continuing efforts to harmonize the federal and state tax regimes.
The fiscal framework needs to be strengthened further . Recent measures to increase transparency taken by the National Treasury, the Court of Accounts, and the Independent Fiscal Institution are welcome. Further steps should include the introduction of common accounting standards across subnational governments, a medium-term budget framework, and greater budget flexibility. Fiscal rules should be consistent with the medium-term consolidation objective.
Monetary policy should remain accommodative
The monetary stance is appropriate. With inflation below target, reflecting the large output gap, and inflation expectations well-anchored, monetary policy should remain accommodative. Any change in the monetary policy stance should be data-dependent and based on an assessment of risks to inflation, taking into consideration both external factors and progress with fiscal consolidation. Enhancing central bank independence would further improve the inflation-targeting framework.
The flexible exchange rate regime is an important cornerstone of the policy framework. Intervention in the foreign exchange market should be limited solely to addressing excessive market volatility. International reserves at the current level provide an important buffer against large external shocks. Monetary policy should respond to movements in the exchange rate only insofar as there are clear risks for inflation expectations.
Strengthening the financial sector architecture
The underpinnings of the banking sector should be strengthened. The 2018 FSAP found banks to be broadly resilient to severe macro financial shocks. The authorities have implemented key reforms to strengthen supervision and regulation at both micro and systemic levels. However, independence of the BCB and legal protection of its staff would strengthen micro-prudential and safety net frameworks. The regulatory and supervisory approach should be upgraded to address related party exposures and transactions, large exposures, country and transfer risk, and restructured loans. Creating multi-agency committees with mandates for macroprudential policy and crisis management should be on the agenda.
The safety net framework should be improved. In particular, a new financial resolution regime in line with the FSAP recommendations should be put in place promptly. The process for providing emergency liquidity assistance should be tightened to avoid the risk of such assistance being provided to insolvent banks. In addition, the deposit guarantee fund should be brought into the public sector to help prevent conflict of interest and retain the mandate for financial stability in the public sector.
Further structural reforms would raise growth substantivelyAdvancing the structural reform agenda requires setting clear priorities. Brazil faces a long list of structural reforms that can boost productivity, but prioritization is key. Staff underscores the importance of measures to improve financial intermediation, enhance trade integration, and tackle corruption.
Improving financial intermediation will increase productivity. The FSAP found that high operating costs, large credit losses, as well as other factors, increase intermediation costs. The mission welcomes government plans to reduce bank costs by implementing a new corporate bankruptcy law, electronic collateral registration and a positive credit registry. In addition, recent enhancements in portability will foster financial intermediation and a new regulation on Fintechs will ease market entry and foster bank competition. Despite these improvements, further actions are needed to facilitate client mobility, for example by improving the transparency and comparability of financial products.
Trade openness and investment in infrastructure are needed. Brazil remains a closed economy, lagging significantly behind other G20 countries with regard to both intra- and inter-regional integration. In this context, recent advances in trade facilitation and progress in finalizing new trade arrangements are welcome. In addition, Brazil’s infrastructure and competitiveness compare poorly with its trading competitors, underscoring the need to advance the implementation of the Investment Partnership Program, mindful of fiscal risks.
The effective implementation of anti-money laundering and anti-corruption measures is critically important . The government continues to make successful efforts to pursue significant money laundering and corruption cases, backed by a strong and independent judiciary. These efforts are supported by legislative changes and jurisprudence that aim to increase the efficiency of the legal framework, although a national risk assessment has not been completed. The government is encouraged to continue focusing on prevention, including through implementing beneficial ownership information requirements, further enhancing risk-based financial sector supervision and the sharing of financial and tax information among relevant competent authorities, and increasing government transparency through the transparency portal.
The mission is grateful to the authorities and other counterparts for excellent discussions.
