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Brazil: Staff Report for the 2014 Article IV Consultation

Author(s):
International Monetary Fund. Western Hemisphere Dept.
Published Date:
May 2015
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Context: Disappointing Growth

1. Brazil’s growth has persistently decelerated in recent years. The impulse from decade-old reforms, expanding labor income, and favorable external conditions, which enabled a consumption and credit-led growth, has lost steam. A major expansion in the operations of the national development bank, BNDES, in the last few years has failed to boost investment, which has been sluggish since 2011 because the economy has lost competitiveness, the business environment has worsened and commodity prices have fallen from record highs. Moreover, structural sources of pressure on fiscal spending have necessitated a high tax burden. At the same time, unwarranted microeconomic interventions have contributed to reduced dynamism and increased financial stress in key sectors. For instance, in the energy sector, instead of promoting measures to increase efficiency, the government introduced a policy to subsidize electricity prices in 2012, increasing demand despite early signs of drought and driving electricity companies to borrow to cover increased generation costs in the expectation of future government compensation. Likewise, a high regulatory burden slowed implementation of the infrastructure investment program, especially in its initial phases.

Brazil: Revisions in Growth Forecasts

(In annual percentage change, per vintage)

Sources: WEO and Fund staff estimates.

2. The economy stalled in 2014. Activity contracted in the third quarter of 2013 and in the first two quarters of 2014. A confluence of external and, more importantly, domestic factors helps explain the recent moderation in activity.

  • Weak investment in recent quarters reflects tighter financial conditions, and, more importantly, policy drift and uncertainty, including in the run up to the presidential elections. Business confidence has dropped to historical lows.

  • Consumption has also moderated notwithstanding strong wage increases, as job creation has halted and financial conditions have tightened, affecting household income and consumer confidence, which is now below levels seen during the global financial crisis.

  • At the margin, additional headwinds in 2014 came from the ongoing drought and the World Cup—which caused a reduction in working days and provided a space for public demonstrations which impacted confidence.

Brazil: Historical Decomposition of Real GDP Growth

(Deviation relative to the sample mean)

Source: Staff estimates. Historical decomposition from a SVAR model with four lags that includes a set of external variables (US GDP, US CPI, US 10-year bond yield, Brazil EMBI Spread, Terms of Trade) and a set of domestic variables (CPI, policy rate, exchange rate, and GDP). All variables are specified in y-o-y percentage changes and orthogonally identified in the order listed above.

3. Poverty, inequality, and unemployment have been on a declining trend for more than a decade, thanks in part to effective social policies, but further progress will depend crucially on strong and sustained economic growth. Over the last 12–15 years, millions of families have been lifted from poverty owing to social policy interventions and buoyant real increases in the minimum wage (Box 1). Income inequality has also declined, and access to education and health has broadened. Over that period, relatively strong growth helped unemployment fall to historically low levels, although most recent declines are largely explained by declining labor force participation rather than job creation (Box 2). Further improvements in living standards hinge on securing strong, balanced, and durable growth, to ensure continuing employment growth and sustained funding for essential social programs.

Box 1.Bolsa Família and Brasil sem Miséria: The End of Extreme Poverty in Brazil1

Bolsa Família (BF), the conditional cash transfer program created in 2003, is the flagship of Brazil’s social programs. Eligibility is determined by household income per capita. Conditionality includes mandatory enrollment and minimum school attendance for children and adolescents, vaccination and good nutrition for young children, and pre- and postnatal care for women, among others. Building on the success of BF, the government launched Brasil sem Miséria in 2011 to overcome extreme poverty. This program goes beyond income transfers and promotes educational qualification, integration in the labor market, and improved access to public services.

A wide reach at a low fiscal cost. BF has expanded from initially 3.6 to 14.0 million families (end-2014), reaching nearly 50 million people or ¼ of the population. Despite its wide reach, its fiscal cost is less than 0.6 percent of GDP per year; the average monthly transfer per family was R$169 (US$65) at end-2014.

Poverty mapping and coordination within the government were strengthened concomitantly. The government has actively worked to identify eligible households. At the same time, a unified registry of beneficiaries was created for monitoring recipient families.

Social outcomes have improved significantly. An estimated 22 million people were lifted from extreme income poverty alone since the 2011 expansion of the program, and extreme poverty has reached historically low levels. The impact of BF on the well-being of beneficiaries goes well beyond income support. Participants have higher school attendance rates, higher school progression and lower grade repetition. Concerning health, low birth weight, infant mortality, and malnutrition and diarrhea have fallen among participants, while breastfeeding and vaccination rates have increased. In addition, by targeting women as cash recipients, BF strengthened women’s financial independence.

Fiscal Cost and Reach of Bolsa Familia

(percent of GDP and million of households)

Sources: Ministry of Social Development, IMF Staff estimates.

Brazil: Extreme poverty

(share of population living under the respective povery line)

Sources: Ministry of Social Development, IMF Staff estimates.

1 Prepared by Flavia Barbosa.

Box 2.Labor Market Dynamics1

Brazil has seen a substantial reduction in unemployment during the past decade; but recent declines mask a weakening of the labor market. The unemployment rate2 reached a record low of 4.5 percent in mid-2014, down from 11.7 percent in 2002, and stands currently at 5.4 percent (January 2015). The most recent declines in unemployment, however, reflect a contraction in the labor force, which masks a halt in employment growth amidst a slowdown in economic activity.

GDP and the Unemployment Rate

(In percentage change and percent)

Employment and Labor Force

(Year on year percentage change)

Job creation has slowed sharply. Net employment in the industry and construction sectors has contracted since early-2014. The creation of jobs in the service and the commerce sectors—though still positive—has weakened at the margin on the back of moderating consumption.

Net Job Creation by Sector

(in thousand jobs)

Labor force participation declined from late 2012, but has increased again more recently. Labor force participation rates fell across all age groups. The fall was especially strong for those aged 18–24 years, as Government scholarship financing programs (such as FIES and ProUni) have offered young people the opportunity to access higher education and therefore delay entrance in the labor market. Social programs and policies—such as Minha Casa Minha Vida, and the minimum old age pension—have boosted household’s cash and non-cash income, which might have affected reservation wages. However, more recently, participation started again to increase.

Participation Rate by Age Group

(percent points, dec 2012=100)

There is insufficient data to determine whether the most recent movement has cyclical causes, or reflects a correction of what might have been an excessive reaction of participation to the factors mentioned earlier.

Wage pressures remain strong. Real wages have continued to expand above productivity, reflecting in part strong increases in the minimum wage. While some formal sector workers receive exactly one minimum wage, others are also affected. More recently, low labor-force participation has also contributed to the pressure on wages.

Wage and Labor Productivity Growth

(index, 2004 = 100)

Sources: Fund staff estimates and Haver Analytics

Unemployment is likely to increase due to continued weak economic activity and recovering participation. The participation rate already started to increase, causing the unemployment rate to increase in 2014Q3. If the participation rate were to return to its 2008-2014 average of 56.8 percent, the unemployment rate could rise to 6.5 percent, other things constant.

1 Prepared by Fabian Lipinsky.2 The source for employment, unemployment, labor force and participation data used in the text and charts is, unless where otherwise explicitly stated, the monthly employment survey of the national statistics office (PME/IBGE). Real GDP data is reported by the quarterly national accounts, also by IBGE. All data were seasonally adjusted.

4. Inflation and inflation expectations remain above the central target. For several years, headline and core inflation have been near the upper-edge of the 2.5 to 6.5 percent inflation tolerance band, owing in part to sustained wage cost pressures, lingering indexation practices, and, more recently, the ongoing drought. In turn, longer-term inflation expectations have risen on average. Moreover, modest increases in regulated energy and fuel prices helped hold back overall inflation. However, overdue adjustments are underway. In particular, Petrobras raised gasoline and diesel prices in November 2014, and electricity tariffs increased in January 2015, when a new system of color “flags” was introduced to signal when generation costs are especially high; tariffs are expected to increase further. In parallel, tighter financial conditions and the still negative output gap have led to a moderation in the rate of growth of market-determined prices, although new inflation pressures are emerging from the nominal depreciation of the currency.

5. Financial markets have been volatile, contributing to reduce confidence. Brazilian asset prices were among the hardest hit following the Fed’s “taper” announcement in May 2013. Volatility rose again in the run-up to the October 2014 elections as well as amidst the Russian ruble depreciation in November. During 2014, both the Bovespa stock exchange index and the exchange rate against the U.S. dollar fell by about 7 percent and 14 percent, respectively. The resulting uncertainty has contributed to lower confidence and higher financing costs, reinforcing other headwinds for activity.

6. Petrobras, the state-controlled oil major, faces unprecedented difficulties because of external and internal factors. Petrobras’ credit rating has been downgraded (one rating agency now classifies it as high yield) and its share price has recently reached multi-year lows. For several years, the slide reflected an expensive domestic content policy for its procurement and persistent delays in domestic product price increases, which amounted to a quasi-fiscal subsidy financed by the company. These policies reduced cashflow from operations, pushing Petrobras into a debt-based strategy to finance its expansion plans. In the closing months of 2014, however, Petrobras’ difficulties intensified under the combined pressure of diminished oil price prospects and serious governance problems that cut the company’s access to external finance (Box 3). Petrobras is at present relying on its cash buffers to finance its expansion projects, and has announced a cut in its capital expenditure program for 2015 (estimated to be a 20 percent reduction), a decision that will bear upon the company’s future production and export plans, and for the economy as a whole because Petrobras accounts for about 10 percent of investment in Brazil. Petrobras, which is excluded from the definition of the public sector for the purposes of the fiscal responsibility law, has become a source of fiscal risk.

Box 3.Petrobras1

Petrobras’ financial situation has worsened. The recent sharp decline in international oil prices has improved the profitability of downstream operations after several years of losses, but prospects of a sustained period of lower prices and the ongoing corruption investigation are casting a shadow over Petrobras. By end-2014, Petrobras’ equity price had fallen by more than 80 percent in U.S. dollar terms over 5 years and its debt levels had increased to be the highest in the industry.

Petrobras: Net Income from the Downstream Segment

(in billions of U.S. dollars, per year)

Source: Petrobras

Investment plans may need to be further revisited. According to the 2014–18 business plan, production growth is projected to rise to 3.2 million barrels a day in 2018 (from around 2 million barrels a day in 2013), contingent on capital expenditures of around US$221 billion over 2014–18. However, since formulating this plan, international oil prices have effectively halved, nearing breakeven estimates under the current tax regime. In late January, the company announced a cut in capital expenditure of 20 percent in 2015 reflecting its need to conserve cash and diminished prospects for oil prices. Further revisions to the plan may be needed.

Oil Industry: Leverage Ratios, 2014Q2/Q3

(Gross debt to earnings or assets ratios, larger = worse 1/)

Citation: 2015, 121; 10.5089/9781484380758.002.A001

Source: Economatica

1/ Gross debt includes total interest-bearing liabilities.

2/ EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization -a cashflow measure. The ratios represent how many years it would take for a company to repay its debt with all its cashflow if earnings and debt are held otherwise constant.

Access to necessary financing at a sufficiently low cost is a key risk. Financing has become more difficult across the oil industry, with Petrobras’ difficulties exacerbated by idiosyncratic factors. Delays in the release of financial statements for the third quarter of 2014 closed access to international markets in early 2015. Uncertainty over asset write-downs has kept the auditor from signing off Petrobras’ financial statements. Also, opportunities to secure financing from state-owned banks are limited by already-large exposures to the company. Petrobras had a large cash cushion going into 2015 but needs to regain access to funding to continue expanding beyond 2015.

Adverse spillovers from the corruption probe could be large. The probe involves several of the largest construction companies in Brazil. At present, 27 such companies have been banned from engaging in new contracts with Petrobras. As already seen in one case (OAS), these companies may face difficulties securing financing, possibly impacting their suppliers and creditors (although any impact on banks appears moderate at this point). Perhaps the most important risk is a prolonged period of insufficient access to markets by Petrobras. Such a situation could necessitate financial support from the government—directly and/or indirectly—putting the government’s debt reduction objectives under stress.

1 Prepared by Troy Matheson (WHD).

7. The central bank has intervened in the foreign exchange market, with the aim of limiting volatility by meeting the demand for hedging. In response to a surge in exchange rate volatility following the Fed’s taper announcement, the central bank launched a program of pre-announced intervention starting in August 2013. Rather than selling dollars from its reserves in the spot market, the central bank has been selling hedging instruments settled in local currency (“FX swaps”).1 The intervention program has been renewed three times since its inception, and is currently in effect through end-March 2015; the amount auctioned daily (excluding rollovers) has been reduced in two steps and is now one fifth of its initial size. Intervention helped tame the real’s volatility in the second half of 2013 and early 2014. However, the second extension of the program in June 2014 occurred at a time of relatively low global volatility. The notional amount of outstanding FX swaps at end-2014 was US$110 billion, exceeding short-term external debt on a residual maturity basis.

8. Despite weakening domestic demand, the current account deficit reached 4.2 percent of GDP in 2014 from 2.4 percent of GDP in 2012.2 The deterioration reflects worsening terms of trade, a drop in exports to Argentina, and an increase in fuel imports necessitated by the drought. The recent depreciation against the U.S. dollar, arising in part from general dollar strength, has not translated one-for-one into gains against competitors in global markets. Moreover, persistently high unit labor costs continue to dampen competitiveness.

9. As a result, the external position is weaker than desirable, with the real still overvalued. Staff estimates that in 2014 the current account was weaker than its level implied by fundamentals and desirable policy settings and the real was stronger than indicated by fundamentals by about 10-20 percent on average during the year. This assessment is derived using methodologies that estimate the deviation of the current account from norms based on country-specific fundamentals, and identify the correction in the real exchange rate that could close this gap (Appendix I). By December 2014, the real had depreciated by 6 percent in real effective terms relative to its 2014 average, implying a corresponding reduction in the degree of overvaluation.3

Brazil: Nominal and Real Effective Exchange Rates

(Indices, Jan-2013 = 100; positive changes represent depreciation) 1/

Citation: 2015, 121; 10.5089/9781484380758.002.A001

Source: Bloomberg, Haver Analytics and Fund staff estimates.

1/ Monthly averages. Data for the exchange rate and nominal effective exchange rate for February 2015 corresponds to the latest observation by mid-February.

10. International reserves are high and capital flows have remained stable. FDI financed more than 70 percent of the current account deficit in 2014, with intercompany loans accounting for about 60 percent of total FDI.4 Portfolio inflows have been buoyant since 2013, as the central bank tightened monetary policy and rolled back CFMs on capital inflows (the IOF). At about US$362 billion, gross international reserves (cash concept) are well above the IMF’s reserve adequacy metric and other standard benchmarks.

11. The banking system’s soundness indicators remain favorable, but sustained low growth and the transition to a low credit growth environment could put bank balance sheets under pressure. Recently, credit growth has decelerated from high rates to 11.3 percent y/y in 2014, driven by a slowdown in credit expansion by public banks, while private bank credit continued to expand at a moderate pace. Real growth in home prices has also slowed down to about 1 percent as of November 2014.

  • Total and Tier 1 capital ratios remain well above the regulatory minimum at 16.5 and 13.1 percent, respectively, in the third quarter of 2014 (broadly in line with fully-loaded Basel III basis). Banks are also well provisioned (170 percent of nonperforming loans), and liquidity risk for the system as a whole is low.5 Banks continue to rely mainly on domestic funding sources, with the ratio of foreign funding to total funding at less than 10 percent.

  • Household and corporate leverage have increased in recent years, to a large degree as a result of increased borrowing from banks. The rising proportion of mortgages in household borrowing has lengthened average maturities, containing the growth in debt service. Corporate bond issuance has become increasingly important, including overseas borrowing, raising FX exposure but also allowing firms to access credit at longer maturities and lower rates. Leverage-already high by international standards-has edged up without translating into higher capital outlays as firms built cash cushions instead of augmenting their capital stock. In the case of commodity exporters, the decline in commodities is also contributing to raising leveraging by reducing free cashflow and equity growth. While FX debt accounts for about 30 percent of the total, it is largely hedged.6

  • Against this backdrop, tepid growth, possibly rising unemployment, exchange rate depreciation and tighter financial conditions ahead will likely put strains on private sector balance sheets. Indeed, there are emerging signs of balance sheet pressures. While the overall NPL ratio remains stable at about 3 percent, weak activity has already caused an uptick in NPL ratios for some segments of consumer and corporate loans, such as overdraft, credit card, working capital, and SME loans, particularly by public banks (Appendix II). These segments have, however, been the ones leading the recent deceleration in credit growth in public banks.

Household Indebtedness

(In percent of disposable income)

Sources: Central Bank of Brazil and Fund staff calculation.

12. The macroeconomic policy mix from mid-2013 through 2014 lacked consistency, undermining credibility.

  • The fiscal stance turned expansionary. In 2013, the nonfinancial public sector (NFPS) primary balance declined to 1.9 percent of GDP, undershooting its 2.3 percent target. Coming on top of tax breaks introduced over 2012 and 2013, slowing revenue and rapid real expenditure growth (arising in part from structural sources of fiscal pressure such as mandatory minimum spending and minimum benefit rules, and wide-ranging earmarking) brought the primary fiscal balance of the NFPS to -0.6 percent of GDP in 2014, despite one-off measures of about ½ percent of GDP. Policy lending to BNDES edged back up in 2014, including a transfer of 0.6 percent of GDP in December, further raising government borrowing. As a result, gross and net public debt increased respectively to 71 and 37 percent of GDP. In 2014, the net interest bill of the nonfinancial public sector was 6 percent of GDP, exceeding the typical volume of spending in education, for example. Declining growth and poor fiscal performance affected Brazil’s sovereign credit rating. Standard & Poor’s cut Brazil’s credit rating to BBB- in March 2014, its first downgrade since July 2002. In September 2014, Moody’s revised Brazil’s sovereign rating outlook to negative.

  • Monetary policy has, however, maintained a tightening bias. In view of persistent inflation pressures, and largely in contrast with the fiscal policy stance, the monetary policy rate (SELIC) was hiked by 375 basis points to 11 percent between April 2013 and April 2014. Policy tightening paused from May through September. But between October 2014 and January 2015, the SELIC was increased by another 125 basis points to prevent second round effects from currency depreciation and the anticipated increases in regulated prices. At times, lending by public banks has been at odds with the thrust of monetary policy, diminishing the latter’s effectiveness.

  • Macro-prudential policies broadly responded to changes in risks along the credit cycle, but in some instances seemed to go against the grain of monetary policy. In September 2013, the central bank introduced limits on loan-to-value (LTV) ratios for mortgages to prevent potential future vulnerabilities.7 In July and August 2014, reserve and capital requirements were selectively loosened. The first of these actions aimed at containing liquidity risk in some segments of the banking system. But the second one largely aimed at boosting certain types of consumer loans, notwithstanding the tightening bias of monetary policy and an uptick in delinquencies of unsecured personal loans.8

13. Over December 2014-January 2015, a new economic team was brought on board with a mandate to strengthen macroeconomic policies and restore credibility. The team announced an ambitious fiscal adjustment strategy to bring the primary surplus to 1.2 percent of GDP in 2015 and to at least 2 percent of GDP in 2016 and 2017. This strategy, together with the ending of policy lending from the treasury to public banks, aims to stabilize and then reduce gross public debt. The economic team also set the objective of reaching the 4.5 percent inflation target by end-2016. Early measures and announcements include the 125 bps increase in SELIC mentioned above; an increase in the interest rate on subsidized loans (known as “TJLP”); a series of adjustment measures on the fiscal side worth about 0.9 percent of GDP in 2015, notably a tightening of eligibility for unemployment benefits, salary bonuses, and survivor pensions, and the reintroduction of the tax on fuels (Box 4).9

14. While efforts to alleviate supply-side constraints and boost the economy’s productive capacity have continued, long-standing obstacles to business and intra- and international trade remain unaddressed.

  • On the one hand, the government has focused on its program of concessions to involve the private sector in key infrastructure projects in transportation (roads and airports), energy transmission and generation, and telecommunications, increasing the program’s flexibility over time to overcome difficulties attracting investor interest. Similarly, in the oil sector, a consortium of Petrobras and international companies were given the rights to explore the Libra pre-salt field, potentially one of the world’s largest

  • On the other hand, structural impediments to growth remain rampant In particular, Brazil remains a relatively closed economy compared to its peers, with limited integration into global value chains; the tax system is uncommonly complex and unit labor costs are high; despite recent initiatives, Brazil’s infrastructure and competitiveness indicators have deteriorated in relation to its competitors; and while Brazil has maintained its average applied Most-Favored Nation (MFN) tariff at an elevated level of around 10 percent, several of its peers, such as China and Mexico, have cut taxes on imports and built a large network of preferential trade agreements (Box 5).

Brazil and Competitors: Competitiveness Indicators, 2011-2014

(Rank out of 144 countries; 1 = best, 144 = worst)

Sources: World Economic Forum Competitiveness Report 2010/11 and 2014/15.

1/ Trade competitors: Argentina, Australia, Canada, China, India, Kazakhstan, Mexico, Russian Federation, South Africa, and United States.

Box 4.Fiscal Policy Measures1

The new economic team has announced several measures to strengthen the fiscal balances; but additional measures will be needed to ensure the attainment of the primary surplus targets set for 2015 and 2016–17. On the expenditure side, the government announced (i) reduced benefits and tighter eligibility criteria for survivor pensions, unemployment and sickness benefits, and salary bonuses for private employees with low earnings, and (ii) the elimination of electricity subsidies (supported by tariff adjustments). The government estimates these measures will yield about 0.5 percent of GDP savings in 2015. In addition, it introduced tight provisional limits on certain discretionary current spending in its continuing resolution for the initial months of 2015; but this measure will be superseded by the changes to the 2015 budget. On the revenue side, taxes were raised on fuels, household credit operations, car sales, imports, and cosmetics, and a planned revision of PIT brackets was vetoed by the President (yielding 0.4 percent of GDP in total). Furthermore, the decision of halting the Treasury transfers to BNDES, tightening the rates of some subsidized loans, and raising the TJLP will lower the net interest bill. Further efforts are necessary to achieve the government’s proposed targets for 2015 because the starting point, given by the 2014 fiscal outcome, is a primary deficit of 0.6 even after some extraordinary revenue is taken into account, and because revenues in 2015 will tend to weaken as a result of the contraction in activity.2 Possible additional measures are indicated in the Table below.

Possible Additional Fiscal Consoditated Measures, Estimated Savings in 2015-19(Percent of GDP, annualized)
20152016201720182019
Revenue measures: Reverse post crisis tax cuts 1/
Reverse cuts in consumption taxes (excluding fuel taxes) 2/0.30.30.30.30.3
Reverse payroll tax cuts0.40.40.40.40.4
Reverse all other tax exemptions (excluding fuel taxes) 3/0.90.90.90.90.9
Expenditure measures
Revise formula for minimum benefits to inflation indexation 4/0.00.40.91.41.8
Rationalization of non-mandatory spending to revert to 2011 ratio to GDP by 2019 5/0.30.60.81.11.4
Source: Staff estimates based on data from Federal Tax Admnistration and National Treasury.

Refers to measures implemented since 2010. Estimates are based on the 2014 cost of such measures.

Includes federal tax exemptions over basic consumption basket, and IPI reductions (except on cars, which is already in place since January 2015).

Excludes also the impact of exclusion of the ICMS from the PIS/Cofins tax base on imports, since compensatory measures were already announced.

Implementation in January 2016.

Achieved through removal of budget rigidities and lower revenue earmarking. Expenditure cuts assumed to be phased in gradually, starting in 2015.

Source: Staff estimates based on data from Federal Tax Admnistration and National Treasury.

Refers to measures implemented since 2010. Estimates are based on the 2014 cost of such measures.

Includes federal tax exemptions over basic consumption basket, and IPI reductions (except on cars, which is already in place since January 2015).

Excludes also the impact of exclusion of the ICMS from the PIS/Cofins tax base on imports, since compensatory measures were already announced.

Implementation in January 2016.

Achieved through removal of budget rigidities and lower revenue earmarking. Expenditure cuts assumed to be phased in gradually, starting in 2015.

In general, fiscal adjustment should fall preferentially on current spending; on the revenue side, the rolling-back of temporary tax breaks would be useful. Curtailing expenditures will bring a lower drag on economic activity than increasing taxes would (see Selected Issues Paper). Given the size of the needed adjustment, however, revenue effort will also be required. The tax exemptions introduced in 2012–13 represent a sacrifice of revenues of 2 percent of GDP; however, they have been largely unsuccessful, and have in fact created new distortions in the treatment of different industries.

A further consideration is to favor adjustment strategies that address sources of long-term fiscal pressure. Spending related to ageing population groups is expected to rise by 3 percent of GDP in the coming 15 years. Structural budgetary reforms that reduce the complex structure of revenue earmarking and mandatory growth requirements for major spending lines, such as health or education, would have long term benefits in terms of increased policy flexibility. About 90 percent of the budget is predetermined at the general government level.3 The value of the minimum pension is indexed to the minimum wage, which grows roughly at the same rate as the tax base; such indexation makes therefore no allowance for the trend increase in the number of beneficiaries, making this system a permanent source of fiscal pressure.

1 Prepared by Joana Pereira (FAD).2 The estimated yield of measures excludes announcements made after February 25.3 Details discussed in the Selected Issues Paper for the 2005 and 2011 Article IV Reports.

Outlook and Risks

15. The pace of economic activity will remain subdued in the near term. Staff projects real GDP to contract by 1.0 percent in 2015 and to grow again by 0.9 percent in 2016.

  • This projection assumes that policy implementation is in line with recent pronouncements, the infrastructure concessions program functions broadly as programmed, and pre-committed Petrobras’ investment projects in the oil sector—as they stand after the cuts announced in late January—proceed largely as planned. The cuts in investment by Petrobras enter the projection with a relatively large multiplier to incorporate collateral effects on Petrobras’ contractors and suppliers. Following a prolonged period of low rainfall and diminished reservoir levels in key regions, the specter of water and electricity rationing is already affecting business and consumer confidence.

  • Staff estimates that the planned fiscal consolidation in 2015 would be a modest drag on growth, although the adverse impact should be increasingly mitigated by the favorable effect that the adoption of concrete measures and successful adjustment will have on credibility and confidence. Judicious deployment of the large transfer of loanable resources to BNDES in December 2014 should provide some support in 2015; fiscal drag in 2016 is expected to be lower, as some of the additional consolidation should come the from full-year effect of measures adopted in 2015, and thus already internalized in economic agents’ decision making.

  • Consistent with the policy announcements, staff assumes that policy lending will stop. Staff also expects some moderate additional tightening in the SELIC and the TJLP in 2015, with the monetary policy stance remaining tight until inflation approaches the 4.5 percent target (although, with the hump in regulated-price inflation behind, policy could ease at the margin in 2016).

  • Investment is projected to contract for a second year running in 2015, reaching its lowest point since 2009, primarily as a result of the change in Petrobras’s expansion plans. Investment growth is projected to recover gradually, especially in the latter part of 2015 as policy uncertainty abates and markets gain confidence in the government’s reform agenda. The recovery in investment in 2016 also assumes that Petrobras will secure reaccess to financing from capital markets.

  • Private consumption growth is projected to stay flat in 2015, reflecting tight financial conditions and some rise in unemployment, while government consumption is assumed to contract as part of fiscal consolidation. Private consumption is projected to regain some strength in 2016, including as a result of investment-related employment and improved confidence. Net exports should make a modest contribution to growth reflecting in part the weaker real, despite a challenging external environment.

16. Growth should gradually rise over the medium term, but its long term potential will depend on addressing structural constraints. Under a scenario of macroeconomic policy strengthening and implementation of the infrastructure concessions program, but otherwise limited structural reforms, potential growth is projected to reach 2.5 percent by 2020. Despite some expected further weakening in commodity prices, the current account is projected to improve modestly on higher oil production and the more depreciated level of the real, although offshore oil exploration plans are assumed to be scaled down at the margin given the diminished prospects for world oil prices.

Box 5.Trade Restrictiveness1

Brazil stands out among its peers for its low degree of integration to global trade. With just above 20 percent of GDP in 2013, Brazil’s goods trade is about half the size of that in Peru, Russia, India and China and about a third of the size of trade in Chile and Mexico. Brazil shows the smallest volume of trade in goods and services relative to GDP among the LA5 and BRICS. Brazilian companies are less integrated into global value chains than those in most emerging market peers.2

Trade openness outcome indicators

Goods trade vs. trade restrictiveness

Brazil’s relatively restrictive system of trade taxes partly explains the low trade integration. As a founding member of MERCOSUR, Brazil shares a common external tariff with other members, subject to exceptions. Its applied MFN customs tariff is entirely ad valorem, with rates ranging from zero to 55 percent. Goods imports face a weighted average applied MFN tariff of around 10 percent according to the WTO, the highest among LA5 and BRICS peers. Moreover, Brazil’s network of preferential trade agreements covers a relatively small share of world trade compared to its peers.3 Besides customs tariffs, imports are subject to a complex system of internal taxes.4

Trading across borders is also hindered by significant behind-the-border constraints. The World Bank’s Doing Business indicators rank Brazil 123rd out of 189 countries in terms of ‘trading across borders’. Brazil stands out in terms of the cost of importing and exporting as the well as the number of documents needed to export/import. The authorities recently introduced procedures, such streamlining customs, aiming at reducing bureaucratic hurdles to trade.

Reducing trade barriers and behind-the-border constraints should be a priority. Reducing the level and complexity of the system of trade taxes—including by extending the network of preferential trade agreements—should boost trade volumes and growth, especially when paired with the push towards trade facilitation. Domestic content restrictions could be eased to promote Brazil’s inclusion in global value chains.

Doing business: trading across borders, overall Rank in 2014

1 Prepared by Christian Saborowski.2 See WTO World Trade Report 2014.3 MERCOSUR has preferential trade agreements with India and Israel, and three further agreements pending entry into force. Negotiations aimed at creating a free trade agreement with the EU are ongoing.4 See 2013 WTO Trade Policy Review for Brazil. Import taxes are also the most restrictive among peers when measured according to the World Bank’s overall trade restrictiveness index (OTRI) which takes into account non-tariff measures.

17. Inflation is expected to fall only gradually. Inflation is expected to converge toward the 4.5 percent target over the medium term as a result of tight monetary policies, although the rate of convergence will be affected by the necessary adjustments in regulated prices, high inflation expectations, and lingering indexation, including in wages.

18. Risks to the outlook are significantly tilted to the downside (Appendix III).

  • A key domestic risk to activity is that investment, including in the areas of oil production and infrastructure concessions, may be further hampered by the probe into corruption at Petrobras, which involves several of the largest construction companies in the country. Insufficient access to funding by these companies can result in adverse spillovers to their creditors, although the impact on banks would likely be moderate. Prolonged insufficient access to markets by Petrobras itself is a risk to the fiscal adjustment strategy. More generally, there is a risk that the fiscal targets for 2015–16 may not be met. This could undermine market confidence, with implications for growth, debt outcomes, and potentially for Brazil’s sovereign rating (Brazil is only one or two downgrades away from losing investment grade, depending on which rating agency one looks at). In turn, this could result in a sell-off of government debt by nonresidents, which could also cause stress in those financial institutions with large exposures to government securities, and affect capital flows to other emerging markets as well. Following a prolonged period of low rainfall and falling reservoir levels in key regions, water and electricity rationing has emerged as a key risk to growth in the near term. Continued low rainfall could result in tightened supply constraints, especially in the Southeast of the country, where a large fraction of GDP originates.

  • External downside risks stem from the increase in financial volatility, as well as from further declines in commodity prices. An abrupt surge in global financial market volatility could increase Brazil’s risk premium, exert pressure on the real (in addition to that coming from the U.S. dollar strengthening), and pose a challenge in financing Brazil’s large current account deficit. The impact on balance sheets should be contained as corporate exposures to foreign exchange risk are largely hedged. A protracted period of slower growth in advanced and emerging economies could weaken exports. A combination of a weaker real and slow growth would put pressure on private sector balance sheets. Further declines in export commodity prices—such as iron ore and soy beans—resulting from a slowdown in China also remains a key vulnerability. A further decline in oil prices, while a boon in the near term, could affect adversely Petrobras’ development plans of high-cost deep-sea oil, as well as prospects for growth and the current account over the medium term, when Brazil is expected to become a net oil exporter. Conversely, a sharp rise in oil prices, as would result from a geopolitical shock, would put pressure on the current account and on Petrobras’ cashflow in the near term.

  • Deeper downside risks to growth involve a combination of external shocks that are amplified by domestic vulnerabilities. In this environment there is a high probability of a sovereign credit downgrade. Such a scenario would see a larger rise in unemployment, with a likely worsening of social indicators, a sell-off of government debt, and negative repercussions for the financial sector, with adverse spillovers for other countries in the region.

19. Policies implemented in 2014 were partially in line with previous Fund advice. At the conclusion of the 2013 Article IV Consultation with Brazil, IMF Executive Directors welcomed the initiation of the monetary tightening cycle and recommended that monetary policy remained geared at containing inflationary pressures and anchoring inflation expectations. In addition, Directors highlighted the importance of adhering to a primary surplus target that placed public debt on a downward path, while also recommending a gradual reduction of policy lending. The continuation of monetary policy tightening since April 2013, with the goal of containing inflation pressures, took the policy rate to 11.75 percent by December, up from 7.25 percent before the start of the tightening cycle. However, in the fiscal policy area, performance deteriorated, with the primary balance slipping into deficit and policy lending edging back up, resulting in an increase in public debt in 2014.

Policy Discussions

Brazil is in a very tough spot, and policymakers face difficult policy choices that will test the grit and determination of the new government. Economic activity continues to contract with significant downside risks, even as inflation remains above target. There appears to be a limited role for demand support, both because there are emerging supply constraints and there is little policy space, underscoring the need to boost the economy’s productivity capacity through supply-side reforms. But this will take time. A key imperative in the near term is to bolster policy credibility, notably through front-loaded fiscal adjustment and monetary tightening, since this is important to boost confidence and, in turn, private demand that would anchor strong and sustainable growth over the medium-term. Adjustment will not be easy; however, any compromise on policy effort could jeopardize medium-term prospects without yielding any significant benefit in the short-term.

Staff Views

Fiscal policy

20. An ambitious and front-loaded fiscal adjustment effort, embedded in a realistic medium-term fiscal plan, is imperative for reducing public debt and bolstering policy credibility. Fiscal policy decisions confront two conflicting objectives: supporting demand and boosting policy credibility. On the one hand, in the context of weakening activity, fiscal policy could be used to bolster demand. On the other hand, however, policy drift and the loss of credibility in policy frameworks in recent years, reflected in plummeting consumer and business confidence, would put a premium on ambitious and front-loaded fiscal adjustment that would anchor strong and sustainable growth over the medium-term, notwithstanding the growth dampening effect such adjustment would have in the near-term. Since current growth woes in Brazil largely reflect supply-side constraints, as evident from limited slack, inflation being at the top end of the band, and the growing need to conserve water and energy, staff is of the view that fiscal policy actions should be geared toward restoring policy credibility.

  • Given the weak underlying fiscal position in 2014, rising public debt and deterioration of fiscal policy credibility over the last years, the announced fiscal target for 2015 of a primary surplus of 1.2 percent of GDP for the NFPS is appropriate. However, while the measures announced so far are welcome, additional effort (estimated at 1.2-1.4 percent of GDP, including to offset cyclical effects on revenue from the contraction in 2015) will be needed to meet the target. Additional expenditure containment is expected to be included in the revised 2015 budget (Box 4).

  • Going beyond 2015, the new government’s target of 2.0 percent of GDP for the primary surplus would begin to reduce public debt in the central macroeconomic scenario; but increasing that target by ½ percent of GDP would help put public debt on a more firmly downward path by reducing the interest bill faster and increasing resilience to shocks and potential fiscal risks.

  • From the perspective of the overall fiscal adjustment strategy, tilting the adjustment towards expenditure consolidation may help limit the drag on economic activity, but preserving and even increasing capital spending would be important (Selected Issues Paper). That said, given the size of the required adjustment, revenue measures are also necessary in the short run. To this end, beyond the measures already announced, consideration should be given to a fuller rollback of tax exemptions, as enlarging the tax base this way supports revenues, reduces distortions, and promotes horizontal equity. Going forward, addressing budget rigidities and ageing-related spending pressures is crucial to reduce debt and build fiscal space (Box 4). To the extent that structural fiscal measures that address key sources of long term fiscal pressure can be adopted early (such as the link between benefits and minimum wages), a more gradual adjustment path could be compatible with strengthening sustainability and credibility; but absent such reforms, adherence to the announced primary surplus objectives would remain key.

  • Furthermore, anchoring fiscal policies and targets in a medium-term framework would improve fiscal predictability. Staff sees merit in such an institutional framework as well as on publishing a debt-sustainability analysis. Moreover, an independent fiscal council would provide further support to transparency and accountability.

21. The commitment to end policy lending to the development bank and more generally to correct relative prices and reduce subsidies is welcome, and should bolster fiscal credibility. The decision to stop policy lending to BNDES starting this year is bold and will alleviate pressures on the fiscal position, while reducing financial distortions. The discontinuation of general subsidies to electricity, underpinned by tariff increases, is a positive step both for fiscal and economic efficiency reasons. The current context of low international oil prices provides a window of opportunity for recouping the downstream losses incurred by Petrobras in past years, and later for introducing formula-based mechanisms to adjust domestic prices regularly in line with the evolution of import parity benchmarks and reasonable domestic margins. More generally, adopting market-related pricing formulas for administered prices would help preserve the integrity of the balance sheets of large state-owned enterprises and reduce future fiscal risks.

22. Improving transparency of the fiscal accounts and reviewing the strength of governance frameworks in state-owned enterprises (SOEs) is critical. Full disclosure of the underlying fiscal position would boost confidence and help communicate the need for adjustment. The irregularities uncovered in Petrobras point to the need to review and strengthen internal and external oversight mechanisms in Petrobras and possibly in other SOEs, a task of the highest priority. The recent appointment of a director for governance in Petrobras is a positive initial step. Strong governance and close oversight of parastatals is also key for containing fiscal risks.

Monetary and financial sector policies

23. Bringing inflation to target by 2016 will likely require some further tightening of monetary policy in 2015. While moderate economic activity and planned fiscal consolidation, together with recent increases in the SELIC, should help reduce inflation, the required re-alignment of regulated prices and recent currency depreciation will necessitate monetary policy maintaining a tightening bias to mitigate the second-round effects on other prices and wages.

24. The renewed emphasis in communication on the 4.5 percent inflation target and the readiness to use the policy instruments to prevent second round effects from the ongoing correction of relative prices will bolster the credibility of the monetary framework.

  • Beyond the immediate, strengthening the inflation targeting framework would improve the effectiveness of monetary policy. In particular, the accountability and autonomy of the central bank could be enhanced by narrowing the tolerance band around the 4.5 percent target and giving a specific term of office to the central bank’s top management, as recommended by the 2002 and 2012 FSAPs (Appendix IV).

  • The widespread use of subsidized lending weakens monetary policy transmission and distorts credit markets. Introducing a direct link between the policy rate (SELIC) and the subsidized lending rate (TJLP) would increase the effectiveness of monetary policy. Reducing the gap between the SELIC and the TJLP—675 bps after the recent 50 bps TLJP hike—would also lower the recurrent fiscal cost arising from the cumulative stock of policy lending by government.

25. The exchange rate should remain the main shock absorber in the face of external shocks, with intervention in foreign exchange market being limited to dealing with excessive volatility. The pre-announced intervention program has helped reduce volatility and pre-empted pressures in the spot market at critical times by providing hedging options for economic agents with exchange rate exposures. However, by reducing the cost of hedging, the program may have encouraged excessive risk taking by the private sector; and, while the flexible exchange rate has remained the main shock absorber, prolonged intervention may have slowed the convergence of the exchange rate needed to restore competitiveness. For these reasons, staff considers the reduction in size and duration of the intervention program announced in December 2014 as a positive development. Going forward, the central bank should refrain from extending the intervention program further and, as conditions permit, continue to use the leeway provided by the calendar of rollovers of maturing swaps to temper the stock of swaps outstanding, with the goals of preserving and increasing policy space and supporting convergence of the exchange rate to levels in line with fundamentals.

26. Banking system soundness indicators are encouraging, but private sector leverage and the rapid past expansion of public banks are potential sources of stress requiring vigilance.

  • The central bank ran stress tests with scenarios constructed by staff, and the overall outcome was within the parameters of the stress tests published in the central bank’s own September 2014 Financial Stability Report—that is, in a high stress scenario, some banks would become noncompliant with capital requirements, but the capital shortfall would be small, less than 0.5 percent of regulatory capital, given existing provisions.10

  • This said, risks could arise from high private sector leverage and growing FX exposure in an environment of sustained low growth and possibly rising unemployment. The increase in delinquencies of high-risk loans by public banks could generate a demand for additional capital if loan defaults increase, but, more importantly, underscores the need for greater vigilance and close monitoring of the health of bank balance sheets in response to evolving economic conditions.

Policies to bolster the economy’s productive potential

27. Broad-ranging structural reforms are critical for improving the economy’s productive capacity, notably by reducing the cost of doing business and fostering investment, and to anchor strong, sustained, and balanced growth. Prioritization of these reforms and getting an early start is essential. Reforms should include:

  • Addressing infrastructure bottlenecks. The infrastructure concessions program is critical for boosting medium-term growth, and should be implemented with greater vigor, notably by assessing factors that have impeded greater private sector participation. In particular, consideration should be given to increasing the program’s scope and size, given the significance of infrastructure bottlenecks, while observing high standards of governance and program design, including regarding transfer of risks, to minimize fiscal risks and attract private sector participation. Tilting the composition of public expenditure away from current spending would also free resources for public investment, including in infrastructure.

  • Tax reforms. Brazil’s tax system is extremely complex and burdensome, especially with regard to distortionary indirect taxes. In particular, a simplification of the State Tax on the Circulation of Goods and Services (ICMS) would be an important way to reduce the cost of doing business.

  • Opening the economy. Brazil’s trade to GDP ratio is one of the lowest among emerging markets. Reducing applied MFN customs tariffs; continuing trade facilitation efforts; lifting domestic content requirements; and pursuing preferential trade agreements would help increase competition and the efficiency of the economy.

  • Improving resource allocation. The banking system’s ability to allocate resources efficiently can be improved by reducing the share of earmarked credit. Focusing public banks’ activities on missing markets, such as providing guarantees for concessions, would improve the allocation of limited financing. Similarly, reducing budget earmarking would release fiscal space and improve the allocation of limited fiscal resources.

  • Pension reform. Reforming the pension system (beyond the announced tightening of survivor benefits) would mitigate foreseeable fiscal pressures. It could also boost savings, much-needed for funding investment. Revising the indexation of certain benefits, including pensions, to the minimum wage would also help raise public saving.

  • Revising the minimum wage indexation formula, so that it better reflects productivity gains. The trade-off between employment and high real wage growth would likely reassert itself in a low-economic growth environment (see Selected Issues Paper). The large and sustained rise in unit labor costs has contributed to the erosion of competitiveness. The current formula for minimum wage, by affecting the growth in pension and other benefits, is also a source of fiscal pressure. A reform of the minimum wage indexation formula is critical, but will likely require extensive consultation among stakeholders. Hence, efforts should begin early and in earnest to develop a broad-based consensus in favor of reform.

G-20 Saving, Invesment, and Growth, 2011-14

(In percent of GDP) 1/

Citation: 2015, 121; 10.5089/9781484380758.002.A001

Sources: WEO and Fund staff estimates.

1/ Average since 2011. Size of bubbles reflects growth of GDP per capita.

Authorities’ Views

28. The authorities agreed that 2015 will be a difficult transition year, but are determined to strengthen policies. They expect activity particularly in the first half of the year to be subdued, but anticipate a recovery in investment in the second half of the year on the premise that a strengthening of macroeconomic policy will help restore credibility and boost market confidence. Over the year, they see consumption remaining subdued given the drag from tighter fiscal and monetary policies. The authorities expressed in strong terms the commitment of the government to the objectives for fiscal and monetary policy that have been set for the next three years, which they see as providing the necessary foundation for the government’s actions to continue improving the living standards of the population. Concerning risks of fallout from the Petrobras probe, the authorities stressed that the investigation was following its course, and that the police and judicial authorities were fulfilling their functions within the framework of the law, illustrating the strength of Brazil’s institutions. They also noted that the company is sound, and that the new management that took the helm at Petrobras in February is working closely with the independent auditor to find a prompt resolution to the question of the markdown of assets, which would permit Petrobras to issue audited accounts.

29. The authorities, however, do not concur with staff forecasts, which they consider to be very pessimistic. According to the authorities, staff forecasts for 2015 overstate the impact of fiscal adjustment on public consumption, which is implicitly expected to decline by 6.9 percent, and hence on aggregate demand. They note that the worst decline of this aggregate demand component in more than two decades (1996-2013) was only -1.8 percent in 1996. In addition, contrary to staff’s forecast for private consumption growth to be flat, the authorities consider that there are still factors in place that would point to a small positive growth, such as projected real wage and credit growth. The authorities also note that estimates of the output gap may not be entirely consistent with the rest of the forecast.

30. The authorities emphasized their strong commitment to delivering the announced primary surplus target of 1.2 percent of GDP in 2015 and at least 2.0 percent of GDP in 2016 and 2017, with no new policy lending by government to the development bank. They further reiterated the link between these fiscal targets and their focus on the stabilization and subsequent reduction of gross debt. They indicated that their commitment to follow through with the consolidation process without delay was demonstrated by the measures announced since the turn of the year.

31. The authorities indicated that, within the existing constraints, they would seek to minimize the impact on activity of their fiscal adjustment. They explained that the situation was not one of crisis, and so they could implement the full adjustment over two years. They further indicated that fiscal adjustment will have to rely on both expenditure cuts and revenue measures, taking care to avoid cuts in key spending items (such as high-value capital and social spending) and increases in distortionary taxes. The authorities reiterated that they do not plan to continue the Treasury funding for public banks in the form of policy lending. Other costly subsidies are also being revised, notably those to energy, where revisions are already being implemented.

32. While authorities agreed that fiscal policies should aim at ensuring long-term sustainability and be fully transparent, they did not see a strong case for introducing a medium term fiscal framework beyond that provided by the three-year Budgetary Directives Law.

33. The authorities emphasized that ensuring inflation convergence to the 4.5 percent target by the end of 2016 is the key priority for monetary policy. The central bank noted that the monetary policy stance had been adjusted over the past year-and-a-half in line with the evolving inflation outlook, most recently to support a process of relative price adjustment that will contribute to reduce vulnerabilities, while preventing relative price adjustments from affecting general inflation. Moreover, they stressed that, although the headline inflation rate had remained broadly stable during 2014, this masked a gradual improvement in its composition, with a progressively decelerating rate of inflation in freely determined prices offsetting a rise in the inflation of monitored prices. The authorities agreed that the TJLP gap relative to SELIC should narrow over time.

34. The authorities argued that their foreign exchange intervention program has aimed at, and has helped preserve, financial stability, and has had no undesirable side-effects. In particular, they stated that the program had not encouraged overseas borrowing by corporates, and stressed, instead, that the program had prevented capital outflows during episodes of high volatility. The central bank argued that, in addition, the FX swaps helped reduce the cost of carrying international reserves, and that, being settled in local currency, they did not compromise or commit international reserves. They also remarked that the exchange rate had continued, and would continue, to move in response to changing fundamentals and external shocks. Taking all of these factors into account, the authorities indicated that at present the notional value of the hedging contracts outstanding is broadly in line with the economy’s hedging needs. The latest extension of the intervention program on a reduced scale and for a shorter period than previous extensions is consistent with this view. Concerning staff’s assessment of Brazil’s external position, the authorities saw the current account in 2014 as weaker than expected, reflecting in part the drop in key export prices; but they noted that it was still mostly FDI-financed, and that the deficit should narrow over the medium term as a result of ongoing adjustments in relative prices and increases in Brazil’s oil exports.

35. The authorities acknowledged staff’s concerns over the recent rapid expansion of public banks’ balance sheets, but remarked that the pace had moderated significantly and that the NPL ratios in these institutions had remained low. The authorities stressed, furthermore, that the asset quality deterioration was mainly concentrated in non-core segments of these banks’ loans, and that the banks were well provisioned for possible loan losses.

36. The authorities reiterated their commitment to advance the implementation of financial reforms. The authorities started to phase-in the implementation of Basel III capital requirement from October 2013.11 Brazilian banks have progressed well towards the fully-fledged implementation of Basel III, which according to authorities’ estimates would require additional capital for only a few banks and be equivalent to 0.3 percent of regulatory capital in the system until 2019. The authorities noted that further progress has been made since the 2013 Article IV consultation in implementing key recommendations from the 2012 FSAP Update, including the introduction of a new framework for Emergency Liquidity Assistance (ELA), and the approval of the updated bylaws of the deposit insurance fund (FGC).

37. The authorities agreed that addressing the infrastructure gaps is essential to boost potential growth and that further domestic private sector participation is needed, given limited fiscal space. They pointed to the recent success of their infrastructure concession program in attracting investors when auctioning the concessions of ports, roads and airports. They added that public banks are expected to continue to play a role in the financing of infrastructure, and that new options to mobilize private financing from capital markets were also under consideration.

38. The authorities agreed that structural reforms would help boost Brazil’s potential growth, but remarked that in some cases improvements in fiscal transfer programs (such as better targeting and reduction in abuses) provided incentives for higher labor productivity equivalent to reforms.

  • The authorities see great potential benefits from a simplification of the ICMS. However, they indicated that this reform would need time as it involves complex negotiations with state governments and the Senate. The simplification of the PIS/COFINS is also receiving consideration, as is the expansion of SIMPLES, the tax regime that applies to most small enterprises, so it includes some medium-sized enterprises as well.

  • The authorities agreed that promoting a more open economy would be beneficial, and highlighted recently introduced procedures for trade facilitation, including in customs, aimed at reducing bureaucratic hurdles to trade.

  • The authorities argued that modifying the minimum wage indexation formula was not a pressing need, as the current formula would imply modest increases in the real value of the minimum wage in the next few years, and it had proved a factor of stability in the last two years.

Staff Appraisal

39. The Brazilian economy faces serious challenges in the context of stalling growth and high inflation. The new government must strengthen macro-financial policies and institutions to restore credibility, and use its political capital to embark on much-needed structural reforms that would improve competitiveness and put the economy on a strong and sustainable medium-term growth path.

40. The announced fiscal targets for 2015–17 are welcome, but implementation will be crucial for bolstering market sentiment. An ambitious and front-loaded fiscal consolidation is required for reducing public debt and restoring policy credibility. For these reasons, staff welcomes the government’s primary fiscal targets for 2015–17, the authorities’ decision to end policy lending, and the emphasis on reducing gross debt. The recent announcements of a series of expenditure and revenue measures have sent an important signal of the authorities’ commitment to their policy strategy. Given the weak underlying fiscal position in 2014, the fiscal target of 1.2 percent of GDP for 2015 is appropriate, but further measures will be needed to meet this target. However, starting in 2016, aiming for a primary surplus above the minimum objective of 2.0 percent of GDP in 2016–17 would bolster fiscal sustainability, lower vulnerability to shocks, help reduce the interest bill faster, and strengthen policy credibility. A more gradual path for fiscal consolidation than the one announced should only be considered in the context that reforms addressing structural sources of fiscal pressure are brought forward and pursued with vigor. Moreover, anchoring fiscal targets in an effective medium-term fiscal framework would improve the predictability of fiscal policy.

41. Improving transparency of public finances is critical. Full disclosure of the underlying fiscal position would boost confidence and help communicate the need for adjustment. The weakening of Petrobras’ financial position poses a risk to the public finances and to the company’s investment plans. In this context, staff welcomes the ongoing investigation, and encourages the authorities to take steps to limit any economic fallout from the probe and to prevent future instances of procurement fraud and corruption.

42. Monetary policy has been appropriately tightened, but bringing inflation to target within the next two years will likely require some further tightening in the near term. While moderate economic activity and planned fiscal consolidation should help reduce inflation, the required re-alignment of relative prices, and the persistent cost-push arising from wage negotiations, will necessitate monetary policy maintaining a tightening bias to deliver a significant reduction in overall inflation by end-2016. Moreover, if currency weakness or the correction of regulated prices were to fuel inflation expectations, monetary policy would need to be further tightened.

43. Staff welcomes the recent scale down of the foreign exchange intervention program. Within the context of the flexible exchange rate regime, intervention can be useful when faced with episodes of excessive volatility, as was the case when the current intervention program was introduced. However, the continuous operation of the program could delay convergence of the exchange rate to a more competitive value. In this context, the recent reduction in the scale of the program should moderate its side effects, and consideration should be given to not renewing the program further.

44. Close monitoring and prudential measures could help deal with latent risks in private sector balance sheets, including banks and corporates. In the current low growth environment, there is a risk of deterioration in the quality of assets on banks’ balance sheets, especially commercial loans to SMEs and non-housing consumer loans. Enhanced supervision and the pursuit of targeted microprudential measures would help reduce such risks. Staff welcomes the enhanced on- and off-site supervision of public banks by the central bank. Public banks should also be encouraged to bolster their capital positions, including by retained earnings. Rising corporate leverage, including through overseas borrowing, should be carefully monitored. It is important to continue assessing whether corporates are adequately hedged.

45. Structural reforms are critical for improving the economy’s productive capacity and to anchor strong, sustained, and balanced growth over the medium term. Prioritizing these reforms and getting an early start would be essential. Staff welcomes the emphasis placed on the implementation of the infrastructure concessions program, and the intention to address tax inefficiencies related to the ICMS and foster a more open economy in particular. It will be essential to follow through with these efforts, and to consider other areas of reform as well.

46. It is recommended that the next Article IV consultation takes place on the standard 12-month cycle.

Table 1.Brazil: Selected Economic and Social Indicators
I. Social and Demographic Indicators
Area (thousands of sq. km)8,512Health
Agricultural land (percent of land area)31.2Physician per 1000 people (2010)1.8
Hospital beds per 1000 people (2011)2.3
PopulationAccess to safe water (2011)97.2
Total (million) (est., 2013)198.3
Annual rate of growth (percent, 2013)0.9Education
Density (per sq. km.) (2012)23.3Adult illiteracy rate (2013)9.7
Unemployment rate (average, 2013)5.4Net enrollment rates, percent in: Primary education (2013)93
Population characteristics (2013)Secondary education (2013)54
Life expectancy at birth (years)75
Infant mortality (per thousand live births)15Poverty rate (in percent, 2013)15.1
Income distribution (2013)GDP (2013)R$4,845 billion
By highest 10 percent of households41.6US$2,246 billion
By lowest 20 percent of households3.2
Gini coefficient (2013)49.5GDP per capita (est., 2013)US$11,326
Main export products: Airplanes, metallurgical products, soybeans, automobiles, electronic products, iron ore, coffee, and oil.
Sources: Central Bank of Brazil; Ministry of Finance; IPEA; and Fund staff estimates.

Includes the federal government, the central bank, and the social security system (INSS). Based on 2015 draft budget, recent announcements by the authorities, and staff projections. Assumes no policy change.

Currency issued plus required and free reserves on demand deposits held at the central bank.

Base money plus demand, time and saving deposits.

II. Economic Indicators
Est.Proj
2011201220132014201520162017201820192020
(Annual percentage change)
National accounts and prices
GDP at current prices9.96.010.34.66.67.67.87.67.77.7
GDP at constant prices2.71.02.50.0−1.00.92.22.32.42.5
Consumption3.63.22.41.9−1.7−0.21.41.52.02.1
Investment3.1−8.87.8−10.1−0.65.64.33.94.04.0
Consumer prices (IPCA, end of period)6.55.85.96.47.05.44.84.64.64.5
(In percent of GDP)
Gross domestic investment19.717.518.116.416.517.217.517.818.018.3
Private sector17.415.015.613.714.214.915.215.415.615.8
Public sector2.32.52.52.72.22.32.32.42.42.5
Gross national savings17.615.114.512.212.913.614.014.414.614.8
Private sector17.915.315.116.115.515.415.315.115.115.3
Public sector−0.2−0.2−0.6−4.0−2.6−1.8−1.3−0.7−0.5−0.5
Public sector finances
Central government primary balance 1/2.21.71.6−0.41.01.51.72.02.02.0
NFPS primary balance3.12.11.9−0.61.22.02.22.52.52.5
NFPS overall balance−2.6−2.8−3.3−6.8−5.1−4.3−3.8−3.2−3.1−3.1
NFPS overall balance (including net policy lending)−3.6−4.2−3.9−7.9−5.1−4.3−3.8−3.2−3.1−3.1
Net public sector debt36.435.333.637.239.338.938.238.138.237.6
General Government gross debt, authorities’ definition54.258.856.764.2
NFPS gross debt64.768.266.271.072.071.470.269.869.768.8
Of which: Foreign currency linked2.73.13.23.93.83.73.73.73.73.7
(Annual percentage change)
Money and credit
Base money 2/10.8−13.613.1−4.56.67.67.87.67.77.7
Broad money 3/18.515.98.915.514.814.514.214.114.014.0
Bank loans to the private sector20.215.815.311.511.611.912.412.813.113.5
(In billions of U.S. dollars, unless otherwise specified)
Balance of payments
Trade balance29.819.42.4−3.99.811.115.722.823.725.0
Exports256.0242.6242.0225.1212.3221.1235.1252.0262.9274.5
Imports−226.2−223.2−239.6−229.0−202.4−210.0−219.4−229.2−239.1−249.6
Current account−52.5−54.2−81.1−90.9−73.5−76.7−79.2−79.7−85.9−90.1
Capital account and financial account112.470.074.299.673.576.779.279.785.990.1
Foreign direct investment (net)67.768.167.566.053.954.052.653.855.356.8
Overall balance58.618.9−5.910.80.00.00.00.00.00.0
Terms of trade (percentage change)7.8−5.8−2.1−3.72.5−1.2−1.1−0.8−0.6−0.6
Merchandise exports (in US$, annual percentage change)26.8−5.3−0.2−7.0−5.74.26.37.24.34.4
Merchandise imports (in US$, annual percentage change)24.5−1.47.4−4.4−11.63.74.54.54.34.4
Total external debt (in percent of GDP)16.319.621.425.728.829.530.030.531.031.5
Memorandum items:
Current account (in percent of GDP)−2.1−2.4−3.6−4.2−3.6−3.6−3.5−3.4−3.4−3.4
Gross official reserves352.0373.1358.8363.6358.3358.8359.6360.4361.2362.3
REER (annual average in percent; appreciation +)3.5−10.0−5.6−1.0
Sources: Central Bank of Brazil; Ministry of Finance; IPEA; and Fund staff estimates.

Includes the federal government, the central bank, and the social security system (INSS). Based on 2015 draft budget, recent announcements by the authorities, and staff projections. Assumes no policy change.

Currency issued plus required and free reserves on demand deposits held at the central bank.

Base money plus demand, time and saving deposits.

Sources: Central Bank of Brazil; Ministry of Finance; IPEA; and Fund staff estimates.

Includes the federal government, the central bank, and the social security system (INSS). Based on 2015 draft budget, recent announcements by the authorities, and staff projections. Assumes no policy change.

Currency issued plus required and free reserves on demand deposits held at the central bank.

Base money plus demand, time and saving deposits.

Table 2.Brazil: Balance of Payments(In billions of U.S. dollars, unless otherwise indicated)
Est.Proj.
2011201220132014201520162017201820192020
Current Account−52.5−54.2−81.1−90.9−73.5−76.7−79.2−79.7−85.9−90.1
Trade balance29.819.42.4−3.99.811.115.722.823.725.0
Exports (fob)256.0242.6242.0225.1212.3221.1235.1252.0262.9274.5
Imports (fob)−226.2−223.2−239.6−229.0−202.4−210.0−219.4−229.2−239.1−249.6
Nonfactor services, net−37.9−41.0−47.1−48.7−44.2−46.4−49.1−51.5−53.8−56.1
Income, net−47.3−35.4−39.8−40.3−41.4−43.7−47.9−53.1−58.0−61.2
Of which: Interest−9.7−11.8−14.2−14.1−15.9−16.9−19.8−24.0−27.7−29.8
Profits and dividends−38.2−24.1−26.0−26.5−25.9−27.2−28.4−29.6−30.7−31.9
Current transfers, net3.02.83.41.92.32.22.12.22.22.2
Capital and Financial Account112.470.074.299.673.576.779.279.785.990.1
Capital account1.6−1.91.20.60.90.80.70.70.70.7
Financial account 1/110.871.973.199.072.676.078.478.985.289.4
Medium- and long-term capital137.088.493.2118.986.182.481.885.088.792.7
Direct investment, net67.768.167.566.053.954.052.653.855.356.8
Foreign66.765.364.062.556.156.555.356.958.660.3
Brazilian1.02.83.53.5−2.2−2.5−2.7−3.1−3.3−3.5
Portfolio investment, net41.48.623.130.223.821.521.222.224.925.6
Other investment, net27.811.72.622.78.46.98.09.08.510.3
Commercial credit−1.2−0.51.30.30.10.20.30.30.40.5
Loans and other29.012.11.422.48.36.77.78.68.19.8
Of which: Monetary authority0.00.00.00.00.00.00.00.00.01.0
Short-term capital−26.1−16.5−20.2−20.0−13.5−6.4−3.4−6.0−3.6−3.3
Errors and Omissions−1.33.10.92.20.00.00.00.00.00.0
Overall Balance58.618.9−5.910.80.00.00.00.00.00.0
Memorandum Items:
Gross reserves (eop) 1/
In billions of U.S. dollars352.0373.1358.8363.6358.3358.8359.6360.4361.2362.3
Net international reserves (eop)
In billions of U.S. dollars352.0373.1358.8363.6358.3358.8359.6360.4361.2361.3
In percent of short-term debt (residual maturity)359.9413.7394.8376.6355.4325.7301.4277.2254.6233.8
Current account (in percent of GDP)−2.1−2.4−3.6−4.2−3.6−3.6−3.5−3.4−3.4−3.4
Trade balance (in percent of GDP)1.20.90.1−0.20.50.50.71.01.01.0
Merchandise exports (in percent of GDP)10.310.810.810.410.410.310.410.610.610.5
Merchandise imports (in percent of GDP)−9.1−9.9−10.7−10.6−9.9−9.8−9.7−9.7−9.6−9.5
Export volume (yoy change, in percent)2.9−0.33.1−1.71.83.55.96.94.34.4
Import volume (yoy change, in percent)8.9−2.38.6−2.7−2.21.83.03.33.63.8
Export price index (yoy change, in percent)23.2−4.9−3.2−5.4−7.30.70.40.30.00.0
Import price index (yoy change, in percent)14.30.9−1.2−1.7−9.61.91.51.10.70.6
Terms of trade (yoy change, in percent)7.8−5.8−2.1−3.72.5−1.2−1.1−0.8−0.6−0.6
Oil price (Brent blend; US$ per barrel)104.0105.0104.196.250.958.863.766.667.868.5
Nominal exchange rate (R/US$, annual average)1.671.952.162.35
REER (annual average in percent; appreciation +)3.5−10.0−5.6−1.0
GDP in billions of U.S. dollars2,4752,2482,2462,1602,0402,1442,2572,3712,4912,618
Sources: Central Bank of Brazil; and Fund staff estimates and projections.

Historical numbers include valuation changes.

Sources: Central Bank of Brazil; and Fund staff estimates and projections.

Historical numbers include valuation changes.

Table 3.Brazil: Main Fiscal Indicators(In percent of GDP, unless otherwise indicated)
Est.Proj.
20102011201220132014201520162017201820192020
FEDERAL GOVERNMENT1/
Nonfinancial revenue2/24.423.923.924.324124124224424.524.624.6
Revenue administered by SRF14.115.214.714.814.814.914.915.115.115.215.2
PIT2.32.62.72.62.92.92.93.03.03.03.0
CIT4.14.54.24.34.54.24.24.24.34.34.3
Indirect Taxes6.76.96.86.86.56.86.96.96.96.96.9
Trade taxes0.60.60.70.80.70.70.70.70.70.70.7
Other0.40.50.30.30.20.20.20.20.20.20.2
Social security contributions5.65.96.36.36.76.66.66.66.76.76.7
Other revenue4.72.82.83.12.72.72.72.72.72.82.8
Total primary expenditure22.721.722.422.724.523.122.722.622.522.622.6
Current expenditures20.020.421.121.423.021.921.421.321.121.121.1
Personnel4.54.44.34.24.34.34.34.34.34.34.3
Transfers3.53.93.93.84.14.14.14.14.24.24.2
Pension benefits6.86.87.27.47.87.77.77.77.67.67.6
Other 3/5.35.35.76.16.75.75.25.15.05.04.9
Capital expenditures2.61.31.41.31.51.21.31.31.41.51.5
Primary balance1.82.21.71.6−0.41.01.51.82.02.02.0
STATES AND MUNICIPALITIES
Nonfinancial revenue2/11.411.612.012.012.112.011.911.911.911.911.9
Own revenues8.58.69.09.19.09.08.98.98.88.88.8
Indirect taxes7.07.17.37.47.37.27.27.17.17.17.0
Other1.51.51.61.81.71.81.81.81.81.81.8
Transfers from the federal government2.93.03.02.93.13.03.03.03.03.13.1
Total primary expenditure10.910.811.511.812.311.911.511.511.511.511.5
Current expenditures9.69.810.410.611.210.810.510.510.510.510.5
Personnel4.95.05.45.45.45.45.45.45.45.45.4
Other 3/4.74.85.15.25.85.45.15.15.15.15.1
Capital expenditures and other1.31.01.11.21.11.01.01.01.01.01.0
Primary balance of municipalities0.10.10.10.10.10.10.10.10.10.10.1
Primary balance0.50.80.50.3−0.20.20.50.50.50.50.5
PUBLIC ENTERPRISES
Primary balance0.10.1−0.10.0−0.10.00.00.00.00.00.0
NONFINANCIAL PUBLIC SECTOR
Primary balance2.43.12.11.9−0.61.22.02.32.52.52.5
Net interest payments of the public sector5.25.74.95.16.16.36.36.15.75.65.6
Overall balance−2.8−2.6−2.8−3.3−6.8−5.1−4.3−3.8−3.2−3.1−3.1
Policy lending 4/2.71.01.50.71.10.00.00.00.00.00.0
Structural primary balance 5/1.42.72.11.6−0.61.72.52.52.52.42.4
Structural primary including policy lending−1.31.70.70.9−1.71.72.52.52.52.42.4
Memorandum items:
Growth Acceleration Program0.60.70.90.91.01.01.01.01.01.01.0
Net public sector debt 6/39.136.435.333.637.239.338.938.238.138.237.6
General Government gross debt, authorities’ definition53.454.258.856.764.2
NFPS gross debt 7/65.064.768.266.271.072.071.470.269.869.768.8
Sources: Central Bank of Brazil; Ministry of Finance; Ministry of Planning and the Budget; and Fund staff estimates.

Comprises the central administration; the Central Bank of Brazil; and the social security system.

Excludes proceeds from privatization.

Includes unallocated fiscal consolidation measures in 2015-20

Policy lending to BNDES and other public financial institutions.

Structural primary balance adjusts for output gap and one-off measures in 2009 and 2010 (sale of Eletrobras debt and Petrobras operation).

Includes assets, which mainly comprise international reserves, outstanding liabilities of public financial institutions to the Treasury, financial assets of public enterprises, and assets of the federal labor fund (FAT).

Gross non financial public sector debt consolidates debt of public enterprises with that of general government. Unlike the authorities’ definition, gross general government debt comprises treasury bills at the central bank’s balance sheet not used under repurchase agreements.

Sources: Central Bank of Brazil; Ministry of Finance; Ministry of Planning and the Budget; and Fund staff estimates.

Comprises the central administration; the Central Bank of Brazil; and the social security system.

Excludes proceeds from privatization.

Includes unallocated fiscal consolidation measures in 2015-20

Policy lending to BNDES and other public financial institutions.

Structural primary balance adjusts for output gap and one-off measures in 2009 and 2010 (sale of Eletrobras debt and Petrobras operation).

Includes assets, which mainly comprise international reserves, outstanding liabilities of public financial institutions to the Treasury, financial assets of public enterprises, and assets of the federal labor fund (FAT).

Gross non financial public sector debt consolidates debt of public enterprises with that of general government. Unlike the authorities’ definition, gross general government debt comprises treasury bills at the central bank’s balance sheet not used under repurchase agreements.

Table 4.Brazil: Depository Corporations and Monetary Aggregates(End of period, in billions of reais)
2008200920102011201220132014 /5
I. Central Bank
Net foreign assets450.9407.1474.6653.8756.9834.5954.9
Net international reserves438.3409.4473.2659.7762.5840.7960.8
Other foreign assets (net)12.7−2.31.5−5.9−5.6−6.2−5.9
Net domestic assets−245.3−178.255.9−66.1−248.9−259.9−423.6
Net claims on public sector61.8228.2292.7176.4276.7266.0466.4
Net credit to other depository corporations−271.2−411.5−227.4−288.6−474.1−479.0−842.4
Other items (net)35.8−5.29.4−46.251.546.947.6
Base money205.6228.9530.6587.7508.0574.6531.3
Currency issued115.6131.9151.1162.8187.4204.1199.4
Liabilities to other depository corporations90.097.1379.4424.9320.0369.0329.8
Reserve deposits32.034.255.751.545.945.542.2
Liabilities to other sectors0.00.00.00.00.61.52.2
II. Depository Corporations 1/
Net foreign assets343.1349.6378.0488.5527.5638.2707.1
Net international reserves438.3409.4473.2659.7762.5840.7960.8
Other foreign assets (net)−95.2−59.8−95.2−171.2−235.0−202.5−253.7
Net domestic assets1,578.81,885.62,210.72,579.43,028.23,234.53,703.6
Net claims on public sector974.71,147.91,225.71,210.11,368.61,346.11,435.7
Credit to other financial corporations247.6232.0294.2342.7383.7431.6498.4
Credit to private sector1,423.71,583.02,050.42,541.73,010.23,424.53,755.8
Of which: loans to private sector426.2515.9661.0817.0966.81,126.61,246.9
Other items (net)1,092.81,130.01,418.31,585.01,838.22,100.12,159.1
Capital514.4490.1613.2631.2793.4791.6829.5
Other liabilities excluded from broad money578.4639.9805.1953.81,044.91,308.51,329.6
Broad money (M2)2/1,921.92,235.22,588.73,067.93,555.73,872.74,410.7
Currency in circulation92.2105.6121.7131.4149.6163.9163.4
Demand deposits133.9147.8165.2159.8182.3189.8173.0
Quasi-money liabilities1,695.81,981.82,301.82,776.73,223.83,519.04,074.3
(Ratio)
Multiplier (M2/base money)9.39.84.95.27.06.78.3
(In percent of GDP)
Base money6.87.114.114.211.611.910.5
Broad money (M2)63.469.068.774.081.079.987.0
M3 3/62.968.067.673.180.178.984.3
M4 4/73.980.380.685.793.490.998.8
Financial sector credit to the private sector47.048.954.461.368.570.774.1
Of which: bank credit37.239.641.845.850.052.254.3
Memorandum item:
GDP (in billions of national currency)3,0323,2393,7704,1434,3924,8455,069
Sources: Central Bank of Brazil; and Fund staff estimates.

Includes the Central Bank of Brazil, commercial banks, multiple banks, financial (money market) investment funds, Banco do Brasil, Federal Savings Bank, state savings bank, investment banks, National Bank for Economic and Social Development (BNDES), state development banks, finance and investment companies, housing credit companies, and mortgage companies.

M2 includes the liabilities to other financial corporations, state and municipal governments, nonfinancial public enterprises, other nonfinanical corporations, and other resident sectors.

Authorities’ definition. M3 comprises M2 plus shares in financial investment funds and the net position of the securities used in their purchase agreements transactions with money holding sectors.

Authorities’ definition. M4 comprises M3 plus federal, state, and municipal liquid securities held by the public.

As of November 2014.

Sources: Central Bank of Brazil; and Fund staff estimates.

Includes the Central Bank of Brazil, commercial banks, multiple banks, financial (money market) investment funds, Banco do Brasil, Federal Savings Bank, state savings bank, investment banks, National Bank for Economic and Social Development (BNDES), state development banks, finance and investment companies, housing credit companies, and mortgage companies.

M2 includes the liabilities to other financial corporations, state and municipal governments, nonfinancial public enterprises, other nonfinanical corporations, and other resident sectors.

Authorities’ definition. M3 comprises M2 plus shares in financial investment funds and the net position of the securities used in their purchase agreements transactions with money holding sectors.

Authorities’ definition. M4 comprises M3 plus federal, state, and municipal liquid securities held by the public.

As of November 2014.

Table 5.Brazil: Medium-Term Macroeconomic Framework, Balance of Payments, and External Debt
Est.Proj.
20102011201220132014201520162017201820192020
MACROECONOMIC FRAMEWORKIn percent of GDP, unless otherwise specified
GDP growth at constant prices (in percent)7.52.71.02.50.0−1.00.92.22.32.42.5
Consumer prices (IPCA, end of period, in percent)5.96.55.85.96.47.05.44.84.64.64.5
Gross domestic investment20.219.717.518.116.416.517.217.517.818.018.3
Private sector17.917.415.015.613.714.214.915.215.415.615.8
Public sector2.32.32.52.52.72.22.32.32.42.42.5
Gross domestic savings18.017.615.114.512.212.913.614.014.414.614.8
Private sector16.917.915.315.116.115.515.415.315.115.115.3
Public sector1.2−0.2−0.2−0.6−4.0−2.6−1.8−1.3−0.7−0.5−0.5
External current account balance−2.2−2.1−2.4−3.6−4.2−3.6−3.6−3.5−3.4−3.4−3.4
Central government primary balance1.82.21.71.6−0.41.01.51.72.02.02.0
Consolidated non-financial public sector
Primary balance2.43.12.11.9−0.61.22.02.22.52.52.5
Overall balance−2.8−2.6−2.8−3.3−6.8−5.1−4.3−3.8−3.2−3.1−3.1
Public sector net debt 1/39.136.435.333.637.239.338.938.238.138.237.6
General Government gross debt, authorities’ definition53.454.258.856.764.2
NFPS gross debt 2/65.064.768.266.271.072.071.470.269.869.768.8
EXTERNAL DEBT3/4/In billions of U.S. Dollars
Total external debt351.9404.1440.6481.7554.7587.6632.0676.6723.2771.8824.7
Medium- and long-term294.6364.0408.0449.1500.1546.5586.0624.5664.0704.7748.4
Nonfinancial public sector82.877.382.282.687.890.593.497.8103.3109.5118.6
Public sector banks17.320.326.331.334.536.538.440.242.043.745.5
Private sector194.5266.4299.5335.2385.3419.6454.2486.5518.7551.4584.4
Short-term57.340.132.632.654.641.046.152.159.167.276.2
Medium- and long-term external debt service52.156.075.376.776.880.079.786.894.3102.0108.1
Amortization36.538.057.657.658.359.858.562.865.969.673.3
Interest15.618.017.619.118.520.221.224.028.432.434.7
In percent of GDP
Total external debt16.416.319.621.425.728.829.530.030.531.031.5
Medium- and long-term13.714.718.220.023.126.827.327.728.028.328.6
Nonfinancial public sector3.93.13.73.74.14.44.44.34.44.44.5
Public sector banks0.80.81.21.41.61.81.81.81.81.81.7
Private sector9.110.813.314.917.820.621.221.621.922.122.3
Short-term2.71.61.41.52.52.02.12.32.52.72.9
In percent of gross international reserves
Medium- and long-term external debt service18.015.920.221.421.122.322.224.126.228.229.8
Amortization12.710.815.416.116.016.716.317.518.319.320.2
Interest5.45.14.75.35.15.65.96.77.99.09.6
Short-term debt19.911.48.79.115.011.412.814.516.418.621.0
MEMORANDUM ITEMS:
Gross reserves (eop) 4/
In billions of U.S. dollars288.6352.0373.1358.8363.6358.3358.8359.6360.4361.2362.3
In percent of short-term debt (residual maturity)302.8359.9413.7394.8376.6355.4325.7301.4277.2254.6233.8
In months of prospective GNFS imports11.513.913.713.515.314.513.813.212.712.2
Net international reserves (eop) 4/
In billions of U.S. dollars288.6352.0373.1358.8363.6358.3358.8359.6360.4361.2362.3
In percent of short-term debt (residual maturity)302.8359.9413.7394.8376.6355.4325.7301.4277.2254.6233.8
Short-term debt in percent of total external debt16.39.97.46.89.87.07.37.78.28.79.2
Intercompany debt (in billions of U.S. dollars)95.1105.9127.7173.1207.1231.2255.6278.6301.8325.3349.2
In percent of GDP4.44.35.77.79.611.311.912.312.713.113.3
GDP (billion US$)2,1432,4752,2482,2462,1602,0402,1442,2572,3712,4912,618
Sources: Central Bank of Brazil; and Fund staff estimates and projections.

Includes assets, which mainly comprise international reserves, outstanding liabilities of public financial institutions to the Treasury, financial assets of public enterprises, and assets of the federal labor fund (FAT).

Gross non financial public sector debt consolidates debt of public enterprises with that of general government. Unlike the authorities’ definition, gross general government debt comprises treasury bills at the central bank’s balance sheet not used under repurchase agreements.

Includes intercompany debt.

Historical numbers include valuation changes.

Sources: Central Bank of Brazil; and Fund staff estimates and projections.

Includes assets, which mainly comprise international reserves, outstanding liabilities of public financial institutions to the Treasury, financial assets of public enterprises, and assets of the federal labor fund (FAT).

Gross non financial public sector debt consolidates debt of public enterprises with that of general government. Unlike the authorities’ definition, gross general government debt comprises treasury bills at the central bank’s balance sheet not used under repurchase agreements.

Includes intercompany debt.

Historical numbers include valuation changes.

Table 6.Brazil: Financial Soundness Indicators by Ownership, 2009-September 2014(In percent)
200920102011201220132014
MarJunSep
Total banking system
Capital Adequacy
Regulatory capital to risk-weighted assets18.716.916.316.416.115.415.516.5
Regulatory Tier 1 capital to risk-weighted assets15.313.712.911.912.612.112.213.1
Capital to assets11.410.310.110.19.39.39.39.3
Gross asset position in financial derivatives to capital8.28.87.47.89.69.28.510.0
Gross liability position in financial derivatives to capital11.610.68.09.310.910.39.312.0
Asset Quality
Nonperforming loans to total gross loans4.23.13.53.42.92.92.92.9
Provisions to Nonperforming loans151.4164.8151.6148.7161.2154.1151.8153.9
Earnings and Profitability
Return on assets1.81.91.71.41.41.41.31.3
Return on equity15.816.816.112.913.013.412.712.9
Liquidity
Liquidity assets to short-term liabilities252.1185.3178.6191.8158.0145.4149.2186.0
Liquidity assets to total assets17.812.011.714.910.910.611.312.7
Net open position in foreign exchange to capital0.21.10.2−0.60.40.31.31.5
External funding to total funding5.87.39.29.38.58.68.69.4
Public banks
Capital Adequacy
Regulatory capital to risk-weighted assets15.315.114.314.514.913.914.015.8
Regulatory Tier 1 capital to risk-weighted assets11.010.79.89.411.310.510.612.1
Capital to assets6.46.86.76.35.65.65.45.4
Gross asset position in financial derivatives to capital1.51.10.81.01.71.51.21.9
Gross liability position in financial derivatives to capital3.83.92.12.13.03.03.22.0
Asset Quality
Nonperforming loans to total gross loans2.72.01.91.81.92.02.12.1
Provisions to Nonperforming loans185.0209.6214.2203.3181.1164.9161.2162.0
Earnings and Profitability
Return on assets1.71.81.71.51.51.41.11.1
Return on equity24.422.921.018.718.117.914.213.9
Liquidity
Liquidity assets to short-term liabilities289.1214.4201.1282.1214.1190.7191.3206.5
Liquidity assets to total assets18.613.412.914.210.510.010.110.6
Net open position in foreign exchange to capital0.41.64.30.01.4−1.62.71.5
External funding to total funding3.02.63.24.44.34.34.34.6
Private banks (domestic and foreign)
Capital Adequacy
Regulatory capital to risk-weighted assets20.117.717.317.416.816.316.316.9
Regulatory Tier 1 capital to risk-weighted assets17.115.014.313.213.312.913.113.6
Capital to assets14.312.211.912.511.811.712.012.1
Gross asset position in financial derivatives to capital9.911.19.49.912.211.710.912.6
Gross liability position in financial derivatives to capital13.512.69.811.613.512.711.215.1
Asset Quality
Nonperforming loans to total gross loans5.33.94.64.93.83.83.83.8
Provisions to Nonperforming loans139.9149.0133.4131.6151.7148.5146.5149.2
Earnings and Profitability
Return on assets1.82.01.71.31.31.41.41.5
Return on equity13.414.914.410.810.811.412.112.4
Liquidity
Liquidity assets to short-term liabilities234.2170.9166.8162.4135.3126.7132.3176.7
Liquidity assets to total assets17.411.211.115.411.211.012.214.1
Net open position in foreign exchange to capital0.11.0−1.1−0.80.10.90.81.5
External funding to total funding7.39.812.612.511.812.112.013.4
Sources: Central Bank of Brazil; and Fund staff calculation.
Sources: Central Bank of Brazil; and Fund staff calculation.
Table 7.Brazil: Statement of Operations of the General Government (GFSM 2001)(Percent of GDP)
Est.Proj.
2011201220132014201520162017201820192020
Nonfinancial Revenue34.534.935.535.235.235.235.335.535.535.5
Taxes24.224.224.324.224.224.224.324.324.324.3
Social contributions5.96.36.36.76.66.66.66.76.76.7
Grants0.00.00.00.00.00.00.00.00.00.0
Other revenue4.34.54.94.34.44.44.44.54.54.5
Primary Expenditure31.432.733.635.834.033.233.133.033.033.0
Expense29.130.231.233.131.830.930.730.630.630.5
Compensation of employees9.49.69.69.79.79.79.79.79.79.7
Use of goods and services13.013.414.215.614.313.513.413.213.213.2
Consumption of fixed capital
Subsidies
Grants
Social benefits6.87.27.47.87.77.77.77.67.67.6
Other expense0.00.00.00.00.00.00.00.00.00.0
Net acquisition of nonfinancial assets2.32.52.52.72.22.32.32.42.42.5
Acquisitions of nonfinancial assets
Disposals of nonfinancial assets
Consumption of fixed capital
Net Interest Payments6.25.55.86.65.45.75.75.55.55.5
Gross Operating Balance−0.9−0.9−1.4−4.5−1.9−1.4−1.1−0.6−0.5−0.5
Net Operating Balance
Net lending (+)/borrowing (−)−3.2−3.3−3.9−7.1−4.2−3.7−3.4−3.0−3.0−3.0
Net acquisition of financial assets2.03.80.10.0
Domestic2.03.80.10.0
Currency and deposits0.61.9−1.0−1.4
Debt securities0.00.00.00.0
Loans1.31.91.11.5
Equity and investment fund shares0.00.00.00.0
Insurance, pensions, and standardized guarantee schemes0.00.00.00.0
Financial derivatives and employee stock options0.00.00.00.0
Other accounts receivable
Foreign0.00.00.00.0
Monetary gold and SDRs0.00.00.00.0
Currency and deposits0.00.00.00.0
Debt securities0.00.00.00.0
Loans0.00.00.00.0
Equity and investment fund shares0.00.00.00.0
Insurance, pensions, and standardized guarantee schemes0.00.00.00.0
Financial derivatives and employee stock options0.00.00.00.0
Other accounts receivable
Net incurrence of liabilities5.06.83.97.1
Domestic4.96.43.56.2
Currency and deposits0.00.00.00.0
Debt securities4.86.13.16.2
Loans0.10.30.40.0
Equity and investment fund shares0.00.00.00.0
Insurance, pensions, and standardized guarantee schemes0.00.00.00.0
Financial derivatives and employee stock options0.00.00.00.0
Other accounts payable
Foreign0.20.40.40.9
SDRs0.00.00.00.0
Currency and deposits0.00.00.00.0
Debt securities0.40.10.30.0
Loans−0.20.30.10.9
Equity and investment fund shares0.00.00.00.0
Insurance, pensions, and standardized guarantee schemes0.00.00.00.0
Financial derivatives and employee stock options0.00.00.00.0
Other accounts payable
Sources: Central Bank of Brazil; Ministry of Finance; and Ministry of Planning and the Budget.
Sources: Central Bank of Brazil; Ministry of Finance; and Ministry of Planning and the Budget.
Table 8.Brazil: General Government Stock Positions (GFSM 2001)(Percent of GDP)
Est.
20072008200920102011201220132014
Stock positions:
Net worth−44.4−38.8−42.5−39.7−37.1−36.0−34.3
Nonfinancial assets0.00.00.00.00.00.00.0
Net financial worth−44.4−38.8−42.5−39.7−37.1−36.0−34.3−37.8
Financial assets20.024.224.024.727.031.531.332.5
Domestic20.024.224.024.727.031.531.332.4
Currency and deposits18.722.119.017.418.922.021.521.5
Debt securities0.00.00.00.00.00.00.00.0
Loans1.22.05.07.28.09.59.810.9
Equity and investment fund shares0.00.00.00.00.00.00.00.0
Insurance, pensions, and standardized guarantee schemes0.00.00.00.00.00.00.00.0
Financial derivatives and employee stock options0.00.00.00.00.00.00.00.0
Other accounts receivable0.00.00.00.00.00.00.00.0
Foreign0.00.00.00.00.00.00.00.0
Monetary gold and SDRs0.00.00.00.00.00.00.00.0
Currency and deposits0.00.00.00.00.00.00.00.0
Debt securities0.00.00.00.00.00.00.00.0
Loans0.00.00.00.00.00.00.00.0
Equity and investment fund shares0.00.00.00.00.00.00.00.0
Insurance, pensions, and standardized guarantee schemes0.00.00.00.00.00.00.00.0
Financial derivatives and employee stock options0.00.00.00.00.00.00.00.0
Other accounts receivable0.00.00.00.00.00.00.00.0
Liabilities67.566.068.964.464.067.565.670.2
Domestic61.759.262.557.056.959.456.158.8
Currency and deposits0.00.00.00.00.00.00.00.0
Debt securities57.355.059.055.955.858.054.557.4
Loans4.34.13.51.21.11.41.61.4
Equity and investment fund shares0.00.00.00.00.00.00.00.0
Insurance, pensions, and standardized guarantee schemes0.00.00.00.00.00.00.00.0
Financial derivatives and employee stock options0.00.00.00.00.00.00.00.0
Other accounts payable0.00.00.00.00.00.00.00.0
Foreign5.86.86.47.37.18.29.511.5
Monetary gold and SDRs0.00.00.00.00.00.00.00.0
Currency and deposits0.00.00.00.00.00.00.00.0
Debt securities4.55.15.36.26.27.08.18.9
Loans1.31.81.11.10.91.21.42.5
Equity and investment fund shares0.00.00.00.00.00.00.00.0
Insurance, pensions, and standardized guarantee schemes0.00.00.00.00.00.00.00.0
Financial derivatives and employee stock options0.00.00.00.00.00.00.00.0
Other accounts payable0.00.00.00.00.00.00.00.0
Other economic flows:
Change in net worth from other flows
Nonfinancial assets
Net financial worth
Financial assets
Domestic
Foreign
Liabilities
Domestic
Foreign
Memorandum item
Government gross debt per national definition58.057.460.953.454.258.856.764.2
Sources: Central Bank of Brazil; and Ministry of Finance.
Sources: Central Bank of Brazil; and Ministry of Finance.
Table 9.Brazil: External Vulnerability(In billions of U.S. dollars, unless otherwise indicated)
Est.
200920102011201220132014
Trade
Exports of GNFS (12-month percent change, US$)−20.929.226.0−4.0−0.5−5.3
Imports of GNFS (12-month percent change, US$)−20.739.823.80.67.2−2.2
Terms of trade (12-month percent change)−2.616.07.8−5.8−2.1−3.7
Current account
Current account−24.3−47.3−52.5−54.2−81.1−90.9
In percent of GDP−1.5−2.2−2.1−2.4−3.6−4.2
Capital and financial account
Capital and financial account71.399.9112.470.074.299.6
Portfolio investment (net)50.462.935.38.825.828.4
Foreign direct investment (net)36.036.967.768.167.566.0
Of which: intercompany loans (net)11.613.216.823.339.236.6
Short-term external liabilities of commercial banks29.451.138.127.427.830.7
External debt
Total external debt 1/277.6351.9404.1440.6481.7554.7
In percent of gross reserves116.4122.0114.8118.1134.3152.6
Amortization of external MLT debt (in percent of GNFS exports)11.711.513.913.713.515.3
External interest payments (in percent of GNFS exports)9.26.46.05.85.95.8
Reserves
Gross reserves238.5288.6352.0373.1358.8363.6
In months of prospective GNFS imports15.314.513.813.212.712.2
In percent of broad money (M2)10.711.111.510.59.38.1
In percent of short-term external debt770.1503.6876.81,145.21,100.5665.7
In percent of short-term external debt by residual maturity376.6355.4325.7301.4277.2254.6
In percent of IMF metric158.2155.1184.0186.8190.3190.3
Exchange rate
Exchange rate (R$/US$, period average)2.001.761.671.952.162.35
REER (annual average in percent; appreciation +)−0.813.43.5−10.0−5.6−1.0
Sources: Central Bank of Brazil; Bloomberg; and Fund staff estimates.

Includes intercompany loans.

Sources: Central Bank of Brazil; Bloomberg; and Fund staff estimates.

Includes intercompany loans.

Table 10.Brazil External Debt Sustainability Framework, 2012-2020(In percent of GDP, unless otherwise indicated)
Est.Proj.Debt-stabilizing non-interest current account 6/
201220132014201520162017201820192020
Baseline: External debt19.621.425.728.829.530.030.531.031.5−1.9
Change in external debt3.31.84.23.10.70.50.50.50.5
Identified external debt-creating flows (4+8+9)1.51.13.32.51.41.20.91.01.0
Current account deficit, excluding interest payments1.62.83.42.62.62.42.22.12.1
Deficit in balance of goods and services1.02.02.41.71.61.51.21.21.2
Exports12.612.512.312.312.212.312.612.512.4
Imports13.514.514.814.013.813.813.813.713.6
Net non-debt creating capital inflows (negative)−2.5−2.5−1.8−1.4−1.9−1.7−1.8−1.8−1.7
Automatic debt dynamics 1/2.40.91.71.30.70.40.50.60.6
Contribution from nominal interest rate0.80.90.91.01.01.11.21.31.3
Contribution from real GDP growth−0.2−0.50.00.3−0.2−0.6−0.7−0.7−0.7
Contribution from price and exchange rate changes 2/1.80.50.81.2−1.2−0.9−0.8−0.8−0.8
Residual, incl. change in gross foreign assets (2-3) 3/1.70.71.0−0.50.40.20.40.30.3
External debt-to-exports ratio (in percent)156.0171.3208.4234.1241.8243.4242.7248.3254.0
Gross external financing need (in billions of US dollars) 4/131.5158.0164.3173.5167.4178.4188.5205.4221.3
in percent of GDP5.87.07.68.57.87.98.08.28.5
Scenario with key variables at their historical averages 5/30.528.025.423.220.918.9−2.6
Key Macroeconomic Assumptions Underlying Baseline
Real GDP growth (in percent)1.02.50.0−1.00.92.22.32.42.5
Exchange rate appreciation (US dollar value of local currency, change in percent)−14.3−9.4−8.1−11.4−2.3−2.4−2.4−2.4−2.4
GDP deflator (change in domestic currency)4.97.64.77.76.65.55.25.15.0
GDP deflator in US dollars (change in percent)−10.1−2.5−3.8−4.64.13.02.72.62.5
Nominal external interest rate (in percent)4.44.33.83.63.63.84.24.54.5
Growth of exports (US dollar terms, in percent)−4.0−0.5−5.3−5.74.26.37.24.34.4
Growth of imports (US dollar terms, in percent)0.67.2−2.2−10.54.04.94.94.34.4
Current account balance, excluding interest payments−1.6−2.8−3.4−2.6−2.6−2.4−2.2−2.1−2.1
Net non-debt creating capital inflows−1.7−0.7−0.71.41.91.71.81.81.7
B. Bound Tests
B1. Nominal interest rate is at historical average plus one standard deviation30.534.237.440.844.147.50.9
B2. Real GDP growth is at historical average minus one standard deviations30.531.532.433.234.034.9−1.6
B3. Non-interest current account is at historical average minus one standard deviations30.535.139.143.347.451.40.5
B4. Combination of B1-B3 using 1/2 standard deviation shocks30.532.033.434.736.137.5−1.6
B5. One time 30 percent real depreciation in 201630.547.748.549.350.050.8−3.0

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure 1.Brazil: Recent Economic Developments

Sources: Haver analytics; IBGE; and Fund staff estimations.

1/ Difference between the current rate and the 10-year average in percentage points.

2/ Data for 2015Q1 is an average of the two first months of the quarter.

Figure 2.Brazil: Inflation

Sources: Haver Analytics, IBGE, and Fund Staff calculations.

1/ Extended Consumer Price Index, Double Weighted (IPCA-DP).

Figure 3.Brazil: Macroeconomic Policies

Sources: Central Bank of Brazil, IBGE, Haver Analytics, and Fund staff calculations.

Figure 4.Brazil: External Sector

Sources: Central Bank of Brazil; Haver Analytics; and Fund staff calculations.

Figure 5.Brazil: Financial Sector

Sources: Central Bank of Brazil, Serasa Experian, and Fund staff calculations.

Figure 6.Brazil: Comparative Financial Sector Indicators

1/ Selected sample: Mexico, Peru, Colombia, Chile, India, South Africa, Turkey, and Indonesia.

Sources: Bloomberg, and Staff estimates.

Figure 7.Brazil: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Source: National authorities, and Fund staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2016.

Appendix I. Brazil: External Sector Assessment 20141

Brazil’s external position is weaker than the level consistent with medium-term fundamentals and desirable policy settings. Reserves are adequate and FDI continues to cover a significant share of the current account deficit. Further efforts to increase national saving are needed, including by advancing with pension reform and shifting the structure of public spending away from consumption. Foreign exchange intervention, including through the use of derivatives, can be appropriate to address bouts of excess volatility in the foreign exchange market arising from unstable capital flows, but should not be used to resist currency pressures that reflect changes in fundamentals.

Current account

1. Brazil’s current account turned into deficit over the past decade, despite large terms of trade gains. Import volumes more than doubled since 2004, supported by strong domestic demand, while export volumes have remained broadly constant. Booming commodity prices sustained exports and helped contain the current account deficit, but the share of manufactured products has declined. As an illustration of the importance of commodity prices, were the terms of trade to return to their 2005 level, Brazil’s current account deficit would have reached 5.1 instead of 3.6 percent of GDP in 2013. In recent years, the terms of trade have fallen from record highs, with the current account deficit reaching 4.2 percent of GDP in 2014.2

Terms of Trade, Import and Export Volumes

(Index, 2005 = 100)

Current Account Balance at Current and 2005 Prices

(in percent of GDP)

2. The observed worsening of the current account balance reflects low savings. The challenge to Brazil’s external sector outlook from a savings-investment perspective is that both private and public savings are relatively low compared with other emerging economies. Since 2004, consumption has accounted for almost all the growth in Brazil. Increasing domestic savings would help prevent further deterioration in external balances over the medium term and support an increase in investment—which is also relatively low compared to other emerging economies. Policies that could help bolster savings include further steps to reform the pension system and containing the rate of growth of public consumption.

Brazil: Saving-Investment Balances, 2000-2019

(percent of GDP)

3. The current account appears weaker than the level consistent with medium term fundamentals and desirable policy settings. For 2014, staff estimates suggest a current account norm in the range of -2.0 (EBA CA regression approach) to -1.2 percent of GDP (ES approach), broadly consistent with staff’s assessment of a norm range of -0.5 to -2 percent of GDP. Combined with a cyclically adjusted current account deficit of about 3.8 percent of GDP, the current account gap in 2014 would range between -1.8 to -3.3 percent of GDP.3

Brazil and the G-20: Saving, 2010-2014

(percent of GDP, unweighted average)

4. The current account deficit will improve over the medium term, but terms of trade volatility and offshore oil exploration plans raise uncertainty surrounding projections. The current account is projected to fall to 3.4 percent of GDP by 2020. This outlook is based on an only modest recovery in domestic demand and some further worsening in the terms of trade. These factors are expected to be more than offset by the weak real, a recovery in trading partner growth and the expected boost to the oil balance. Further declines in export commodity prices remain a key vulnerability as iron ore, soybeans and oil alone account for one third of total exports. The development of Brazil’s off-shore oil potential will support the current account. The oil balance—oil and distillates exports net of direct oil and distillates imports—is expected to improve by around 1 percent of GDP by 2020. However, a variety of factors including pressures on Petrobras’ balance sheet as part of the recent corruption scandal as well as the price of oil in international markets increase uncertainty surrounding exploration projections. Moreover, imports of machinery and other intermediate goods related to the construction of platforms and the development of the oil fields will partly offset the boost to the current account.

Exchange rate and relative prices

5. The CPI-based real exchange rate has depreciated since 2010. The real effective exchange rate (REER) has risen by more than 30 percent since end-2004, but depreciated some 20 percent between end-2010 and December 2014. Following the Fed announcement to taper its asset purchases, the REER depreciated by 14 percent from April 2013 to August 2013, but then appreciated by 6 percent until March 2014 as global market pressures receded. The REER depreciated during the second half of 2014 and is now broadly in line with its long-term (10-year) average level.

Real effective exchange rate

REER, various measures

(Q4 2010 = 100)

6. Alternative measures of relative prices do not suggest improvements in price competitiveness. Unit labor costs (ULC) increased markedly in recent years on the back of high nominal wage increases and tight labor market conditions. Despite substantial nominal depreciation, the ULC based real exchange rate did not depreciate since 2010, suggesting stagnating price competitiveness. A direct measure of relative prices based on prices on non-tradables and tradables even points into the opposite direction, illustrating that relative prices have risen by some 10 percent since 2010.

2014 Current Account and REER Gaps
EBA Methodologies /1
Current accountReal effective exchange rateExternal Sustainability
Actual Current Account (% GDP)−4.2
Cyclically Adjusted Current Account (% GDP) /1−3.8
Medium Term Current Account (% GDP) /1−3.4
Adjusted Medium Term Current Account (% GDP) /1−3.7
Current Account Norm (% GDP) /1−2.0−1.2
Exchange rate gap (+ is over-valuation) /1−3%
Staff Assessment of 2014 CA and REER
Lower boundUpper bound
Current Account Norm (% GDP)−2.0−0.5
Current Account Gap (% GDP)−1.8−3.3
Exchange rate gap in 201410%20%
as of end-December 2014−4%−14%

Based on January 2015 EBA estimates.

Based on January 2015 EBA estimates.

7. The real effective exchange rate in 2014 was overvalued by some 10–20 percent on average during the year. Estimates from the EBA REER approach suggest that the real was undervalued by some 3 percent. However, staff assesses the REER approach to be less reliable than other approaches in general, and especially so in the case of Brazil due to the wide dispersion in the evolution of different measures of the REER. Based on the assessment of a current account gap of −1.8 to -3.3 percent, staff’s assessment is that the real was some 10 to 20 percent over-valued on average in 2014. As of December 2014, the REER had depreciated by some 6 percent compared to its 2014 average. For this reason, staff’s assessment is that the REER was approximately 5–15 percent above the level implied by fundamentals and desirable policies at end-2014.4

Capital account flows and the policy toolkit

8. Following the global crisis, Brazil attracted sizable capital inflows that helped finance the current account deficit and contributed to reserve accumulation. In the crisis’ aftermath Brazil experienced large capital inflows amid robust economic growth and high interest rate differentials. The financial account achieved a surplus of 4.1 percent of GDP on average between 2007 and 2014 as reserve accumulation reached 1.9 percent of GDP per year. Following years of particularly strong portfolio flows, FDI has become the largest component in net capital inflows, attaining about 3 percent of GDP per year since 2012. Both FDI and portfolio flows remained buoyant in 2014 as the central bank tightened monetary policy and eased the IOF tax.

FDI composition 2007-14 in percent of GDP

9. FDI financed more than 70 percent of the current account deficit in 2014, with intercompany loans boosted by offshore issuance by foreign incorporated subsidiaries of Brazilian parent companies. Intercompany loans accounted for some 60 percent of total FDI in 2014. Interestingly, about 60 percent of total intercompany loans is made up of loans to Brazilian foreign investors extended by their own subsidiaries. A likely cause for such loans is the large offshore debt security issuance by foreign incorporated subsidiaries of Brazilian parent companies. The relevant subsidiaries are largely based in the Cayman Islands and the Netherlands, with the parents predominantly engaged in extractive industries and banking. The striking correlation between offshore issuance by non-financial corporations and intercompany loans to Brazilian foreign investors suggests that the majority of offshore issuance indeed returns to Brazil in the form of FDI (an inflow of intercompany loans resulting from such offshore issuance can be regarded as carrying a risk profile more similar to portfolio debt than other types of FDI inflows).

Capital flows 2007-14 in percent of GDP

Offshore issuance 1980-2013 by industry

Offshore issuance by residence of subsidiary

NFC Offshore issuance and FDI, in millions of USD

10. Brazil’s flexible exchange rate remains the most important shock absorber, although prolonged intervention may have slowed convergence of the real toward more competitive levels. Brazil has a flexible exchange rate which remained the most important shock absorber, including during the market turbulence since May 2013. The authorities have not conducted any spot market interventions since 2012 but relied on the use of foreign exchange swaps (conventional non-deliverable forwards settled in local currency) and Brazilian foreign exchange repos (conventional foreign exchange swaps) to contain market volatility (see Selected Issues Paper on FX intervention). Intervention can be useful when faced with episodes of excessive volatility, as was the case when the current intervention program was introduced. The program initially served this purpose well, being targeted directly to reducing the cost of hedging during the financial market turmoil following the Fed’s tapering announcement but may also have encouraged additional risk taking by the private sector. Moreover, the continued extension of the program may have slowed convergence of the exchange rate to a more competitive value.

International reserves, net international investment position and external debt

11. International reserves remain above adequate levels. Central bank intervention has been geared towards reducing volatility and managing capital inflows, which resulted in a large increase of international reserves during 2006 to mid-2011. International reserves have since stabilized, and are considered more than adequate with respect to various metrics, including the IMF’s composite adequacy measure. As such, Brazil is well placed to withstand potential external shocks. In addition, Brazil and other BRICS countries signed a treaty to establish the BRICS Contingent Reserve Arrangement (CRA) in July 2014. The CRA involves commitments by members to support each other through currency swaps in case of actual or potential short-term balance of payments pressures.5

Reserve adequacy in 2014

Net international investment position in 2013

Net international investment position (NIIP), percent of GDP

12. Brazil’s net international investment position (NIIP) improved modestly in recent years but is projected to deteriorate. The NIIP position strengthened from -48 percent of GDP in 2003 to -36 percent in 2014 (with gross assets and liabilities of 36 and 72 percent of GDP, respectively). FDI liabilities account for about half of total liabilities. Brazil’s NIIP position is high relative to peers but compares reasonably well to the wider spectrum of emerging market economies. However, with the envisaged persistent current account deficit, the NIIP position would worsen over the medium term (at a constant real exchange rate). In the longer run, as Brazil’s large “pre-salt” oil reserves come on line, added efforts to increase savings and therefore strengthen the country’s NIIP position would be appropriate.

Sectoral breakdown of FX exposure 2003-2013

13. External debt and foreign exchange exposure remain low although corporate borrowing in foreign exchange has increased. External debt remains relatively low at about 26 percent of GDP as of 2014. Total foreign exchange exposure is also low in the international comparison and has decreased significantly over the past decade.6 However, corporate issuance in foreign exchange—though largely hedged—has increased recently, partly offsetting the reduced sovereign exposure (see Selected Issues Paper on corporate vulnerabilities). Foreign holdings of domestic debt securities have increased dramatically in recent years and now account for close to a fifth of outstanding public debt securities and some 8 percent of GDP. While local bond market development and reduced sovereign exposure to foreign exchange debt are welcome, local yields may become more sensitive to global developments as foreign investors take on foreign exchange risk.

Emerging Economies: Foreign Holdings of Local Public Debt

(In percent of total debt)

Sources: Haver Analytics; country authorities; World Economic Outlook; and Fund staff calculations.

Appendix II. Nonperforming Loans of Public Banks1

1. Nonperforming loan ratios at public banks have been around 2 percent in recent years; but these banks now face the risk of a gradual deterioration in loan quality. Public banks have traditionally specialized in relatively low-risk credit segments: Caixa Econômica Federal (Caixa) provides housing loans; Banco do Brasil supplies rural credit; and BNDES finances exports, working capital for large firms, and long-term infrastructure projects. Nevertheless, in recent years Caixa has ventured into other, higher-risk credit segments, such as non-payroll personal loans, credit card, and SME loans. Delinquencies at public banks started to pick up in 2014, a trend which is likely to continue, especially in the newer credit segments. This said, credit growth deceleration in public banks in 2014 was most marked in these newer credit segments.

Public Banks: Credit Growth and NPL Ratios

(In percent and in percent of total loans by public banks)

Sources: Central Bank of Brazil; and Fund staff calculation.

2. When looking at loan performance, it is clear that traditional business lines have held up their quality over time. BNDES’s NPL ratio has been under 0.3 percent over the past three years, even taking into account the effects of OGX’s bankruptcy last year, a much publicized case. Banco do Brasil (BB) reduced the share of non-earmarked loans and replaced it with rural credits and real estate loans, and as a result its NPL by loan vintage has gradually decreased over the past three years. Caixa maintained the quality of its mortgage loans high by applying loan-to-value caps at around 70 percent.

3. However, some high-risk lines of business have recently shown declining performance. Delinquencies in these loans are rapidly increasing. Should the deterioration of economic activity persist, the repayment capacity of households and firms will be weakened and thus public banks will need to set aside more provisions, impairing its earnings. Even if this trend does not imply systemic risk given their large loan loss provision and capital buffers (which guard against expected and unexpected losses, respectively), they will need to tighten lending standards to preserve asset quality.

Public Banks: Selected Indicators

Source: Central Bank of Brazil.

1/ NPL ratio of overdraft loans by public banks dropped in December 2014 due to sales of past due loans.

Appendix III. Brazil: Risk Assessment Matrix1
Nature/Source of ThreatLikelihoodExpected Impact on EconomyPolicy Responses
Domestic Risks
Delays in the resolution of the Petrobras corruption probeMH. Firms under investigation, including Petrobras, could see their access to funding diminished and their investment programs at risk. The infrastructure concession program could be hampered by the ineligibility of construction companies. Pressure would rise to use public funds, possibly through public banks, to support Petrobras’ investment.Strengthen governance standards and anticorruption safeguards in procurement procedures to ensure the success in attracting private sector participation in the infrastructure program. Ease the requirement that Petrobras’ participate in all new oil developments, and domestic content requirements.
Drought and power rationingHH. Growth slowdown from electricity rationing accompanied by inflationary pressures as consumers will have to bear the additional energy cost in the absence of energy subsidies. Water rationing could affect manufacturing as well as agriculture, including in Sao Paulo state.Keep policies tight to contain spillovers into inflation and refrain from introducing additional Treasury subsidies which will weaken the fiscal outturn. Make sure that prices reflect scarcity to promote the efficient use of resources, while protecting basic level of access for vulnerable households.
Falling short of the fiscal targetMH. Fiscal balances would continue to disappoint and fail to stabilize debt. Further loss of confidence would result in lower investment and growth. Inflationary pressures would remain elevated. Brazil could lose its investment grade, which would further dampen confidence and growth, weakening the primary balance and increasing sovereign borrowing costs and public debt. Corporates could be vulnerable to capital flow reversals and exchange rate depreciation. The strains would worsen if banking system soundness deteriorated owing to an increase in NPLs.Additional fiscal consolidation measures should be identified to restore credibility in the fiscal framework and to ensure debt stabilizes. Focus efforts on boosting competitiveness and productivity. If the sovereign loses its investment grade, triggering economic side-effects, additional policy actions would be necessary, possibly including monetary policy tightening.
Intensified inflationary pressuresMH. Worsening inflation expectations and further erosion to the inflation targeting framework.Further monetary tightening to preserve the credibility of the inflation framework and ensure the convergence of inflation towards the target.
External Risks
Protracted period of low growthMH. Employment destruction would lead to a deterioration of households’ balance sheet and income resulting in a rise in delinquencies on consumer loans. Increased financial vulnerabilities among banks with portfolio concentrated in consumer/housing loans. Potential knock on effects on public finances. For example, Caixa extends housing loans to low-income families with a government guarantee. Lower corporate profits may expose some highly leveraged corporatesMonitor for signs of emerging domestic financial and corporate vulnerabilities. Take measures to strengthen the fiscal framework including public debt, and refrain from adding further demand stimulus. Impose targeted prudential measures to reduce risks in weak financial institutions. Smooth out the employment loss by relying on strategies such as reduced hours. Accelerate efforts to improve the business environment and foster investment.
Abrupt surges in global financial market volatilityHH. Increasing Brazil’s risk premiums, pressures on the real and reversal of capital flows. Increasing yields in domestic bond markets. In particular corporates lacking FX hedging could be exposed.The flexible exchange rate remains an important capital flow shock absorber. Recourse to FX intervention if FX volatility becomes excessive. Provide FX liquidity and support individual banks if dollar shortages appear. Increase policy rate to ensure adequate external financing. May also need to tighten fiscal policy to further strengthen policy credibility and avoid sell-offs of Brazilian domestic bonds.
Financial imbalances from protracted period of low global interest ratesMM. Building-up vulnerabilities as some corporates may further increase leverage.Monitor highly leveraged corporate; consider CFMs to discourage shorter-term borrowing. Tighten monetary policy further if financial risk taking becomes excessive.
Protracted period of slower global growth in advanced and emerging economiesHH. Worsening current account deficit and weaker growth. Highly indebted corporates could see their profits decline. A sharp decline in commodity prices would have a direct impact on the exporting sector.Use the exchange rate as first shock absorbers. Limited room for monetary and/or fiscal policy stimulus to smooth shock. Instead, prioritize structural reforms to boost potential growth.
Sharp rise in world oil pricesML. Mild negative impact on the trade balance in the short-term, but improving current account in the medium term, when Brazil is expected to become a net oil exporter. In the near term, an adverse impact on the finances of Petrobras if domestic fuel prices are not adjusted sufficiently.Domestic pricing policies should ensure Petrobras obtains an adequate return from commercialization of imported fuel.
Appendix IV. The Inflation Targeting Framework1

1. Inflation has been above the midpoint of the central bank’s tolerance band for several years, and longer-term inflation expectations have risen. Estimates suggest that inflation expectations (1–3 years ahead) have risen due to both higher inflation outturns and perceptions of higher inflation in the medium term2, reflecting at particular times foreseeable price pressures, but also some questions about the operation of the policy framework itself.

1 Year Ahead

(deviation from inflation target, in percent)

2 Years Ahead

(deviation from inflation target, in percent)

3 Years Ahead

(deviation from inflation target, in percent)

2. Brazil’s central bank has enjoyed ‘de facto’ independence since 1999, but it does not have statutory independence. The central bank currently enjoys what is commonly known as ‘instrument independence’, choosing how to best meet the inflation target determined by the National Monetary Council. However, as shown in a survey conducted by the Bank of England3, Brazil’s central bank is unique among inflation-targeting central banks for two reasons: (i) it does not have ‘statutory independence’—that is, the ultimate objective of the central bank, price stability, is not enshrined in law—and, (ii), the central bank’s Governor and Deputy Governors do not have fixed-term contracts and can be dismissed by the president at any time.

3. While no institutional framework guarantees success, experience suggests a higher degree of autonomy can help central banks execute their functions more effectively. Over the medium term, this can make them less prone to episodes where doubts are raised over government influence, particularly when inflation deviates from the midpoint of the tolerance range for some time. In fact, “central bank independence, accountability and transparency” is a core Basel principle of banking regulation.

4. Brazil’s inflation tolerance band is relatively wide and can accommodate persistent inflation deviations from target midpoint. Brazil has a wide tolerance band relative to other central banks with inflation targets, with a target that allows inflation to range between 2.5 percent and 6.5 percent. Moreover, the inflation target as currently specified (in terms of 12-month inflation in December) allows inflation to be outside the tolerance band for all but one month of the year, unlike other central banks whose targets are specified in a more permanent fashion. This design permits outcomes which, while formally in compliance with the framework, can erode its credibility and contribute to increases in long-run inflation expectations.

5. To support the central bank’s effectiveness and credibility going forward, further strengthening of the inflation targeting framework would be useful. The 2002 and 2012 Financial Sector Stability Assessments for Brazil, jointly prepared by the IMF and the World Bank, recommended that the inflation-targeting framework be strengthened further, inter alia, through the passage of legislation providing for the terms of the bank’s Board members. At the same time, strengthened autonomy should be complemented with measures that enhance accountability, such as mandating the achievement of price stability as the monetary policy objective (also recommended in the FSAP), narrowing the inflation tolerance band, and better clarifying the medium-term inflation target. Stronger autonomy and accountability for the central bank would bolster the effectiveness of the inflation targeting framework over the long term.

Inflation Target Regimes: Cross Country Comparison

(in percent)

Source: IMF country teams

Appendix V. Measurement of Gross Public Debt in Brazil1

This Appendix explains in detail the methodological difference between the Brazil’s Central Bank (BCB) indicator of General Government Gross Debt (GGGD) and that employed by the Fund, which follows the guidelines in the current Government Financial Statistics Manual (GFSM 2001 and 2014 editions).2 The key difference between these indicators is the treatment of government bonds held by the BCB and not pledged as security in monetary policy operations, which are counted as part of government debt under GFSM standards, but not under the BCB’s definition.

A. Institutional background and the GFSM 2001 conceptual approach

1. As many other central banks, the BCB performs monetary policy interventions through the use of government securities.3 The Fiscal Responsibility Law of 2000 (FRL) prevents the Brazilian central bank from issuing its own debt instruments; thus, the FRL obliges the BCB to retain government securities for the conduct of monetary policy operations. In fact, when the FRL went into effect, the BCB was in possession of a stock of government securities of different kinds acquired over time in different ways. By also banning direct financing of the Treasury by the BCB, the FRL in effect called for special procedures for the central bank to maintain and increase its holdings of government bonds. Between December 2000 and September 2003, the central government issued securities (amounting to 7.8 percent of GDP) which were included in the BCB’s restructured portfolio (Figure 1). The issuance of these securities was fully reflected in the increase of central government gross debt reported by the government in its official statistics.

Figure 1.Securities Used by BCB for Monetary Policy Purposes

(In billion Brazilian reais)

Source: BCB.

2. Since 2008, the government can issue securities directly to the BCB, which can be automatically rolled over by the latter. A 2008 law authorized the direct issuance of securities by the Treasury to the BCB, without a counter-payment by the BCB, consistent with the FRL’s principle of no central bank financing for the government (see Box). These direct issuances have the same terms and a similar maturity structure as the bonds in the hands of the public.4 Since 2008, the accumulation of government securities in the BCB’s balance sheet reflects to a large extent compensation for unrealized financial losses by the BCB, related to changes in the valuation of international reserves (see Box) and, more recently, losses on FX swaps operations. In addition, the 2008 law foresees that the central bank can automatically roll over the Treasury securities, which in practice the BCB always does to keep an adequate amount of securities available for liquidity management (REPOs).5

Box.Equalizaçâo Cambial and the Evolution of Debt

The legal framework governing the relations between the Federal Government (FG) and the BCB states that whenever the BCB makes a profit, the whole amount must be transferred to the Federal Government through a deposit in the single treasury account. If the BCB makes a loss, the Federal Government must compensate that loss by issuing debt securities to be placed in the BCB’s portfolio.

In November 2008, the Law 11803 established a swap operation between the BCB and the National Treasury regarding the financial results of international reserves and financial derivatives operations. The law applies to unrealized and realized gains or losses incurred by the BCB as the holder of those assets.1 Data on this financial result (positive or negative) are disseminated by the BCB under the item “Equalização Cambial” (EC) on the General Government Debt tables. The authorities consider it in the compilation of the net debt (a positive result decreases net debt; a negative result increases net debt), but not in the gross debt (GGGD) indicator. While profits are transferred semi-annually 10 days after the publication of the budget, recapitalization takes place with some delay.

EC is calculated by the BCB on a daily basis and includes changes in the valuation of reserves, carry cost of reserves, and the result of operations with swaps and derivatives.

1 At end-2008, the financial result of these operations resulted in a holding gain of R$171.4 billion. Although unrealized, this gain was effectively transferred to the single treasury account (in March 2009). At end-2009 the result was a holding loss of R$52.2 billion, which was compensated by the central government through the issuance of a corresponding amount of securities to be placed in the BCB’s portfolio. The end-2014 result was a holding gain of R$65.2 billion.

B. The BCB’s measure of GGGD: concept and comparative evolution

3. The BCB’s portfolio of government securities is divided in two subsets: securities currently pledged as collateral under repurchase agreements, and securities not in use as collateral (free securities), which the authorities consider of BCB’s “outright ownership.” The evolution of these securities over time can be seen in Figure 1 and reflects (i) government security issuances for accumulation at the BCB, and (ii) the trend increase in REPO operations. Under the GFSM 2001/2014, assets pledged for REPOs remain on the original owner’s balance sheet, a criterion consistent with generally accepted accounting practice, and a criterion that had also been followed by the BCB in its own reporting of GGGD until 2008.

4. In January 2008, the Brazilian authorities changed the methodology for disseminating GGGD by excluding the government securities that are under the BCB’s outright ownership, while keeping under the new GGGD indicator the securities used as collateral in REPOs. The preference for excluding free securities is based on a number of considerations, including the following: (i) the authorities consider that free securities do not represent a claim on government revenue (although interest is accrued, no cash payments take place; instead, new securities are issued to service the liability); (ii) free securities do not affect the market conditions (yield and maturities of normal debt issuances), as those securities are not acquired by the BCB in the market; (iii) they do not reflect the financing needs of the general government; and (iv) these securities do not give rise to refinancing risk. Although true in practice, arguments (i) and (ii) are not relevant for the definition of “liability” under GFSM 2001/2014.6 Neither are arguments (iii) and (iv), which are further discussed below.

5. Regardless of whether they were meant to finance a government deficit or not, Treasury securities held by the BCB represent a claim on the general government and are therefore considered part of the GGGD under the GFSM 2001/2014. The GFSM standard defines the BCB as a financial corporation, classified outside the government sector. Consequently, gross transactions and stock positions between the BCB and the government are to be recorded accordingly. In particular, when the government issues securities to the BCB, a financial claim (on the government) is created and recorded at the BCB’s balance sheet. The government is obliged to service this debt. From the accounting perspective, a liability of equal value is to be simultaneously incurred by the government as the counterpart of the BCB financial asset. So long as the BCB holds the asset, the liability is part of the GGGD, according to the GFSM 2001/2014. It bears noting that, in its own balance sheet, the BCB still counts its total holdings of government securities as part of its assets.

6. The wedge between the national and GFSM definitions of gross debt (that is, the stock of free securities held by the BCB) has varied considerably over time. The evolution of the two indicators—GGGD with and without free securities—is plotted in Figure 2. Although the difference amounted to over 15 percent of GDP in the past, it has narrowed considerably through November 2014 (to 3.2 percent of GDP), although it increased to 6.1 percent of GDP in December 2014. Incidentally, the two series suggest somewhat different trends in public debt; with the Fund measure showing a clearer declining trend in the pre-crisis years.

Figure 2.Evolution of Different Measures of General Government Debt and Net Lending

7. By excluding free securities, the authorities’ measure of GGGD is affected by central bank sterilization operations. For a given stock of government securities in its portfolio, every time the central bank conducts REPO transactions, the authorities’ GGGD indicator will change in equal measure. Thus, by this definition, public debt rises (falls) when the central bank mops up (injects) liquidity. The authorities find this a useful feature of the indicator as it induces lower monthly variation of the GGGD series (because the BCB sterilizes the short-term impact of government operations on market liquidity), even if the same smoothing effect is not observed at a yearly frequency. In any case, neither the Fund’s nor authorities’ gross debt concept is simply explained by the trajectory of the general government deficit in the last several years owing to the accumulation of government debt issued in favor of public banks (policy lending). Changes in net debt are thus closer to the government’s net lending, as both the Treasury Single Account and claims on public banks are netted out.

8. The negligible refinancing risk of public debt held by the central bank is acknowledged in the discussion of risks in staff’s Debt Sustainability Analysis for Brazil. While there is no legal obligation for the BCB to roll over its holdings of government debt indefinitely, the BCB has always done it, meaning that amortization of this debt does not create a need for financing from capital markets. Thus, actual gross financing needs from the market are lower than those measured by the amortization of total government debt (as measured by GFSM2001/2014): about 14 of GDP in public debt will be rolled over in 2015, of which 10.3 percent of GDP in the market.

See Selected Issues Paper on “Assessment of Foreign Exchange Intervention”.

The authorities are in the process of revising external sector statistics in line with the sixth edition of the Balance of Payments and International Investment Position manual (BPM6). This movement is consistent with the adoption of the new methodology of the System of National Accounts (SNA 2008) in Brazil, due to be published by end March 2015. Revised BOP data are expected to be published in April 2015, with revised external debt data expected in June. As part of this conversion, at least two important revisions will be made: foreign holdings of domestic debt securities will be included in external debt statistics, and its income, up to now reflected jointly with principal outflows in the portfolio account, will be recorded separately in the income account. Staff expects that these changes will lead to upward revisions of both external debt and the current account deficit.

Staff has determined that the tax on financial transactions (Imposto sobre Operações Financeiras, IOF) of 6.38 percent on exchange transactions carried out by credit card, debit card, and traveler’s checks (including cash withdrawals) companies in order to fulfill their payment obligations for purchases of goods and services abroad by their customers gives rise to multiple currency practices (MCPs) subject to Fund approval under Article VIII, Sections 2(a) and 3. Staff and the authorities are discussing the next steps on an appropriate way forward to address this issue.

About 60 percent of intercompany loans reflect proceeds from overseas borrowing by foreign incorporated subsidiaries of Brazilian parent companies which, arguably, carry a risk profile more similar to portfolio debt flows (Appendix I).

Liquidity risk is assessed based on the BCB’s liquidity index, which is the same concept as the liquidity coverage ratio (LCR)—an index introduced under Basel III. It relates the volume of liquid assets available to the institution to stressed cash flow (disbursement 30 days out in the stress scenario). As of September 2014, the liquidity index is 190 percent. The LCR will be implemented in October 2015 as a regulation.

See Selected Issues Paper on “Non-financial Corporate Sector Vulnerabilities.”

The LTV limits are 90 percent for constant amortization mortgage loans and 80 percent for all other mortgage loans.

The relaxation of macroprudential measures includes, inter alia, (i) reducing the risk weights on vehicle and personal loans; (ii) increasing the fraction of reserve requirements on time deposits that can be met by extending loans or purchasing loan portfolios from other banks; and (iii) allowing banks to use part of their reserve requirements to increase working capital loans.

The estimated yield of measures excludes announcements made after February 25.

The stress tests indicate that in an extreme scenario designed by staff defaults peak at 5 percent, requiring a recapitalization less than 0.4 percent of regulatory capital in the system as of March 2016. The scenario, which is constructed based on cross-country banking crisis experience, assumes that GDP growth, interest rate, foreign exchange rate, inflation, and unemployment would be -3.1 percent, 14.2 percent, R$3.35/U$, 11.6 percent, and 7.2 percent, respectively, during the 18 months between September 2014 and March 2016.

Brazilian banks will be required to build 0.625 percent of regulatory capital as conservation buffers from 2016 and the required buffers will increase to 2.5 percent. The possibility of activation of countercyclical capital buffers, equivalent to the size of conservation buffers, will be available from 2016.

Prepared by Christian Saborowski.

The authorities are in the process of revising external sector statistics in line with the sixth edition of the Balance of Payments and International Investment Position manual (BPM6). This movement is consistent with the adoption of the new methodology of the System of National Accounts (SNA 2008) in Brazil, due to be published by end March 2015. Revised BOP data are expected to be published in April 2015, with revised external debt data expected in June. As part of this conversion, at least two important revisions will be made: foreign holdings of domestic debt securities will be included in external debt statistics, and its income, up to now reflected jointly with principal outflows in the portfolio account, will be recorded separately in the income account. Staff expects that these changes will lead to upward revisions of both external debt and the current account deficit.

Results are based on EBA estimates updated in January 2015. The staff assessment remains broadly in line with the 2014 EBA.

The exchange rate gap estimated based on the EBA REER approach moved from +7 percent to -3 percent between the Spring 2014 and Fall 2014 EBA rounds, partly as a result of revisions in the measurement of Brazil’s CPI based REER.

The initial size of the CRA will be US$100 billion, with individual commitments of US$41 billion by China; US$18 billion by Brazil, Russia, and India; and US$5 billion by South Africa. These committed resources are unencumbered and would continue to count as reserves by individual countries. For Brazil, Russia and India, maximum access will equal their financial commitment to the CRA. Up to 30 percent of a member’s maximum access will be available without conditionality and the remainder requires an on-track financial arrangement with the Fund.

Non-financial corporate debt in foreign exchange is approximated by the stock of outstanding bonds in foreign exchange (Dealogic) plus domestic loans in foreign exchange (IFS and country authorities) plus cross-border loans to the domestic non-bank sector (BIS).

Prepared by Heedon Kang (MCM).

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

Prepared by Troy Matheson.

Inflation expectations data are sourced from Consensus Economics. Contributions to inflation expectations are estimated using a non-linear Kalman filter with time-varying parameters and state constraints. At each horizon h, expectations are modeled as: πth=αthπt+(1αth)πt*+εth, where πth is inflation expectations at horizon h, πt is year-over-year inflation in the IPCA, πt* is an unobserved expectation of medium-term inflation, and εth is an idiosyncratic error. The weight associated with current inflation and medium-term inflation at horizon hαth is restricted to be between 0 and 1.

Bank of England, Handbook No. 29, State of the Art Inflation Targeting.

Prepared by Miguel Alves (STA), Izabela Karpowicz (WHD), and Joana Pereira (FAD).

The appendix focuses on differences pertaining to the measurement of gross debt of the General Government only. These differences carry over to the measurement of gross debt of the nonfinancial public sector, which is presented in Table 3 of the Staff Report.

The BCB reduces liquidity by selling government securities under repurchase agreements (REPOs) to money market participants; these securities remain on the balance sheet of the central bank, which effectively uses them as collateral. To increase liquidity, the BCB engages in buy-back transactions of the central government debt securities.

The average maturity of securities held by the public was 4.4 years (average life was 6.1 years) at end-2014.

An additional 2009 regulation is still in place stipulating that the government will issue new paper to the BCB when its uncollateralized portfolio (see Footnote 3) falls below R$20 billion.

The national definition is nevertheless reported as a memorandum item in the GFSM Brazil country Table 8, as well as in Table 3 of the Staff Report.

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