Brazil: Recent Economic Developments

This paper describes major economic developments in Brazil in 1997. A number of issues were analyzed in the paper, including the slow progress being made in the negotiation of the fiscal adjustment programs with the states, the sustainability of the growing current account deficit, as well as the strength of the banking system following macroeconomic stabilization. The paper discusses the post-Real crisis in the states and the state adjustment programs being negotiated with the federal government. Privatization and the associated foreign direct investment flows are also described.


This paper describes major economic developments in Brazil in 1997. A number of issues were analyzed in the paper, including the slow progress being made in the negotiation of the fiscal adjustment programs with the states, the sustainability of the growing current account deficit, as well as the strength of the banking system following macroeconomic stabilization. The paper discusses the post-Real crisis in the states and the state adjustment programs being negotiated with the federal government. Privatization and the associated foreign direct investment flows are also described.


1. Chapter I describes major economic developments in Brazil in 1997, as additional background for the policy discussions in EBS/98/12. A number of issues have been raised in these discussions, including the slow progress being made in the negotiation of the fiscal adjustment programs with the states, the sustainability of the growing current account deficit, as well as the strength of the banking system following macroeconomic stabilization. These issues are looked at in more detail in Chapters II-VII. Chapter II discusses the post-Real crisis in the states and the recent state adjustment programs being negotiated with the federal government. Privatization and the associated foreign direct investment flows are described in Chapter III, highlighting the impact of investment plans on future export potential and growth. Chapter IV discusses the monetary transmission mechanism in Brazil, particularly in light of the sharp reduction in inflation after the Real Plan. Chapter V provides an update on the condition of the banking system and the recent measures taken by the authorities to strengthen the banks. It also looks at the supervision of banks and of the large derivatives market in the light of the Asia crisis. Chapter VI describes trends in export performance and analyzes price and nonprice competitiveness. This is followed-up in Chapter VII by a discussion of developments in tradable and nontradable prices and the external current account.

I. A Review of Major Economic Developments in 19971

A. Macroeconomic Trends

2. On October 28, 1997 Brazil suffered the well-known contagion effects in its financial and exchange markets from the turmoil in Asia. The São Paulo stock market (Bovespa) dropped by about 30 percent and the net losses of international reserves by the central bank amounted to US$8 billion (or about 13 percent of total reserves) at the end of the month. The government’s response was swift and went a long way to reassure financial markets, with stock prices recovering part of the earlier losses by the end of the year despite continuing volatility in international markets. The central bank doubled its intervention interest rates (to a range of 3.05–3.28 percent a month) on October 30. This move was followed by the announcement of a strong fiscal package (equivalent to over 2½ percent of GDP in 1998) and a renewed effort to accelerate the structural reforms needed to ensure a lasting improvement in the fiscal accounts. The government moved quickly to implement the fiscal measures, with the fiscal package approved by congress, with minor modifications, on December 4, recognizing that an early improvement in the fiscal situation is necessary to ensure a timely reduction in interest rates and minimize the potential negative impact on growth in 1998.

3. The pressures on the currency in the last week of October occurred against the background of increased concerns regarding the sustainability of the current policy mix during 1997, despite signs of a modest improvement in the external and fiscal accounts. The Real Plan which marked its third anniversary in 1997 has achieved substantial progress in the macroeconomic area with:

  • three years of positive growth of per capita income, relatively low unemployment, and improved living standards for the lower income groups;

  • a sharp and sustained decline in inflation;

  • strong growth of productivity and investment, including foreign direct investment; and

  • renewed access to international capital markets.

On the structural front an important start has been made in a number of areas: a reduction of the involvement of the state in the economy through privatization, concessions and deregulation; restructuring of the debt of the states; public debt management; strengthening of the banking and financial system; and the opening up of the economy associated, in particular, with the process of regional trade integration.

4. Nevertheless, despite these achievements, aspects of the macroeconomic performance have given cause for concern. In particular, growth has been entirely led by domestic demand with a loss of export market share, a sharp increase in import penetration, and a deteriorating current account balance. A deceleration of consumer demand from the second quarter of 1997, and some improvement in competitiveness, led to a modest recovery of exports and some moderation of import growth from midyear. Nevertheless, for the year as a whole, the current account deficit is estimated to have been about 4.3 percent of GDP compared with 3.3 percent in 1996, although about half of this deficit was estimated to have been financed by foreign direct investment.

5. Progress was made in improving the public sector accounts in 1997, although the primary balance of the public sector, which improved from a deficit of 0.1 percent of GDP in 1996 to an estimated surplus in 1997 of 1 percent of GDP, fell short of the government target of 1.5 percent of GDP. The public sector borrowing requirement is estimated to have declined from 6.1 percent of GDP in 1996 to about 4.4 percent of GDP in 1997, reflecting the introduction of a new bank debit tax, a real decline in personnel spending at the federal level, a decline in average interest rates for the year, and some adjustment effort at the state level. Monetary policy remained relatively tight as the central bank kept nominal interest rates unchanged from April until October, in the face of declining inflation. This contributed to a deceleration of domestic demand and import growth which, together with an acceleration in the growth of exports, led to a modest improvement in the external accounts from midyear on.

6. The progress on inflation, combined with strong foreign investment inflows linked to the acceleration of the privatization program, gave some assurances to the market that the country would be able to avoid the kind of disturbances that were already being seen in Asia in mid-1997. However, the deepening of the Asian crisis led to a change in the perception of risk in international markets and raised concerns that a more balanced mix of economic policies was needed in the face of the deteriorating external environment. Market concerns were probably heightened by the political calendar which calls for presidential and gubernatorial elections in October 1998, and which were expected to further hinder the approval of the constitutional reforms of the civil service and social security needed to help secure a lasting improvement in the fiscal accounts. The stock exchange had experienced repeated bouts of weakness before the October 28 collapse, albeit with subsequent rebounds, while interest rates and the expected rate of depreciation began edging upward in the forward exchange market.

7. The package of fiscal measures announced in early November 1997 is expected to increase the primary surplus of the consolidated public sector from an expected 1 percent of GDP in 1997 to about 2½ percent of GDP in 1998, taking into account the impact of slower growth on revenues. The fiscal package includes a range of revenue-enhancing measures, reductions in fiscal benefits, cuts in current and investment spending, increases in public sector tariffs and reductions in state financing limits. The government has also taken steps to accelerate the passage of the administrative and social security reforms, with approval of both reforms expected in early 1998. While these reforms have been weakened in congress, they will still have a positive impact in the short and, especially, the medium term.

B. The Real Economy

8. The fall in the rate of growth of GDP in the third quarter of 1997 confirmed the signs of a cooling of economic activity already given by other indicators such as retail sales and stocks. For the year as a whole, real GDP growth is estimated to have been 3.5 percent compared with 2.9 percent in 1996. While the doubling of interest rates at the end of October hit the normally buoyant Christmas sales period, the main impact on growth was expected to be felt in early 1998. The slowing of economic activity followed exceptionally strong growth of consumer demand through mid-1997 due to the easing of credit restrictions in the middle of 1996. The slowdown reflects, among other factors:

  • a reduction in the growth of purchasing power. The rate of growth of real wage rates fell to 2.5 percent in the 12 months to September 1997 compared with 7.4 percent in 1996 and 10.3 percent in 1995;

  • growth in consumer retail credit delinquency. The level of consumer retail credit delinquency (measured as the percentage share of late credit installment payments to total sales for São Paulo) increased to 8 percent in the first half of November, its highest level since July 1995, suggesting that the strong growth of consumer purchasing power in 1996 could have caused retailers to overestimate consumer capacity for indebtedness in 1997; and slowdown in consumer credit from the banking system. The decision to maintain central bank intervention rates constant from April 1997 led to a progressive increase in real interest rates and tightening of monetary policy in the course of 1997. The growth of bank consumer credit slowed significantly as from midyear, with the share of loans to individuals (which had risen rapidly since mid-1996) falling from a 12-month rate of 95 percent in April to a rate of 71 percent in November.

The slowdown in consumption more than offset a pickup in investment in the course of the year (Figure 1). Accordingly, the growth of production of consumer durables slowed from mid-1997, while the production of capital and intermediate goods remained, reflecting in part, the impact of the speeding up of the privatization program (discussed in Chapter III) on investment. For the year as a whole, consumption is expected to grow by 5.5 percent in real terms while investment which still only accounts for about 20 percent of domestic demand is expected to grow by 12 percent.

Figure 1.
Figure 1.

Brazil: Contribution to GDP Growth

(Percent change)

Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A001

Source: Fund staff estimates.

9. Economic growth in 1997 reflects exceptionally strong growth in mining, telecommunications, agriculture, and construction (Figure 2). This was offset to some extent, however, by a slowdown in manufacturing, commerce, and related services, which together account for about 65 percent of GDP. The growth in the mining sector (7.9 percent) reflects the domination of this sector by the mining giant, CVRD, and its exceptionally good financial results, as well as a 50 percent increase in investment since 1995. Telecommunications has also showed strong growth (7 percent) following the wide-scale restructuring of the telecommunications sector prior to privatization. Agricultural growth (4.9 percent) reflected good weather conditions coupled with high international prices, financial restructuring of farm debt and improved agricultural financing facilities. Construction growth (7.6 percent) benefited from new housing financing facilities and higher investment in infrastructure associated with the privatization program. On the other hand, the continuing contraction of the financial sector reflects the restructuring of the banking system following the stabilization of the economy.

Figure 2.
Figure 2.

Brazil: Gross Domestic Product by Sector, 1997

(Percentage change)

Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A001

Source: IBGE.

10. Progress in reducing inflation continued in 1997 with the 12-month increase in consumer prices falling to less than 4.5 percent in December 1997 compared with 9.1 percent in December 1996. Upward pressure on prices during the year came from adjustments in transport, electricity and telephone tariffs in May, June, and November which together are estimated to have accounted for more than 35 percent of the increase in prices in 1997. This pressure was offset to some extent by relative small increases in food prices which benefited from favorable weather conditions. One important trend observed in 1997 is that, despite higher public utility tariffs, the rate of growth of tradable and nontradable prices have shown clear signs that they are beginning to converge which, together with improvements in productivity growth, have eased overall inflation and signal that competitiveness is beginning to improve (see Chapter VII).

11. In keeping with the tendency in 1995 and 1996, employment continued to fall in 1997 (by ½ percent in the 12 months to August 1997), although at a much slower rate than previously. As a result, unemployment is estimated to have increased from 5.4 percent in 1996 to close to 6 percent by end-1997. Employment cutbacks occurred mainly in industry, with some modest growth in commerce and services. This has been a direct consequence of the process of economic liberalization begun in the early 1990s which has resulted in a large-scale restructuring of the productive sector (much of the decline in employment being concentrated in the large urban areas). Cutbacks in employment have been particularly intense in privatized enterprises which have seen cuts in employment as high as 50 percent (Chapter III). This accounts for the sharp drop in employment in the utilities sector, with telecommunications and electricity experiencing the largest cutbacks (Figure 3). Nevertheless, indications of poverty and irregularity showed some signs of improvement (Box 1).

Figure 3.
Figure 3.

Brazil: Recent Employment Trends

Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A001

Sources: Ministry of Labour.

12. Changes have also occurred in the structure of employment, with an increasing degree of outsourcing and greater use of informal labor and self-employed workers. According to ministry of labor data, formal employment has dropped 20 percent since 1990 to about 30 percent of the labor force while informal employment has increased 11 percent, reflecting rigid labor laws and the high incidence of taxation on labor (see Figure 3). Nevertheless, with the fall in employment, workers’ bargaining power in wage negotiations has been reduced significantly, reversing the growth in real wages since mid-1994. Confirming this picture are recent figures (released by the Inter-Union Department for Statistics and Socio-Economic Studies (DIEESE)), showing an increase in the number of wage agreements including adjustments below the growth of the consumer price index (Table 1).

Table 1.

Brazil: Wage Settlements in Relation to Consumer Price Inflation

(Percent of total wage settlements)

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Source: Inter-Union Department of Statistics and Socio-Economic Studies (DIEESE).

Brazil: Poverty and Income Distribution

The stabilization of the economy following the introduction of the Real Plan has had a major impact on poverty and income distribution, reversing part of the earlier erosion of real incomes due to high inflation. The reduction in poverty and inequality since 1994 was due largely to an increase in the minimum wage of 43 percent in May 1995 at a time when inflation had already fallen sharply to a level of 2.1 percent a month.

The table below shows data on inequality based on data for the six metropolitan areas in Brazil as measured by the ratio of the share of income of those in the top 20 percent income bracket to the income of those in the lowest 50 percent. The ratio fell from an average of 4.5 percent in the 12 months to May 1994 to 4.0 in the 12 months to May 1997 (latest available data). While the increase in the minimum wage in May 1995 had a major effect in reducing inequality, the subsequent deindexation of the wage structure from the minimum wage meant that the increase in the minimum wage in May 1996 had less effect on this measure of income distribution.

Brazil: Measures of Poverty and Income Distribution

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Source: IPEA (M. Neri).

Nevertheless, increases in the minimum wage have continued to have an impact in reducing poverty, although not on the poverty gap. The table presents two measures of poverty:

  • Poverty (P0) is equal to the percentage of the population falling under a poverty line of US$50 a month. P0 fell from an average of 33 percent in the 12 months to May 1994 to an average of 25 percent in the 12 months to May 1997. Since 1994, more than 16 million people have risen above the poverty line.

  • Poverty gap (P1) is equal to the distance below the poverty line of the average income of those households falling below the poverty line1 (i.e., in the 12 months to May 1997 the average income of these households was 16.6 percent below the poverty line). P1 shows that the sharp reduction in the “poverty gap” occurred between 1994 and 1996.

1/ The poverty gap (P1) is measured using the following formula:P1 = (q/n).((Z-Y)/Z)where q is the number of individuals below the poverty line, n is the number of individuals in the population, Z is the poverty line and Y is average income of those below the poverty line (expressed in percentage terms).

C. Balance of Payments

13. A deceleration of consumer demand, in combination with improvements in competitiveness, led to a recovery in exports and moderation in imports since mid-1997. This helped slow the deterioration in the trade balance which had been associated with the strong growth of consumption in the second half of 1996 and early 1997 and a stagnation of nonagricultural exports, and had led to concerns regarding the sustainability of the current account deficit. For the year as a whole, the trade deficit was US$8.5 billion, compared with US$4.2 billion in 1996, but lower than consensus forecast estimates of US$11–12 billion made earlier in 1997. This, together with net service payments associated with tourist expenditures and profit remittances, resulted in a current account deficit of almost US$34 billion, equivalent to 4.3 percent of GDP, compared with a deficit of 3.3 percent in 1996. Despite the high short-term capital outflows associated in part with the October 28 stock market fall, medium- and long-term inflows were strong in 1997, with nearly half the current account deficit being financed by foreign direct investment (which showed little signs of being affected by the October events). Gross international reserves ended the year at US$52.2 billion, equivalent to about eight months of imports of goods and nonfactor services, and to 162 percent the official estimate of short-term external debt. This compares with gross reserves of about US$62 billion in mid-October 1997.

14. There was a recovery in the performance of total exports in 1997, which grew by 11 percent, in U. S. dollar terms. This was mainly a reflection of the strong growth in exports of basic commodities, in particular coffee and soybeans, which grew by about 26 percent, largely due to favorable international prices. The growth of manufactured exports was also encouraging (about 9 percent), although growth was concentrated in automobiles, which benefits from the special automobile regime with Mercosul, and airplanes.2 Nevertheless, other areas such as processed sugar, cigarettes, cargo vehicles and heavy machinery, performed well, although it is too early to say whether this points to the prospect of a more widespread improvement in response to recent improvements in profitability, following a declining in unit labor costs and the depreciation of the real exchange rate (for a discussion of competitiveness see Chapter VI). Among semimanufactured exports, iron and steel plates showed the weakest performance (a decline of 35.5 percent) as a result of higher domestic demand, particularly from the automobile industry, demonstrating a counter cyclical pattern of trade, with domestic manufacturers largely concentrating on the domestic market. The negative performance of other semimanufactured products, on the other hand, can be explained by price declines for pulp, aluminum, and unrefined sugar.

15. While total exports are reasonably diversified and evenly distributed by region of destination, Figure 4 shows that their composition by region varies sharply by product type. For commodities, around 75 percent of exports in 1997 were to the European Union and Asia. The European Union alone accounted for 55 percent of the total. For manufactured products about 65 percent are exported to Latin America and the United States. Since 1995, the United States’ share has fallen and the share of Latin America (especially Mercosul) has increased. Mercosul accounted for about 28 percent of total exports in 1997, compared with 19 percent in 1995, the first year of the common external tariff.

Figure 4.
Figure 4.

Brazil: Exports by Region in 1997

Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A001

Sources: Brazilian authorities.

16. A number of measures were adopted in 1996 and 1997 to stimulate exports. These measures included the extension to nonmanufacturing exports of the exemption from the state level value-added tax (ICMS) as well as from some federal social contributions (PIS/PASEP and COFINS). The export pre-financing program (FINEMEX) of the National Development Bank (BNDES) was broadened to cover up to 100 percent financing of exports, and the BNDES introduced a program to finance exports of small- and medium-sized companies (PROEX). The government also introduced an export credit insurance scheme, and simplified customs procedures. The privatization of some ports contributed to the reduction of port charges.

17. The growth of total imports decelerated from an annual rate of about 23 percent in the first half of 1997 (relative to the same period in 1996) to 15 percent for the year as a whole. In the second half of 1997, the growth of imports of consumer goods decelerated rapidly while that of capital goods rose, despite the removal of exemptions from duty for many capital goods in July. This is consistent with the shift in the dynamics of domestic demand from consumption to investment observed in the national accounts. Import growth decelerated sharply in the last two months of the year, due to the impact of higher real interest rates on consumer demand.

18. The deterioration in the current account deficit in 1997 also reflected a weakening of the services account due to: (a) higher net remittances of profits and dividends (up US$2.9 billion) and (b) net international travel (up US$0.8 billion). Concern with the deterioration in the services account led the central bank to impose restrictions on installment purchases through international credit cards (this type of spending accounted for about 70 percent of travel debits in 1997).

19. The rise in automobile exports observed in 1997 is almost entirely within the special automobile regime with Brazil’s Mercosul partner countries. Cars produced in Mercosul countries and exported to Mercosul markets pay only half of the 63 percent import tariff paid on cars imported from outside the regime. Also, local car producers can import machinery, equipment, and parts paying a tariff of 2 percent instead of 17 percent paid by nonproducers. Under current arrangements, this regime should end by 1999 and the external tariff decline to 20 percent.3

20. Apart from the increase in the average common external tariff for Brazil from 14 to 17 percent in November (as part of the package of fiscal measures introduced to strengthen the real), there was just one other major change to trade policy in 1997. A new import tariff on capital goods was imposed at 17 percent. While the unweighted average external tariff is 17 percent, specific tariffs range as high as 65 percent for some products.

21. About half the current account deficit was covered by foreign direct investment which, together with an increase in long-term capital inflows, led to an improvement in the quality of external financing. Prior to October, Brazil had not experienced any difficulties raising external financing despite a sharp increase in amortization payments in 1997 (gross financing needs, minus foreign direct investment reached US$40 billion during the first nine months of 1997, compared with US$22 billion in the same period in 1996). Brazil’s increased access to international financing had been demonstrated by the placement of a global bond of US$3 billion, at favorable terms in May 1997, allowing for the retirement of some US$2.25 billion in Brady bonds and the freeing of the associated U.S. collateral bonds.4 During the last two months of the year, however, the sharp increase in interest rate spreads for Brazilian paper inevitably limited the scope for new placements and reduced net portfolio inflows for the year as a whole. On the other hand, there was a sharp increase in suppliers’ credits due to the impact in 1997 of a central bank regulation introduced in March limiting import financing to 360 days or more.5 This measure, which was introduced to limit the scope for interest rate arbitrage, had the effect of increasing net medium- and long-term import financing in 1997.

22. Short-term capital flows suffered from the contagion effects from Asia in late 1997. Net short-term capital outflows, which are estimated at US$20 million for 1997, had been effected negatively at the beginning of the year as the return on fixed income assets adjusted by the expected exchange rate changes became increasingly unattractive, causing the central bank to halt its policy of reducing nominal interest rates in April. Central bank intervention in the exchange market to defend the exchange rate band resulted in a net loss of US$8.2 billion in international reserves in the last few days of October. As noted above, the overall loss of international reserves is estimated at US$7.9 billion for 1997.

23. During 1997 the authorities continued their policy of an adjustable exchange rate band system. The outer band of R$1.05 to R$1.14 per U.S. dollar was established on February 18, 1997 and, during the year, the authorities maintained their policy of depreciating the real vis-à-vis the U.S. dollar at an average of monthly rate of about 0.6 percent, notwith-standing the turmoil in financial markets in the last quarter of the year. On January 18, 1998, the central bank announced a new band of R$1.12 per U.S. dollar (lower limit) and R$1.22 per U.S. dollar (upper limit) which represents about a 7 percent adjustment from the previous band.

D. Monetary Policy

24. Monetary policy remained cautious in the first ten months of the year, mainly because of concern over the vulnerability of the external position. In April, the central bank departed from the policy of gradually reducing interest rates in line with the decline in inflation and maintained unchanged the central bank basic rate (TBC) at 1.58 percent a month in nominal terms until the foreign exchange market turmoil at the end of October. Market interest rates, particularly lending rates, remained quite high in real terms during this period, contributing to the strength of the capital account, as well as to a slowdown in economic activity. The annualized overnight rate of interest averaged 21.4 percent in nominal terms and 13.6 percent in real terms during the first ten months of the year.

25. The rate of growth of outstanding credits from the financial system to the private sector showed clear signs of deceleration after May, especially in loans to individuals for acquisition of goods, the major factor responsible for the strong performance of sales of durable and nondurable goods since the middle of 1996. The rate of growth of bank lending to the private sector increased to 17.4 percent in November 1997 (compared with 7.6 percent in December 1996). However, the growth of consumer lending, (which accounts for about 10 percent of credit to the private sector) rose to a peak annual rate of 106 percent in July (on rumors that restraints on credit were to be imposed), before decelerating to 71 percent in November 1997. The slowdown in the growth of consumer credit also reflected lenders’ reaction to rising delinquency rates (Figure 5), and the slowdown in domestic demand.

Figure 5.
Figure 5.

Brazil: Consumer Delinquency Levels, July 1996-August 1997

(Index 1994=100)

Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A001

Source: Cental Bank of Brazil.

26. The conservative stance of monetary policy in the first three quarters of 1997 is confirmed by a number of other factors including (a) the qualitative improvement in the composition of the factors effecting liquidity in the economy (improved treasury performance reduced the need for sterilization and the slower growth of the international reserves made a contribution in the same direction); and (b) the greater flexibility of interest rate policy provided by the skillful construction of a yield curve based on a lengthening of the average maturity of federal public securities. The growth of the monetary aggregates in 1997 reflected (a) the gradual remonetization of the economy (even so the monetary base is still only about 3 percent of GDP); (b) the introduction of a financial transactions tax (CPMF) in January 1997 which is charged on any drawing from bank accounts and money market instruments (as a result, funds that would have normally been deposited in short-term investment funds remained in demand deposits, increasing bank reserves);6 and (c) the increase in real interest rates from April which resulted in a pickup in savings and time deposits.

27. The 12-month rate of expansion of M2, which in recent years has tracked inflation well, decelerated at the beginning of 1997 from 12.9 percent from end-1996 to about 6 percent at end-March 1997, before accelerating in the second and third quarter under the combined influence of the CPMF and higher real interest rates (to 14.6 percent in October). On the other hand, the rate of growth of M4, which was not effected by the CPMF, continued to slow from 29 percent at end-1996 to 25 percent at end-October 1997. It is estimated that the rate of growth of M4 picked up to about 30 percent by the end of the year, partly reflecting the increase in real interest rates. Overall, these movements suggest that allowing for the distortions in the narrow monetary aggregates, the remonetization of the economy is being carried out in a cautious manner, without causing inflationary pressures.

28. The central bank and treasury continued successfully the process of lengthening the maturity of federal debt prior to the recent turbulence in financial markets. The average maturity of federal debt increased from just under 80 days at end-1996 to 224 days at end-September 1997 (Figure 6). This resulted in a downward sloping yield curve for government debt. As well as lengthening the maturities of fixed rate debt with treasury notes (LTN) and central bank bonds (BBC), the supply of two-, three-, and five-year foreign exchange rate pegged NBC-Es and NTN-Ds was increased. This was largely in response to the demand for an exchange rate hedge late in the year and to reduce pressures in the forward market. The outstanding stock of U.S. dollar indexed debt increased from 9.1 percent of securitized public debt at end-1996 to 12.6 percent at end-1997.

Figure 6.
Figure 6.

Brazil: Average Maturity of Federal Debt, 1995-1997

(In months)

Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A001

Source: Fund staff estimates.

29. The sharp increase in interest rates on October 30 when the central bank basic rate was doubled from 1.58 to 3.05 percent a month, equivalent to 43.4 percent on an annual basis, represented an appropriate response to the pressures on the exchange rate, and clearly reduced these pressures in the short-term with some recovery of reserves and reducing the rates on the forward market. However, the maintenance of such high real interest rates for an extended period of time would be likely to lead to:

  • a pronounced downturn in activity (real rates are now higher than in mid-1995 when they caused a sharp decline in real GDP);

  • an increase in nonperforming loans (see Chapter V for a discussion of the condition of the banking system); and

  • an increase in the interest payments burden for the public sector (at the current level of net public sector debt, each 1 percent increase in the annual effective interest rate on the net debt increases the interest bill by about 0.3 percent of GDP). Since the initial interest rate hike the central bank has taken steps to reduce its basic rate further to 2.7 percent by January 1998, although rates remain high in real terms (26 percent).

E. Fiscal Policy

30. The fiscal position strengthened moderately in 1997, with the primary surplus of the public sector estimated to have reached 1 percent of GDP (compared with a primary deficit of 0.1 percent of GDP in 1996), mainly as a result of net improvements in the finances of the states and municipalities, and of the public enterprises. The package of fiscal measures announced in November is not expected to significantly affect the outcome for 1997, the main impact being felt in 1998. The overall deficit of the public sector is expected to decline from 6.1 percent in 1996 to about 4½ percent in 1997, reflecting the impact of lower interest rates on interest payments for the year as a whole (despite the recent interest rate increase). The primary surplus of the federal government is expected to remain little changed at 0.5 percent of GDP in 1997 (compared with 0.4 percent in 1996), because of a 5 percent decline in corporate tax revenue resulting from the 1996 tax reform and substantial increases in social security and other nonwage spending, which roughly outweighed the favorable effects of the introduction of the tax on financial transactions (CPMF), revenue from telecommunication concessions and wage constraint (a general wage increase for civil servants was not granted for a second year in a row).

31. Federal revenues in 1997 were boosted by the impact of the financial transactions tax (CPMF) introduced in February 1997, the increase in the tax on financial operations (IOF) in May, and revenues of R$1.4 billion from the sales of the “B” band telephone concessions. These new revenues amount to 1 percent of GDP, and without them total revenues would have fallen in 1997 as a percent of GDP (Figure 7).7 One of the reasons for the slow pace of fiscal adjustment, even with a high tax burden of 30 percent of GDP is the rigidity of public sector expenditure, with only about 20 percent of total federal spending within the government’s discretionary power. The other 80 percent includes expenditure on social security benefits, personnel, constitutionally obligatory transfers and interest, none of which can be strongly influenced without approval of congress and the passage of the social security and administrative reforms (Figure 8).8

Figure 7.
Figure 7.

Brazil: Federal Revenue

(Percent of GDP)

Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A001

Sources: Brazilian authorities, and Fund staff estimates.
Figure 8.
Figure 8.

Brazil: Distribution of Federal Expenditures

(Percent of total)

Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A001

Source: Ministry of Finance.

32. There was an important improvement in the fiscal position of the states and municipalities in 1997 as measured below the line, which is estimated to have fallen to a primary deficit of 0.1 percent of GDP in 1997, compared with 0.6 percent in 1996. This improvement was mainly the result of expenditure restraint, including no general wage increases, increases in local enterprise tariffs and some reductions in employment. In addition, the privatization and closure of enterprises which relied heavily on state transfers more than offset the negative impact on revenues of the exemption (effective September 1996) from the state level value added tax (ICMS) of nonmanufactured exports and to purchases of capital goods. However, the lack of reliable above-the-line fiscal data makes it difficult to assess the sustainability of this improvement.

33. The fiscal package announced by the government on November 10, 1997 is expected to yield the equivalent of over 2½ percent of GDP in net savings to the public sector in 1998. (The steps taken to speed up the associated administrative and social security reforms are discussed in Box 2.) This improvement, however, is likely to be partly offset by the impact of the expected downturn in economic activity and higher interest rates, resulting in a net improvement in the primary balance of about 1½ percent of GDP in 1998. The package includes far-reaching measures to improve the finances of the federal government, states and public enterprises. At the federal level, the revenue measures include a personal income tax surcharge of 10 percent for all taxpayers in the upper 25 percent tax rate, limits on deductions from taxable income, a 25 percent reduction in regional fiscal incentives for 1998, with further reduction in an increase in the industrial products tax (IPI) for automobiles, beverages, and temporary increases in the prices of petroleum derivatives and alcohol. On the expenditure side, the measures include cuts in budgeted payroll spending, a 15 percent cut in budgeted, nonwage current expenditures in the 1998 budget, except for education, health, social assistance and agricultural reform, and a 6 percent cut in budgeted capital outlays. The measures also call for the elimination of 70,000 unfilled posts, as well as a reduction in employee benefits.

34. At the state and municipal level, the federal government in seeking to harden budget constraints through limits on bank credit for states and municipalities, tightening access to external borrowing with federal guarantee, and accelerating the conclusion of the fiscal adjustment programs with the states in connection with the rescheduling of state debts. In addition, the senate has passed a resolution requiring each state to use 50 percent of its privatization revenues to reduce state debt, although the use of privatization proceeds by the states has not yet been finalized.

35. The negotiation of fiscal adjustment programs with the states as counterparts for the recent rescheduling of state debt, proceeded slowly in 1997. While 22 of the 27 states had signed debt rescheduling protocols with the federal government by early 1997, only São Paulo, by far the largest debtor, and two other states had signed fiscal adjustment programs (Mato Grosso and Ceará) by the end of the year (the negotiations of the states fiscal adjustment programs is discussed in Chapter II).

36. The primary surplus of the public enterprises is expected to increase from 0.1 percent of GDP in 1996 to 0.5 percent in 1997 as a result of the increase in public sector tariffs, and a cutback in spending, mainly on investment projects.

37. The broadening of the privatization program to include infrastructure sectors (telecommunications, electric power, transportation, sanitation and gas) as well as the financial sector, resulted in an acceleration of privatization and is expected to improve efficiency and reduce costs for domestic industries. Privatization receipts in 1997 are estimated at US$22 billion (2.6 percent of GDP) with transfer of debts accounting for R$3.6 billion. Most of the federal privatization proceeds of R$4 billion were used to reduce public debt. Progress was being made in establishing a clear regulatory framework for the sector, with a general telecommunications law and an oil deregulation bill approved by congress in recent months (the privatization program is discussed in Chapter III).

Administrative and Social Security Reform

After almost three years of legislative delays, mounting pressures have speeded the passage of the administrative and social security reforms through congress with final approval of both reforms expected in early 1998. In November 1997, the lower house approved the administrative reform which has now passed to the senate. The version of the administrative reform approved by the lower house contains important instruments for reducing personnel costs:

  • the establishment of a salary ceiling of R$12,720 for all civil servants;

  • provision for the dismissal of civil servants for inadequate performance;

  • the possibility of dismissing civil servants with job tenure when personnel costs exceed 60 percent of net revenue; and

  • the possibility of temporarily laying off civil servants and paying them a lower salary than those who are working.

According to the ministry of public administration and reform of the state, the reform should save about 1 percent of GDP in its first three years of operation, although its impact in 1998 may be limited because of severance costs and the need for a complementary law to define the criteria for dismissing civil servants. Some of the major states, however, have already taken action to reduce excessive personnel costs without waiting for the law to be passed. The state of São Paulo, for example, has already dismissed 124,000 state workers during 1997 and is close to meeting the 60 percent payroll cap.

In November 1997, the senate also approved a strengthened version of the social security reform which has now returned to the lower house. The senate version has a number of positive aspects:

  • the introduction of a minimum pensionable age and a minimum number of years of contribution to the system; and

  • the elimination of the possibility of receiving a pension and a civil service wage, and more than one pension.

The social security reform would reduce the costs of (a) the civil service pension scheme which eats up nearly half the federal payroll, and (b) the national social security system (Previdencia) which covers the private sector. The finances of the national social security scheme for private employees, which covers about 16 million pensioners, have deteriorated steadily from rough balance in 1995 to an estimated deficit of 0.3 percent of GDP in 1997. The government recognizes, however, that the current version of reform falls short of what would be eventually needed to put the pension system on a financially viable path, as it sets a minimum retirement age of 60 for men and 55 for women (which is high by international standards) and continues to grant generous criteria for the accrual of pensions rights and the calculation of the pensionable base.


Prepared by Graeme Justice.


Airplane exports include the re-export of Boeing planes owned by VASP, a Brazilian airline company, to the Bolivian airline, which VASP bought last year.


Other important distortions to the trade regime beside automobiles, include the “information law” which protects the computer sector with a nominal tariff of about 50 percent.


A similar operation in December freed an additional US$1.1 billion in U.S. collateral bonds.


If they cannot obtain these terms, they are required to enter into a forward contract for the necessary foreign exchange several months before the payment is due or be subject to a penalty by the central bank.


This caused a sharp increase in the rate of growth of M1 to over 50 percent in the first half of 1997.


The CPMF tax on financial transactions was introduced for one year effective February 1997 at a rate of 0.2 percent, with proceeds earmarked for health expenditure. In November 1997, it was extended to December 1998.


Of the 55,000 workers without job tenure in the federal government, nearly all are concentrated in the education and health sectors where the political costs of laying off workers are high. The administrative reform is therefore needed to allow the layoff of workers with tenure, although the immediate savings would be offset by severance costs.

Brazil: Recent Economic Developments
Author: International Monetary Fund