On October 31, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Brazil.
The government that took office in May 2016 has announced a series of measures to address long standing fiscal imbalances and budget rigidities. A strong push to implement the proposed measures on the expenditure side would go a long way towards restoring policy credibility and market confidence with positive effects on investment and growth. Early implementation of key fiscal policy measures would also help moderate inflation expectations and facilitate monetary policy easing.
Brazil is poised to emerge from a deep recession. The economy has contracted markedly in 2015 and 2016, reflecting mostly long-standing domestic issues, although terms of trade changes and weak global demand also played an important role. Tighter financial conditions and slowing credit and uncertainty surrounding the political scene have been the main factors behind the declining investment and consumption, and the ratcheting unemployment. A sharp realignment of regulated prices and monetary policy tightening also represented a drag on growth.
Headline and core inflation have been above the central target and around the upper limit of the central bank’s tolerance range for several years. Monetary policy has correspondingly remained at its current tight level for over a year. But in 2016, some price increases have begun to moderate although disinflation proceeded slowly due to above target, albeit declining, inflation expectations and rising food prices.
The central bank has intervened in the foreign exchange market less frequently than in the past and broadly symmetrically, limiting corrective action to containing short-term excessive volatility. Taking advantage of the market rally started in March 2016, the central bank has lowered the net notional value of outstanding FX swaps to about US$35 billion (from a high of about US$110 billion) by issuing reverse swaps and failing to roll over maturing swaps.
International reserves are above most IMF adequacy and other standard indicators and FDI fully financed the current account deficit which narrowed from 4.3 percent of GDP in 2014 to 3.3 percent in 2015. Brazil’s external position remained, however, moderately weaker than the level consistent with fundamentals reflecting the recent reversal of exchange rate depreciation that occurred in 2015.
The health of the banking sector deteriorated somewhat but remains solid: the system wide capital ratios fell in 2015, but remain well above the regulatory minima; liquidity risk increased in 2015, but the overall funding profile of the system remained strong; external funding exposures are low and foreign exchange risks are largely hedged; profitability declined owing to a spike in provisions for loan losses and higher funding costs; non-performing loans (NPLs) have gradually increased, but remain moderate at 4.1 percent. Banks have remained well provisioned with loan loss reserves covering 150 percent of NPLs. However, nonfinancial corporates are leveraged and vulnerable.
Fiscal outcomes have been disappointing. In 2015 the non-financial public sector primary deficit reached 1.9 percent of GDP and the overall deficit was 10.4 percent of GDP. The primary deficit in 2016 is expected to reach 2.7 percent of GDP, and the overall balance would be close to that observed in 2015.
Since May 2016, the government announced a series of measures to strengthen macro policies and restore credibility. Notably, the government has sent to Congress a constitutional amendment limiting the growth in federal noninterest spending to the rate of consumer price inflation of the previous year for the next 20 years. The government has also announced a reform of the social security system, needed in its own right and also necessary to make the expenditure limit viable.
Fund staff expects activity to start to recover gradually, but remain weak for a prolonged period. Staff project output growth of -3.3 percent in 2016 and about ½ percent in 2017. The projection is predicated on the assumption the fiscal spending cap and social security reform are approved in a reasonable timeframe, and the government will meet the proposed fiscal targets for 2016 and 2017. With these improvements on the fiscal front, and assuming uncertainty continues to decline, investment is projected to continue to recover, supporting a gradual return to positive sequential growth beginning in late 2016. The outlook is subject to downside risks, including the re-intensification of political uncertainties (e.g., as a result of developments in the corruption probe) and risks related to a protracted period of slower growth in advanced and emerging economies, especially China, further declines in export commodity prices, and tighter financial conditions.
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.