Brazil: 2023 Article IV Consultation-Press Release; Staff Report; Staff Supplement; and Statement by the Executive Director for Brazil

International Monetary Fund. Western Hemisphere Dept.

doi:10.5089/9798400249020.002.A001

Author: International Monetary Fund. Western Hemisphere Dept.

Publication Date:: 31 Jul 2023

eISBN:: 9798400249020

Language:: English

Keywords:: disinflation effort; core inflation; monetary policy stance; potential GDP; credit market

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1. The new administration took office in January 2023 pledging an ambitious agenda of inclusive and sustainable growth. Key government priorities include addressing hunger and inequality, turning Brazil into an environmental leader, and ensuring fiscal credibility and robust public policies.1 First steps are already in train, including: protecting the most vulnerable under the renewed Bolsa Familia program, which replaced Auxilio Brasil; launching measures to halt illegal deforestation and re-establishing the Amazon Fund; proposing a new fiscal rule and identifying measures to restore fiscal revenues; and advancing indirect tax reform.

Abstract

Context

1. The new administration took office in January 2023 pledging an ambitious agenda of inclusive and sustainable growth. Key government priorities include addressing hunger and inequality, turning Brazil into an environmental leader, and ensuring fiscal credibility and robust public policies.^¹ First steps are already in train, including: protecting the most vulnerable under the renewed Bolsa Familia program, which replaced Auxilio Brasil; launching measures to halt illegal deforestation and re-establishing the Amazon Fund; proposing a new fiscal rule and identifying measures to restore fiscal revenues; and advancing indirect tax reform.

2. Delivering on this agenda requires navigating both near-term and long-standing economic challenges. The timely and large response to the pandemic prevented millions from falling into poverty, boosted poorer households’ incomes, and dampened the economic downturn.^² However, high inflation has depressed real incomes in the recent period, notably for the poorest, and record-high indebtedness has added to household vulnerabilities. On the structural side, potential growth has been too low to lift households out of poverty and set Brazil on a sustainable convergence path. Entrenched budget rigidities constrain space for priority spending, including for much needed public investment. Moreover, absent investment in safe and resilient infrastructure and energy production, climate change will continue to pose risks to inclusive and sustainable growth.

Recent Developments

3. Following a rapid recovery from the pandemic, GDP growth is moderating. Real GDP grew by 5 percent in 2021, on the back of supportive fiscal measures, the reopening of the services sector, and favorable commodity prices. Growth slowed to 2.9 percent in 2022, still above staff’s estimate of potential (Annex I). In the first months of 2023, growth was supported by very strong agricultural output, while manufacturing and services were subdued. Slowing private consumption and falling investment point towards further growth moderation in the remainder of 2023. Employment growth also cooled down to 0.9 percent year-over-year in May 2023, from 9.8 percent at end-2021, but labor market conditions remain relatively tight, including due to declining labor force participation rates. At the same time, progress in closing the gender participation gap has stalled following the pandemic (Box 1).

^{Box 1.}

Labor Market Developments and Gender Gaps Since the Pandemic

Labor markets in Brazil have recovered strongly since the pandemic. The unemployment rate increased significantly during the pandemic, particularly affecting less educated people. However, since around mid-2021, the unemployment rate has declined across the board. Moreover, real wages have bounced back to pre-pandemic levels. One striking feature in the post-pandemic recovery has been the rapid growth in employment and real earnings in the so-called gig/new economy, encompassed to some extent by the self-employed and informal private sector jobs. This trend brings new challenges to ensure adequate social security coverage and job protection for these groups.

However, progress in narrowing the gender gap in labor force participation has stalled in the post-pandemic recovery. Prior to the pandemic, female labor participation rates were trending upward, helping close gender gaps. However, progress has slowed in recent years, with the participation rate for women with young kids falling the most below trend (by about 3.9 percentage points compared to the pre-pandemic trend, compared to a 0.14 percentage point decline of equivalent male counterparts), followed by less educated and urban women. The responses to the PNADc survey suggest that attending to household responsibilities is one of the key factors behind the decline in the female participation rate. About 25 percent of women reported care work as the reason for not searching for jobs in the Q1 2023 survey.

The policy focus on early childhood and planned expansion of day-care centers is welcome and would help narrow the gender participation gap. Apart from making childcare more widely available and affordable, steps to decrease gender salary gaps, increase the transparency of pay, and provide more parental leave could create a level playing field to enable women to work, develop their potential, and reduce gender gaps. This, in turn, would boost potential growth and increase equality of opportunities (IMF Fiscal Monitor, April 2021, Chapter 2).

4. Price pressures have eased but remain elevated. Headline inflation peaked at 12 percent year-over-year in April 2022, driven by global supply shocks, including high energy and food prices, and a strong domestic economy. Headline inflation then declined steadily to 3.9 percent in May, within the inflation tolerance band, on the back of tight monetary policy, lower regulated prices, and favorable base effects. However, non-regulated prices and core inflation have been stickier, with the latter declining from a peak of 9.7 percent in June 2022 to 7.2 percent in May.^³ Despite tighter monetary policy, core inflation has also been more persistent when compared to past episodes of high inflation, including due to a positive output gap, tighter labor markets, and more persistent inflation expectations (Box 2). After falling sharply in 2021, real wages recovered in 2022 and reached pre-pandemic levels in early 2023.

5. The BCB was among the first central banks to raise the policy interest rate and has been on hold since August 2022. With the policy rate at 13.75 percent, the ex-ante real rate has hovered around 9 percent in recent months (using 12-month ahead inflation expectations), compared to neutral rate estimates of at least 4 percent. Despite the tight monetary policy stance, inflation expectations both in the short and the medium term edged up in early 2023, affected by uncertainty about the inflation target and the medium-term fiscal outlook. Uncertainty subsided with the decision of the National Monetary Council (CMN) in June to adopt a continuous target of 3 percent from 2025 onwards, in line with regional peers, to be established by Presidential decree. The proposed new fiscal rule and planned revenue increases have also helped reduce fiscal uncertainty.

^{Box 2.}

Drivers of Inflation in Historical Perspective

The charts compare the before and after evolution of indicators during three episodes (2022, 2016, and 2003) when headline inflation surpassed 10 percent year-over-year, with peak months: April 2022, January 2016, and May 2003. Compared to previous episodes, monetary policy has been tighter in 2022, while the Brazilian Real performed better. Headline inflation fell more compared to 2016 due to a faster decline in regulated prices. Core inflation in the 2022 episode has been more persistent with a lower correlation with headline inflation compared to past episodes, due to tighter labor markets, stronger services growth, a positive output gap (negative in the last two episodes), and more persistent inflation expectations.

6. Credit growth is slowing, in part reflecting the tight monetary policy stance. Bank credit growth declined to 10 percent year-over-year in May, down from 18 percent in mid-2022. However, the credit gap remains positive, as tightening financial conditions have been partially offset by a structural broadening of credit in some sectors. Financial innovation, including swift digital underwriting, has fostered easier access to credit for households.^⁴ The households’ DSTI ratio reached an all-time high of 27.7 percent in April, driven partly by riskier products such as credit cards and non-payroll loans. Banks’ non-performing loan (NPL) ratios have picked up since the start of the monetary tightening cycle, particularly on unsecured credit to households, though remain close to their long-term average of about 3 percent.

7. Financial markets weathered well domestic and external stress events that took place earlier this year. External credit spreads and the Brazilian Real have been relatively insulated from increased global volatility in the first quarter of the year, helped by Brazil’s low external debt and high real interest rates compared to peers. Year-to-date currency inflows were the highest since 2018, on the back of a strong trade surplus and small financial outflows. The Treasury took advantage of favorable market conditions and returned to international bond markets in April after an almost two-year hiatus. The authorities are also planning the issuance of the first sustainable sovereign bond in the second half of the year. The bankruptcy of a large corporate in mid-January following ‘accounting inconsistencies’ had a negative but temporary effect on local markets. As of the second quarter of the year, conditions in corporate credit markets had largely normalized against the backdrop of overall credit moderation.

8. The 2022 external position remained broadly in line with fundamentals. Despite a sizable trade surplus in goods boosted by commodity exports, the current account deficit reached 3 percent of GDP in 2022, reflecting high deficits in services and primary income. The current account deficit was financed by solid net FDI inflows (3.1 percent of GDP) amid limited net portfolio outflows (0.3 percent of GDP). International reserves remained adequate relative to the ARA metric, despite declining to US$325 billion at end-2022 (from US$362 billion at end-2021), mostly owing to valuation effects. Reserves recovered to US$345 billion in May. The appreciation of the exchange rate in the first four months of 2022 was largely reversed, and the Brazilian Real has stayed broadly stable since July 2022 with some strengthening in April. The 2022 external position is assessed to be broadly in line with the level implied by fundamentals and desirable policies (Annex II). In the first few months of 2023, strong exports, supported by commodities, and moderating imports have led to a large trade surplus, notwithstanding the decline in international prices.

9. The headline fiscal position improved markedly in 2022 and NFPS gross debt declined below pre-pandemic levels. The primary surplus of the NFPS increased from 0.7 in 2021 to 1.3 percent of GDP in 2022, helped by record commodity revenues (around 3½ percent of GDP, double the decade-long average) and a public sector wage/hiring freeze. NFPS gross debt declined to 86 percent of GDP at end-2022, below pre-pandemic levels. Notwithstanding these strong headline results, the fiscal stance turned expansionary in 2022, as the structural balance deteriorated amid broad tax cuts on essential goods and services (ICMS, PIC/COFINS) and industrial goods (IPI), and higher spending for social support.

10. For 2023, the government approved a constitutional amendment to increase the spending envelope, while proposing measures to restore revenues. The ‘transition constitutional amendment’ expanded the projected federal primary deficit in the 2023 budget to 2.2 percent of GDP to make space for (i) the continuation of social benefits at the 2022 benefit level under Bolsa Familia and other social support; (ii) public investment programs, including social housing; and (iii) increases in public wages and pensions. The amendment also ended the federal spending cap, Brazil’s fiscal anchor since 2016, and called for a new fiscal rule, which the government unveiled in March. The authorities reversed pandemic-related tax cuts on fuels and financial revenues and implemented tax changes on transfer pricing and offshore financial revenues. Recent court decisions to allow for double taxation on goods and services across levels of government are expected to be implemented in coming months.^⁵ The authorities estimate these measures would yield about 2.3 percent of GDP in the near term, of which 1.6 percent of GDP would be permanent.

Revenue Measures Announced by the Government

Sources: Ministry of Finance, media outlets, market participants, and Fund staff calculations.

Revenue Measures Announced by the Government

		BRL billion	Percent of GDP
Permanent Measures		184	1.8
	Double taxation of goods and services (ICMS in PIS/COFINS tax base)	30	0.3
	Double taxation of goods and services (ICMS in CSLL/CIT tax base)	70	0.7
	PIS/COFINS taxes on financial revenues (reversal)	4	0.0
	PIS/COFINS taxes on fuels (reversal)	29	0.3
	CARF tax litigation reduction	15	0.1
	Voluntary settlements of tax disputes	5	0.0
	Transfer pricing	23	0.2
	Off-shore financial revenues	8	0.1
Extraordinary Revenues		73	0.7
	CARF tax litigation reduction	35	0.3
	Voluntary settlements of tax disputes	15	0.1
	Unclaimed funds (PIS/PASEP)	23	0.2
Total Measures		257	2.5

Sources: Ministry of Finance, media outlets, market participants, and Fund staff calculations.

Revenue Measures Announced by the Government

		BRL billion	Percent of GDP
Permanent Measures		184	1.8
	Double taxation of goods and services (ICMS in PIS/COFINS tax base)	30	0.3
	Double taxation of goods and services (ICMS in CSLL/CIT tax base)	70	0.7
	PIS/COFINS taxes on financial revenues (reversal)	4	0.0
	PIS/COFINS taxes on fuels (reversal)	29	0.3
	CARF tax litigation reduction	15	0.1
	Voluntary settlements of tax disputes	5	0.0
	Transfer pricing	23	0.2
	Off-shore financial revenues	8	0.1
Extraordinary Revenues		73	0.7
	CARF tax litigation reduction	35	0.3
	Voluntary settlements of tax disputes	15	0.1
	Unclaimed funds (PIS/PASEP)	23	0.2
Total Measures		257	2.5

Sources: Ministry of Finance, media outlets, market participants, and Fund staff calculations.

Outlook and Risks

11. Growth is expected to moderate in the remainder of 2023 before gradually recovering to potential over the medium term. Growth is projected to moderate from 2.9 percent in 2022 to 2.1 percent in 2023,^⁶ and then reach staff’s estimated potential rate over the medium term, with the positive output gap closing. Headline inflation is expected to reach 5.4 percent by end-2023 and converge to the target of 3 percent by mid-2025, while core inflation is projected to come down more gradually. The monetary policy stance would remain in restrictive territory in coming years, with the real policy rate approaching its neutral level by 2025. The baseline scenario reflects a NFPS primary deficit of 1.3 percent of GDP in 2023, consistent with a fiscal impulse of about ¾ percent of GDP. The NFPS primary balance is then projected to improve to a surplus of around 1¼ percent of GDP over the medium term, contingent on the implementation of 2 percent of GDP in revenue measures, with NFPS gross debt stabilizing at around 97 percent of GDP over the longer term. The current account is expected to narrow to about 2.3 percent of GDP this year and remain broadly stable over the medium term.

12. The balance of risks is tilted to the downside. Key external risks include an abrupt global slowdown; commodity price volatility; and a sharp tightening of global financial conditions (Annex III). Domestic downside risks include renewed fiscal uncertainty; more persistent inflation, including due to tight labor markets for longer; an intensification of adverse climate events; and social discontent, for instance triggered by global supply shocks that increase the cost of living. On the upside, successful fiscal consolidation, particularly if supported by an enhanced fiscal framework, a further broadening of the tax base, and reforms that tackle budget rigidities as recommended by staff, could help create conditions conducive to an earlier reduction in the monetary policy rate, lower risk premia, and help protect priority spending. In addition, approval and implementation of the indirect tax reform would simplify the tax regime and boost potential output. Leveraging Brazil’s vast green growth opportunities could further lift potential.

13. Strong buffers support resilience. Adequate FX reserves, a flexible exchange rate regime, and an external position broadly in line with fundamentals help cushion risks. Low FX debt and large public sector cash buffers, as well as a sound financial system, further support resilience.

Authorities’ Views

14. The authorities concurred that growth would moderate somewhat in 2023, while emphasizing the Brazilian economy had consistently beat expectations. Despite the deceleration in the second half of 2022, the authorities were more optimistic than staff, with stronger projected growth, converging to a potential rate of around 2.5 percent over the medium term, supported by social assistance, a reduction in inequality, minimum wage policies, increased public and private investment (mainly guided by the ecological transformation), and lower uncertainty and inefficiencies brought about by the new fiscal and tax regimes. The authorities agreed that leveraging green growth opportunities and implementing the VAT reform could further boost economic potential. The authorities saw inflation gradually declining and pointed out that lower food price inflation was already bringing relief to the poor, while easing labor and credit market conditions would further support disinflation. The BCB noted that inflationary pressures could prove persistent and inflation components more sensitive to the economic cycle remained above the range compatible with meeting the inflation target, slowing the convergence towards the target. The authorities highlighted fiscal uncertainty had declined substantially after the unveiling of the new proposed fiscal rule, as can be confirmed by lower long-term yields. They concurred strong buffers support resilience, including adequate FX reserves, a flexible exchange rate, an external position broadly in line with fundamentals, a sound financial system, and large cash buffers by the public sector.

Policy Discussions

A. Securing Fiscal Sustainability while Preserving Inclusive and Growth-Friendly Spending

15. The authorities’ commitment to improve the fiscal position is very welcome. Acknowledging the need for fiscal consolidation to maintain debt sustainability, mitigate risks, and support monetary policy’s disinflation effort, the authorities aim to improve the federal primary balance from a projected deficit of 2.2 percent of GDP in the 2023 budget to a deficit of 0.5 percent of GDP in 2023 and a surplus of 1 percent of GDP by 2026, within a narrow tolerance band. Based on more favorable assumptions than staff, the authorities estimate such consolidation (of about 3 percent of GDP) would stabilize public debt (authorities’ definition) by 2026. Given the design of the new fiscal rule (Box 3), staff estimates that the authorities’ strategy would require increasing revenues by about 2.5 percent of GDP over the near to medium term from the 2023 budget. The authorities’ announced near-term revenue generating measures focus on reversing pandemic-related tax cuts, mitigating tax litigation losses, and closing loopholes, while forthcoming plans would focus on pursuing a direct tax reform and reducing inefficient tax expenditures. The authorities are also advancing a well-designed indirect tax reform that would be revenue neutral (see below).

16. Staff’s baseline scenario projects a NFPS primary deficit of 1.3 percent of GDP in 2023, relative to a projected deficit in the 2023 budget of 2.2 percent of GDP.^⁷ Staff’s projection includes the gradual reversal of PIS/COFINS taxes on fuels and financial revenues, tax changes on transfer pricing and off-shore financial revenues, the unwinding of pandemic-related unused funds (PIS/PASEP), and some spending restraint. Staff’s baseline only partially reflects the impact of other tax measures in the near term, including the double taxation on goods and services, given uncertainty around estimated yields and considering the full impact would materialize with a lag.^⁸ Staff welcomes the authorities’ intention to deliver a more ambitious improvement in the 2023 federal primary deficit to 0.5 percent of GDP, which would be consistent with an adequately neutral fiscal stance, requiring saving any revenue overperformance compared to the baseline. Over the medium term, staff projects an improvement to a NFPS primary surplus of 1.3 percent of GDP, in line with a more gradual implementation of tax revenue measures than the authorities, coupled with some moderation in spending growth guided by the new fiscal rule.

17. Staff recommends a more ambitious fiscal effort that continues beyond 2026 to put debt on a firmly declining path. Brazil’s debt is high and projected to rise further in the coming years, with debt stabilizing around 97 percent of GDP in 2032.^⁹ Although staff’s debt sustainability assessment finds risks of debt distress to be moderate under the baseline scenario, the debt trajectory remains highly sensitive to shocks to borrowing costs and real GDP growth, and the materialization of fiscal risks (Annex IV). In particular, large fiscal risks stem from the sizable stock of judicial claims,^¹⁰ the postponement of settling court-ordered payments, and delays in tax litigation (Annex V). The overwhelmingly domestic investor base, low external debt, and large cash buffers by the public sector (at 10 percent of GDP) mitigate risks and provide room for gradual consolidation over the medium term. Staff estimates that a total fiscal effort of around 4–4½ percent of GDP over the medium term, supported by an enhanced fiscal framework, a further broadening of the tax base, and reforms that tackle budget rigidities, would put debt on a firmly downward path, while preserving space for inclusive and growth-friendly spending.^¹¹ A shift towards a tighter fiscal stance than in the baseline would support the disinflation effort, reduce its costs, and help create the conditions that could allow monetary policy to ease sooner.

^{Box 3.}

Proposed New Fiscal Rule

An indicative primary balance path. The authorities aim to improve the federal primary balance from a deficit of 0.5 percent in 2023 to a surplus of 1 percent of GDP in 2026, within a narrow band of +/-0.25 percent of GDP.

A spending corridor. Real federal spending growth would have a floor of 0.6 percent and a ceiling of 2.5 percent, contingent on revenue collection and the distance to the primary balance targets. Concretely:

If the primary balance in year t is within the band, planned real federal spending growth in t+2 = 0.7 x real revenue growth in t+1 (mid-year)
If the primary balance in year t is outside the band, planned real federal spending growth in t+2 = 0.5 x real revenue growth in year t+1 (mid-year)

Floor on investment. The new rule includes a floor on public investment of 0.6 percent of GDP. Up to 70 percent of the overperformance of the primary balance relative to target can be used towards higher capital spending, with a limit of 0.25 percent of previous year’s GDP.

Revenue growth. Acknowledging volatility in nonrecurring revenues, revenue growth used to determine spending growth in the fiscal rule exclude other revenues such as dividends, concessions, and royalties.

Within-year correction mechanism. If the primary balance target is at risk within the year, spending would be corrected through bans on: new hiring, increases in public wages, new mandatory spending, or increases in assistance policies or tax benefits.

18. There is scope to build on the proposed new fiscal rule to strengthen sustainability and credibility, while providing flexibility. Model simulations show that a credible consolidation path, while protecting inclusive and growth-friendly spending, would foster sustainability and growth (Box 4). Possible enhancements to the framework include (see Selected Issues Paper):

A strong fiscal anchor that puts debt on a firmly downward path within a medium-term perspective. The proposed rule does not feature a built-in reduction in debt, while the primary balance path remains indicative.^¹² Under staff’s macroeconomic assumptions, a primary surplus of around 1½ percent of GDP would be needed to stabilize debt over the longer term. Considering the need for buffers, staff estimates an adequate anchor for the longer term would be a net general government debt-to-GDP ratio of around 55 percent (NFPS gross debt of 80-85 percent), consistent with staff’s recommended fiscal effort of 4–4½ percent of GDP. Alternatively, building on the authorities’ proposed new rule, the framework could be anchored in a binding multi-year primary balance path that underlies budget formulation with a correction mechanism to offset deviations. Continuing to transparently report on fiscal developments and projections to ensure consistency with fiscal targets would support fiscal efforts, transparency, and accountability.
A spending rule that addresses Brazil’s large public spending ratio and reduces the risks of consolidation through revenues only.^¹³ Unless accompanied by sustained revenue measures, the new fiscal rule would entail a shift towards a structural fiscal easing. Aiming for a sizable and rapid increase in revenues carries implementation risks, given slowing cyclical conditions in the near term and an already significant revenue ratio on a structural basis, and could be harmful for growth. Taking into account government preferences for safeguarding priority spending while increasing revenues, and, building on the new proposed rule, the spending ceilings could be strengthened by (i) ensuring consistency with primary balance targets; (ii) linking spending growth to sustained increases in the structural revenue-to-GDP ratio;^¹⁴ (iii) reducing the embedded pro-cyclical bias; (iii) harmonizing rules on current versus capital spending to mitigate risks of misclassification; and (iv) allowing spending cuts in the budget preparation process if needed.
A well-defined economic escape clause that guides the response to shocks and allows for countercyclical support, while remaining consistent with debt sustainability.
A mechanism to promote additional government savings when commodity prices are high and thus shield public finances from commodity cycle fluctuations.
Rules for subnational governments that harden budget constraints and strengthen monitoring. Ideally, expenditure rules should be set for each level of government in a concerted effort and supported by structural reforms, while respecting relative autonomy within Brazil’s federal system.
A more comprehensive medium-term fiscal framework (MTFF) and strong institutions that bolster transparency and accountability. The authorities’ plans to undertake a spending review, coupled with performance-based budgeting, would support consolidation efforts and improve efficiency. In addition to forecasts of main budget aggregates, the MTFF could distinguish between recurrent and capital spending, as well as old and new projects. The Independent Fiscal Council (IFI) could be tasked with monitoring the activation and implementation of escape clauses, running debt sustainability analysis with independent assumptions, performing reality checks on the feasibility and stability of budget plans, and publishing goalposts and milestones.

19. Tackling spending rigidities, while protecting social and investment spending, would foster sustainability and inclusive growth. Mandatory spending, mainly on pensions and wages, has reached more than 90 percent of general government spending and generally benefits higher-income households. Entrenched budget rigidities further constrain room for priority spending. While recognizing their complexity, reforms of pension and public administration are needed to put spending growth on a sustainable path and create space for priority programs. Revisiting indexation and revenue earmarking would provide flexibility and additional room to respond to shocks. Reform options, generating savings of about 2–3 percent of GDP materializing over time, include (see Selected Issues Paper):^¹⁵

Pensions: The 2019 pension reform introduced several good practices into the general pension system (RGPS) and the federal civil servants’ regime (federal RPPS) and stabilized their deficits. The federal and subnational RPPS regimes generate a deficit of about 2.5 percent of GDP, equivalent to the RGPS deficit but covering far fewer contributors. The subnational RPPS regimes should be reformed swiftly through an alignment of all RPPS to RGPS parameters. Deficits can be gradually eliminated by a well-parametrized combination of (i) reduced replacement rates (including lower accrual rates and a cap on pension indexation); (ii) increases in the effective retirement age; (iii) higher contribution rates while avoiding unintended effects on formalization; (iv) full income taxation of pensions; and (v) a coordination of non-contributory regimes with other social programs. Moreover, implementing an automatic adjustment mechanism for pension parameters (e.g., retirement age or replacement rates) would allow pension spending to adapt automatically to demographic changes.
Public Administration: Employee compensation accounts for about 30 percent of general government spending and 12 percent of GDP, above the 8–9 percent average for emerging and Latin American economies, and is mainly driven by high premia relative to private sector wages rather than by high employment.^¹⁶ Adjusting wage growth below nominal GDP (e.g., by IPCA) and implementing targeted attrition policies could save up to 1 percent of GDP, while additional savings can be achieved by revamping career progression and service structure and changing salary structures. A public administration reform will also support RPPS reforms by limiting the mechanical link between growth in the wage bill and pensions.
Budget Rigidities: Reviewing spending indexation and revenue earmarking rules, combined with sectoral spending reviews, is key to create space for priority spending and could bring efficiency gains.

20. The authorities’ revenue-neutral indirect tax reform plan is well-designed, would significantly streamline the tax regime, and could boost potential growth. The envisaged indirect tax reform, merging all consumption taxes and introducing an integrated value added tax (VAT), would foster substantial efficiency and productivity gains, reduce tax competition among subnational governments, mitigate risks from judiciary disputes, and boost potential growth. Plans to support the poor through targeted VAT refunds and/or cash transfers, rather than generalized exemptions, are welcome.

^{Box 4.}

Alternative Fiscal Scenarios: The Role of Credibility

The IMF GIMF model is used to assess the benefits of policy credibility during fiscal consolidation. The simulation considers tackling spending rigidities through entitlement reform and other spending restraint (about 2½ percent of GDP), while preserving inclusive and growth-friendly spending, complemented by tax measures of around 1 percent of GDP, in line with staff’s recommendations. Savings span over a 5-year horizon, allowing for a decline in the sovereign risk premium of 25 bps per year.

The model considers the impact of fiscal consolidation on real GDP and other key macroeconomic variables under two modes of expectations: limited credibility and credibility under stepwise updating.

Under limited credibility, economic agents consider fiscal plans for one year only and update their actions each year. Consolidation weighs on GDP, mainly driven by a decline in government consumption and transfers, and higher labor and corporate taxes. Real GDP declines relative to the baseline, while effects on investment are small despite the lower risk premia given limited foresight.
Under credibility with stepwise updating, agents consider the fiscal path to be credible (and update as next year’s plan is released, yet without full foresight). They decide to invest, also boosted by the decline in the sovereign risk premia. The increase in investment broadly offsets the negative impact of consolidation on real GDP, with limited overall output losses relative to the baseline.

The results reinforce the benefits of fiscal consolidation supported by reforms that tackle spending rigidities and bolster the credibility of an enhanced fiscal framework that aims to put debt on a downward path.

21. Even with spending reforms, additional revenue mobilization is necessary to secure fiscal consolidation. In particular, the direct tax reform expected in the second half of 2023 will be key to generate additional revenues, eliminate inefficient tax expenditures, and increase progressivity. Measures that bring short-term revenue gains but introduce undesirable distortions are not advisable, as they increase risks for growth and sustainability. Staff estimates the following measures could yield about 1–2 percent of GDP in additional revenues:

Personal Income Tax: Broadening the base through the elimination of regressive exemptions as well as by strictly limiting income tax deductions (e.g., health and education expenses). There is also scope to improve progressivity by keeping the exemption threshold constant and increasing the marginal PIT rates for higher incomes.
Corporate Income Tax: Broadening the base by continuing efforts to strictly limit exemptions (e.g., allowances for corporate equity, presumptive regime) and reintroducing dividend taxation, aligning Brazil with international practice.
SIMPLES:^¹⁷ Exploring options to lower the eligibility threshold. Steps to improve ‘graduation’ out of SIMPLES are key to avoid the Small and Medium-size Enterprise trap.
Property Taxes: Broadening and strengthening collection capacity.
Commodity Revenues: Refraining from ad hoc temporary taxes (e.g., export levies) and tailoring taxes to better capture rents (e.g., excess profit taxes in the short term and a lower share of price-independent royalties in upcoming oil and gas extraction contracts).

Authorities’ Views

22. The authorities reaffirmed their commitment to improve Brazil’s fiscal position. They were confident that tax measures in train would help rebuild the tax base, meet fiscal targets, and stabilize public debt over the medium term. They stressed that efforts to close loopholes would significantly reduce compliance costs and mitigate risks from judiciary disputes. In addition, the long overdue indirect tax reform, which could be approved in coming months, would significantly streamline the tax regime, reducing inefficiencies and boosting potential output. The reform of direct taxes could follow in the second half of the year, focused on increasing progressivity and mobilizing revenues. The authorities viewed the proposed new fiscal rule as sufficient to guide consolidation, while providing flexibility for new spending priorities. Under the new framework, public debt would stabilize by 2026 and gradually decline thereafter. They noted that following the 2019 pension reform and a federal public wage freeze lasting several years, further reforms of pension systems or public administration were not a priority at this point in time. The authorities underscored the shortcomings of the IMF concept of General Government Gross Debt in capturing elements of the debt dynamics and fiscal/rollover risks in the case of Brazil, which, indeed, would be better portrayed by a net debt concept.

B. Bringing Inflation Back to Target

23. The monetary policy stance is appropriate and consistent with inflation converging to target. Bringing inflation down remains critical to protect the real income of vulnerable households, who are hurt the most by high inflation. The BCB reacted early to price pressures in a pro-active manner, in line with the inflation targeting framework that has served Brazil well, and the current monetary policy stance is appropriately tight. Despite the recent large decline in headline inflation, the components of inflation that are more sensitive to the economic cycle, such as core services, remain elevated and highly inertial. Inflation expectations are above target but have come down more recently. The start of the monetary policy easing cycle expected later this year should proceed with caution to ensure inflation converges to target, guided by incoming data on price pressures and inflation expectations.

24. The recent decision to adopt a continuous inflation target better aligns Brazil’s inflation targeting framework with regional peers and increases the effectiveness of monetary policy. Inflation targets have been set three years in advance by the CMN, comprising two ministers and the central bank governor. In June, the CMN Resolution set a 3 percent inflation target for 2026, the same level as 2024 and 2025. Furthermore, the CMN decided to change the inflation-targeting framework, with the adoption of a continuous 3 percent target (instead of calendar year targets) from 2025 onwards, to be established by Presidential decree. This will reduce uncertainty around the determination of targets and facilitate the re-anchoring of medium-term expectations. A continuous target also increases monetary policy flexibility by better acknowledging the inflation-output tradeoff in the short run, as well as lags in the transmission of monetary policy that extend beyond the calendar year (see Selected Issues Paper, 2016). Given this change in the inflation targeting framework, it will be critical that monetary policy action and communication aim to strengthen credibility around the continuous target.

25. Legislative reforms in recent years have supported the BCB’s ability to deliver on its mandate. Improvements to BCB autonomy and the financial relationship with the treasury have been positive and have strengthened the inflation targeting framework. Future reform efforts could provide the BCB with flexibility in budgetary decisions in a manner that allows it to hire and retain personnel to fulfil its mandate.^¹⁸ Future reforms could also bolster other aspects of financial autonomy by providing the BCB with flexibility in setting up risk buffers based on its own assessment of risk exposures, while reducing the stock of federal securities held by the BCB (see Selected Issues Paper). These changes would also align the BCB’s institutional framework with other successful central banks in the region.

26. The flexible exchange rate regime and adequate FX reserves remain important shock buffers. Given continued risks from an abrupt tightening of global financial conditions, exchange rate flexibility is instrumental to absorb shocks. FX intervention could be used to address episodes of higher risk premia when FX liquidity becomes shallow but should not substitute for warranted adjustment of macroeconomic policies. Reserve adequacy remains well within adequate ranges (136 percent of the IMF ARA metric as of end-2022) despite the small deterioration in 2022, which was largely due to valuation effects. Brazil also retains a comfortable net creditor status on external debt that acts as an insurance against a tightening of global financial conditions.

27. Developing additional guidance around the use of FX swaps, aiming to reduce the outstanding stock when conditions allow, would be advisable. Since 2020, the authorities have increased the stock of non-deliverable futures denominated in local currency (FX swaps) by close to US$70 billion primarily to deal with market dysfunctionality issues.^¹⁹^,^²⁰ The stock of FX swaps has risen to over 30 percent of reserves in line with the highs seen during the 2015–16 exchange rate pressures. Although there is no well-established limit on FX swap interventions (see Selected Issues Paper, 2015), the outstanding stock can be seen as a contingent demand of hard currency reserves depending on the ability of corporates to roll over external liabilities and foreigners’ desire to hold BRL denominated exposures. Additionally, realized losses/gains on these swaps are directly reflected on the public sector interest rate bill and FX swap losses could contribute to central bank losses in some scenarios. When market conditions are conducive, a plan to reduce the outstanding FX swap stock would be advisable. Over the medium term, initiatives that improve currency convertibility and deepen FX spot markets would reduce the need for interventions in the non-deliverable market.^²¹^,^²²

Authorities’ Views

28. The authorities concurred that monetary policy is consistent with reducing inflation to target. The BCB stressed that taming excess demand-driven price pressures (mostly in services) remained challenging and required serenity and patience to ensure that inflation converges to target. They agreed with staff on the need for caution, given that the disinflationary process tends to be slower in an environment of de-anchored inflation expectations and elevated inflation in sectors with high inertia. The Ministry of Finance (MoF) expressed concern about the impact on growth of the level of real interest rates, perceived as too high compared to other countries facing similar inflationary pressures. The authorities noted the CMN Resolution setting a 3 percent inflation target for 2026, the same level already set for 2024 and 2025. They also noted the decision to change the inflation-targeting framework, with the adoption of a continuous target, instead of targets for calendar years, from 2025 onwards, in line with regional peers, which would be established by Presidential decree, helping reduce uncertainty and improving monetary policy effectiveness. The authorities reiterated their commitment to the flexible exchange rate and the BCB highlighted there is adequate guidance on the use of FX swaps as a policy tool. As for the financial relationship between the BCB and the Treasury, they considered that the current arrangement, after the 2019 reform, adequately meets the needs of both institutions and does not require any revision at this point.

C. Safeguarding Financial Stability while Fostering Inclusion and Innovation

29. The financial system remains resilient, the banking system is sound, and systemic risks are contained. Banks are adequately capitalized, with an average Tier1 ratio of 14.2 percent at end-2022, and highly profitable. They are also highly liquid, with liquidity coverage ratios well above the regulatory minimum. Although asset quality deteriorated, and credit losses have picked up on banks’ loans for households and corporates since mid-2022, provisioning remains adequate. The authorities’ stress tests published in May confirm banks’ resilience to significant hypothetical credit, market, liquidity, and climate shocks.^²³ Linkages with non-bank financial institutions, particularly with insurance companies, would benefit from quantitative analysis in the upcoming FSAP. The resilience of the insurance sector has been supported by the rise in interest rates over the past couple of years. The authorities have also made important strides in addressing FSAP recommendations (Annex VI).

30. Banks have limited exposure to interest rate shocks such as those experienced by US banks in early 2023. Banks have low exposure to interest rate risk, as their security holdings are mostly of short maturity or with variable coupons, and remaining interest rate exposure is actively hedged in Brazil’s deep derivative markets. Unrealized losses from held-to-maturity portfolios are small, representing 2–3 percent of equity for the two largest private banks and less than 1 percent for other major banks, while unrealized losses in available-for-sale portfolios are reflected in book value. The risk of an adverse bank-sovereign nexus is mostly alleviated by banks’ appropriate interest-rate risk management, but a major increase in sovereign risk premia could have an adverse effect on bank balance sheets and lending appetite.

31. The authorities are taking welcome steps to address household debt vulnerabilities and protect consumers. The DSTI ratio has risen well-above previous episodes of turning credit cycles, largely due to riskier modalities such as credit cards and non-payroll loans. Based on credit registry data, the government estimates that nearly 70 million individuals (one-third of the population) are in default on some form of debt, including bank loans and utility bills. The government’s Desenrola program aims to restructure existing household debt owed to different creditors through a digital application for indebted households. The government would provide a guarantee for the consolidated and restructured debt of low-income households, using a BRL 10 billion fund (0.1 percent of GDP) that has already been allocated.^²⁴ The authorities are also promoting financial literacy among households, particularly regarding credit cards, which carry no interest charges on a fixed number of regular installments, but rapidly adjust to high charges (as much as 400 percent) in case of a missed payment.

32. The authorities’ planned measures to facilitate household debt restructuring could be supplemented with targeted prudential limits. IMF analysis suggests that a prudential limit would be appropriate in situations where the DSTI ratio exceeds 20–25 percent and is rising above a 15-year trend, as is the case in Brazil.^²⁵ In the present late stage of the credit cycle, a prudential limit, set by the BCB based on appropriate industry consultation and targeted to riskier credit modalities, would help to address underwriting risks and protect consumers on future borrowing. Interest rate caps could help curb excessive interest rate costs for some households, but possible negative implications for the quantity and quality of credit need to be carefully assessed.

33. Carefully managing a bigger role for public banks is important to mitigate risks for fiscal sustainability and monetary policy transmission. Prior to the Taxa de Longo Prazo (TLP) reform in 2017, the government provided subsidized funding to public banks for household mortgages and strategic developmental corporate loans, which had a negative impact on fiscal accounts and monetary policy transmission in the past.^²⁶ At present, public banks are well-capitalized, profitable, and liquid, and have been paying dividends and pre-paying (mainly BNDES) liabilities to the government. The government intends to expand earmarked credit in key strategic developmental areas where there are market failures, without reintroducing interest rate subsidies and maintaining rigorous and sound practices. Earmarked credit at subsidized rates can distort the allocation of credit from private banks and impose higher costs on non-targeted borrowers. Ongoing initiatives to issue loan guarantees and co-finance projects with both public and private banks are welcome. Maintaining appropriate credit underwriting standards will be key to allowing greater expansion of credit with available funds (Annex VII).

34. The BCB is at the forefront of financial innovation. Notable initiatives already in operation include the highly successful instant payment system Pix launched in late 2020 (see Selected Issues Paper), and the Open Finance environment introduced in 2021 for sharing data and services between regulated entities. These initiatives have increased financial inclusion, efficiency, and competition.

35. Looking ahead, BCB’s flagship initiative is to introduce a wholesale CBDC (the Digital Real-RD) by early 2025. The RD would aim to underpin a public blockchain infrastructure in a regulated environment (Box 5).^²⁷ The RD would be interoperable with existing payment infrastructures and facilitate new business models. The design of this infrastructure also aims to minimize financial disintermediation risks through tokenized deposits/accounts issued by regulated institutions as the main payment instrument. Over time, the new platform will require the digital representation of more real-world assets to enable a transition towards more token-based financial services. Such a transition would need to be gradual and supplemented with changes in the legal and regulatory environment, so tokens fulfil their functions reliably without jeopardizing consumer protection, financial stability, and market integrity.^²⁸

Authorities’ Views

36. The authorities concurred that the financial sector remains resilient, the banking system is sound, and systemic risks are contained. They noted that credit growth is slowing, largely due to tight monetary policy, while credit quality weakened but has been improving recently. However, the BCB’s recent stress tests show that systemic risks are contained. The authorities noted that rising household debt does not pose a financial stability risk but requires policy attention given the high share of households affected. The MoF expects that the Desenrola program will contribute to reduce credit delinquency, especially among the poor. The BCB noted that a targeted macroprudential limit on household DSTI ratios would be operationally difficult to implement and could incentivize households to borrow from unregulated entities. They agreed that the pros and cons of interest rate caps should be carefully assessed, including possible allocation inefficiencies. The authorities concurred that any broader role for public banks should be focused on addressing market failures, and not impact the fiscal accounts or monetary policy transmission. The MoF highlighted the recent measures that were adopted to improve capital markets efficiency, such as the simplification in the process of private bonds issuance. The BCB aims to launch the Digital Real at end-2024 or early 2025 but recognized that addressing some challenges (e.g., around privacy standards) could require a more gradual approach.

^{Box 5.}

The Digital Real: Objectives, Key Design Features, and Challenges

Unlike other CBDC projects, the RD is envisioned as a ‘smart’ platform that fosters financial innovation. In most countries, plans to introduce a CBDC pursue a combination of objectives, including promoting financial inclusion; making payments systems more competitive, resilient, and cost-effective; and improving cross-border payments. In Brazil, Pix has already been successful in improving financial inclusion and enabling efficient retail payments. Hence, the RD is envisioned as a ‘smart’ platform for financial services based on a digital ledger (DLT) that leverages the digital representation of assets (tokenization) and programmability, seeking to foster innovation.

The RD platform aims to harness the benefits of new technologies in a safe and reliable environment. These technologies are currently available to users mainly through the crypto ecosystem. Significant efforts have been made globally and domestically to regulate this ecosystem, including the Brazilian virtual assets law of December 2022, but several challenges remain, especially due to regulatory asymmetries and weak enforcement (IMF, 2023). Common issues include: a) crypto exchanges based in offshore jurisdictions that don’t comply with recommendations by international standard setting bodies; b) decentralized finance protocols that make it difficult to establish what is the right entity to regulate; and c) the use of technologies that comply with the existing regulatory framework, including know-your-customer (KYC) requirements, as well as international recommendations (e.g., on anti-money laundering).

BCB ongoing pilots rely on tokenized deposits to mitigate monetary sovereignty and financial disintermediation risks. The RD will enable change of ownership and real time settlement on a DLT, which requires the use of a medium of exchange that is native to the platform. In principle, this would require using either i) crypto assets such as Stable coins; ii) a retail CBDC; or iii) tokenized deposits/accounts. The shortcomings of the first two options are well documented (see IMF (2023)). Most notably, US dollar based Stable coins can amplify currency substitution risks, while retail CBDCs could lead to financial disintermediation risks if users substitute bank deposits with central bank liabilities (CBDC). The latest BCB pilot (piloto-RD) utilizes option (iii) by testing the transfer of tokenized deposits and accounts held at banking and payment institutions, respectively. The former is fully backed by demand deposit balances and the latter by compulsory reserves held at the BCB. The RD will only be used for wholesale purposes, such as bank reserves and settlement accounts.

A key policy goal is to allow the migration to a token-based world by enabling a trading environment for a diverse set of tokenized assets. At an initial stage, the tokenization technology will be used for deposits/accounts and other financial assets (e.g., federal securities), while at a later stage more complex assets will be tokenized. As an example, the BCB’s Lift Challenge already includes pilot projects that rely on tokenization of vehicles and real estate ownership titles, as well as rural financing solutions based on tokenized agricultural produce.

The transition to a token-based world will require changes in the legal framework that ensure a reliable ‘bridge to reality’. As discussed in Garrido (forthcoming), some types of tokens need additional legal provisions to ensure that holders have an actual right over a real-world asset or service. Existing solutions that rely on programming code such as Oracles can integrate reliable real-world information (for instance the latest dollar-BRL exchange rate) but cannot deal with more fuzzy type of information (e.g., faulty sensors for machine-to-machine integration) nor guarantee token holder rights in the real world. Establishing a reliable ‘bridge to reality’ will likely necessitate the authorization of qualified intermediaries tasked with guaranteeing that the asset or service corresponds to its contractual description. Additional changes will likely be needed to determine whether the transfer of tokens prevails over the transfer of real-world assets (or vice versa), reconcile the rights of token holders in cases where their private keys are stolen or lost, protect holder rights during insolvency of the token issuer, and enforce court decisions related to tokens.

Other considerations necessitate a gradual transition to the new RD platform.

Funding Risks. Enabling a financial aggregator model that allows customers to access services in real time from different banks could amplify funding risks in the system (e.g., accelerate flows from riskier banks to safer banks). Such risks can be mitigated, for instance, by imposing limits on the speed of transfers allowed on the platform and adjusting liquidity stress testing parameters.

Scaling-Up Challenges. Achieving large-scale adoption could prove challenging if the costs to invest and participate in the RD platform are significantly higher (e.g., compared to Pix), especially for smaller players that are not part of existing RD pilots. Relatedly, some entities might be unable to adjust their business model in time of the RD launch (e.g., banks that specialize in credit modalities that will become standardized and part of aggregators). A set of minimum hardware/software tools to facilitate the entry of smaller financial companies in the RD platform could help address these challenges.

Compliance with Privacy Laws. Some of the innovative financial services that rely on composability and traceability might not be compliant with the Brazilian General Personal Data Protection Law. The introduction of such services would require ensuring prior compliance with domestic legislation.

Reputational and Operational Risks. Failures in the RD platform (whether due to programming errors of already approved services, operational errors by regulated institutions, or cyber-attacks) could undermine trust in central bank operations.

D. Boosting Potential Growth

37. Brazil’s real GDP growth per capita has been low in recent decades, driven by low capital and labor growth and stagnant productivity growth. In the last decades, agriculture was the only sector with high productivity growth, while productivity growth in the industry and services sectors has been stagnant.^²⁹ Potential growth is also projected to be lower in Brazil than in regional and emerging market peers over the medium term.

38. To lift inclusive growth, the authorities are rightly focusing on prioritizing both public and private investment, boosting education and training, increasing the supply of day-care centers, and promoting green growth opportunities (see also section on climate). Specific measures to lift potential growth could include the following:

Public Investment. Tackling spending rigidities remains key to make room for much-needed public investment. Well-prioritized multi-year investment plans, commensurate with multi-year investment budgets and coordinated across levels of government, would improve investment spending efficiency, including from public-private partnerships (PPPs), state-owned enterprises (SOEs), and public banks. The upcoming regulatory framework for PPPs is expected to support the expansion of public investment. Clear provisions to mitigate and manage fiscal risks from PPPs will be key.
Skills. Brazil needs skilled labor to lift labor productivity, innovate further, reduce informality, and embrace new green technologies. Priorities include improving education quality, increasing secondary school enrolment, and upgrading curricula. Recalibrating the mix of salaries and personnel in line with ratios of high performing countries would help improve PISA scores.^³⁰
Minimum Wage Policies. Brazil’s minimum wage has hovered around the 30^th percentile of the income distribution and around 70 percent of median wage over the last decade, including all jobs and sources. Minimum wages have generally grown faster than labor productivity (and faster than regional peers particularly in the first part of the 2000s). Future minimum wage increases should reflect productivity growth, with due consideration to tradeoffs between inequality, job creation, and competitiveness.
Labor Markets. Easing job protection could increase employment and investment, if enacted during economic normal or good times (IMF World Economic Outlook, October 2019). The policy focus on early childhood and planned expansion of day-care centers is welcome and would help narrow the gender labor force participation gap.

39. Further trade integration would also support productivity and competitiveness. Brazil has made important strides in trade liberalization, including lowering import tax rates and reducing non-tariff barriers. Regional integration plans and the ongoing OECD accession process offer opportunities to further open Brazil to international trade and support productivity and competitiveness. Labor market and other domestic policies can help to better share the gains from trade and technological adoption, including to update skills, facilitate labor reallocation, and strengthen social safety nets.

40. There is scope to strengthen the effectiveness of the AML/CFT and anti-corruption frameworks. Against the ongoing FATF/GAFILAT assessment, strengthening the effectiveness of the AML/CFT regime would mitigate threats from money laundering, tax evasion, and organized crime. In addition, and in line with past IMF recommendations, an enhanced anti-corruption strategy should aim to bolster the independence of related institutions and address corruption risks in macro-relevant areas.

Authorities’ Views

41. The authorities were confident their economic reform agenda would foster competitiveness, productivity, and efficiency, and help lift living standards. The authorities agreed the pandemic had set back progress in female labor market participation. They emphasized their forthcoming National Policy for Care would be key to promote formalization, increase access to child- and elderly-care, and implement full day schooling. The authorities reiterated that the policy of real increase in the minimum wage, which is being resumed, was important for reducing poverty and inequality, while risks of fostering labor informality were low.

E. Changing Climate in Brazil

42. Changing climate conditions are already affecting Brazil’s economy. Rising temperatures in Brazil (between +1°C and +5°C by the end of the century) and temperature variability have increased both present occurrences and the future likelihood of extreme weather events. The most common extreme events in Brazil include: w(i) floods, which have more than doubled relative to the 1980s-90s and often result in physical and human capital losses, temporary productivity losses, fiscal costs, and sometimes durable output scarring; and (ii) droughts and extreme heat waves that directly impact agricultural output and decrease labor productivity.^³¹ The 2021 drought, for instance, increased inflation by 0.7 percentage points and led to agriculture output losses of BRL 45.3 billion (0.5 percent of GDP) in four states, of which 40 percent was not insured,^³² while private insurers experienced loss ratios on rural plans peaking at 90 percent in 2022. Extreme weather events also exacerbate household vulnerabilities. The World Bank estimates that natural disasters can push an additional 0.6–1.3 percent of the population into extreme poverty by 2030.^³³

43. Agriculture and power generation are key sectors at risk, with potential repercussions for the financial sector.

Agriculture is estimated to lose 1 percent of its sectoral GDP per year due to extreme weather events (World Bank CCDR, 2023). About 20 percent of farming activity is covered by insurance,^³⁴ with Southern farmers significantly more insured than peers in the North. However, drought risks affect both Northern and Southern regions.
Hydropower generation is being affected by lower water availability and changing rainfall patterns. Past deviations from mean temperatures by +0.1C have led to a lower capacity utilization of 2–3 percent, increasing the likelihood of energy supply disruptions and higher energy costs, and pushing up inflation. Considering the slow-moving effects of climate change through temperature increase and precipitation pattern change, hydropower generation could decline by 5 percent in 2050 under moderate climate assumptions and by 20 percent in a more severe scenario.^³⁵
About 20 percent of the financial sector’s credit portfolio is exposed to sectors vulnerable to climate change, with the share of agriculture (businesses and rural households) increasing to around 12 percent of total bank loans over the past decade. The BCB estimates that around 8 percent of the financial sector’s credit portfolio is sensitive to transition risks, concentrated on smaller financial institutions, notably lending to the cattle and soybean industry, as well as cargo and transportation. Focusing on physical risks and drought scenarios, about 20 percent of the credit stock is with water-intensive borrowers. Operations at risk from heavy rainfall events are currently contained but estimated to increase to 16 percent in 2030 and 30 percent in 2050.^³⁶

44. Current patterns of land-use amplify climate change risks by profoundly affecting water cycles. Increasing dry-season length and drought frequency have diminished the Amazon’s resilience against shocks and may have already pushed the Amazon close to a critical threshold of rainforest dieback.^³⁷ Deforestation has further increased the likelihood of reaching a tipping point that would durably disrupt water cycles, accelerate erosion, limit carbon storage, and release sizeable amounts of carbon into the atmosphere. In decreasing the availability of fresh water, deforestation makes water-intensive sectors more vulnerable (such as agriculture and hydropower, but also mining and industry). Some estimates quantify the output loss of reaching the Amazon tipping point for Brazil alone at 10 percent of 2022 GDP through 2050 (World Bank CCDR, 2023).

45. The authorities are in the process of defining their climate strategy and considering several policy options. Measures to address the adverse trajectories of temperature and precipitation could include the following (see Selected Issues Paper):

Boosting the Amazon’s resilience to climate shocks via fiscal incentives for forest protection. To meet the new government’s pledges to eliminate illegal deforestation by 2030 and restore 12mn hectares of forests, a revenue-neutral feebate scheme covering larger landowners at the forestry/agriculture border could provide comprehensive incentives for forest protection.
Investing in climate smart agriculture and strengthening insurance mechanisms. Improvements in irrigation infrastructure and soil management, new technologies, and more resilient crops could help offset reduced yields and productivity. To accelerate the adoption of climate smart technologies, policies could focus on de-risking the investment by the farmer in the short term,^³⁸ for instance by redirecting public funds from credit to insurance. Promoting climate-indexed insurance schemes and linking agricultural loans to sustainability criteria could further support the transition and generate also benefits for protecting the forest and lowering emission intensity.
Continuing diversification of power supply to solar, wind, and biomass, while leveraging existing hydropower. Solar and wind production capacities have rapidly expanded in the past years, and Brazil’s energy share from biomass is among the largest worldwide, almost exclusively financed through private investment.^³⁹ Planned private investments in renewables would more than offset the expected decline in production due to temperature and precipitations changes and generate opportunities for energy export, including through green hydrogen. To fully leverage Brazil’s large potential, handle increased weather volatility, and avoid higher fossil fuel consumption in the short term to fill climate-related power gaps, it is important to address key bottlenecks, in particular strengthening grid infrastructure, cross-border connections, and energy storage.
Leveraging the BCB Sustainability Agenda to green the financial sector. Since 2017, the BCB has been integrating social and environmental risk in the risk framework for financial institutions,^⁴⁰ successfully inducing larger lenders to start reallocating their portfolio to less environmentally exposed sectors.^⁴¹ From end-2023 onwards, disclosure will be expanded to quantitative metrics and targets. The BCB is also considering a liquidity facility that would offer preferential conditions to bonds based on ESG criteria. The BCB’s green credit bureau for agribusiness is helping enforce social and environmental regulations, including by stopping farming credit operations in protected lands. Considerations could be given to further linking agricultural credit (Proagro) to sustainability criteria.

46. The government aims to boost green growth. Opportunities for greener growth are considerable and include: (i) fostering sustainable farming, a greener industry, the bioeconomy, and socio-biodiversity businesses; and (ii) taking advantage of opportunities for green financing. Brazil can leverage its very green and relatively low-cost energy mix to expand export-oriented manufacturing, seize growing demand for green goods and services, and step-up green production sites. Brazil also holds a competitive advantage in green manufacturing, such as biofuels, hydropower, and wind energy equipment (World Bank CCDR, 2023). Plans to double annual investment in deep-water oil production by 2026 should consider synergies with green growth objectives as well as exposure to risks in a decarbonizing world.^⁴²

47. The authorities’ plans to develop a mandatory carbon market are welcome. While still under discussion, the first stage of the mandatory carbon market would focus on companies and industries responsible for 90 percent of Brazil’s emissions (Box 6), and then gradually include other sectors.^⁴³ A limited share of nature offsets (~10 percent) might be considered. The design of the ETS will determine whether it can effectively reduce emissions at a low economic cost, leveraging crosscountry experience. Ideally, the market should cover all sectors and incorporate price stabilizing mechanisms. Staff also recommends using possible receipts from auctioning emission allowances to compensate vulnerable households.

48. The authorities aim to develop an economy-wide green and social taxonomy and a yield curve for green bonds that could catalyze private financing. With the ESG framework at an advanced stage, the authorities plan to issue their first green and social bond in H2 2023, following successful issuances by peers over the past years. By regular, possibly biannual issuances, the authorities also aim to create a conducive environment for private sector ESG issuances.^⁴⁴ In other countries in the region, estimates for sovereign greenium, i.e. the yield discount of an ESG bond compared to a similar conventional bond have been in the range of 10–20 bps,^⁴⁵ and similar benefits could be expected in Brazil.^⁴⁶ In collaboration with the industry, government ministries, the BCB, BNDES, and CVM are working to agree on an economy-wide taxonomy. Regional coordination on standards would help avoid fragmentation and support green capital flows.

^{Box 6.}

Carbon Footprint and Commitments

Brazil’s carbon emissions account for about 3.5 percent of global emissions despite a very green energy mix. Emissions are concentrated in carbon dioxide (60 percent) and methane (32 percent). Average emissions from 2017 to 2020 were driven by: agriculture (34 percent); land-use change (29 percent, LULUCF); industry (12 percent, of which about half are process emissions); transportation (12 percent); and waste, power generation, and buildings (11 percent combined). The relatively low emissions through power generation are due to the high share of renewables in energy production (about 90 percent of electricity was generated by renewables in 2022).

Brazil increased its climate pledges in 2022. The updated Nationally Determined Contribution (NDC) commits to reducing emissions by 50 percent below 2005 levels by 2030, covering all major emissions sources (including methane and land-use change), and reaching net zero emissions by 2050. Achieving the NDC requires reversing trends in deforestation and agricultural emissions, and continuing reductions in transportation and industrial emissions. Brazil will need to reduce 2020 emissions by 28 percent by 2030 to achieve its NDC.

Authorities’ Views

49. The authorities broadly agreed with the macroeconomic challenges posed by climate change. They are considering a number of policy options to strengthen climate resilience and decarbonize the economy, in particular those aimed at deepening the carbon market, and were open to discuss how the engagement with the Fund on this matter could proceed within the limits of its mandate. At this early stage of the discussion with the Fund, the authorities consider that the preliminary analysis and proposals presented by the staff still need to be developed taking into account Brazil’s specificities and the government agenda being elaborated. The authorities underscored that they are revamping the framework to cope with environmental and climate issues and are developing a new sustainability strategy that aims to tackle these challenges, including through ongoing progress to establish a domestic carbon market, develop a green and social taxonomy, build climate resilient infrastructure, and restore climate justice for poorer households. The authorities emphasized a key goal is to shape a ‘bio economy’ by integrating agricultural production with forest protection through ecotourism, biotechnologies, and payment for environmental services. They saw vast opportunities to accelerate the energy transition and export green hydrogen, building on Brazil’s success in hydropower generation and the use of bioethanol in the transport sector. They emphasized climate initiatives should foster competitiveness and growth and expressed skepticism on the suitability of cross-border adjustments, voicing serious doubts on the compatibility of such mechanisms with the rules of the international trade regime.

Staff Appraisal

50. Growth is moderating but is expected to gradually improve towards staff’s estimate of potential over the medium term. Growth is projected to slow to 2.1 percent in 2023, from 2.9 percent in 2022, and gradually improve to staff’s estimate of potential over the medium term. Headline inflation has rapidly declined from last year’s peak, but core inflation remains elevated, and inflation expectations are above target. Headline inflation is expected to converge to target by mid-2025, in line with the inflation targeting framework that has served Brazil well. The external position was broadly in line with fundamentals and desirable policy settings in 2022, and the current account deficit is expected to narrow this year and remain broadly stable over the medium term.

51. Strong buffers support resilience in the face of prevailing downside risks. On the external front, downside risks include an abrupt global slowdown; a sharp tightening of global financial conditions; and commodity price volatility. On the domestic front, downside risks mainly stem from renewed fiscal uncertainty and more persistent inflation. On the upside, more ambitious fiscal consolidation could facilitate conditions for an earlier monetary policy easing and help lower risk premia. In addition, approval and implementation of the indirect tax reform would simplify the tax regime and boost potential output. Leveraging green growth opportunities also presents upside risks. A sound financial system, low reliance on FX debt, a flexible exchange rate regime, adequate FX reserves, and large cash buffers by the public sector support resilience.

52. The authorities’ commitment to improve the fiscal position is very welcome. Staff’s baseline scenario projects a NFPS primary deficit of 1.3 percent of GDP in 2023 (relative to a projected deficit of 2.2 percent of GDP in the 2023 budget), consistent with an expansionary fiscal stance. Acknowledging the need for fiscal consolidation to maintain debt sustainability, mitigate risks, and provide room for monetary policy to ease, the authorities aim to improve the federal primary balance to a deficit of 0.5 percent of GDP in 2023, which would be broadly consistent with an adequately neutral fiscal stance, requiring saving any revenue overperformance compared to the baseline. The authorities further aim to improve the fiscal position to a surplus of 1 percent of GDP by 2026. They intend to boost revenues to meet fiscal targets, focusing on closing loopholes, streamlining inefficient tax expenditures, broadening the tax base, and reforming direct taxes.

53. Staff recommends a more ambitious fiscal effort that continues beyond 2026 to put debt on a firmly declining path. Although staff’s debt sustainability assessment finds risks to be moderate, the debt trajectory remains highly sensitive to shocks and the materialization of fiscal risks. Staff estimates that a fiscal effort of 4–4 ½ percent of GDP is needed to put debt on a firmly downward path, supported by both spending and revenue measures. A tighter fiscal stance would also improve the policy mix, help the disinflation effort, and create conditions conducive to an earlier easing of monetary policy. The overwhelmingly domestic investor base, low external debt, and large cash buffers by the public sector mitigate risks and provide room for consolidation to proceed gradually. There is scope to enhance the fiscal framework, building on the new proposed fiscal rule, including through a strong medium-term fiscal anchor, stricter provisions that ensure consistency between the spending corridor and fiscal targets, and mechanisms to limit procyclicality. A more comprehensive MTFF, as well as plans for a spending review and performance-based budgeting, would support consolidation and improve efficiency. Reforming pensions and public administration, and revisiting indexation and revenue earmarking would reduce budget rigidities, create space for priority spending, and provide additional room to respond to shocks.

54. The proposed indirect tax reform is commendable, though additional revenue mobilization is still necessary to secure fiscal sustainability. The revenue-neutral VAT reform is well-designed, would significantly streamline the tax regime, and could boost potential output. The planned direct tax reform will be key to generate revenues, eliminate inefficient tax expenditures, and increase progressivity. Measures that bring short-term gains but introduce unnecessary distortions are not advisable, as they increase risks for growth and sustainability.

55. The monetary policy stance is appropriate and consistent with inflation converging to target. Bringing inflation down is critical to protect vulnerable households. The BCB reacted to price pressures in a pro-active manner in line with the inflation targeting framework that has served Brazil well, and the monetary policy stance is appropriately tight. Given upside risks from more persistent inflation at present, the start of the monetary policy easing cycle should proceed with caution to ensure inflation converges to target, guided by incoming data and inflation expectations. The recent decision to adopt a continuous inflation target has aligned Brazil’s inflation targeting framework with peers and should improve monetary policy effectiveness. Building on the improvements to BCB autonomy, future efforts could focus on flexibility in budgetary decisions and in setting risk buffers. Adequate FX reserves and the flexible exchange rate regime remain important to absorb shocks. Developing further guidance on the use of FX swaps would be advisable.

56. The financial sector remains resilient, systemic risks are contained, and the authorities are taking welcome steps to address household debt vulnerabilities. Banks are profitable, adequately capitalized, and liquid, and the financial system weathered well domestic and external stress events. Targeted policy measures and financial literacy initiatives to address pockets of household debt vulnerabilities and protect consumers are welcome. The authorities could also consider a prudential limit targeted to riskier credit modalities to protect consumers on future borrowing. Careful management of a bigger role for public banks will be important to mitigate risks for fiscal sustainability and monetary policy transmission.

57. The BCB is at the forefront of financial innovation. Initiatives such as the highly successful Pix and the Open Finance environment have increased financial inclusion, efficiency, and competition. Plans for a wholesale CBDC are expected to underpin a public blockchain infrastructure that fosters financial innovation within a regulated environment.

58. The authorities are embarking on an ambitious agenda to steer a sustainable, inclusive, and green economy. Priorities are rightly focused on fostering innovation, trade integration, and competitiveness; upgrading investment and skills; tackling poverty and inequality; and promoting green growth opportunities. Continuing efforts to strengthen the effectiveness of the anti-corruption and AML/CFT frameworks remains important. With agriculture and energy generation being the most vulnerable sectors to climate change, plans to strengthen climate resilience, halt illegal deforestation, and decarbonize the economy, including by creating a mandatory ETS and leveraging the BCB Sustainability Agenda, are welcome. Launching the first sovereign green bond will also help green the financial system.

59. Staff recommends that the next Article IV consultation take place on the standard 12-month cycle.

^{Table 1.}

Brazil: Selected Economic Indicators, 2021–28

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

^{^1/}Computed by IBGE using World Bank’s threshold for upper-middle income countries (U$5.5/day).

^{^2/}Includes the federal government, the central bank, and the social security system (INSS).

^{^3/}Currency issued, required deposits held at the Central Bank plus other Central Bank liabilities to other depository corporations

^{^4/}Currency outside depository corporations, transferable deposits, other deposits and securities other than shares

^{^5/}Unemployment rate for 2021 and 2022 shows the average of March, June, September, and December.

^{Table 1.}

Brazil: Selected Economic Indicators, 2021–28

I. Social and Demographic Indicators
Area (thousands of sq. km.)		8,510	Health
Agricultural land (percent of land area)		30.2		Physicians per 1000 people (2022)		2.6
				Hospital beds per 1000 people (2022)		2.0
Population				Access to safe water (2021)		84.2
	Total (million) (2022)	203.1
	Annual rate of growth (percent, 2022)	0.7	Education
	Density (per sq. km. est., 2022)	23.9		Adult illiteracy rate (2019)		6.4
	Unemployment rate (2022)	7.9		Net enrollment rates, percent in:
					Primary education (2019)	98
Population characteristics (2021)					Secondary education (2019)	85
	Life expectancy at birth (years)	77
	Infant mortality (per thousand live births)	11	Poverty rate (in percent, 2021) ^1/			29.4
Income distribution (2017)
	Ratio between average income of top 10		GDP, local currency (2022)			R$9,915 billion
	percent of earners over bottom 40 percent		GDP, dollars (2022)			US$1,920 billion
Gini coefficient (2020)		48.9	GDP per capita (2022)			US$9,455
Main export products: airplanes, metallurgical products, soybeans, automobiles, electronic products, iron ore, coffee, and oil.

II. Economic Indicators
				Proj.
		2021	2022	2023	2024	2025	2026	2027	2028
		(Percentage change)
National accounts and prices
GDP at current prices		16.9	11.4	5.9	7.0	5.5	5.4	5.6	5.6
GDP at constant prices		5.0	2.9	2.1	1.2	1.7	1.9	2.0	2.0
	Consumption	3.6	3.7	0.8	0.4	1.1	1.5	1.9	1.9
	Investment (GFCF)	16.5	0.9	0.5	0.6	1.2	1.4	1.4	1.4
Consumer prices (IPCA, average)		8.3	9.3	5.1	4.6	3.0	3.0	3.0	3.0
Consumer prices (IPCA, end of period)		10.1	5.8	5.4	3.9	3.0	3.0	3.0	3.0
GDP deflator		11.4	8.3	3.8	5.7	3.7	3.5	3.5	3.5
		(Percent of GDP)
Gross domestic investment
	Private sector	17.1	15.4	15.1	14.5	14.5	14.4	14.4	14.3
	Public sector	2.4	2.7	2.8	3.2	3.2	3.2	3.1	3.1
Gross national savings
	Private sector	19.7	18.4	21.9	20.9	19.7	18.9	18.3	17.7
	Public sector	-3.1	-3.2	-6.4	-5.7	-4.5	-3.8	-3.1	-2.6
Public sector finances
Central government primary balance ^2/		-0.4	0.5	-1.3	-0.8	-0.3	0.3	0.9	1.3
NFPS primary balance		0.7	1.3	-1.3	-0.8	-0.3	0.3	0.9	1.3
NFPS cyclically adjusted primary balance (in percent of potential GDP)		0.8	1.0	-1.7	-0.9	-0.3	0.3	0.9	1.3
NFPS overall balance		-4.3	-4.6	-7.9	-7.4	-6.2	-5.4	-4.8	-4.2
Net public sector debt		55.8	57.1	60.1	63.5	66.2	68.3	69.3	70.1
General Government gross debt, Authorities’ definition		78.3	72.9	77.1	79.3	81.3	82.7	83.4	83.6
NFPS gross debt		90.7	85.9	89.2	91.2	93.3	94.8	95.6	95.9
	Of which: Foreign currency linked	5.1	4.2	4.2	4.2	4.2	4.3	4.3	4.3
Money and credit		(Annual percentage change)
Base money ^3/		2.7	16.6	5.9	7.0	5.5	5.4	5.6	5.6
Broad money ^4/		8.7	10.6	6.9	6.7	5.4	5.6	5.5	5.6
Bank loans to the private sector		17.6	14.6	8.0	8.0	8.0	8.0	8.0	8.0
Balance of payments		(Billions of U.S. dollars, unless otherwise specified)
Trade balance		36.4	44.2	50.1	47.0	47.8	49.0	50.1	50.2
	Exports	284.0	340.3	338.5	343.3	349.4	357.4	366.5	379.0
	Imports	247.6	296.2	288.4	296.3	301.6	308.4	316.4	328.8
Current account		-46.4	-56.9	-48.0	-56.1	-58.6	-60.0	-61.4	-64.2
Capital account and financial account		50.4	64.4	48.0	56.1	58.6	60.0	61.4	64.2
	Foreign direct investment (net inflows)	30.2	60.8	54.2	53.2	52.4	53.3	54.3	55.3
Terms of trade (percentage change)		14.4	-7.1	-6.1	-6.4	-3.5	-1.9	-0.6	-1.1
Merchandise exports (in US$, annual percentage change)		34.8	19.8	-0.5	1.4	1.8	2.3	2.6	3.4
Merchandise imports (in US$, annual percentage change)		38.9	19.6	-2.6	2.7	1.8	2.2	2.6	3.9
Total external debt (in percent of GDP)		40.6	35.5	34.1	33.1	32.9	32.6	32.0	31.1
Memorandum items:
Output Gap		-0.2	0.9	1.0	0.2	0.0	0.0	0.0	0.0
Current account (in percent of GDP)		-2.8	-3.0	-2.3	-2.5	-2.5	-2.4	-2.4	-2.3
Unemployment rate ^5/		13.2	9.3	9.5	9.4	9.4	9.4	9.4	9.4
Gross official reserves		362	325	346	346	346	346	346	346
REER (annual average in percent; appreciation +)		-3.2	12.1

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

^{^1/}Computed by IBGE using World Bank’s threshold for upper-middle income countries (U$5.5/day).

^{^2/}Includes the federal government, the central bank, and the social security system (INSS).

^{^3/}Currency issued, required deposits held at the Central Bank plus other Central Bank liabilities to other depository corporations

^{^4/}Currency outside depository corporations, transferable deposits, other deposits and securities other than shares

^{^5/}Unemployment rate for 2021 and 2022 shows the average of March, June, September, and December.

^{Table 1.}

Brazil: Selected Economic Indicators, 2021–28

I. Social and Demographic Indicators
Area (thousands of sq. km.)		8,510	Health
Agricultural land (percent of land area)		30.2		Physicians per 1000 people (2022)		2.6
				Hospital beds per 1000 people (2022)		2.0
Population				Access to safe water (2021)		84.2
	Total (million) (2022)	203.1
	Annual rate of growth (percent, 2022)	0.7	Education
	Density (per sq. km. est., 2022)	23.9		Adult illiteracy rate (2019)		6.4
	Unemployment rate (2022)	7.9		Net enrollment rates, percent in:
					Primary education (2019)	98
Population characteristics (2021)					Secondary education (2019)	85
	Life expectancy at birth (years)	77
	Infant mortality (per thousand live births)	11	Poverty rate (in percent, 2021) ^1/			29.4
Income distribution (2017)
	Ratio between average income of top 10		GDP, local currency (2022)			R$9,915 billion
	percent of earners over bottom 40 percent		GDP, dollars (2022)			US$1,920 billion
Gini coefficient (2020)		48.9	GDP per capita (2022)			US$9,455
Main export products: airplanes, metallurgical products, soybeans, automobiles, electronic products, iron ore, coffee, and oil.

II. Economic Indicators
				Proj.
		2021	2022	2023	2024	2025	2026	2027	2028
		(Percentage change)
National accounts and prices
GDP at current prices		16.9	11.4	5.9	7.0	5.5	5.4	5.6	5.6
GDP at constant prices		5.0	2.9	2.1	1.2	1.7	1.9	2.0	2.0
	Consumption	3.6	3.7	0.8	0.4	1.1	1.5	1.9	1.9
	Investment (GFCF)	16.5	0.9	0.5	0.6	1.2	1.4	1.4	1.4
Consumer prices (IPCA, average)		8.3	9.3	5.1	4.6	3.0	3.0	3.0	3.0
Consumer prices (IPCA, end of period)		10.1	5.8	5.4	3.9	3.0	3.0	3.0	3.0
GDP deflator		11.4	8.3	3.8	5.7	3.7	3.5	3.5	3.5
		(Percent of GDP)
Gross domestic investment
	Private sector	17.1	15.4	15.1	14.5	14.5	14.4	14.4	14.3
	Public sector	2.4	2.7	2.8	3.2	3.2	3.2	3.1	3.1
Gross national savings
	Private sector	19.7	18.4	21.9	20.9	19.7	18.9	18.3	17.7
	Public sector	-3.1	-3.2	-6.4	-5.7	-4.5	-3.8	-3.1	-2.6
Public sector finances
Central government primary balance ^2/		-0.4	0.5	-1.3	-0.8	-0.3	0.3	0.9	1.3
NFPS primary balance		0.7	1.3	-1.3	-0.8	-0.3	0.3	0.9	1.3
NFPS cyclically adjusted primary balance (in percent of potential GDP)		0.8	1.0	-1.7	-0.9	-0.3	0.3	0.9	1.3
NFPS overall balance		-4.3	-4.6	-7.9	-7.4	-6.2	-5.4	-4.8	-4.2
Net public sector debt		55.8	57.1	60.1	63.5	66.2	68.3	69.3	70.1
General Government gross debt, Authorities’ definition		78.3	72.9	77.1	79.3	81.3	82.7	83.4	83.6
NFPS gross debt		90.7	85.9	89.2	91.2	93.3	94.8	95.6	95.9
	Of which: Foreign currency linked	5.1	4.2	4.2	4.2	4.2	4.3	4.3	4.3
Money and credit		(Annual percentage change)
Base money ^3/		2.7	16.6	5.9	7.0	5.5	5.4	5.6	5.6
Broad money ^4/		8.7	10.6	6.9	6.7	5.4	5.6	5.5	5.6
Bank loans to the private sector		17.6	14.6	8.0	8.0	8.0	8.0	8.0	8.0
Balance of payments		(Billions of U.S. dollars, unless otherwise specified)
Trade balance		36.4	44.2	50.1	47.0	47.8	49.0	50.1	50.2
	Exports	284.0	340.3	338.5	343.3	349.4	357.4	366.5	379.0
	Imports	247.6	296.2	288.4	296.3	301.6	308.4	316.4	328.8
Current account		-46.4	-56.9	-48.0	-56.1	-58.6	-60.0	-61.4	-64.2
Capital account and financial account		50.4	64.4	48.0	56.1	58.6	60.0	61.4	64.2
	Foreign direct investment (net inflows)	30.2	60.8	54.2	53.2	52.4	53.3	54.3	55.3
Terms of trade (percentage change)		14.4	-7.1	-6.1	-6.4	-3.5	-1.9	-0.6	-1.1
Merchandise exports (in US$, annual percentage change)		34.8	19.8	-0.5	1.4	1.8	2.3	2.6	3.4
Merchandise imports (in US$, annual percentage change)		38.9	19.6	-2.6	2.7	1.8	2.2	2.6	3.9
Total external debt (in percent of GDP)		40.6	35.5	34.1	33.1	32.9	32.6	32.0	31.1
Memorandum items:
Output Gap		-0.2	0.9	1.0	0.2	0.0	0.0	0.0	0.0
Current account (in percent of GDP)		-2.8	-3.0	-2.3	-2.5	-2.5	-2.4	-2.4	-2.3
Unemployment rate ^5/		13.2	9.3	9.5	9.4	9.4	9.4	9.4	9.4
Gross official reserves		362	325	346	346	346	346	346	346
REER (annual average in percent; appreciation +)		-3.2	12.1

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

^{^1/}Computed by IBGE using World Bank’s threshold for upper-middle income countries (U$5.5/day).

^{^2/}Includes the federal government, the central bank, and the social security system (INSS).

^{^3/}Currency issued, required deposits held at the Central Bank plus other Central Bank liabilities to other depository corporations

^{^4/}Currency outside depository corporations, transferable deposits, other deposits and securities other than shares

^{^5/}Unemployment rate for 2021 and 2022 shows the average of March, June, September, and December.

^{Table 2.}

Brazil: Balance of Payments, 2021–28

(In billions of US dollars, unless otherwise indicated)

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

^{^1/}Historical numbers include valuation changes.

^{Table 2.}

Brazil: Balance of Payments, 2021–28

(In billions of US dollars, unless otherwise indicated)

							Proj.
					2021	2022	2023	2024	2025	2026	2027	2028
Current Account					-46.4	-56.9	-48.0	-56.1	-58.6	-60.0	-61.4	-64.2
	Trade balance				36.4	44.2	50.1	47.0	47.8	49.0	50.1	50.2
		Exports (fob)			284.0	340.3	338.5	343.3	349.4	357.4	366.5	379.0
		Imports (fob)			247.6	296.2	288.4	296.3	301.6	308.4	316.4	328.8
	Income, net				-55.8	-61.0	-60.8	-63.1	-65.3	-66.6	-67.6	-68.0
Capital and Financial Account					50.4	64.4	48.0	56.1	58.6	60.0	61.4	64.2
	Capital account				0.2	0.2	0.2	0.2	0.2	0.2	0.2	0.2
	Financial account ^1/				50.2	64.1	47.8	55.9	58.4	59.8	61.2	63.9
			Direct investment, net		30.2	60.8	54.2	53.2	52.4	53.3	54.3	55.3
				Assets	16.2	30.7	32.5	33.7	35.1	36.5	38.0	39.6
				Liabilities	46.4	91.5	86.7	86.9	87.5	89.9	92.3	94.9
			Portfolio investment, net		7.9	-4.1	-6.4	-6.4	-5.7	-6.0	-4.9	-3.5
			Financial Derivatives, net		1.0	2.0	3.3	3.5	3.6	3.8	3.9	4.1
			Other investment, net		25.1	-1.9	-3.4	5.7	8.0	8.7	7.8	8.1
			Change in Reserve Assets, net		-14.0	7.3	0.0	0.0	0.0	0.0	0.0	0.0
Errors and Omissions					-4.0	-7.5	0.0	0.0	0.0	0.0	0.0	0.0
Memorandum Items:
	Gross reserves (eop) ^1/
		In billions of U.S. dollars			362.2	324.7	345.7	345.7	345.7	345.7	345.7	345.7
	Current account (in percent of GDP)				-2.8	-3.0	-2.3	-2.5	-2.5	-2.4	-2.4	-2.3
	Trade balance (in percent of GDP)				2.2	2.3	2.4	2.1	2.0	2.0	1.9	1.8
		Merchandise exports (in percent of GDP)			17.2	17.7	16.4	15.4	14.9	14.5	14.1	13.7
		Merchandise imports (in percent of GDP)			15.0	15.4	13.9	13.3	12.9	12.5	12.2	11.9
	Export volume (yoy change, in percent)				2.3	5.9	9.1	7.2	4.8	4.0	2.9	3.4
	Import volume (yoy change, in percent)				17.4	0.3	0.0	2.0	1.2	2.0	2.4	2.9
	Export price index (yoy change, in percent)				29.5	13.7	-8.5	-5.1	-2.6	-1.3	0.0	0.3
	Import price index (yoy change, in percent)				13.1	22.4	-2.6	1.4	1.0	0.7	0.6	1.5
	Terms of trade (yoy change, in percent)				14.4	-7.1	-6.1	-6.4	-3.5	-1.9	-0.6	-1.1
	Oil price (Brent blend; US$ per barrel)				69.2	96.4	76.4	71.7	68.9	66.7	64.9	63.4
	REER (annual average in percent; appreciation +)				-3.2	...	...	...	...	...
	GDP in billions of U.S. dollars				1,650	1,920	2,069	2,228	2,339	2,461	2,598	2,768

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

^{^1/}Historical numbers include valuation changes.

^{Table 2.}

Brazil: Balance of Payments, 2021–28

(In billions of US dollars, unless otherwise indicated)

							Proj.
					2021	2022	2023	2024	2025	2026	2027	2028
Current Account					-46.4	-56.9	-48.0	-56.1	-58.6	-60.0	-61.4	-64.2
	Trade balance				36.4	44.2	50.1	47.0	47.8	49.0	50.1	50.2
		Exports (fob)			284.0	340.3	338.5	343.3	349.4	357.4	366.5	379.0
		Imports (fob)			247.6	296.2	288.4	296.3	301.6	308.4	316.4	328.8
	Income, net				-55.8	-61.0	-60.8	-63.1	-65.3	-66.6	-67.6	-68.0
Capital and Financial Account					50.4	64.4	48.0	56.1	58.6	60.0	61.4	64.2
	Capital account				0.2	0.2	0.2	0.2	0.2	0.2	0.2	0.2
	Financial account ^1/				50.2	64.1	47.8	55.9	58.4	59.8	61.2	63.9
			Direct investment, net		30.2	60.8	54.2	53.2	52.4	53.3	54.3	55.3
				Assets	16.2	30.7	32.5	33.7	35.1	36.5	38.0	39.6
				Liabilities	46.4	91.5	86.7	86.9	87.5	89.9	92.3	94.9
			Portfolio investment, net		7.9	-4.1	-6.4	-6.4	-5.7	-6.0	-4.9	-3.5
			Financial Derivatives, net		1.0	2.0	3.3	3.5	3.6	3.8	3.9	4.1
			Other investment, net		25.1	-1.9	-3.4	5.7	8.0	8.7	7.8	8.1
			Change in Reserve Assets, net		-14.0	7.3	0.0	0.0	0.0	0.0	0.0	0.0
Errors and Omissions					-4.0	-7.5	0.0	0.0	0.0	0.0	0.0	0.0
Memorandum Items:
	Gross reserves (eop) ^1/
		In billions of U.S. dollars			362.2	324.7	345.7	345.7	345.7	345.7	345.7	345.7
	Current account (in percent of GDP)				-2.8	-3.0	-2.3	-2.5	-2.5	-2.4	-2.4	-2.3
	Trade balance (in percent of GDP)				2.2	2.3	2.4	2.1	2.0	2.0	1.9	1.8
		Merchandise exports (in percent of GDP)			17.2	17.7	16.4	15.4	14.9	14.5	14.1	13.7
		Merchandise imports (in percent of GDP)			15.0	15.4	13.9	13.3	12.9	12.5	12.2	11.9
	Export volume (yoy change, in percent)				2.3	5.9	9.1	7.2	4.8	4.0	2.9	3.4
	Import volume (yoy change, in percent)				17.4	0.3	0.0	2.0	1.2	2.0	2.4	2.9
	Export price index (yoy change, in percent)				29.5	13.7	-8.5	-5.1	-2.6	-1.3	0.0	0.3
	Import price index (yoy change, in percent)				13.1	22.4	-2.6	1.4	1.0	0.7	0.6	1.5
	Terms of trade (yoy change, in percent)				14.4	-7.1	-6.1	-6.4	-3.5	-1.9	-0.6	-1.1
	Oil price (Brent blend; US$ per barrel)				69.2	96.4	76.4	71.7	68.9	66.7	64.9	63.4
	REER (annual average in percent; appreciation +)				-3.2	...	...	...	...	...
	GDP in billions of U.S. dollars				1,650	1,920	2,069	2,228	2,339	2,461	2,598	2,768

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

^{^1/}Historical numbers include valuation changes.

^{Table 3.}

Brazil: Main Fiscal Aggregates, 2021–28

(In percent of GDP, unless otherwise indicated)

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

^{^1/}Comprises the central administration and the social security system.

^{^2/}Total primary expenditure is the sum of current (on trend) plus capital (on trend) expenditures, minus unallocated cuts to meet the ceiling.

^{^3/}Excluding Petrobras and Eletrobras.

^{^4/}Structural primary balance adjusts for output gap and one-off measures.

^{^5/}Policy lending to BNDES and others.

^{^6/}Includes assets mainly comprised of international reserves, financial assets of public enterprises, and assets of the federal labor fund (FAT).

^{Table 3.}

Brazil: Main Fiscal Aggregates, 2021–28

(In percent of GDP, unless otherwise indicated)

						Proj.
				2021	2022	2023	2024	2025	2026	2027	2028
FEDERAL GOVERNMENT ^1/
Net nonfinancial revenue				21.7	23.3	22.4	22.8	23.2	23.8	24.2	24.5
	Revenue administered by SRF			13.4	14.0	13.9	13.9	13.7	13.7	13.7	13.7
		PIT		2.8	3.0	3.0	2.9	2.9	2.9	2.9	2.9
		CIT		4.4	5.3	5.2	4.9	4.8	4.8	4.8	4.8
		Indirect taxes		5.3	4.8	4.9	5.0	5.0	5.0	5.0	5.0
		Trade taxes		0.7	0.6	0.6	0.7	0.7	0.7	0.7	0.7
		Other		0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3
	Social security contributions			5.2	5.4	5.5	5.5	5.5	5.5	5.5	5.5
	Other revenue			3.1	3.9	3.0	2.8	2.9	3.0	3.2	3.3
		Of which: royalties and dividends from resource extraction		1.3	1.9	1.3	1.4	1.7	1.7	1.8	2.0
	Unallocated measures			0.0	0.0	0.0	0.7	1.1	1.6	1.8	2.1
Total primary expenditure ^2/				22.1	22.8	23.7	23.6	23.5	23.5	23.3	23.2
	Current expenditures			21.5	22.3	23.2	22.9	22.8	22.8	22.6	22.5
		Personnel		3.7	3.4	3.5	3.4	3.4	3.4	3.3	3.4
		Pension benefits		8.0	8.0	8.1	8.1	8.1	8.0	8.0	8.0
		Transfer to subnational governments		4.0	4.6	4.4	4.4	4.4	4.4	4.4	4.4
		Other		5.8	6.3	7.2	7.0	7.0	7.0	6.8	6.8
	Capital expenditures			0.6	0.5	0.5	0.7	0.7	0.7	0.7	0.6
Fund surpluses and statistical discrepancy				0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Primary balance				-0.4	0.5	-1.3	-0.8	-0.3	0.3	0.9	1.3
Overall balance				-5.0	-4.5	-6.9	-6.4	-5.2	-4.5	-3.9	-3.3
STATES AND MUNICIPALITIES
States
	Nonfinancial revenue			13.1	13.2	13.0	13.0	13.0	13.0	13.0	13.0
		Own revenues		10.5	10.2	10.3	10.3	10.2	10.2	10.2	10.2
			Indirect taxes	7.7	7.3	7.5	7.5	7.5	7.5	7.5	7.6
			Other	2.9	2.9	2.7	2.7	2.7	2.7	2.7	2.7
		Transfers from the federal government		2.5	3.0	2.8	2.8	2.7	2.7	2.7	2.7
	Total primary expenditure			12.2	12.8	13.1	13.1	13.0	13.0	13.0	13.0
		Current expenditures		11.6	11.9	12.1	12.1	12.1	12.1	12.1	12.1
			Personnel	4.1	4.4	4.5	4.5	4.5	4.5	4.5	4.5
			Other	7.5	7.5	7.7	7.6	7.6	7.6	7.6	7.6
		Cpapital exp enditure s a nd other p y p g		0.6	0.9	0.9	0.9	0.9	0.9	0.9	0.9
Primary balance of states				0.9	0.4	0.0	0.0	0.0	0.0	0.0	0.0
Primary balance of states and municipalities				1.1	0.7	0.0	0.0	0.0	0.0	0.0	0.0
Overall balance				0.7	-0.1	-1.0	-0.9	-0.9	-0.9	-0.9	-0.9
PUBLIC ENTERPRISES ^3/
Primary balance				0.0	0.1	0.0	0.0	0.0	0.0	0.0	0.0
Overall balance				0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
NON FINANCIAL PUBLIC SECTOR (NFPS)
Nonfinancial revenues				34.8	36.5	35.4	35.9	36.2	36.7	37.1	37.5
Total primary expenditures				34.3	35.6	36.8	36.7	36.5	36.5	36.3	36.2
			Personnel	7.8	7.8	8.0	7.9	7.9	7.9	7.8	7.9
			Pension benefits	8.0	8.0	8.1	8.1	8.1	8.0	8.0	8.0
			Other	17.3	18.4	19.3	19.1	18.9	18.9	18.8	18.7
			Capital expenditures	1.2	1.4	1.4	1.6	1.6	1.6	1.6	1.6
Primary balance				0.7	1.3	-1.3	-0.8	-0.3	0.3	0.9	1.3
Overall balance				-4.3	-4.6	-7.9	-7.4	-6.2	-5.4	-4.8	-4.2
Structural primary balance (percent of potential GDP) ^4/				0.3	-1.4	-2.2	-0.9	-0.3	0.3	0.9	1.3
Memorandum items
	Loans to public financial institutions ^5/			-0.9	-0.8	-0.4	0.0	-0.1	-0.1	0.0	0.0
	NFPS net interest expenditure			5.0	5.9	6.6	6.6	5.9	5.7	5.7	5.5
	Net public sector debt ^6/			55.8	57.1	60.1	63.5	66.2	68.3	69.3	70.1
	Gross NFPS debt			90.7	85.9	89.2	91.2	93.3	94.8	95.6	95.9
	Nominal GDP (billions of reais)			8,899	9,915	10,501	11,241	11,855	12,498	13,196	13,936

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

^{^1/}Comprises the central administration and the social security system.

^{^2/}Total primary expenditure is the sum of current (on trend) plus capital (on trend) expenditures, minus unallocated cuts to meet the ceiling.

^{^3/}Excluding Petrobras and Eletrobras.

^{^4/}Structural primary balance adjusts for output gap and one-off measures.

^{^5/}Policy lending to BNDES and others.

^{^6/}Includes assets mainly comprised of international reserves, financial assets of public enterprises, and assets of the federal labor fund (FAT).

^{Table 3.}

Brazil: Main Fiscal Aggregates, 2021–28

(In percent of GDP, unless otherwise indicated)

						Proj.
				2021	2022	2023	2024	2025	2026	2027	2028
FEDERAL GOVERNMENT ^1/
Net nonfinancial revenue				21.7	23.3	22.4	22.8	23.2	23.8	24.2	24.5
	Revenue administered by SRF			13.4	14.0	13.9	13.9	13.7	13.7	13.7	13.7
		PIT		2.8	3.0	3.0	2.9	2.9	2.9	2.9	2.9
		CIT		4.4	5.3	5.2	4.9	4.8	4.8	4.8	4.8
		Indirect taxes		5.3	4.8	4.9	5.0	5.0	5.0	5.0	5.0
		Trade taxes		0.7	0.6	0.6	0.7	0.7	0.7	0.7	0.7
		Other		0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3
	Social security contributions			5.2	5.4	5.5	5.5	5.5	5.5	5.5	5.5
	Other revenue			3.1	3.9	3.0	2.8	2.9	3.0	3.2	3.3
		Of which: royalties and dividends from resource extraction		1.3	1.9	1.3	1.4	1.7	1.7	1.8	2.0
	Unallocated measures			0.0	0.0	0.0	0.7	1.1	1.6	1.8	2.1
Total primary expenditure ^2/				22.1	22.8	23.7	23.6	23.5	23.5	23.3	23.2
	Current expenditures			21.5	22.3	23.2	22.9	22.8	22.8	22.6	22.5
		Personnel		3.7	3.4	3.5	3.4	3.4	3.4	3.3	3.4
		Pension benefits		8.0	8.0	8.1	8.1	8.1	8.0	8.0	8.0
		Transfer to subnational governments		4.0	4.6	4.4	4.4	4.4	4.4	4.4	4.4
		Other		5.8	6.3	7.2	7.0	7.0	7.0	6.8	6.8
	Capital expenditures			0.6	0.5	0.5	0.7	0.7	0.7	0.7	0.6
Fund surpluses and statistical discrepancy				0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Primary balance				-0.4	0.5	-1.3	-0.8	-0.3	0.3	0.9	1.3
Overall balance				-5.0	-4.5	-6.9	-6.4	-5.2	-4.5	-3.9	-3.3
STATES AND MUNICIPALITIES
States
	Nonfinancial revenue			13.1	13.2	13.0	13.0	13.0	13.0	13.0	13.0
		Own revenues		10.5	10.2	10.3	10.3	10.2	10.2	10.2	10.2
			Indirect taxes	7.7	7.3	7.5

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About

Resources

Abstract

Context

Recent Developments

Outlook and Risks

Authorities’ Views

Policy Discussions

A. Securing Fiscal Sustainability while Preserving Inclusive and Growth-Friendly Spending

Authorities’ Views

B. Bringing Inflation Back to Target

Authorities’ Views

C. Safeguarding Financial Stability while Fostering Inclusion and Innovation

Authorities’ Views

D. Boosting Potential Growth

Authorities’ Views

E. Changing Climate in Brazil

Authorities’ Views

Staff Appraisal