Basic Statistics of Brazil (2008 unless noted)
The global financial and economic crisis has not left Brazil unscathed. But a recovery is getting under way and should gather momentum in the second half of 2009 and into 2010. Continued macroeconomic consolidation – based on a sound policy framework combining inflation targeting, a flexible exchange rate and rules-based fiscal management – together with a much improved external liability position have underpinned the economy’s resilience. Policymakers should nevertheless not lose sight of longer-term challenges that will need to continue to be addressed to bolster the economy’s growth potential and to close the gap in living standards in relation to the OECD area at a faster pace.
Assessment and recommendations
Domestic financial conditions tightened considerably as the global financial and economic outlook deteriorated from mid-September 2008. The supply of foreign credit to Brazilian enterprises, including exporters, had been abundant before the crisis but dried up rapidly. The cost of domestic borrowing rose sharply, and the real depreciated by over 40% from the highs of mid-2008 through year-end. Activity plummeted in the last quarter, dragged down by a collapse in industrial production, especially in credit-sensitive sectors, such as the motor industry, and a run-down in inventories, albeit from high levels. Demand for Brazilian exports also began to weaken later in the year. However, pressures were notably lower than those experienced by other large emerging-market economies. This is due essentially to the continued consolidation of macroeconomic adjustment following the floating of the real in 1999 – based on a policy framework combining inflation targeting, a floating exchange rate, rules-based fiscal policymaking and prudent public-debt management. This policy framework has delivered gradually falling inflation and public indebtedness, and has reduced external vulnerabilities. These factors have been essential for increasing resilience to external shocks and have laid the groundwork for raising the economy’s growth potential. Another reason for relatively good performance in spite of the crisis is that the banking sector is in good shape, and the non-financial corporate and household sectors do not suffer from the balance-sheet weaknesses that are at the heart of financial distress elsewhere. Indeed, there are signs that the economy is recovering, although the global economic outlook remains extremely uncertain.
Looking beyond the global financial and economic crisis towards sustained growth
Brazil’s economic fundamentals have improved considerably in the ten years following the abandonment of exchange rate management in 1999 and adoption of a policy framework combining inflation targeting, rules based fiscal management and a flexible exchange rate. The economy is therefore weathering the effects of the unfolding global financial and economic crisis rather well, and an incipient recovery is getting under way. The policy responses to the crisis have been appropriate: measures were taken to enhance liquidity and prop up credit, the monetary stance began to be relaxed in January 2009, and the tax burden on selected financial transactions and activities was alleviated. The banking sector is sound, and Brazilian households and firms do not suffer from the financial imbalances that have been at the core of financial distress in other parts of the world. The largest payoff from macroeconomic consolidation over the last few years has been improved growth outcomes. The fruits of higher growth have also been fairly well distributed, contributing to falling income inequality, which has been traditionally highly skewed. But further progress will be needed in several policy areas to sustain high growth over the long term, once the deleterious effects of the global crisis have waned. In particular, initiatives to raise labour productivity and to maintain the current dynamism of private investment could have the largest payoffs in terms of raising the economy’s growth potential.
Reaping the benefits of macroeconomic consolidation
Despite the current problems related to the global financial and economic crisis, ongoing macroeconomic adjustment continues to bear fruit. Attainment of the primary budget surplus targets has delivered falling public debt-to-GDP ratios since 2003. Prudent debt management has reduced refinancing risk and external vulnerabilities. The forward-looking conduct of monetary policy within a framework combining inflation targeting with a floating exchange rate has yielded reasonably low and progressively less volatile inflation, as well as anchoring inflation expectations around the pre-announced targets. Credit, which had traditionally been in short supply, began to expand in earnest in 2003 on the back of favourable market conditions, monetary easing and financial innovation to improve access to bank loans among the underserved population. While there may be room for some further monetary easing during 2009-10, depending on the pace and strength of the recovery, additional counter-cyclical discretionary fiscal action in response to the global crisis would be inadvisable, unless activity weakens much further, because it would put additional strain on financial markets at a time when credit is scarce for private-sector activity. A long-standing challenge remains in the fiscal area: expenditure growth will need to be contained to make room in the budget for raising pro-growth public investment and reducing the tax take over the longer term. Further financial deepening should also feature prominently in the authorities’ structural reform agenda. In this respect, a gradual elimination of compulsory bank reserve holdings, which began to be eased as part of a liquidity-enhancing package in response to the global crisis, as well as of directed credit operations, would also be advisable.
Reforming indirect taxes and labour levies
The complexities and fragmentation of Brazil’s tax system make it particularly onerous to enterprises, making it a priority for reform. The state-level VAT has often been used as an industrial policy instrument, resulting in predatory tax competition among the states. Remaining federal levies on enterprise turnover are detrimental to the competitiveness of Brazilian exports. The burden of payroll taxes and social security contributions encourages labour informality. A reform package is under discussion in Congress. The draft legislation is well thought-out; it proposes to unify the state-level VAT, to replace federal levies on enterprise turnover by a federal VAT and to alleviate the tax burden on labour income. Options for compensating those states that are expected to lose revenue as a result of the VAT reform include an overhaul of the country’s regional development programmes. The authorities’ main policy challenge in this area is to secure political support for reform, especially among the state governments, in a manner that is revenue-preserving, efficiencyenhancing and consistent with ongoing fiscal-adjustment efforts.
Making government operations more cost-effective
Despite considerable progress in many areas, there remains substantial scope for making government operations more cost-effective. Brazil spends a high share of GDP on selected government-financed programmes in relation to many OECD countries and its emerging-market peers, but outcome indicators are often comparatively poor. As a result, in the absence of efficiency gains, further increases in spending would need to be financed through additional tax hikes and, most importantly, would likely fail to deliver commensurate improvements in outcomes. Initiatives to enhance the efficiency of government operations are therefore necessary and call for concerted action in many policy areas. The largest payoff would most probably come from greater emphasis on longer-term budget planning to facilitate the identification of, and secure adequate funding for, cost-effective programmes. At the same time, enhanced budget flexibility would make it easier for policymakers to shift budgetary resources towards the programmes that are most cost-effective. Options are being considered for developing the recently discovered offshore oil fields and to ensure that the revenue accruing to the budget is saved or allocated to programmes with the highest returns for future generations.
List of acronyms
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