Brazil - iuj.ac.jp · Brazil 1 Country Report December 2003 ' The Economist Intelligence Unit Limited 2003 Contents 3 Summary 4 Political structure 5 Economic structure 5 Annual indicators

Country Report December 2003

Brazil

December 2003

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

Brazil at a glance: 2004-05

OVERVIEWThe president, Luiz Inácio Lula da Silva, will use his personal popularity andundisputed leadership to help his government to continue to keep macro-economic policy tight and to push through some difficult structural reforms. Inthe coming year the emphasis will shift towards addressing problems ofpoverty and marginalisation, but his traditional supporters on the left will becritical of disappointments in these programmes, while his new-found ad-mirers in the financial and business sectors will be quick to react if they detectany relaxation of policy discipline. He will also encounter resistance fromvested interests. In international affairs relations with the US will be cool attimes, but the Economist Intelligence Unit expects trade talks to make furtherprogress. Public debt ratios will improve gradually as a result of tight fiscalcontrols and a cautious relaxation of monetary policy. Falling inflation andincreasing confidence will create the conditions for stronger GDP growth in2004-05. Barring major shocks, the exchange rate will be stable. A large tradesurplus will keep the current-account deficit small.

Key changes from last month

Political outlook• Further signs that the administration�s honeymoon period has ended

include declining public confidence in the government and dissent in thecabinet, but Mr da Silva�s popularity continues to hold up well.

Economic policy outlook• The decision to extend the IMF stand-by agreement for another year was

not unexpected, but its confirmation provides additional reassurance thatBrazil will be able to meet its financing needs in 2004.

Economic forecast• Our forecasts for an upturn in GDP growth and a fall in inflation in 2004-05

are unchanged.

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Brazil 1

Country Report December 2003 www.eiu.com © The Economist Intelligence Unit Limited 2003

Contents

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2004-057 Political outlook8 Economic policy outlook9 Economic forecast

12 The political scene

17 Economic policy

22 The domestic economy22 Output and demand23 Employment, wages and prices24 Financial indicators25 Manufacturing26 Agriculture27 Infrastructure29 Oil and gas

29 Foreign trade and payments

List of tables9 International assumptions summary

11 Forecast summary

13 Winners and losers in the Chamber of Deputies

18 Public-sector borrowing requirement

18 Net public-sector debt

22 Real GDP, 2003

23 Retail sales

25 Manufacturing production by category

26 Manufacturing production

27 Agricultural production estimates for 2003

29 Trade balance

30 Exports by category

30 Imports by category

31 Current account

32 Capital and financial account

33 Foreign direct investment by sector

2 Brazil


List of figures11 Gross domestic product

11 Consumer price inflation

19 Selic rate and expected inflation

24 Prices

25 Stockmarket performance, 2003

31 Monthly trade

Brazil 3


Summary December 2003

The president, Luiz Inácio Lula da Silva, will use his personal popularity andundisputed leadership to help his government to continue to keep macro-economic policy tight and to push through some difficult structural reforms. Inthe coming year the emphasis will shift towards addressing problems of pov-erty and marginalisation, but his traditional supporters on the left will becritical of disappointments in these programmes, while his new-found admirersin the financial and business sectors will be quick to react if they detect anyrelaxation of policy discipline. He will also encounter resistance from vestedinterests. In international affairs relations with the US will be cool at times, butthe Economist Intelligence Unit expects trade talks to make further progress.Public debt ratios will improve gradually as a result of tight fiscal controls and acautious relaxation of monetary policy. Falling inflation and increasing con-fidence will create the conditions for stronger GDP growth in 2004-05. Barringmajor shocks, the exchange rate will be stable. A large trade surplus will keepthe current-account deficit small.

Although government�s popularity fell, Mr da Silva�s ratings remain very highand the ruling coalition�s majority in the Chamber of Deputies increased. Acabinet reshuffle is imminent and preparations for the October 2004 municipalelections have begun. Attention turned to proposals for legal reforms, andsocial programmes have been advanced. The firm stance adopted in trade talksdrew criticism.

The new agreement with the IMF confirmed policy continuity. Fiscal targetshave been met, but interest rates have been high and the public debt expanded.Base interest rates were reduced and spreads narrowed. Progress has beenmade on social security reform, but the tax reform package was undermined.Policy on regulation has yet to be clarified.

GDP growth and retail sales rose in the third quarter. Despite an increase in thenumber of people in work, the unemployment rate did not decline. Inflationcontinued to fall, while stockmarkets, risk premiums and the currency allreflected improved optimism. The upturn in manufacturing was broad-basedand agriculture flourished. Infrastructure regulation was discussed, including anoutline for electricity reform and a proposal to establish public-private par-tnerships for transport and sanitation. Oil and gas grew strongly.

Trade surpluses have been huge, but have started to stabilise. The current-account surplus exceeded 1% of GDP in the first nine months of 2003. FDI re-mained depressed. IMF lending increased the stock of external debt andboosted reserves. The tough line on trade negotiations has had mixed results.

Editors: Emily Morris (editor); John Bowler (consulting editor)Editorial closing date: December 1st 2003

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2004-05

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 Brazil


Political structure

Federative Republic of Brazil

Federative republic

The president, who is elected for a term of four years, chooses a cabinet, which he heads;he holds considerable discretionary powers

Elected president

Bicameral national Congress: 81-seat Senate, comprising representatives of 26 states, plusthe federal district of Brasilia; 513-member directly elected Chamber of Deputies

Each of the 26 states and the district of Brasilia have a legislature and an administration

Each state has its own judicial system; the country has a system of courts for dealing withdisputes between states and matters outside the jurisdiction of state courts

Municipal elections were last held in October 2000; presidential, congressional and stateelections were held in October 2002; the next elections are due by October 2006

Luiz Inácio Lula da Silva became president on January 1st 2003

Parties allied to the government: Partido dos Trabalhadores (PT); Partido DemocráticoTrabalhista (PDT); Partido Trabalhista Brasileiro (PTB); Partido Popular Socialista (PPS);Partido Liberal (PL); Partido Socialista Brasileiro (PSB); Partido Comunista do Brasil(PCdoB); Partido do Movimento Democrático Brasileiro (PMDB)Others: Partido da Social Democracia Brasileira (PSDB); Partido Progressista (PP); Partidoda Frente Liberal (PFL); Partido Social Democrático (PSD)

President Luis Inácio Lula da SilvaVice-president José Alencar

Agrarian reform Miguel RosesettoAgriculture Robert RodriguesCivil chief-of-staff José DirceuCommunications Miro TeixeiraDefence José Viegas FilhoDevelopment, industry & trade Luiz Fernando FurlanEducation Christovam BuarqueEnvironment Marina SilvaFinance Antônio PalocciFood security & antihunger José Graziano da SilvaForeign affairs Celso AmorimHealth Humberto CostaJustice Marcio Thomas BastosLabour & employment Jacques WagnerMines & energy Dilma RoussefNational integration Ciro GomesPlanning, budget & management Guido MantegaScience & technology Roberto AmoralSocial security Ricardo BerzoiniTransport Angelo AdautoUrban development Olívio Dutra

Henrique Meirelles

Official name

Form of state

The executive

Head of state

National legislature

Regional legislatures

Legal system

National elections

National government

Main political organisations

Key ministers

Central Bank governor

Brazil 5


Economic structure

Annual indicators1999 a 2000 a 2001a 2002 a 2003 b

GDP at market prices R bn 973.8 1,101.3 1,200.1 1,321.5 1,531.2GDP US$ bn 536.6 601.7 510.6 452.4 497.2

Real GDP growth (%) 0.8 4.3 1.3 1.9 0.4Consumer price inflation (av; %) 4.9 7.0 6.8 8.5 14.7Population (m) 171.2 172.9 174.5b 176.0 b 177.5

Exports of goods fob (US$ m) 48,011 55,086 58,223 60,362 73,235Imports of goods fob (US$ m) -49,272 -55,785 -55,572 -47,218 -50,829

Current-account balance (US$ m) -25,400 -24,225 -23,215 -7,696 4,345Foreign-exchange reserves excl gold (US$ m) 34,796 32,488 35,739 37,684 50,284Total external debt (US$ bn) 243.7 238.8 226.4 227.1 b 224.6

Debt-service ratio, paid (%) 117.2 93.2 75.2 71.8 b 60.9Exchange rate (av) R:US$ 1.81 1.83 2.35 2.92 3.08

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2002 % of total Components of gross domestic product 2002 % of totalAgriculture 8.2 Final consumption 78.5Industry 37.8 Fixed investment 18.7

Services 53.9 Trade balance, goods & services 2.1

Principal exports 2002 US$ m Principal imports 2002 US$ mTransport equipment & parts 9,906 Machinery & electrical equipment 13,300Metallurgical products 6,269 Chemical products 8,508

Soybeans, bran & oils 5,906 Oil & derivatives 6,281Chemical products 1,160 Transport equipment & parts 5,121

Main destinations of exports 2002 % of total Main origins of imports 2002 % of totalUS 25.2 US 28.9

Argentina 9.0 Argentina 15.7Germany 5.3 Germany 10.9

China 4.5 France 6.4

6 Brazil


Quarterly indicators2001 2002 20034 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Government finance (R m)a

Revenue 77,316 74,707 75,091 79,748 101,275 85,067 91,008 87,497Expenditure 80,865 74,694 77,111 80,712 105,493 79,938 94,911 83,175Balance -3,549 13 -2,021 -964 -4,218 5,129 -3,903 4,322Outputb

Real GDP index (1995=100) 181.3 183.3 186.0 187.7 188.1 186.5 184.2 185.0Real GDP index (% change, year on year) -0.8 -0.7 1.6 3.1 3.7 1.7 -0.9 -1.5Industrial prodn index (1991=100) 124.2 127.1 129.8 129.3 131.7 130.4 127.1 129.3Industrial prodn index (% change, year on year) -3.6 -2.2 2.3 3.2 6.0 2.5 -2.1 0.0Employment, wages and pricesUnemployment rate (% of the labour force) 11.3 12.2 12.0 11.7 10.9 11.6 12.7 12.9Average nominal monthly wages (R) 769.1 766.6 790.2 799.8 n/a 856.3 846.6 n/aAverage nominal monthly wages (% change,

year on year) 0.5 3.5 6.0 6.5 n/a 11.7 7.1 n/aConsumer prices (1993=100)c 1,801 1,830 1,860 1,901 1,992 2,116 2,173 2,190Consumer prices (% change, year on year) 7.5 7.6 7.8 7.6 10.6 15.6 16.9 15.2General price index (1994=100)d 213.3 214.9 219.6 233.1 261.1 281.1 284.9 288.2General price index (% change, year on year) 10.7 9.7 9.3 12.1 22.4 30.8 29.7 23.6

Financial indicatorsExchange rate R:US$ (av) 2.55 2.38 2.51 3.13 3.67 3.49 2.99 2.94Exchange rate R:US$ (end-period) 2.32 2.32 2.84 3.90 3.53 3.35 2.87 2.92Deposit rate (av; %) 19.0 18.3 18.3 18.3 21.9 24.4 24.3 21.3Money market rate (av; %) 19.1 18.9 18.3 18.0 21.3 25.7 26.2 23.3M1 (end-period; R m) 83,550 72,998 79,740 88,202 107,208 88,605 88,109 n/aM1 (% change, year on year) 12.8 11.9 20.8 29.2 28.3 21.4 10.5 n/aM2 (end-period; R bn) 352.07 355.29 373.15 409.84 433.12 422.30 423.18 n/aM2 (% change, year on year) 12.1 14.4 17.2 24.4 23.0 18.9 13.4 n/aBovespa stockmarket index (end-period;

1968=0.000000001) 13,578 13,255 11,139 8,623 11,268 11,274 12,973 16,011Bovespa stockmarket index (% change, year on year) -11.0 -8.2 -23.5 -18.9 -17.0 -14.9 16.5 85.7Sectoral trendsVehicle production (�000) 381.2 402.1 473.0 442.7 474.9 444.5 456.7 446.7Manufacturing production index (1991=100)b 119.4 121.4 123.7 123.4 126.5 124.0 120.8 123.2Metals production index (1991=100)b 126.8 128.4 128.3 133.4 141.5 139.1 134.2 137.7Chemicals production index (1991=100)b 124.1 131.0 132.2 131.4 128.9 131.8 131.5 132.2Paper & manufacturing production index

(1991=100)b 124.0 125.7 126.3 127.1 129.8 130.7 130.1 131.0Retail trade index, volume (2000=100) 110.0 92.4 94.7 96.0 108.0 86.8 89.7 91.8

Foreign trade and payments (US$ m)Exports fob 13,849 11,890 13,161 18,466 16,844 15,045 17,957 19,788Imports fob -12,463 -10,862 -11,592 -13,185 -11,576 -11,282 -11,379 -12,386Trade balance 1,386 1,028 1,569 5,282 5,268 3,763 6,578 7,401Services balance -1,741 -1,112 -1,567 -1,241 -1,119 -793 -1,492 -1,420Income balance -5,879 -3,550 -5,716 -3,742 -5,182 -3,497 -5,304 -3,542Net transfer payments 453 366 557 699 768 616 612 879Current-account balance -5,781 -3,267 -5,157 997 -265 82 395 3,303Reserves excl gold (end-period) 35,740 36,585 41,852 38,237 37,684 42,187 47,802 52,504

a Treasury finances only. b Seasonally adjusted. c IPCA index. d IGP-DI index.

Sources: Fundação Getúlio Vargas, Conjuntura Econômica; IMF, International Financial Statistics; Banco do Brasil.

Brazil 7


Outlook for 2004-05

Political outlook

Since assuming the presidency in January 2003 Luiz Inácio Lula da Silva of theleft-wing Partido dos Trabalhadores (PT) has been remarkably successful inwinning the confidence of the IMF and business sectors, while maintaining ahigh level of public support. However, the government�s popularity has nowslipped significantly more than that of the president. A firm commitment totight macroeconomic discipline contributed to economic stagnation in the firsthalf of 2003, but as the honeymoon period comes to an end there is room forpolicy to be relaxed a little. To maintain popular support the government willseek to shift the emphasis of policy towards addressing problems of povertyand marginalisation through income redistribution, land reform and welfareprogrammes, but there will be challenges from all sides. Among the party�straditional supporters and a group of left-wing PT members in Congress, thereare increasing signs of impatience, but the government must also maintain theconfidence of the business sector as it is acutely aware of the economic con-sequences of any loss of confidence by the IMF and the financial markets. Inthe context of the tight fiscal constraints imposed by the need to bring downthe public debt, the government will be looking to free resources for highersocial spending by increasing the efficiency of the public sector and the taxsystem. Such changes will involve extracting concessions from some powerfulprivileged groups.

Mr da Silva�s handling of a cabinet reshuffle expected at the end of 2003 or inearly 2004 will be an important test as the approach of local elections inOctober 2004 begins to encourage more outspoken criticism of the governmentin Congress. His new ministerial team will need to achieve a workable balancebetween PT loyalists, the representatives of coalition partners and inde-pendents. There will inevitably be tensions within the cabinet, which will testthe president�s leadership. On the basis of his strong performance so far and hisauthority as head of the administration, the Economist Intelligence Unit expectsprogress to continue on economic and social reforms in 2004-05, despite thesetensions. The government�s chances of success will be strengthened if theeconomy improves as we expect, but if the economy underperforms, politicaldifficulties could become more acute.

Mr da Silva�s government views maintaining good relations with the US asimportant. However, it is sceptical about the benefits of the proposed Free-TradeArea of the Americas (FTAA), the US-led hemispheric trade integration init-iative. Differences between the US and Brazil have already resulted in a weakerproposal for the FTAA, which is due to be implemented in 2005. The US hasagreed to leave out demands for Brazil to strengthen intellectual propertyprotection and to open its market for services and government procurement inreturn for Brazil�s agreement to leave out demands for the US to reduce farmsubsidies and to dismantle barriers to Brazilian exports. These compromisesimprove the chances that an FTAA will be agreed on schedule, but the impactof the agreement will be weaker than previously anticipated. Brazil�s assertive

Domestic politics

International relations

8 Brazil


position has also brought some concessions in World Trade Organisation talks.However, there are dangers for Brazil in taking this stance. Access to newmarkets could be curtailed if the momentum of multilateral talks is lost, andalready the US has signalled that it will push ahead with bilateral trade deals inthe Americas rather than wait for Brazil�s agreement on a stronger FTAA. Thismove would undermine the Brazilian strategy of rebuilding the MercadoComúm do Sul (Mercosul, the Southern Cone customs union), then widening itto include other South American countries to negotiate with the US as a bloc.

Economic policy outlook

The government is maintaining the orthodox macroeconomic framework en-compassing fiscal discipline, a floating exchange rate and inflation targeting.The agreement with the IMF that established the macroeconomic frameworkfor 2003 has been followed by a further stand-by agreement for 2004, con-cluded in November 2003. The Economist Intelligence Unit expects economicpolicy to continue to be governed by the targets set out in the IMF-approvedmedium-term framework. The target for the primary fiscal surplus was set at4.25% of GDP for 2003-06 in order to stabilise public debt dynamics. Havinggained investor confidence in its macroeconomic management by tighteningpolicy to meet the target in 2003, the government now has some room to relaxpolicy to help to lift the economy out of stagnation, but policy will still becautious. The Banco Central do Brasil (the Central Bank) cut the benchmarkSelic rate from 26.5% in June to 17.5% in November, and further reductions arein prospect.

To fulfil its promises to assist the poor, the government plans to improve theefficiency of public spending and to implement redistributive policies. It hasalso promised to adhere to market friendly policies, but political pressures arelikely to force concessions favouring employment creation. Proposals to reformthe tax and pensions systems have almost completed their journey throughCongress. The social security reform will reduce long-term public liabilities,although it will yield only modest cost savings in the short term. The proposalto simplify the cumbersome tax system has been weakened during negot-iations, and the government will therefore be expected to prepare further legis-lation to improve the efficiency of the tax system in 2004-05.

We expect the current administration to maintain its tight fiscal policy through-out its term. Deep cuts to discretionary spending plans in early 2003 areexpected to have helped to achieve a primary surplus of 4.25% of GDP for theyear, excluding interest payments. Higher GDP growth and modest savingsfrom pensions reform will ease pressures on the public finances slightly in2004-05, allowing the government to keep the primary surplus at 4.25% of GDPwithout further cuts. A stable Real and declining nominal interest rates willreduce interest payments on the public debt, although the nominal deficit willcontinue to be substantial, at over 4% of GDP, keeping the net public debt/GDPratio in the 55-58% range.

Policy trends

Fiscal policy

Brazil 9


The Central Bank�s Comitê de Política Monetária (Copom, monetary policycommittee) has cut the benchmark Selic overnight rate every month since June,with a 1.5-percentage-point cut in November reducing the Selic rate to 17.5%.Copom has been able to cut rates aggressively because inflation has fallenmore rapidly than had been expected owing to currency appreciation, highunemployment and the decline in real earnings. Reductions in the Selic rate arebarely keeping pace with the decline in forecast inflation. As the real Selic rateis still high, at over 10%, Copom has scope to make further cuts in 2004 withoutjeopardising the revised annual inflation target of 5.5%, which has a margin oftolerance of 2.5 percentage points. Reductions in reserve requirements on sightdeposits are likely to provide additional monetary stimulus.

Economic forecastInternational assumptions summary(% unless otherwise indicated)

2002a 2003b 2004c 2005c

GDP growthWorld 2.9 3.4 4.1 4.1US 2.4 3.0 4.0 3.3EU 1.0 0.6 1.9 2.2Exchange ratesUS$ effective (1995=100) 127.7 113.0 106.7 110.4¥:US$ 125.3 115.7 109.8 114.8US$:� 0.94 1.13 1.23 1.19Financial indicatorsUS$ 3-month commercial paper rate 1.70 1.08 1.38 3.56¥ 2-month private bill rate 0.10 0.10 0.10 0.10Commodity pricesOil (Brent; US$/b) 25.0 28.7 22.4 20.1Soybeans (US$/tonne) 209.3 242.5 249.0 256.0Food, feedstuffs & beverages (% change in US$

terms) 12.7 5.5 3.2 11.1Industrial raw materials (% change in US$ terms) 2.2 9.5 5.2 4.8

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

World GDP grew at just 3.4% in 2003 measured using purchasing power parityweights, but the Economist Intelligence Unit expects most major markets toreturn to more normal rates of growth in the forecast period. World tradegrowth will accelerate in 2004-05, providing a stimulus to Brazil�s export per-formance. The outlook for crossborder capital flows is mixed. Foreign directinvestment (FDI) flows have been subdued in 2003, but Brazil has benefitedfrom the search by investors for high-yielding assets, which has contributed to adecline in the country risk premium. However, risk appetite is likely to bevolatile given the imbalances in the world economy and the risk to emergingmarket debt of a correction in developed country debt markets. The global eco-nomy also continues to be exposed to the possibility of a downturn as a con-sequence of a rapid correction of long-standing imbalances in the US economy,including the large current-account deficit and high levels of private debt. Withsubstantial overcapacity discouraging a recovery in investment, the upturnthere in coming months will be largely the result of income tax cuts. As the

Monetary policy

International assumptions

10 Brazil


effects of these cuts fade, US growth could falter once more. Were a downturnto coincide with a falling off in consumer or business confidence, the resultingdrop in US growth would reduce world output growth.

The return of GDP growth in the third quarter of 2003 confirmed expectationsthat full-year growth will be small but positive. In 2004 the government willagain restrict public spending growth to meet fiscal targets, but further cuts ininterest rates and a return of confidence will stimulate a gradual recovery ofprivate consumption and investment. Together with continued albeit moremodest export growth, these changes will allow GDP growth to rise to 2.4% in2004, and given the extent of spare capacity in less export-oriented sectors,growth could be stronger than we currently assume. In 2005 the recovery isexpected to gather pace and to become more broad-based as traditional ind-ustries such as clothing, footwear, beverages and tobacco benefit from the returnof real earnings growth, but economic performance will continue belowpotential owing to structural rigidities and the crowding out of the private sector.

Sluggish demand and a stable currency will help to ease inflation to some 9.2%at the end of 2003, down from a peak of over 17% in May. The year-endinflation target for 2004 set by the Banco Central do Brasil (the Central Bank) is5.5% within a band of 2.5 percentage points. On the assumption that the Realweakens only modestly, we expect inflation to fall within this band, helping torestore the credibility of the inflation targeting framework following severalyears when targets have been overshot. Further progress on price stabilisation isexpected to be made in 2005, barring major shocks. We expect the official year-end target for 2005 of 4.5% within a 2.5-percentage-point band to be met.

Several factors have supported the strengthening of the currency in the firsthalf of 2003 and its subsequent stability: positive sentiment stemming from thegovernment�s commitment to orthodox macroeconomic policy; record exportearnings and trade surpluses; the large interest differential between Brazil andOECD countries, which has stimulated inflows of short-term arbitrage funds;and a strong appetite for risk, which has driven up prices of emerging marketassets. Our forecast is for the Real to be stable in real terms in 2004-05, despiteBrazil�s increased external financing needs. The extension of the agreementwith the Fund for another year will support the Real, but major shocks arisingfrom domestic political difficulties or external factors could still createinstability. A competitive currency would contribute to the policy aim ofreducing external vulnerability and promoting exports. There could be pressurefor the currency to appreciate further, but if this were to happen we wouldexpect the authorities to take the opportunity to build up foreign exchangereserves and to reduce the stock of US dollar-indexed domestic debt.

The full-year trade surplus for 2003 will reach a record of around US$22.4bn,while the current account will record a small surplus. In 2004-05 we expect arecovery in domestic demand to increase imports as export growth slows. Evenso, the trade surplus will stay in substantial surplus, at US$21.5bn in 2004 and at19.7bn in 2005. The current account will return to deficit in 2004-05. Althoughthe deficit will be modest, the financing requirement will be substantial owing

Exchange rates

External sector

Economic growth

Inflation

Brazil 11


to repayments on the US$220bn stock of foreign debt, the largest in thedeveloping world. Scheduled amortisations of medium- and long-term debt in2004 will be more than those for 2003. Part of this finance is expected to comefrom increased FDI, but most of it will be obtained by tapping the internationalbond markets more intensely. This forecast is therefore contingent on the contin-uation of favourable conditions in international capital markets. In the event of arise in risk aversion, external financing constraints could lead to another year ofsubdued import demand. Sentiment towards Brazil improved in 2003 and thecountry risk premium as measured by the yield spreads on Brazilian gov-ernment and US Treasury bills is now below 600 basis points, the lowest levelsince 1998, which will facilitate the roll-over of debt by Brazilian borrowers. Weexpect the government to continue to accumulate reserves in 2004 both to stemthe appreciation of the Real and in order to prepare itself to discontinue theassociation with the IMF in 2005. Brazil�s foreign debt will rise in the short runas liabilities with the Fund expand, but in the medium term the debt willcontract as repayments to the IMF exceed net new borrowing.

Forecast summary(% unless otherwise indicated)

2002a 2003 b 2004c 2005c

Real GDP growth 1.9 0.4 2.3 3.0

Industrial production growth 2.3 0.2 2.7 2.8Gross fixed investment growth -4.2 -4.5 6.0 5.5

Consumer price inflation (av) 8.5 14.7 6.2 5.2Consumer price inflation (year-end) 12.5 9.2 6.7 3.9

Short-term interbank rate 62.9 63.6 55.9 49.7Nominal PSBR (% of GDP) 9.9b 4.9 3.5 3.4Exports of goods fob (US$ bn) 60.4 73.2 74.7 75.2

Imports of goods fob (US$ bn) -47.2 -50.8 -53.2 -55.5Current-account balance (US$ bn) -7.7 4.3 -0.8 -3.9

Current-account balance (% of GDP) -1.7 0.9 -0.2 -0.7External debt (year-end; US$ bn) 227.1b 224.6 231.2 235.1Exchange rate R:US$ (av) 2.92 3.08 3.13 3.34

Exchange rate R:¥100 (av) 2.33 2.66 2.85 2.91Exchange rate R:� (av) 2.76 3.49 3.85 3.96

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

12 Brazil


The political scene

As it nears the end of its first year in office, the government led by the Partidodos Trabalhadores (PT) appears to have come to the end of its extended honey-moon period. Its approval ratings had slipped to 42% in October, down from48% in August, putting it close to the level of approval enjoyed by the previousadministration under Fernando Henrique Cardoso at the same stage in its term.However, the current government has a strong advantage over its predecessorin terms of the level of support enjoyed by the current president, Luiz InácioLula da Silva, whose approval rating in October stood at 71%. This figure is lessthan the 77% he registered in August, but well above the 39% approval rating forMr Cardoso ten months into his 1999-2002 term. The declines in the approvalratings for the government and the president spring largely from dis-illusionment with the lack of improvement in living standards or employmentprospects. Scepticism among those on the left has also grown as a corollary ofthe positive response from financial markets. The government has responded tothe president�s buoyant approval rating by giving him a high profile, and hassought to appease those impatient for bolder social initiatives by stressingpromises of reforms to come, including the extension of the Bolsa Familia(Family Basket) initiative to help the poorest members of society and the ann-ouncement of targets for agrarian reform. To placate other critics legislation hasalready been approved in the lower house to stem the proliferation of smallarms, and a compromise on genetically modified (GM) crops has been pro-posed. The first victim of the PT�s efforts to reassert its authority over its con-gressional representatives is the senator, Luiza Helena, who had voted againstthe social security reforms, and who is likely to be expelled from the partyshortly. Another rebel, this time from the lower house, is Fernando Gabeira,who resigned his PT membership in protest at government policy.

The loss of support from some on the radical wing of the PT may have causedconcern among party activists, but the government�s position in Congress hascontinued to strengthen. Since the election in October 2002 only three of themain parties in the ruling coalition have lost members in the House of Repre-sentatives, while all opposition parties have done so. The result is that the sizeof the PT-led coalition�s majority has risen from 36 seats in October 2002 to 64seats in November 2003. This amount of party switching is not unusual inBrazil as under the previous government the ruling Partido da SocialDemocracia Brasileira (PSDB) grew by 30% in the House of Representatives inits first year in office. What is new is that the party heading the current coal-ition, the PT, has gained few new members, while other members of the coal-ition have grown. This is because the PT is different from traditional Brazilianpolitical parties in that the degree of party discipline around an agreed pro-gramme is stronger, and its representatives are mainly recruited from amongparty activists.

If all members of the Chamber of Deputies who belong to ruling coalitionparties were to vote with the government, they would provide the three-fifthsmajority required for passage of constitutional amendments. However, as disci-pline tends to be weak, party switching still does not guarantee the easy passage

The government takes stock asthe honeymoon ends

Ruling coalition gains as partyswitching slows

Brazil 13


of legislation. In the months leading up to the municipal elections due inOctober 2004 the loyalty of coalition partners is likely to weaken further asrivalries in local contests spill over into congressional debates. Nonetheless, thegovernment�s position in Congress is still strong, and legislation lined up forJanuary-October 2004 does not include constitutional changes. Moreover,further party switching will be inhibited in the coming year as any politicianwishing to run would be barred from switching parties in the 12 months beforethe election.

Winners and losers in the Chamber of Deputies(no. of seats)

Oct 2002 Nov 2003 ChangeWinnersPartido Trabalhista Brasileiro (PTB)a 26 53 27Partido Liberal (PL)a 26 43 17Partido Popular Socialista (PPS)a 15 21 6Partido dos Trabalhadores (PT)a 91 93 2Partido do Movimento Democrático Brasileiro (PMDB)a 75 77 2Partido Verde (PV)a 5 6 1LosersPartido Comunista do Brasil (PCdoB)a 12 10 -2Partido de Reedificação da Ordem Nacional (Prona) 6 4 -2Partido Progressista (PP) ex-PPB 49 46 -3Partido Socialista Brasileiro (PSB)a 22 18 -4Partido Democrático Trabalhista (PDT)a 21 13 -8Partido da Frente Liberal (PFL) 84 68 -16Partido da Social Democracia Brasileira (PSDB) 70 51 -19

Other parties 11 10 -1Total 513 513 0

a Members of ruling coalition in January 2003; the PDT has since joined the opposition.

Source: National Congress, count undertaken on November 20th 2003.

A cabinet reshuffle is expected around the end of 2003. The government hastwo objectives: to strengthen its position in Congress by bringing members ofother coalition parties into government, and to rationalise administration. ThePartido do Movimento Democrático Brasileiro (PMDB), which has allied itselfwith the PT coalition since May (September 2003, The political scene), isconsidered certain to gain cabinet posts in the reshuffle. Despite the PMDB�sreputation for lacking discipline and being beset with internal divisions, it hasprovided strong backing for the government�s legislative reform agenda. As thesecond largest party, its support has been very important. Two-thirds of itsmembers supported the social security reform in the lower house in August,and in the Senate 83% of its members voted in favour of it in late November. Itis understood that the government has offered at least two ministerial posts inreturn. One of the portfolios widely expected to go to the PMDB is theCommunications Ministry. The current minister, Miro Teixeira, is a member ofthe Partido Democrático Trabalhista (PDT), whose members voted against thereforms in Congress. Two other coalition parties, the Partido Liberal (PL) and thePartido Trabalhista Brasileiro (PTB), are also hoping to increase their repre-sentation in the cabinet; each currently holds one post. The PL�s chances maybe damaged by the embarrassment that has been caused by its existing cabinet

Candidates line up forexpected cabinet reshuffle

14 Brazil


member, the vice-president José Alencar, who has called for interest rates to belowered. The PTB, whose numbers in the Chamber of Deputies have grown themost, currently has only one cabinet post, the Ministry of Transport.

Government ministers who seem to be secure in their positions include theleading members of the economic and political teams: the minister of finance,Antônio Palocci, and the civil chief-of-staff, José Dirceu. In public speeches Mr daSilva has given his personal backing to Mr Palocci�s economic policies, whichcould imply that he may seek to strengthen the minister�s hand by appointinglike-minded figures to some major economy-related portfolios. Likewise,Mr Dirceu occupies a pre-eminent position as a political negotiator, which is un-likely to be weakened in the reshuffle. Other senior ministers who have per-formed strongly in their posts are the foreign minister, Celso Amorim, and theminister for development, industry and trade, Luiz Furlan. These two wererecruited from outside politics: Mr Amorim is a career diplomat and Mr Furlan aprominent businessman. The social security minister, Ricardo Berzoini, is alsoconsidered to have been successful so far in his job, having steered the socialsecurity reform successfully through Congress. He too has the full backing of thepresident, despite a recent overzealous attempt to reduce pensions fraud, whichcut pensions for infirm over-90-year-olds. The minister of justice, Marcio Bastos,has also performed well. Although his work has not yet assumed a high profile,it has laid the groundwork for judicial reform and national policy on law andorder, two of the government�s main legislative priorities for 2004.

One PT member of the current cabinet who looks vulnerable is the minister forsocial assistance and promotions, Benedita da Silva. The fact that she had usedpublic funds to pay for a private religious trip to Argentina was picked upenthusiastically by the press. Although she hastily apologised and returned theamount, a small sum, the mistake was a damaging embarrassment to the PT,which has vowed to tackle corruption in public office, and the party�s ethicscommission unanimously censured her. However, her departure from office isnot certain as she appears to retain the personal support of the president. Otherministers who have failed to make a positive impression and could fall victimto the reshuffle are the ministers of transport, science and technology, urbandevelopment, food security and antihunger programmes, and tourism. ThePMDB will be keen to obtain the transport brief, but the government may findit difficult to take that portfolio away from the PTB.

Parties are already starting to develop strategies and to choose candidates forthe campaign for the October 2004 local elections. The contest likely to attractmost attention will be that for the mayorship of São Paulo, the largest electoraldistrict in the country. The current PT mayor, Martha Suplicy, is well-placed tobe re-elected, but the opposition would like to use the contest to put the gov-ernment on the defensive. So far the PT appears to be in strong position, andsenior party figures have given their support to Ms Suplicy, while the oppos-ition has yet to find any nationally recognised candidates worthy of the contest.

Having led what it describes the �responsible opposition� in Congress byhelping the government to secure approval for social security and tax reforms,the opposition PSDB appears to be gearing up to challenge the government

Parties start to prepare for the2004 municipal elections

Brazil 15


more forcefully. It has lost 19 deputies to date and is now only the fourth largestparty in the lower house. At its national convention in late November the PSDBelected José Serra, its failed presidential candidate, as party leader, while formerpresident Mr Cardoso retains his post as its honorary president. In his firstspeech as PSDB leader, Mr Serra sought to establish the party�s role inopposition in a mature democracy by presenting a critique of theinconsistencies and inefficiencies of the PT administration, in particularfocussing on its social policy failings. His stance was more aggressive than thatof other leading party figures such as senator Tasso Jereissati or the governor ofSão Paulo, Geraldo Alckmin.

Having lost 16 deputies, the Partido da Frente Liberal (PFL) is now the thirdlargest party in the legislature. It has been divided of late, and a national partyleader, senator Jorge Bornhausen, has demanded the expulsion of the partyleader, Antônio Magalhães. Mr Magalhães suffered a fall from grace during theprevious administration because of a scandal involving the manipulation of anelectronic voting system. In recent months he has also been co-operatingclosely with the government rather than following the PFL line, distancing itselffrom the administration. The party congressional leadership has focused itsopposition on tax reforms, resisting any changes that might increase the totaltax burden.

The issue of judicial reform and the government�s performance on law andorder are likely to come to the fore as the 2004 municipal elections approach.The government has pledged to tackle inefficiency and the lack of account-ability of the judicial system. The judiciary, a cohesive institution when its priv-ileges are threatened, is on the defensive. It has argued against reforms beingimposed by the executive or legislature on the basis that its independence mustbe preserved. The president of the Supreme Court, Mauricio Correa, has soughta direct dialogue with Mr da Silva in order to persuade him that the judiciarymust be allowed to reform itself, but so far he has failed. Support for judicialreform appears to be growing following a series of cases of corruption withinthe legal system. In the latest of these, on October 30th arrests were made afterover a year of surveillance.

The Ministry of Justice is currently preparing its proposals for reform. One ofthe most important areas will be the rationalisation of judicial procedures. Oneof the changes proposed is the elimination of appeals from lower courts againstsupreme court rulings. Of 171,000 supreme court rulings in 2002, only 600rulings were on new cases; the rest were appeals brought by lower courtschallenging previous high court rulings. There have also been suggestions thatmore effective external supervision of magistrates be introduced, although it isunclear what form such checks would take. Other likely reforms includechanges to the role of public prosecutor and improving access to legal redress.

Law and order consistently appears in opinion polls as an issue of great publicconcern, and the administration�s performance in this area will affect publicperception of its effectiveness. However, central government influence on theissue can only be indirect as policing is the responsibility of local government.In October Mr da Silva�s administration announced an initiative to improve

Attention turns to judicialreform and to law and order

16 Brazil


policy co-ordination nationally in order to strengthen law enforcement throughthe exchange of information, the sharing of resources and the rationalisation oftasks. The effectiveness of the strategy will depend on the willingness of localofficials to work with central government, and indications so far suggest thatimplementation will be patchy. For example, in the state of Espirito Santo col-laboration between the central and local authorities since the start of 2003appears to be bringing about some improvements, while in the city of Rio deJaneiro, the man in charge of law and order is former governor AntônioGarontinho, whose wife is the current governor, Rosinha Garontinho, and whois unwilling to share the credit for any amelioration with central government.

Further law and order legislation is in the pipeline in the form of a law torestrict the sale of firearms. The bill has been approved in the lower house andis expected to have an easy passage in the Senate. According to polls, theproposal has the support of more than three-quarters of the population.

The challenge to the government from the Movimento Sem Terra (MST, a bodyrepresenting landless workers), has receded since the president of the PT, JoséGenoino, met MST leaders in July (September 2003, The political scene). Tofulfil its promises to the MST, the government launched a plan for agrarianreform in November. Mr da Silva announced the programme personally in ameeting with MST leaders and activists who had congregated in Brasilia tolobby government officials. The plan sets targets for the redistribution of land to2006, including pledges to give formal land titles to 500,000 families whoestablished plots in 1995-2002, as well as to an additional 400,000 families andto provide credits for 130,000 other households. It also pledges to improve san-itation, electricity, infrastructure and housing. Although the programme hasbeen seen as a victory for the leadership of the MST, traditionally a socialmovement closely aligned with the PT, MST militants will watch thegovernment carefully to make sure it fulfils its promises. In the context of tightfiscal constraints and the legal complexities involved in land transfers, therecould be delays in meeting targets, which would create renewed tensionsbetween the MST and the government.

Another contentious agricultural issue has been GM crops. In late September apresidential decree opened the way for GM crops to be introduced, pendingmore detailed legislation. The environment minister, Marina Silva, is closelyaligned with the environmentalist lobby, which had opposed the legalisation ofGM crops, but she appears to have agreed to the decree in return for a promisethat rules setting out limitations and restrictions on their use would followshortly. Legislation currently being prepared will cover the labelling anddistribution of GM crops, and experimental research on them. The Septemberdecree appears to have been precipitated by the fact that GM crops had alreadybeen widely introduced (up to 80% of soya grown in the south of the countrybelieved to be GM), making the development of a regulatory framework anurgent need. Nonetheless, environmentalists were dismayed by the decision,which highlights the gulf between the more business friendly wing of thegovernment and the PT�s traditional supporters. Details of the legislation arecurrently being contested by Ms Silva, who is seeking tight regulation, and theministers of agriculture and finance, who favour fewer controls.

Social programmesmove ahead

Brazil 17


Following the weak start of the Fome Zero (Zero Hunger) project (September2002, The political scene), a review of welfare programmes led to the launch ofthe new Bolsa Familia programme in October in order to bring togetherbenefits distributed under a host of existing provisions, including not only theZero Hunger project, but also other more successful schemes developed by theprevious government. The aim is to reach 3.6m families by the end of 2003. Thetotal amount distributed to the poorest families is targeted to rise by 75% on2002 levels, and a major monitoring programme is to be put in place tomeasure its effectiveness in terms of social indicators.

The government has paid a domestic political cost for the firm stance taken intrade talks (see Foreign trade and payments). Differences within the cabinetcame to light after Brazil emerged as a leading member of the G22 group ofdeveloping countries at a World Trade Organisation meeting at Cancun inSeptember, and its contestation of the terms proposed by the US at a meeting inTrinidad on September 29th-October 3rd to discuss the proposed Free-TradeArea of the Americas (FTAA). The agriculture minister, Robert Rodrigues, andthe development and trade minister, Mr Furlan, openly criticised the conduct ofthe negotiations, arguing that greater consultation with the private sector wasrequired, the first display of significant dissent from the business-oriented wingof the government. Underlying these debates is a concern that this approach toforeign policy could risk souring relations with the US. Most of the 17 foreigntrips undertaken by Mr da Silva since January have been uncontentious, butvisits to two countries with which the US has hostile relations, Cuba in lateSeptember, and Libya, which was included in the itinerary for his tour of theMiddle East in December, have been criticised.

Economic policy

On November 5th the government confirmed that it would renew its agree-ment with the IMF. In previous months it had refrained from announcingwhether it would do so, insisting that the decision would be made on the basisof a considered judgement of the benefits for Brazil. The reticence springs fromthe traditional suspicion of the Fund within the ruling Partido dosTrabalhadores (PT). The government had to convince its own supporters thatthe benefits!protecting the economy from external shocks and encouraginginvestment and growth!would outweigh the costs in terms of dependency.Some of its supporters were unconvinced, however, while careful managementof the issue ensured that the announcement did not provoke a political storm.

The agreement provides continuity following the US$30bn deal signed by theoutgoing administration in September 2002, which runs to the end of 2003.There are no significant changes in the economic programme previously agreedwith the IMF, which reiterated its satisfaction with the conduct of policy. Inorder to allow Brazil time to build up reserves while meeting a demandingamortisation schedule, a total of US$14bn will be made available in 2004,comprising US$6bn in new money and US$8bn in undrawn funds availableunder the existing agreement, while US$5.5bn in payments due to the Fund in2005 will be postponed to 2007. In addition, Brazil has secured agreement that

IMF agreement confirmspolicy continuity

Brazil�s foreign policy stancedraws criticism

18 Brazil


if the primary surplus for 2003 is above the target of 4.25% of GDP, the amountof the overshoot can be used in 2004 to increase investment in sanitation. Assanitation services are a responsibility of local government, the use of suchfunds could give the PT a boost in the 2004 municipal elections.

Fiscal results suggest that the government will be able to meet its primary fiscalsurplus target of 4.25% in 2003 without difficulty. Between January andSeptember 2003 the primary surplus was R57.1bn (5.1% of GDP), surpassing theR54.2bn target for the period set out in the IMF agreement. Central governmentaccounted for most of the total, although its contribution declined in the thirdquarter, partly as a result of the widening deficit on the private-sector socialsecurity system, which was adversely affected by the weak labour market. Theprimary surplus reported by states and municipalities was stable in 2003, at 1%of GDP. The hefty interest burden of 10.1% of GDP in the first three quarters of2003, which led the public sector to record a nominal deficit of 5.1% of GDP,was the result of high nominal interest rates and the large public debt.Although we expect the fiscal accounts to improve in 2004 as a stable primarysurplus combines with lower interest rates and higher GDP growth, thesefigures highlight the main weakness of Brazil�s macroeconomic framework: thehigh cost of servicing its public debt. If the public debt is to be reduced,significant primary fiscal surpluses would have to be recorded for several years.

Public-sector borrowing requirement(% of GDP; negative figure indicates surplus)

2002 2003Jan-Sep Year Jan-Sep

Primary balance -5.0 -4.0 -5.1 Central government -3.2 -2.4 -3.5 States & municipalities -1.0 -0.8 -1.0 Publicly-owned enterprises -0.8 -0.7 -0.6Interest payments 7.6 8.6 10.1

Nominal PSBR 2.6 4.7 5.1

Source: Banco Central do Brasil.

Despite the large primary surplus and currency appreciation, the net publicdebt/GDP ratio continued to rise, reaching 57.7% of GDP at the end ofSeptember, up from 56.5% of GDP at the end of 2002. The increase reflects thehigh interest burden and to a lesser extent, low real GDP growth.

Net public-sector debt(% of GDP; end-period)

2001 2002 Sep 2003Central government 33.3 36.4 36.2Banco Central do Brasil (the

Central Bank) -0.6 -0.4 0.1State governments 16.2 16.6 17.5

Municipal governments 2.1 2.1 2.5Publicly-owned enterprises 1.6 1.8 1.4

Total 52.6 56.5 57.7


Fiscal management is on target

Public debt expands further

Brazil 19


However, the quality of the public debt profile has improved in the past sixmonths, during which time the authorities have taken advantage of thestrengthening of the currency by declining to roll over maturing US dollar-linked domestic debt. As a result, the share of US dollar-indexed liabilities inthe stock of central government debt fell from 28.1% in April to 24.3% inSeptember, while the share of fixed rate liabilities jumped from 1.8% to 8.3% ofthe total. The authorities will seek to deepen this debt substitution process incoming months in order to improve the structure of the public debt and toreduce vulnerability to external shocks.

The Banco Central do Brasil (the Central Bank) has been loosening monetarypolicy since late June in response to falling inflation, the appreciation of theReal and depressed domestic demand. Between June and September the Selicovernight rate fell from 26.5% to 20%, while reserve requirements on sightdeposits were reduced from 70% to 55%. At meetings in both October andNovember the Central Bank�s Comitê de Política Monetária (Copom, monetarypolicy committee) cut the Selic overnight rate by an additional 1 and1.5 percentage points respectively to take the November rate to 17.5%, the lowestlevel for two years. If the fall in inflation expectations is taken into account, thereal Selic rate measured by the difference between the Selic rate and expectedinflation dropped by some 7 percentage points since July, but at around 11%, itis still high.

The Central Bank�s survey of expected inflation indicates that there is furtherroom for reduction in the Selic rate without jeopardising the year-end inflationtarget for 2004 of 5.5%, but rate reductions in the coming year will be made at aslower pace than recently. Although lower interest rates would provide wel-come relief by reducing public debt service and would also help to lift the eco-nomy both by encouraging private-sector spending and by discouraging afurther strengthening of the Real, the authorities will remain cautious, while theimpact of monetary easing on price pressures will be monitored closely.

Although Brazil�s high lending rates are partly the result of heavy governmentborrowing, there are also institutional reasons for them, one of which is weakbankruptcy law. Currently, lenders have very weak claims on company assets,

Interest rates keepcoming down

Measures takento reduce spreads

20 Brazil


and risk premiums are therefore high. This problem has been long-recognisedand while governments have sought for a decade to introduce changes to bank-ruptcy rules, on October 14th the House of Deputies finally approved such abill. A bankruptcy process closer to Chapter 11 legislation in the US is proposed,one that would focus on restructuring companies in difficulties rather thansimply closing them down. If the bill completes its progress through thelegislature it would be expected to speed up bankruptcy proceedings and toweaken the claims of the tax authorities on company assets, thereby facilitatingsales of such assets and improving the positions of other creditors.

In a further effort to reduce risks to lenders, on September 17th permission wasgranted under a medida provisória (a provisional measure signed by thepresident that has to be ratified by Congress) for banks to deduct interest andrepayments directly from individual borrowers� payroll accounts. The value of aloan is capped at five times the net income of the borrower, and debt servicepayments are made in fixed instalments that cannot exceed 30% of netearnings. This measure appears to have had a significant effect on reducinginterest rates for personal loans for employees in the formal sector. Publicbanks have also created special low-cost credit lines for the purchase ofdomestic appliances, which seems to have been successful in boosting demandfor such goods (see The domestic economy).

The public debt/GDP ratio can only be brought down to a sustainable level inthe medium term by maintaining a significant primary surplus. The currentgovernment has achieved this target so far by imposing stringent curbs oncurrent and capital spending, but these efforts will be outweighed byexpanding deficits for both the public and private social security systems owingto demographic trends and rising real minimum wages unless reforms are intro-duced. Having been passed by the House of Deputies in August (September2003, Economic policy), the government�s first pension reform bill was sub-mitted to the Senate in early October, and on November 26th won approval atthe first vote with only minor changes, including the omission of a clause thatwould have brought the provision of work accident insurance into the publicsector. A ceiling on public-sector salaries was approved, although the issue islikely to be raised again in a revised, more flexible form with different rates fordifferent branches of government in a separate constitutional amendment at alater date. The social security reform is now expected to win approval inDecember without further changes. Although it has been amended since thefirst draft, it will still significantly reduce the fiscal burden of future publicpensions liabilities. The Economist Intelligence Unit now expects the gov-ernment to turn its attention to the growing deficit of the Instituto do SeguroSocial (INSS, the state-run social security system for private-sector workers). Theaccumulated 12-months INSS deficit is widening steadily. Having been under 1%of GDP until the end of 2001, it had reached 1.5% by September 2003 and isexpected to continue to grow. In order to contain it the government will beexpected to reduce its liabilities by establishing a minimum retirement age anddelinking pensions from the minimum wage. Delinking will be imperative ifthe president, Luiz Inácio Lula da Silva, is to fulfil his election pledge to doublethe real value of the minimum wage during his term.

Social security reformprogresses slowly

Brazil 21


The Senate is also debating the tax reform bill, a watered-down version ofwhich was approved by the House of Deputies in September (September 2003,Economic policy). The Senate Justice and Constitution Committee approved adraft of the bill on October 29th, but some significant alterations have beenmade to it. In order to win approval for the most urgent items the governmentis expected to split the bill so that measures to maintain existing tax revenuecould be pushed through hastily by year-end. Other provisions designed toimprove efficiency are likely to be debated further in Congress. The most urgentpriority for the government will be to ensure the renewal of two temporarymeasures, the contribuição provisória sobre movimentação financeira (CPMF, thetax levied on financial transactions) and the desvinculação de receitas da união(DRU, the mechanism giving the government discretion over the allocation of20% of tax revenue that would otherwise be earmarked for specific pro-grammes). The Senate has not amended provisions extending both measuresfor four more years, and it seems certain that these will be approved. As theyhave not been altered, these clauses do not need further approval from theHouse of Representatives and so if split from the rest of the tax reform bill canbe approved by the end of the Senate session. A further important tax reformproposal, the conversion of the contribuição para o financiamento da seguridadesocial (Cofins, employers� social security contributions) from a payroll to avalue-added tax, bypassed Congress under a medida provisória issued onNovember 4th. The rate at which the Cofins is charged was converted from 3%of turnover to 7.6% of value added. According to government calculations, thechange will not generate an increase in total revenue. This assertion has beendisputed, suggesting that it may be challenged when submitted to Congress forapproval. Other aspects of the bill that have been altered substantially in theSenate will be referred back to the lower house for approval, including:

• the unification of taxes on goods and services such as the imposto sobre acirculação de mercadorias e serviços (ICMS, a local sales tax), the imposto sobre osserviços (ISS, a local services tax) and the imposto sobre os productos industrial-izados (IPI, central government tax on manufactured goods);

• shifting responsibility for setting tax rates from the Conselho de PolíticaFazendária (Confaz, tax policy council) to the Senate; and

• Senate approval for any tax exemptions granted to firms by states andmunicipalities between April and September 2003, when the tax reform, whichaims to clamp down on exemptions, was being drafted.

The changes to local and central tax systems are still very contentious as theyinvolve the distribution of substantial tax revenue between the central gov-ernment, states and municipalities. The ultimate aim of unifying rates seems asdistant as ever as all levels of government are extremely reluctant to accept anyoutcome that reduces their shares. The Senate has proposed that the changes bepostponed until 2007, but the timetable could slip further because of inter-minable horse trading over transition periods and compensatory payments asthe bill makes its passage through Congress. The measures will involve furtherconstitutional amendments requiring approval by a three-fifths majority in twovotes in both houses.

Tax reform falls apart

22 Brazil


With the economy starting to recover and the social security and tax reformson their way to winning Senate approval, the focus has begun to shift frommacroeconomic stabilisation to improving the business, regulatory and legalenvironments. Discussions have centred on the low level of investment and thechanges required to increase it sufficiently to spur medium- and long-termgrowth. The second stage of the tax reform package will be part of this processas distortionary taxes not only reduce the efficiency of investment allocation,but also add to the weight of bureaucracy. Beyond these measures are pro-posals to improve regulation, particularly for utilities, as well as labour marketreforms. The issue of regulation has highlighted ambiguities in the gov-ernment�s position. Traditionally, the ruling Partido dos Trabalhadores (PT) hasfavoured state intervention in setting prices and directing investment, but ingovernment it has insisted on its commitment to attracting private investmentto build capacity. This stance has given rise to some confusion and uncertainty,discouraging investors. The issue is further complicated by the lack of acoherent approach from the business lobby. Businesses have argued in favourof explicit rules and against state interference, but have also sought to use theirlobbying strength to push for special incentives and rules that inhibit com-petition. Regulatory uncertainty has been a particular problem in the energysector, and a failure to tackle this problem could have a damaging effect onoverall confidence in the coming year. Labour market reforms are extremelypolitically sensitive, and the government is unlikely to pursue the issue withany enthusiasm. Having made impressive progress on pensions, furtheradvances will be limited by the government�s ability to win trade unionconsent. Mr da Silva�s background as a union leader is an asset, but unless anduntil he is able to show some achievements in terms of employment creationand poverty reduction, organised labour will resist reforms that weakenworkers� bargaining strength.

The domestic economy

Output and demand

Indicators suggest that the economy began to pick up in the third quarter inresponse to monetary policy easing and improved confidence. As the Selicovernight rate fell the most between July and November, the impact of mone-tary easing will be strongest in the fourth quarter of 2003 and the first of 2004.

Real GDP, 2003Jan-Sep (% change,

year on year)Jul-Sep (% change,

quarter on quarterJul-Sep (% change,

year on year)Household consumption -4.2 -0.2 -3.7

Government current spending 0.6 -0.1 0.9Gross fixed investment -7.2 2.8 -9.1

Exports of goods & services 15.8 0.8 3.7Imports of goods & services -5.8 -0.1 -5.5Total GDP -0.3 0.4 -1.5

Source: Instituto Brasileiro de Geografia e Estatística.

Indications of recovery at last

Further reforms workingthrough the pipeline

Brazil 23


Local surveys confirm that business and consumer confidence has improved.Manufacturing firms report declines in inventories in the third quarter, thereplenishment of which will boost output in coming months.

Domestic demand is still weak, but there are some signs of a possible rebound.Lower household incomes and weak labour market conditions accounted forthe 5.2% year-on-year contraction in retail sales in the first eight months of 2003,but the year-on-year fall was significantly lower in September, suggesting thatsales are picking up, particularly as retail sales were strong in 2002. According tothe Associação Nacional dos Fabricantes de Veículos (Anfavea, the vehiclemanufacturers� association), wholesale vehicle sales were up by 12.8% inOctober on the September level. It is not clear how much of this rise wasaccounted for by the replenishment of inventories. Further improvement isexpected in 2004, although owing to declines in real earnings in 2003 and thelagged recovery in the labour market the retail recovery is likely to be slowerthan that of industry.

Retail sales(% real change, year on year)

Jan-Aug 2003Fuels & lubricants -5.3Hypermarkets & supermarket sales, food, beverages & tobacco -6.1

Fabric, clothing & footwear -4.2Furniture & home appliances -6.5Other personal items -2.9

Cars, motorcycles, vehicle parts & other -11.2Total retail sales -5.2


An increase in the volume of loans to individuals, which rose by 11.3% innominal terms in the first nine months of 2003, was fostered not only by lowerinterest rates, but also by the introduction of rules allowing banks to deductinterest and repayments directly from borrowers� payroll accounts, plus low-cost credit lines offered by public banks for the acquisition of domesticappliances (see Economic policy). As well as increasing demand for durableconsumer goods, the measures have helped to reduce the average spread onloans to individuals!the difference between deposit and borrowing rates!from60 percentage points in May to 52.1 in September. However, this spread is stillgreater than that seen in the year-earlier period as the average spread inSeptember 2002 was 50.6 percentage points. As economic prospects improveand banks try to compensate for the lower income earned on public debtsecurities, spreads are expected to narrow further in coming months, whilecredit will expand, helping to fuel GDP growth in 2004.

Employment, wages and prices

The unemployment rate was stable during the third quarter, at around 13%. Theincrease of around 1.4 percentage points since September 2002 reflected higherparticipation rates, that is, a rise in the proportion of the working agepopulation in the labour force, which in turn may have reflected attempts to

Employment is up, but theunemployment rate is steady

Retail sales are rising

24 Brazil


sustain household incomes as real earnings are in decline. In September 2003the total number of people employed was 1.2% higher than in the previousmonth, and 4.3% higher than September 2002. Average real earnings continuedto fall. A 2.4% drop in September brought average real earnings down to 14.6%below the September 2002 level. Despite the rise in employment, aggregatelabour earnings continued to shrink in real terms as a result, contributing tolower private consumption. Prospects for 2004 are mixed. As annual pay risestend to reflect past inflation, real wage gains would be expected as inflationdeclines, but the lag between improvements in output and the recovery in thedemand for labour suggest that aggregate earnings growth will take some timeto pick up. The delay will be longest in the informal sector, in which over one-half of the total labour force works.

Tight monetary policy and a stronger Real have succeeded in bringing inflationdown. Market expectations suggest that the year-end rate of inflation for 2003measured by the indice de preços ao consumidor amplo (IPCA, a nationalconsumer price index based on surveys in ten cities) will be 9.2%. The mainremaining source of pressure on inflation comes from administered prices,which account for roughly 29% of the IPCA. These prices are linked to inflationin the previous 12 months and so will rise faster than other prices as overallinflation subsides. Administered prices rose by 12.2% between January andOctober, compared with an 8.4% increase in the IPCA. The Banco Central doBrasil (the Central Bank) projects that administered prices will rise by 13.9% in2003 and by 8.9% in 2004, making them an important source of pressure oninflation. Barring another major devaluation, by 2005 administered priceinflation is expected to start to converge with that for other prices.

Financial indicators

Macroeconomic discipline, the strong adjustment in the external accounts andabundant international liquidity have kept demand for Brazilian financialassets buoyant. The results have been a sharp narrowing in sovereign debtspreads (EMBI+), an impressive rise in the Sao Paulo stock exchange index

Inflation eases

Country riskpremium subsides

Brazil 25


(Ibovespa) and an appreciation of the exchange rate since the start of 2003. Thegap between Brazil�s sovereign debt spreads (EMBI+) and those of otheremerging economies, excluding Argentina, contracted in the past quarter, froman average of 419 basis points (bp) in August to 311 bp in October and further,to 270 bp in the first half of November. With tax and social security reformshaving been approved, this gap is expected to continue to shrink. The stock-market also staged a further rally since August, pushing up the rise in the indexbetween February and October to 75%, surpassing its previous nominal peak ofMarch 2000. The nominal exchange rate has been stable in the R2.85-R3:US$1range since April. With inflation in Brazil running ahead of that in its tradingpartners, real effective currency appreciation in the first ten months of 2003was about 15%.

Manufacturing

Despite a significant upturn in manufacturing output in the third quarter, totaloutput of both durable consumer and capital goods in the first nine months of2003 was still below that in the year-earlier period. The consumer goods sectorwas depressed by high real interest rates and falls in real earnings, while thecapital goods sector was hit by the contraction in investment. Stronger inter-mediate goods production in the period was attributable to the robustperformance of the mining sector, as well as of other export-oriented sectors.

Manufacturing production by category(% change, year on year)

Jan-Sep 2003Capital goods -1.4Intermediate goods 1.3Consumer goods -3.7 Durables -3.5 Semi- & non-durables -3.8

Total -0.1


Broad-based upturn inthe third quarter

26 Brazil


Disaggregated sectoral performances also reflect the divergence in fortunesbetween industries dependent on the domestic market and more export-oriented activities. Among industries dependent on the domestic market areweak performers such as pharmaceuticals, clothing and footwear, and plastics,while more export-oriented activities include mechanical, metallurgical, woodand leather products, rubber, and paper and cardboard. The decline in telecom-munications investment after the post-privatisation boom has led to a con-traction in output of electrical and communications equipment, while loweroverall domestic investment has reduced the demand for processed non-metallic minerals used in construction.

Manufacturing production(% change, year on year)

Jan-Sep 2003Non-metallic mineral processing -5.6Metallurgical products 5.3

Mechanical products 9.3Electrical & communications equipment -5.4Transport equipment 0.0

Wood products 4.0Furniture -7.3

Paper & cardboard 3.3Rubber 5.9

Leather goods 4.7Chemicals 0.3Pharmaceuticals -18.6

Perfume, soap & candles -0.4Plastics -11.7

Textiles -7.7Clothing & footwear -13.8Food products 0.0

Beverages -7.5Tobacco products -9.3

Total manufacturing production -0.1


Agriculture

Only minor changes have been made to official crop forecasts for 2003, andagriculture is likely to record a strong overall performance. Grain output is ex-pected to rise by 26%, and particularly remarkable expansions are likely forsoya, corn and wheat production. Improvements have been evident in allregions, but especially in southern and central-western areas, which supply47.4% and 30.7% of output respectively. The cultivated land area is estimated tohave risen by 8.3%, up from 49.4m in 2002 to 53.6m ha in 2003. The mostdramatic increase is for soya, land cultivated for which grew by an estimated12.8%, up from 16.3m ha in 2002 to 18.4m ha in 2003. Of the main crops, onlyrice, manioc, oranges and coffee output is expected to have declined in 2003;the drop in coffee production is a consequence of the current stage in the lifecycle of coffee trees.

Agriculture is booming

Brazil 27


Agricultural production estimates for 2003(% change, year on year)

Cotton 1.7Rice -2.4

Potatoes (first crop) 1.0Potatoes (second crop) 1.1Potatoes (third crop) 0.5

Cocoa 0.9Coffee -20.2

Sugar cane 6.2Onions -1.6Beans (first crop) 1.4

Beans (second crop) 15.3Beans (third crop) 16.0

Oranges -6.6Manioc -3.3

Corn (first crop) 18.7Corn (second crop) 104.8Soya 22.7

Sorghum 125.4Wheat 81.4


The Instituto Brasileiro de Geografia e Estatística (IBGE, the national statisticsinstitute) has published preliminary estimates for the 2004 harvest, indicatinganother year of expansion, but by a much more modest 3.6%.

Infrastructure

Although investors have been reassured by the government�s firmness onmacroeconomic policy, concerns persist about shortcomings in policy towardsinfrastructure. In the medium term, investment in the sector would preventbottlenecks, particularly for energy and transport, but potential private in-vestors have been deterred by the government�s failure to develop a trans-parent regulatory framework. If the electricity sector fails to attract new in-vestment, the growing imbalance between rising demand and stagnatingsupply risks creating another crisis similar to that of 2001, when shortages ledto power cuts, seriously disrupting industrial production. The transport networkis also barely able to keep up with demand, and the quality of roads, whichwas already poor, is deteriorating. According to the Ministry of Transport, therehabilitation of the road network would require annual investment of R5.5bnfor eight years; only R1.5bn was disbursed in 2003. Although not a directbottleneck to growth, sanitation is another sector in which Brazil suffers asignificant infrastructure shortfall. This sector has been prioritised for stateinvestment in 2004, although much of the spending is conditional onsurpassing IMF targets in 2003 (see Economic policy).

Conscious of the need to clarify the regulatory framework for infrastructure in-vestment, the government has stated its intention to set out new rules. A pro-posal published for discussion in early October would bring the agencies under

Infrastructure regulationunder discussion

28 Brazil


closer supervision by sector ministries. Under the proposal agencies would beobliged to sign a performance contract with the government; be subject to therulings of an ombudsman with as yet undefined powers who would beresponsible for checking complaints against the agency; and lose the power toaward concessions, which responsibility would be transferred to the sectorministry. Since the minister also chairs the board of directors of publicly-ownedcompanies, this change might create significant conflicts of interest. After aperiod of public consultation that ended in mid-October, the bill is now underrevision, and a new version is expected be sent to Congress in the first quarterof 2004. Discussion of the proposal suggests that its goals are not very clear, toa certain extent reflecting conflicting views on the subject among governmentofficials. The government�s position is expected to be clarified in the next fewmonths, when new directors are due to be nominated to fill vacant positionson the boards of the regulatory agencies for oil, transport and telecoms.

The current regulatory framework for electricity was originally designed on theassumption that the large power companies in public ownership would bebroken up and privatised to create a competitive market. Since the powershortage of 2001, the drive to restructure and to privatise the sector has beenabandoned, leaving the generation and transmission operations as a mixbetween the state and private sectors. The weakness of demand and theincreased burden of non-hedged US dollar-linked liabilities have severely com-promised the financial health of the mostly privately-owned electricitydistribution companies. The new administration has extended a financialsupport package to distribution companies and sketched out a framework forthe reform of the regulatory framework. The aims of the reform are to increasethe role of the state in investment allocation; to reduce investment andoperational risk by shifting some types of risk from producers to consumers;and to establish a single price for electricity that is lower than the long-runmarginal cost by creating a pool to which high-cost new investors and low-costpublicly-owned generators would sell. The new model also includes aprogramme to give universal access to electricity. Launched on November 11th,it envisages the disbursement of R7bn in 2003-08 to extend electricity suppliesto an estimated 12m people, 80% of them in rural areas.

To foster infrastructure investment, notably for transport and sanitation, thegovernment has prepared another bill to be sent to Congress shortly that willestablish the rules to be used by central, state and municipal governments inpublic-private partnerships (PPPs). PPPs are expected to provide a means bywhich the private sector would be able to finance and to manage investmentprojects that would be repaid over the life of an investment by tariffs and gov-ernment subsidy. The main novelty of this proposal is the potential it offers forthe creation of different kinds of collateral to guarantee that future admin-istrations will indeed reimburse investors. Among the proposed guarantees are:giving preference to payments to PPP investors over other contractual gov-ernment liabilities; providing collateral in the form of property, financial assetsor receivables; and capitalising trustee funds with budget resources and fundsfrom public institutions.

Electricity reform outlined

Public-private partnershipsfor transport and sanitation

Brazil 29


Public investment in sanitation will be a priority in 2004. With that aim, thenew agreement to be signed with the IMF foresees that the public sector will beallowed to fall short of meeting the primary fiscal target of 4.25% of GDP by theamount invested in sanitation, up to an ceiling of an estimated R2.9bn.Municipalities and local state-owned sanitation companies will be responsiblefor carrying out this investment, and specific rules will have to be defined toaccount for the difficult financial situation some of them are experiencing.

Oil and gas

Regulatory uncertainty also surrounds oil and gas activity. The sector is stilldominated by Petróleo Brasileiro (Petrobrás, the publicly-owned oil company).In third-quarter company results released in mid-November Petrobrás reportedthat oil and gas production between January and September 2003 had reachedan average of 2m barrels/day, 11.6% up on output for the year-earlier period.This rise in output allowed the company to reduce imports of oil, gas and der-ivatives by some 14% in volume terms and to boost profits to R14.8bn, almosttwice the 2002 level.

The company seems set for further rapid expansion in the medium term. Anextensive programme of investment, up by 40% year on year in January-September to R13.1bn, has been put in place, which includes explorationactivity. Estimates of offshore natural gas reserves outside the city of Santoshave been revised up to 419bn cu metres, twice the total national currentproven reserves. These reserves may help Brazil to achieve its long-term goal ofincreasing the share of gas in its energy supplies from less than 4% at present tomore than 10% within ten years. However, the main constraint on lifting gasproduction is excess supply. Supply is already 40m cu metres/day, comparedwith consumption of only 29m cu metres/day. A contract for the import of gasfrom Bolivia via a 3,150-km pipeline linking Santa Cruz in Bolivia to Sao Pauloprovides for the supply of 24m cu metres/day, but imports through the pipelineare currently only around 14m cu metres/day, and Petrobrás is therefore seekingto renegotiate the contract.

Foreign trade and payments

Brazil�s trade surplus has continued to grow, reaching US$20.3bn in the first tenmonths of 2003, twice the level recorded in the year-earlier period. The surplusresulted from a combination of higher exports and stagnant imports.

Trade balance(US$ m)

2002 2003Jan-Oct Year Jan-Oct % change

Exports 49,992 60,362 60,356 20.7Imports 39,946 47,216 40,016 0.2Trade balance 10,046 13,146 20,340 �

Source: Secretariat for Foreign Trade.

Trade surpluses are huge

Production and reservesare up

30 Brazil


Export growth, particularly of primary and semi-manufactured goods, has beenboosted by higher prices, which rose by 7% and 12.4% respectively, as well as byincreased volumes. The strongest growth has been in exports to Argentina andChina. Exports to Argentina, which despite a sharp contraction caused by theeconomic crisis there accounted for almost 10% of the total in 2002, and grewby 93% between January and October. By contrast, the 85% surge in the sameperiod in sales to China, which accounted for around 5% of total exports in2002, represents a structural shift in trading relations. The expansion of tradewith China has been marked by energetic trade promotion both by officialdelegations and private business organisations. Exports to the US and to LatinAmerican countries not belonging to the Mercado Comúm do Sul (Mercosul,the Southern Cone customs union) have grown modestly, at 10% and 8%respectively, compared with a 20% rise in sales to the EU, 28% to eastern Europe,24% to Africa, and 17% to the Middle East.

Exports by category(US$ m)

2002 2003 % change inJan-Oct Year Jan-Oct value terms

Primary products 14,325 16,952 17,910 25.0Semi-manufactures 7,322 8,964 9,053 23.6

Manufactured goods 27,070 33,001 32,293 19.3Non-categorised goods 1,275 1,446 1,100 -13.7Total 49,992 60,362 60,356 20.7

Sources: Banco Central do Brasil.

Flat import spending between January and October 2003 was the product ofhigher prices and lower volumes. A 5.9% rise in average import prices wasmainly accounted for by a 25.1% increase in prices for oil and oil derivatives. Asignificant decline in fuel imports (see Oil and gas) was made possible bystrong growth in domestic production. As a result of this contraction ininvestment, capital goods imports fell by almost 15% in value terms, althoughaverage prices were 3.9% higher.

Imports by category(fob, US$ m)

2002 2003Jan-Oct Year Jan-Oct % change

Capital goods 10,002 11,613 8,508 -14.9Consumer goods 4,951 5,907 4,601 -7.1 Non-durable goods 2,842 3,400 2,573 -9.5 Durable goods 2,109 2,507 2,028 -3.8Fuels & lubricants 5,175 6,241 5,672 9.6Other intermediate goods 19,818 23,459 21,235 7.2

Total 39,946 47,220 40,016 0.2

Sources: Banco Central do Brasil.

Monthly data show an significant upturn in import growth since August, in linewith the recovery in industrial production and sales (see The domestic eco-nomy), suggesting that monthly trade surpluses will be smaller for bothNovember and December.

Brazil 31


The expansion of the trade surplus has helped to lift the current account intosurplus. The total surplus between January and September 2003 was US$3.9bn(1.1% of GDP), compared with a deficit of US$7.4bn (2.2% of GDP) in the year-earlier period. Lower deficits in the services and income accounts, and anincrease in net remittances, also helped to boost the current-account balance. Acurrent-account surplus is now expected to be recorded for full-year 2003, thefirst for almost a decade.

Current account(US$ m)

Jan-Sep 2002 Jan-Sep 2003Trade balance 7,869 17,797Services balance -3,919 -3,705 Receipts 7,108 7,542 Spending 11,027 11,247Income balance -13,009 -12,343 Receipts 2,322 2,476 Spending 15,331 14,820

Net current transfers 1,622 2,106Current-account balance -7,438 3,856% of GDP -2.2 1.1


With the current account having moved into a surplus and with medium- andlong-term debt amortisations having declined from US$22.4bn in the first ninemonths of 2002 to US$19.5bn in the same months of 2003, Brazil�s externalfinancing needs fell by almost one-half year on year in the first nine months of2003, to US$15.6bn.

Flows of foreign direct investment (FDI) are still depressed!US$6.5bn in the firstnine months of 2003, compared with US$12.7bn in the year-earlier period!butthe return of a positive balance on portfolio flows helped to keep the capitaland financial account balance for January and September 2003 close to that forthe year-earlier period.

Current-account surplus over1% of GDP

FDI is still depressed

32 Brazil


Capital and financial account(US$ m)

Jan-Sep 2002 Jan-Sep 2003Capital & financial account balance 10,175 11,006Capital account 312 340

Financial account 9,863 10,666 Direct investment (net) 10,368 6,244 Inflows 12,665 6,467 Outflows -2,297 -223 Portfolio investment -2,874 3,649 Assets -386 -1 Equity securities -375 -227 Debt securities -11 226 Liabilities -2,487 3,650 Equity securities 1,233 1,424 Debt securities -3,721 2,226 Financial derivatives -316 -180 Assets 774 430 Liabilities -1,090 -610 Other investments 2,684 954 Assets -2,241 -3,012 Liabilities 4,925 3,966

Errors & omissions -629 -1,707Overall balance-of-payments balance 2,108 13,154


This decline in FDI reflects both external and domestic factors. Total world FDIflows have slowed in 2003, but FDI in Brazil has fallen faster owing to the extrauncertainty associated with the change of government. FDI inflows shrank formost sectors, but the contraction in services was especially strong. FDI inflowsfor electricity, gas and telecommunications declined to less than one-third of2002 levels, reflecting the lack of clarity about infrastructure regulation. Bycontrast, inflows to non-oil primary sectors rose, accounting for 12.4% ofinflows in the first nine months of 2003, compared with only 0.7% in the year-earlier period. Chinese investors appear to have shown a strong interest inBrazil, particularly in primary processing sectors, reflecting growth in bilateraltrade. Although figures for January-September 2003 show a decline in FDI,there were some signs of improvement in the third quarter, when averagemonthly FDI inflows reached US$1.2bn, compared with US$800m in the firsthalf of the year.

Foreign direct investment by sector(US$ m)


Agriculture & mining 436 638 1,322 Oil 326 508 255 Other agriculture & mining 110 129 1,067Manufacturing 5,505 7,617 3,357 Basic metallurgy 116 139 350 Food & drink 1,674 1,873 269 Vehicles 1,568 1,819 854

Brazil 33


Foreign direct investment by sector(US$ m)


Chemicals 1,149 1,573 601

Electronics & communications 77 544 323 Other manufacturing 921 1,670 961Services 8,878 10,498 3,932 Telecommunications 3,800 4,166 1,125 Electricity & gas 1,369 1,534 434 Commerce 1,225 1,504 698 Financial services 951 1,206 482 Services supplied to firms 601 791 516 Other services 932 1,297 677Total 14,818 18,753 8,610


According to the Banco Central do Brasil (the Central Bank), Brazil�s total foreigndebt reached US$217bn at the end of July 2003, up from US$211bn at the end of2002. The composition of the debt has continued to tilt towards the publicsector as public external debt has risen, while private-sector debt has declined.In July the non-financial public sector accounted for 55.4% of the total,compared with 52.4% at the end of 2002 and only 44.2% in 2000. Governmentdebt to the IMF rose from US$20.8bn in December 2002 to US$29.6bn in July,and further, to US$33.5bn in September.

The significant surplus on the balance-of-payments account has led to anincrease in foreign exchange reserves. On a net asset basis reserves reachedUS$52.7bn in September, representing 14 months� cover of goods imports.Although much of the rise in reserves in 2003 was the result of IMF lending,some increase net of those loans also occurred, up from US$16.3bn at the endof 2002 to US$19bn in September 2003.

Brazil�s negotiating stance in trade negotiations has led to strains in relationswith some important trade partners. Brazil emerged as a leader of a new groupof 22 (G22) developing countries at the World Trade Organisation meeting atCancún in early September. The new group took a firm stand, refusing to makeconcessions on the �Singapore issues� covering government procurement,investment and competition being pushed by the more powerful economiesunless those countries agreed to reduce protectionism, particularly for agri-culture. The meeting closed without agreement. Critics of the G22 claimed thatthe tough stance had backfired, but Brazilian negotiators insisted that progresshad been made. This view seems to have been borne out by the indicationfrom the EU in late November that the �Singapore issues� might be negotiatedseparately from the core agreement in return for the acceptance by developingcountries of weaker commitments on the reduction of agricultural subsidies.

Negotiations towards the establishment of a Free-Trade Area of the Americas(FTAA) have been similarly affected by Brazil�s firm line. In a meeting inTrinidad in October, Brazil insisted that unless progress was made on reducingUS subsidies and tightening antidumping rules, there would be no concessions

IMF lending lifts external debtand international reserves

Tough line on tradenegotiations has mixed results

34 Brazil


on US demands on government procurement, investment and intellectualproperty rights. A compromise was reached at a subsequent next meeting atMiami on November 22nd-24th, when contentious issues were omitted fromthe first round of talks. This move was heralded as an achievement by bothsides as it ensures the survival of the FTAA project, which had appeared closeto collapse in previous weeks. However, there have been costs. In Brazil thenegotiating stance has stirred dissent within the cabinet (see The politicalscene), while in Latin America some countries that had belonged to the G22have begun to distance themselves from Brazil as the US has pushed aheadwith bilateral negotiations. The US, which is already negotiating free-tradeagreements with all Central American countries, announced at the Miamimeeting that it would also seek bilateral trade deals with Colombia, Peru,Ecuador and Bolivia. It is also unclear whether the compromise is feasible asUS negotiators have come under heavy criticism from US business interestsclaiming that the agreement is too weak. The 2004 US presidential election willcomplicate the process further, and could make it hard to meet the January2005 deadline for reaching agreement on the FTAA.

There have also been important developments in trade negotiations betweenMercosul and the EU. Meetings to be held in Brussels (December 2003) andBuenos Aires (February 2004) are expected to advance discussions on marketaccess, trade facilitation reforms and public procurement. In April 2004Mercosul and the EU are expected to improve their liberalisation offers, and inOctober a draft agreement is expected to be reached at a ministerial meeting tobe held in Europe. It is expected that subsidies and market access in agricultureon the European side and services and public procurement on the Mercosulside will be the most sensitive issues. As with the FTAA, the final outcome ofthe negotiations may be a lean agreement that excludes changes in those areas.

Brazil - iuj.ac.jp · Brazil 1 Country Report December 2003 ' The Economist Intelligence Unit Limited 2003 Contents 3 Summary 4 Political structure 5 Economic structure 5 Annual indicators

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