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Brazil - Economic Briefing August 2002

Confidence Bolstered by New IMF Accord

Brazil has received a higher than expected financing package from the International Monetary Fund (IMF), which served to bolster domestic financial markets battered in the past few months by political jitters and debt concerns. The government will have to maintain fiscal discipline but will now be equipped with a more solid international reserve position. The prospects for increased currency stability may ease inflationary expectations and give the Central Bank additional leeway to lower interest rates.

IMF support package bolsters confidence
On 7 August, the International Monetary Fund (IMF) announced its intention to provide Brazil with a new 15-month, US$ 30 billion stand-by agreement. The IMF will allow monetary authorities to lower the floor of international reserves that the Central Bank has to maintain from US$ 15 billion to US$ 5 billion. The release of international reserves from the IMF conditions immediately frees up US$ 10 billion in international reserves that the Central Bank can use to defend the currency, if deterioration should persist. The package is expected to receive approval in the September meeting of the IMF board. The agreement will provide for some US$ 6 billion in disbursements this year with the balance of US$ 24 billion released in 2003. The exact details of the loan will not be available until official approval next month but several conditions have been made public. Brazilian officials have committed to maintaining strict fiscal discipline, which will include meeting a primary fiscal surplus of 3.75% of GDP (balance of revenues less expenditures, excluding interest payments) every year through 2005. Fiscal accounts will be monitored quarterly to ensure compliance. The programme does not appear to warrant additional structural reforms (i.e. tax and pension reform) nor is the Central Bank required to strengthen monetary discipline.

The amount of the IMF package was well above market expectations of around US$ 20 billion and prompted a strong rally across markets. The stock market had experienced a 12.4% drop by the end of July but bounced back 6.0% on 8 August. Similarly, the benchmark Brazilian sovereign debt J.P. Morgan EMBI+ spread, which had deteriorated to 2,307 basis points to the comparable US Treasury (UST) securities by the end of July tightened by over 300 basis points from before the announcement to 1,759 at the end of 8 August. Finally, the real appreciated a whopping 5.9% on 8 August, after having lost 17.0% to the US$ in July. The Central Bank appears to be banking on a more permanent confidence boost, as monetary authorities say they will cease the daily sales of US$50 million that had been used to shore up the fledgling currency. Panellists appear to share the Central Bank’s optimism and expect the real to appreciate 10.6% in the remainder of the year to close at 2.61 reais to the US$ by year-end.

Market uncertainty persists amid fiscal concerns
All of the presidential candidates have claimed that they support the new IMF plan. However, the will power of the new president will be severely tested, as desire to embark on campaign promises to generate employment, cut taxes and increased private sector subsidies will have to be tempered by the reality that high debt payments will continue to curtail any meaningful shift in public spending priorities. This is precisely why markets remain somewhat nervous about the prospects for fiscal policy and debt under the next administration. On 9 August, market uneasiness about the candidate’s fiscal commitment prompted the Brazil EMBI+ spread to experience it biggest daily deterioration of 300 basis points to close 2,005 basis points to the comparable US Treasury. Similarly, the real lost ground, depreciating 3.6% to the US$ in one day.

Currency weakening exerts some inflationary pressure
Consumer prices increased 1.2% in July, which was well above the 0.8% expected by the Consensus and more than double the average monthly rate of the first six months of the year. Nevertheless, the July figure lowered the annual inflation rate to 7.5%, from 7.7% in June. At its current level, annual inflation is still well above the 5.5% upper limit of the Central Bank’s inflation target range for this year. The July consumer price hike can be attributed to the recent acceleration of currency weakening, which is passing through to domestic prices. The real depreciation appears to have prompted participants to make more permanent upward adjustments to inflation expectations. Panellists this month no longer expect the Central Bank to be able to maintain inflation below the upper limit of the current target rangean raised their forecasts by 0.5 percentage points from last month’s forecast.


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