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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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