Press Release No. 98/59

Press Release: IMF Approves SDR 13 Billion Stand-By Credit for Brazil; Activates NAB

December 2, 1998

The International Monetary Fund (IMF) today approved Brazil’s request for a three-year stand-by credit equivalent to SDR 13,025 million (about US$18.1 billion) in support of the government’s economic and financial program. The stand-by credit is equivalent to 600 percent of Brazil’s IMF quota¹ of SDR 2,170.8 million (about US$3.0 billion). To help finance Brazil’s drawings under the credit during the first year, the IMF also approved the first activation of the New Arrangements to Borrow (NAB).

Of the total credit, 70 percent--or SDR 9,117 million (about US$12.7 billion)--will be made available under the Supplemental Reserve Facility (SRF) (see Press Release No. 97/59), and the remainder through IMF’s regular lending facilities. Through end-1999, the equivalent of SDR 11,288 million (about US$15.7 billion) will be made available, of which SDR 3,799 million (about US$5.3 billion) is available immediately.

Subject to implementation of the key fiscal measures and the completion of a review by the IMF Executive Board, a further SDR 3,256 million (about US$4.5 billion) would be available under the SRF by end-February 1999. However, this tranche could be brought forward at the request of the Brazilian authorities and subject to approval by the Executive Board. There are two further disbursements under the SRF, each in the amount of SDR 1,302 million (about US$1.8 billion), and each available subject to reviews currently scheduled to be completed by May 31, 1999, and August 31, 1999, respectively. Depending on circumstances and subject to the completion of these reviews, these two disbursements could be also brought forward to as early as March 1, 1999, and June 1, 1999, respectively, at the request of the Brazilian authorities. The remaining IMF financial support would be available on a quarterly basis, starting with SDR 543 million (about US$755 million) after February 28, 1999, and the rest through the remainder of the program.

The IMF is financing SDR 9,117 million of the total of SDR 13,025 million by borrowing the equivalent amount under the NAB, which became effective on November 17, 1998 (see Press Release No. 98/57 and the attached announcement by Chairman of the NAB). Calls on the lending participants will be made in proportion to the amounts in Table 1, and in line with drawings by Brazil under the SRF.

Background

Since its inception in July 1994, Brazil’s Real Plan has been instrumental in promoting a remarkable and sustained reduction of inflation, in combination with significant growth of real GDP per capita--a performance that contrasts sharply with the stagnation of real incomes and high inflation of the 1980s and early 1990s. Progress in achieving macroeconomic and financial stability was accompanied by substantial structural reforms--including a continued opening of the economy, large scale privatization, demonopolization and deregulation of key sectors, and a substantial strengthening of the financial system. These reforms contributed to a recovery of domestic investment, a surge of foreign direct investment, and significant productivity growth.

The public finances, however, continued to be beset by fundamental weaknesses, made more evident by the progressive disappearance of the inflation tax. As a result, the primary balance of the consolidated public sector--including all levels of government, the central bank, and public enterprises--shifted from a surplus equivalent to 5.3 percent of GDP in 1994 to a deficit of about one percent of GDP by 1997. The sharp decline in public sector savings--only partly redressed by a recovery of private savings--was reflected in a deterioration of the external current account balance--from near equilibrium in 1994 to a deficit equivalent to 4.1 percent of GDP by 1997. This, in turn, heightened Brazil’s vulnerability to external shocks and to sudden changes in market sentiment.

Strong external pressures developed after the Russian devaluation in mid-August 1998. The Government responded swiftly by sharply rasing interest rates, taking emergency measures to reduce the 1998 federal budget expenditures and the federal enterprises investment program, and creating a high level interministerial commission to closely monitor the public finances and propose corrective measures as needed. The authorities also announced in September, ahead of the Presidential elections, the intention to put in place a front-loaded three-year fiscal adjustment program with growing primary surpluses sufficient to stabilize the ratio of the public debt to GDP by the year 2000. They also intensified the dialogue with the international financial institutions and other members of the international financial community to gain support for their adjustment program.

Program Objectives

The authorities’ medium-term economic program is centered on fiscal adjustment and structural reform and is expected to allow the resumption of sustained growth in real per capitaincome beginning in the year 2000, following a likely decline in 1999; the continuation of low inflation; and a gradual improvement of the current account deficit to a level fully sustainable over the medium term. The main elements of the program are:

• a strong and front-loaded fiscal adjustment effort--with most of the fiscal adjustment expected to occur already in the first half of 1999--aimed at arresting quickly the rapid growth of the public sector debt;
• the maintenance of the current exchange rate regime;
• a firm stance of monetary policy, aimed at supporting the exchange rate regime, while safeguarding net international reserves; and
• wide-ranging structural reforms.

The macroeconomic scenario underlying the fiscal program assumes that confidence will be rebuilt gradually, as the announced measures are implemented and begin to improve the fiscal accounts and as access to foreign financing improves for Brazil, as well as other emerging market borrowers. Under this scenario, interest rates are assumed to remain relatively high, albeit declining, through the first half of 1999 and to further decline beyond this period Real GDP growth is expected to recover to 3 percent and 4 percent respectively in 2000 and 2001.

The Fiscal Adjustment

The government’s fiscal adjustment program aims at broadly stabilizing the ratio of the net public debt to GDP by the year 2000, and reducing it gradually thereafter in accordance with the achievement of primary surpluses of the consolidated public sector equivalent to 2.6 percent of GDP in 1999, 2.8 percent in 2000, and 3 percent in 2001. Under these assumptions, the Public Sector Borrowing Requirements (PSBR) would decline to about 4.7 percent of GDP in 1999, and further to about 3 percent 2000, and to 2 percent in 2001. All levels of government are expected to contribute to the fiscal adjustment effort.

To achieve the targeted improvement at the federal level, the government has announced a comprehensive set of revenue-raising and expenditure-reducing measures designed to yield overall savings to the budget on the order of 3.4 percent of GDP in 1999. On the revenue side, measures include increases in the financial transactions tax and in social security contributions by public employees. On the expenditure side the measures include substantial cuts in discretionary current and capital spending , as well as savings expected from the implementation of the recently approved constituional reforms of the civil service and the social security. In the allocation of the expenditure cuts the government has endeavored to safeguard social programs as much as possible.

Structural Reforms

The Brazilian authorities fully recognize that a sustainable improvement in public sector finances requires fundamental structural reforms to address longstanding weaknesses in the budget process, the tax system and the tax administration, public administration, social security, and the efficiency of public expenditure, especially in the social area.

To these ends, the government intends to introduce a number of reforms in the budget process aimed at strengthening budget discipline at all level of government and making the budget a more effective instrument for allocating of public resources. A centerpiece of this effort will be the Fiscal Responsibility Act, which will be submitted to Congress shortly.

To complete the recently approved administrative reform, the government has already submitted to Congress various enabling laws and regulations, that should ensure that reforms begin to produce effects during 1999. The government has also just announced a comprehensive reform of the system of indirect taxation.

Following the recent approval by Congress of a constitutional amendment on social security reform, the authorities intend to introduce early next year complementary legislation to deepen the reform, with a view to putting the social security finances on sound footing and increasing the fairness of the system, while broadening the scope for individual choice.

In the past few years the Brazilian government has undertaken one of the most ambitious privatization programs in the world. In 1999 the program will include companies in the electrical sector - power generation and distribution - some of the remaining state banks, and some water, gas, and sewage public utilities.

The authorities recognize that well-targeted and efficient social expenditure programs play a vital role in the alleviation of poverty and in the development of human capital. The government intends to give priority to primary education and basic health care in the allocation of social expenditures, to promote the more efficient use and financing of health and education--particularly at the higher levels--and to better target social expenditures for the poor.

Additional Financing

In addition to the IMF funding in support of the Brazilian program, the President of the World Bank, has indicated his readiness to recommend for the Bank’s Board approval the provision of up to US$4.5 billion in support of Brazil’s program. Similarly, the President of the Inter American Development Bank (IADB), has also recommended to his Board an IADB support package of US$4.5 billion.

Brazil’s program will also receive bilateral support from a number of industrial countries in North America, Europe, and Asia, whose governments or central banks will provide through, or in coordination with, the Bank for International Settlements (BIS) additional financing totaling approximately US$14.5 billion. This additional amount will be available over the next 12 months.The first disbursement will be proportional to Brazil’s first drawing from the SRF resources under the credit.

Brazil is an original member of the IMF. Its outstanding use of IMF credit currently totals SDR 7.8 million (about US$11 million).