Brasília, March 14, 2001

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431
United States of America

Dear Mr. Köhler:

In its letter of November 13, 1998, the government of Brazil requested support from the Fund in the form of a stand-by arrangement (SBA) for a period of 36 months. That letter, as well as our subsequent letters requesting the completion of the periodic reviews under the SBA, the sixth of which was completed by the IMF Executive Board on November 27, 2000, had attached a Memorandum of Economic Policies (MEP) describing the government's program of economic policies that has been supported under the SBA. Brazil is now in the third year of the three-year SBA, and the government remains fully committed to the thrust of that program. The MEP attached to this letter outlines the recent progress in implementing the government's economic policies and discusses its current economic program, as well as the economic outlook for this year. As usual, also attached is a Technical Memorandum of Understanding that sets out the specific quantitative targets (in the form of performance criteria, indicative targets, and structural benchmarks) that are to be observed under the SBA, which expires on December 1, 2001.

Brazil's economy performed strongly last year, with the economic growth accelerating to 4.2 percent (the highest level since 1995), inflation continuing to decline, the external accounts strengthening, and the fiscal performance improving further. We believe that the reforms that are currently underway, and which are detailed in the attached MEP, will help address Brazil's priority social needs, being instrumental in further promoting sustainable, noninflationary economic growth. The government stands ready to take additional policy measures, as needed to ensure the achievement of its overall objectives. We look forward to continued support from the Fund to these policies.

During the period of the arrangement, we will maintain the customary close policy dialogue with the Fund on the implementation of the program under the SBA.

Yours sincerely;

Brazil—Memorandum of Economic Policies

Brazil is now in the third year of the Three-Year Stand-By Arrangement (SBA) from the International Monetary Fund (the Fund), that was approved by the Fund's Executive Board on December 2, 1998. Two years of successful implementation of the government's program have helped to overcome the crisis of late 1998 and early 1999, and invigorate economic growth, to the benefit of the population. This Memorandum of Economic Policies (MEP) for the seventh review under the SBA outlines the most recent performance of the Brazilian economy, and the government's proposed policy framework for the remainder of the SBA, which expires on December 1, 2001, and beyond.

I.  Recent Performance of the Brazilian Economy

The economy continued to perform strongly in the year 2000. Real GDP growth reached 4.2 percent in 2000, with positive growth in all components of demand. On the supply side, the recovery was particularly pronounced in the industrial sector, which grew by 4.8 percent on average in 2000 (led by mining and manufacturing), and some services (particularly communications, which grew by 16.9 percent on average in 2000). Industrial production, which rose by 6.5 percent on average in 2000 compared to 1999, showed especially marked increases in the consumer durables (20.5 percent) and capital goods (12.7 percent) industries.

The recovery of economic activity has been reflected in strong growth of employment (4.3 percent on average during the twelve months to January 2001), with data from the six major urban areas surveyed by the Brazilian Statistical Institute (IBGE) pointing to the creation, in the twelve months to January 2001, of almost 600 thousand additional jobs in these areas alone. Although labor participation rates increased as employment prospects continued to improve, the number of unemployed declined by almost 340 thousand in the twelve months to January 2001, as the average rate of unemployment fell from 7.6 percent of the economically active population in the twelve months to January 2000, to 7.0 percent in the twelve months to January 2001. During November 2000–January 2001 the average unemployment rate was 1.5 percentage points below the same period a year earlier.

Continued progress has been made in reducing inflation. Following a temporary acceleration in the middle of 2000, in reflection of adjustments of administered prices (including electricity, telecommunication, and transport tariffs, and prices of oil products) and of adverse weather conditions that damaged seasonal crops in a number of states, inflation declined again in the remainder of the year. For 2000 as a whole, consumer prices (IPCA) rose by a cumulative 6.0 percent, in line with the government target and below the 8.9 percent recorded in 1999; the general price index (IGP–DI) increased by 9.8 percent, compared to 20 percent in 1999. This points to a continued increase in the relative prices of tradable goods (which have a larger weight in the IGP–DI than in the IPCA), albeit at a more moderate pace than in 1999. In January 2001, the IPCA registered the lowest January inflation since the index was created over 20 years ago, rising by 0.57 percent, as a reflection of reflected seasonal adjustments in transport fares and school fees, as well as some food price increases.

Brazil's external accounts continued to improve in 2000, albeit at a pace slower than initially projected. The trade deficit declined from US$6.6 billion in 1998, and US$1.3 billion in 1999, to US$0.7 billion in 2000. While export volumes posted a strong performance, rising by 11 percent on average (17 percent for manufactured goods), import volumes also rebounded markedly rising by 13 percent (24.5 percent for intermediate goods). Non-oil commodity prices remained subdued, and thus the terms of trade improved by only 3 percent from the depressed level of 1999. During January–February 2001, the trade balance recorded a US$399 million deficit, reflecting a continued rise in intermediate and capital good imports, and continued pressures from oil prices.

The external current account strengthened in 2000. Although the deficit in the services account of the balance of payments was slightly higher in nominal terms than in 1999, the current account deficit declined to 4.2 percent of GDP (US$24.6 billion) in 2000 from 4.7 percent of GDP (US$25.1 billion) in 1999. Reflecting the attractiveness of Brazil's investment environment, and despite some slowdown in privatizations, net foreign direct investment (FDI) continued to increase to a record US$30.6 billion in 2000, after having reached US$30 billion in 1999, significantly exceeding the current account deficit for the second consecutive year. In January 2001, Brazil recorded a current account deficit of US$2.3 billion, which was largely driven by payments of dividends and interest, while net FDI amounted to US$1.5 billion.

The capital account of the balance of payments also continued to improve. Net portfolio investments remained on a moderately positive trend, amounting to US$2.7 billion in 2000, and there was a substantial (US$7.8 billion) net inflow of medium- and long-term debt capital. Spreads on Brazilian sovereign bonds declined during 2000, helped also by upgrades in Brazil ratings, and recently have fluctuated around the average of the emerging market composite index. Sovereign debt issues in international capital markets amounted to US$12.0 billion, of which US$6.1 billion reflected exchanges to retire outstanding Brady bonds.

The total external debt declined to US$231.5 billion (39.7 percent of estimated GDP) at end-November 2000, from 241.5 billion (45.6 percent of GDP) at end-1999, and its public sector component decreased to US$90.4 billion from US$100.7 billion at end-1999. These declines mainly reflected the repayment in April 2000, partly ahead of schedule, of most of the special international support package of late 1998. Reflecting the rapid expansion of trade credits, the short-term component of the external debt, measured on an original maturity basis, rose from US$27.4 billion at end-1999 to US$29.0 billion by end-November 2000, but declined in relation to net international reserves from 115 percent to 92 percent over the same period.

The short-term capital account registered a US$6.4 billion deficit in 2000, as the decline in domestic interest rates reduced incentives for speculative inflows. The overall balance of payments recorded a surplus of around US$7.7 billion in 2000, and a surplus of US$2.6 billion in January 2001 alone. Gross international reserves increased from US$28.3 billion at end-June 2000 to US$35.6 billion at end-January 2001, equivalent to over 6 months of imports of goods and nonfactor services, and about 60 percent of estimated short-term debt on a residual maturity basis. On the same date, net international reserves stood at US$33.8 billion, US$8.8 billion above the Fund program floor for December 2000.

Brazil's fiscal performance was strong at all levels of government in 2000. The primary surplus of the consolidated public sector (measured from below the line) reached R$38.2 billion (3.5 percent of estimated GDP) for the year 2000, R$1.4 billion above the program floor; in January 2001 the primary surplus reached R$5.6 billion, about 19 percent of the government's target for January–September 2001. December 2000 marked the ninth consecutive quarter since the beginning of the program in which Brazil met its program target for the consolidated primary surplus. The overall deficit of the public sector (PSBR) declined to the equivalent of 4.6 percent of GDP in 2000, compared to 10.0 percent of GDP in 1999, while the net public debt remained broadly unchanged at around 49.5 percent of GDP at end-2000. The fiscal results for January 2001 showed a broadly stable PSBR relative to GDP (on a 12-month basis), and a small decline in the net public debt to 49.2 percent of GDP.

The improvement in the primary balance of the public sector was concentrated outside the central government. The primary surplus of the latter declined from 2.4 percent of GDP in 1999 to 1.9 percent of GDP in 2000, as revenues were adversely affected by the disappearance of substantial revenue from concessions and by the less than full pass-through of increases in international oil prices to domestic prices. Primary spending in 2000 remained broadly unchanged at around 16.5 percent of GDP.

The primary surplus of the states more than doubled, to the equivalent of 0.4 of GDP in 2000, helped by both the recovery of economic activity, which boosted revenues from the state-level VAT (ICMS), and the positive effects of the adjustment programs agreed with the federal government in the context of the debt restructuring agreements of 1998–99.

The primary surplus of the municipalities also more than doubled to over 0.1 percent of GDP in 2000, notwithstanding the municipal elections in October 2000, mainly reflecting improved fiscal management that has been promoted by the enactment of the Fiscal Responsibility Law. In addition, the federal government has now concluded debt restructuring agreements with about 180 municipalities (including those of São Paulo and Rio de Janeiro) which, together with the continued application of the Fiscal Responsibility Law, should contribute to maintaining fiscal discipline at the municipal level in the years ahead.

The improvement in the public enterprises' primary surplus from 0.7 percent of GDP in 1999 to 1.1 percent of GDP in 2000 reflected gains at all levels of government. However, the gains were most pronounced for the federal enterprises, particularly Petrobrás, which benefited from the impact of the high level of international oil prices on the company's gross profits, that more than offset higher investment in oil exploration, the construction of new thermolectrical plants, and upgrading of existing capacity.

The government's successful debt management was also reflected in significant improvements in the structure of the federal securitized domestic debt. By January 2001, the portion of this debt placed at fixed rates had increased to 16 percent of the total, from 9 percent at end-1999, while the share of debt linked to the overnight (SELIC) rate declined from 61 percent to 51 percent. At the same time, the government reduced its foreign exchange-indexed domestic debt from 24 percent of total federal securitized debt at end-1999 to 22 percent in January 2001, while expanding its outstanding stock of inflation-indexed debt from 2 percent of the total at end-1999 to almost 7 percent in January 2001. In the 12 months to January 2001 the average maturity of the debt increased by almost 10 months to 18.2 months. In early 2001 the government placed two 30-year inflation-indexed bonds totaling R$7 billion, and, for the first time since the Asian crisis in late-1997, succeeded in placing in the market a substantial amount of fixed-rate notes with an initial maturity of 24 months or more.

The government continued in 2000, albeit at a slower pace, to implement its privatization program, which has involved asset sales totaling over US$100 billion. The government decided to revise the privatization model for a major electricity generation company (Furnas) to facilitate the acquisition of shares by small investors, and it continued its efforts to restructure state-owned banks. In October 2000, the state bank of Paraná (BANESTADO) was successfully privatized for a total of R$1.6 billion; in November 2000, the majority of the voting shares of the former state bank of São Paulo (BANESPA) were sold to Spain's Banco Santander Central Hispánico (BSCH) for about R$7 billion.

The central bank (BCB) continued its cautious conduct of monetary policy within the inflation targeting framework. The benchmark overnight interest rate (SELIC) was kept at an annualized 16.5 percent from July 20 to December 20, largely on account of the unsettled conditions in international markets, and the potential impact of high oil prices on consumer price inflation. In light of the improved outlook for domestic inflation, and in line with market expectations, the rate was subsequently lowered in two steps, to 15.25 percent by January 17, 2001, and has been kept constant since.

At the same time, the BCB sought to facilitate reductions in the still high bank lending rates, by inter alia reducing the high minimum reserve requirements on bank deposits and strengthening the risk classification system for bank loans. As a result, as indicated in the most recent monthly BCB report on interest rates and lending spreads, average annualized bank lending rates declined from 62 percent in December 1999 to 49 percent in January 2001 (from 49 percent to 33 percent for enterprises), and average bank lending spreads fell by almost 10 percentage points during the same period. Further reductions in lending spreads will be fostered by the approval of the proposed new bankruptcy law, currently under consideration in congress, which, among others, aims to facilitate the realization of collateral.

The decline in lending rates contributed to a pickup in various components of bank credit to the private sector. Bank loans outstanding rose by 10.5 percent in the 12-months to December 2000, with particularly strong growth in some categories, especially credit to households. The improved economic environment was reflected in a significant decline in the share of loans overdue more than 180 days, from 10 percent in March 2000 to 6 percent in December 2000. Total bank provisions at end-December 2000 amounted to over R$22 billion (120 percent of all loans overdue more than 180 days), with private-sector institutions as a whole exceeding minimum provisioning requirements.

The BCB also continued to work on strengthening Brazil's financial system, its own supervision capacities, and overall transparency. Substantial progress was made in setting up a real-time gross settlements system to improve payments arrangements, and significantly reduce default risks, which is expected to become fully operational in October 2001. Progress has also been underway to have financial institutions operate a clearing system for foreign exchange operations at the Brazilian futures exchange (BM&F). Banking supervision was strengthened, in cooperation with the various supervisory authorities, and the BCB has continued to enhance the transparency of its operations. Later this year, the BCB plans to make publicly available on its website a procedures manual for bank supervision. Staffing improvements are underway at the BCB to ensure greater continuity of onsite bank supervision of large financial conglomerates and sectoral specialization of staff. In the area of offsite supervision of financial institutions, BCB staff is preparing weekly overview reports, and is developing improved supervision models. The BCB is conducting in-depth reviews of the mechanisms for lending to agricultural producers, micro-enterprises, and housing, with a view toward facilitating access to credit and strengthening the prudential framework. For some time already, the BCB has been publishing the minutes of its Monetary Policy Committee (COPOM) one week after each meeting, and also disseminates widely several monthly press releases that detail policy outcomes in the main macroeconomic areas. These releases supplement the wealth of high-frequency data and information the central bank makes available on its website. The BCB has nearly completed in-depth audits of the major federal banks, and, in cooperation with the Ministry of Finance, is defining an appropriate strategy for strengthening these banks.

II.  Policies and Prospects for 2001

The policy framework for 2001 aims at promoting the consolidation of the economic recovery, continued growth of employment, and a sustainable improvement in living standards for the majority of the Brazilian people, especially those in the lower income groups, in a context of low and declining inflation. In an international environment fraught with significant uncertainties, the simultaneous pursuit of these objectives will require a flexible management of macroeconomic policies, and a firm commitment by the government to the continued implementation of its structural reform agenda. This, in turn, should facilitate a further strengthening of market confidence, and a smooth financing of the external current account deficit.

The macroeconomic policy framework centers on the maintenance in 2001 of a substantial (3 percent of GDP) primary surplus of the consolidated public sector which, in conjunction with some further decline in interest rates, should allow a broad stabilization of the net public debt in relation to GDP. Monetary policy will aim at promoting a further decline of the rate of inflation in consumer prices (IPCA) to around 4 percent by year end, and the exchange rate will continue to float freely. The structural reform agenda will center on the proposed further reforms of the social security and tax systems, monetary and financial institutions, and corporate governance. The government will also endeavor to further the implementation of its privatization program.

In conjunction with a relatively benign international environment, these policies should facilitate the achievement of a rate of real GDP growth around 4½ percent this year, led by industrial activity and a strong performance in agriculture, where a bumper harvest of over 90 million tons is expected for this year. The growth of investment in equipment is expected to outpace that of consumption, as enterprises benefit from the recent decline in lending rates, strong profit growth, and face narrowing spare capacity margins; construction investment is also expected to accelerate in 2001. The continued strength of activity should be reflected in a sustained growth of employment, and a further decline in the unemployment rate. The expected productivity gains should facilitate continued moderation in unit labor costs, and the targeted decline of inflation, as well as a further recovery of real wages.

The real trade balance is likely to show some deterioration in 2001, also reflecting the impact on exports of a more subdued foreign demand. Nevertheless, exports are still projected to score significant gains in market shares, as a result of further gains in competitiveness, in part related to the weakening of the U.S. dollar vis-à-vis the Euro, and recent steps to facilitate Brazilian enterprises' access to foreign markets. Imports are expected to continue rising at a sustained pace, and the terms of trade to improve moderately, reflecting the projected decline in international oil prices and some recovery in non-oil commodity prices. On the whole, the trade balance may well show a modest deficit in 2001. The current account deficit of the balance of payments is also likely to widen somewhat, to around US$27 billion or 4½ percent of GDP. Despite an expected slowdown, FDI is projected to cover more than 80 percent of the current account deficit.

Other net capital inflows are expected to remain, on balance positive, reflecting the continuing improvement in Brazil's standing in international capital markets. In January 2001, Brazil successfully made two international bond issues totaling US$2.5 billion, covering 60 percent of the US$4.2 billion rollover needs for external public debt for the year. In February, the Treasury announced that it intends to buy US$100 million a month directly on the spot market (rather than drawing on the Central Bank's international reserves) for payment of interest on its external debt in 2001; such purchases had already totaled US$260 million in January 2001.

The overall balance of payments is expected to show a small surplus of around US$2 billion in 2001, allowing for some further increase of net international reserves (NIR), which is therefore projected to remain well above the US$25 billion program floor for March–November 2001, established in the attached Technical Memorandum of Understanding (TMU). On the assumption that no further purchases are made under the SBA, gross international reserves at end-2001 are projected to be equivalent to over 5½ months of imports of goods and nonfactor services, and to nearly two thirds of the total short-term debt on a residual maturity basis.

The central government budget for 2001 which, in contrast to 2000, was approved by congress before the beginning of the year, aims at facilitating the further planned consolidation of the public finances, while pursuing the government's social agenda. Thus it targets, on the one hand, the maintenance of a primary surplus equivalent to around 2 percent of GDP, while allowing for a significant expansion of expenditure on education, health, minimum pensions, rural development, as well as the creation of a R$3.1 billion poverty-alleviation fund, which will focus on education-linked income support programs and on basic sanitation facilities for poor areas.

These increases in social spending are expected to be facilitated by a continued strong growth of revenues, supported by the buoyancy of demand, by continuing improvement in tax enforcement—following in particular the recent passage by congress of legislation to curb tax evasion and avoidance—and by a modest increase (0.08 percentage points) in the financial transactions tax. The budget also projects increased revenues from concessions, especially for new airwave frequencies. The enactment in November 2000 of an automatic quarterly adjustment mechanism of domestic prices for oil products will also entail greater predictability of the surplus of the oil account in the budget (PPE). The government will continue to monitor closely the evolution of revenues during the year, and adjust the monthly spending limits provided to the various ministries, so as to ensure a budget outturn in line with the R$29.45 billion (2.45 percent of GDP) combined primary surplus of the central government and the federal enterprises targeted in the budget framework law (LDO) for this year.

The states and municipalities are also expected to continue consolidating their finances in 2001, registering a primary surplus broadly equivalent to that recorded in 2000, or around 0.55 percent of GDP. Most states and municipalities will need to continue their efforts to reduce their ratio of indebtedness and of personnel expenditures to revenues, in line with the requirements of the Fiscal Responsibility Law. Some of the states are also expected to make further progress in the privatization of their enterprises, including in the energy and utilities sectors, and of their banks.

The primary surplus of the public enterprises is likely to decline significantly from its record level of 2000, to around 0.5 percent of GDP, mainly reflecting the adverse impact of the projected decline in international oil prices on the finances of Petrobrás. On the whole—assuming some further decline in interest rates and in spreads on Brazil's sovereign debt, and stability of the exchange rate—the PSBR is projected to decline to around 3.5 percent of GDP, and the net public debt to increase slightly to 49.7 percent of GDP, after allowance for privatization revenues and the planned securitization of unrecorded liabilities, as set out in the attached TMU.

The government will continue its efforts to further increase the share of fixed-rate instruments in the securitized domestic federal debt, reduce the share of foreign exchange-indexed securities, and raise average maturities. It will also endeavor to further improve the structure of its external debt, by extending duration, smoothing the amortizations profile, and diversifying the currency mix.

The government is committed to further progress during 2001 in the structural fiscal reforms which it considers important to improve the quality, equity, and sustainability of the fiscal adjustment achieved so far. It therefore will continue to work toward rapid congressional approval of the pending legislation in the reform of pension funds, the introduction of a social security contribution for retired civil servants, and the remaining two pieces of implementing legislation for the administrative reform, a law regulating dismissals of tenured public employees for inadequate performance, and a constitutional amendment that establishes remuneration limits for public employees. It will also seek to move forward the proposed reform of indirect taxation through a constitutional amendment establishing national legislation for the state-level VATs, as well as an explicit system of taxation for domestic oil products to replace the implicit taxes embodied in the oil account in the budget by end-2001, when the domestic oil market is scheduled to be fully liberalized. In addition, the government is seeking through ordinary legislation to revise the main federal indirect taxes and contributions, with a view to reducing their cascading effects and eliminating their implicit bias against exports. The government is also continuing its efforts to improve the management of public spending, through the pluriannual plan (PPA) and the budget formulation and execution process.

Monetary policy will continue to be conducted within the inflation targeting framework, aiming at reducing inflation in the IPCA to 4 percent by year end, in line with the central target set by the government. As set out in the attached TMU, a quarterly path for inflation consistent with the end-year target, has been established under the program, in line with the practice initiated in 2000. The BCB intends to continue its periodic exchange of views with the Fund staff about the evolution of monetary policy.

The BCB is planning a number of additional steps (detailed in the attached TMU) to enhance the regulatory framework for banks, and its off-site supervision systems. It is also considering to participate in the Financial Sector Assessment Program (FSAP), building on the previous assessment of the Observance of Basel Core Principles that was carried out with the assistance of the IMF and the World Bank.

In addition, the government intends to put forward soon draft legislation to strengthen capital markets supervision by unifying various regulatory agencies active in this area into a single one. It will also continue to work closely with congress toward the passage of the pending draft law on publicly traded companies, which aims at improving transparency and governance in these enterprises.

Promoting further regional integration and policy coordination within Mercosur remain high on the government's policy agenda. An important milestone was reached with the adoption in December 2000 of common macroeconomic and fiscal targets among the Mercosur members, Chile and Bolivia, which was ratified by the presidents of the six countries. This agreement is expected to promote greater macroeconomic convergence, and reduce the risks of financial instability in the region. In addition, Brazil remains committed to multilateral trade liberalization in the context of broad-based negotiations to include trade in agricultural products. Brazil agreed in December with its Mercosur partners to reduce the 3 percent surcharge on the Mercosur common external tariff by 0.5 percentage points, at the beginning of 2001, and to phase it out by end of 2002.

Brazil has made substantial progress in improving its statistical base, and has now met all requirements for subscribing to the SDDS. Further progress is expected to be made in 2001, particularly in preparing quarterly national accounts for aggregate demand components, developing a producer price index, and defining monetary aggregates that are more in line with common international practice, as outlined in the attached TMU.

In summary, Brazil's performance under the SBA has been remarkably successful. The government remains fully committed to the objectives and policies of the program, and to a continued close and constructive dialogue with the Fund. The eighth and final review of the program will be conducted later this year, before the SBA expires on December 1, 2001.

Brazil—Technical Memorandum of Understanding

This Technical Memorandum of Understanding (TMU) for the Seventh Review under the Stand-By Arrangement (SBA) for Brazil sets out the specific performance criteria (PCs), indicative targets (ITs), structural benchmarks (SBs) and assumptions that will be applied under the SBA during 2001 for the remainder of the SBA.

I.  Phasing of Purchases and Reviews

The general phasing of purchases and reviews through 2001 is shown in Table 1 below. Accordingly, after completing the seventh review, which will make available to Brazil a purchase under the credit tranches (CT), there will be one more review, and a total of three purchases available under the CT in the year 2001.

Table 1. Brazil: Phasing of Purchases and Reviews

II.  Quantitative Targets

1.  Fiscal Targets

a.  Performance criterion for the primary balance of the consolidated public sector¹

The cumulative primary balance of the consolidated public sector is defined as the sum of the cumulative primary balances of the various entities that make up the public sector. The public sector is defined to comprise the central government, state and municipal governments, and the public enterprises (including federal, state and municipal enterprises); the central government includes the federal government, the social security system, and the Central Bank of Brazil (BCB).

For any given month, the primary balance of the consolidated public sector is measured, in Brazilian reais (R$), as the total net interest (i.e., net interest accrued on the consolidated net domestic debt of the public sector, plus the net interest due (competência contratual) on the net external debt of the public sector) minus the borrowing requirement of the consolidated public sector, where the public sector is defined as above. For foreign-exchange indexed government securities, the interest rate is the accumulated rate of change of the U.S. dollar vis-à-vis the R$, plus the fixed coupon rate. The fixed coupon rate applies to the nominal value of the security revalued by the rate of change of the U.S. dollar vis-à-vis the R$ from the issuance date to the relevant date. For any given month, the borrowing requirement of the consolidated public sector is defined as the change in the nominal outstanding net domestic debt plus the change in the net external debt, converted into R$ at the actual period average R$/US$ exchange rate.¹ The stock of the U.S. dollar-indexed domestic debt is revalued at the end of a given month to reflect any change in the value of the real vis-à-vis the U.S. dollar that has taken place during the month. The proceeds from privatization during that period are added to these results; amounts representing the recognition of unregistered liabilities during that period are subtracted from these results. The cumulative primary balance from January 1 of a given year to the relevant date of the same year is the sum of the monthly primary balances of the consolidated public sector for that period.

Also, the above floor for the cumulative primary balance of the consolidated public sector is predicated on the baseline path for concession revenue shown in Table 2 below. Deviations from this path will be taken into account as appropriate during the eighth review.

b.  Indicative target on the net debt of the consolidated public sector ¹

Total net debt outstanding of the consolidated public sector (dívida líquida total) equals the public sector's gross debt (including the monetary base), net of its financial assets; it is defined as the sum of the registered net domestic and net external debt (all valued in R$), of the central government, state and municipal governments, and the public enterprises (including federal, state and municipal enterprises); the central government is defined as above.

Total net debt outstanding of the consolidated public sector is measured on an accrual basis (including accrued interest) for the domestic debt component, and on an interest-due basis (competência contratual) for the external debt component. The stock of external debt and of foreign-exchange indexed domestic debt is valued at the actual R$/US$ exchange rate prevailing at the end of each period.

The central government will continue to incorporate into its registered debt various unregistered liabilities that are currently outstanding. The above ceilings for the total net debt outstanding of the consolidated public sector are predicated on the paths for privatization receipts (defined here to exclude concession revenue) and the recognition of unregistered liabilities that are shown in Table 2 below. These ceilings will be adjusted downward (adjusted upward) to the extent that privatization receipts exceed (fall short of) the amounts implied by Table 2 below; they will be adjusted upward (adjusted downward) to the extent that the recognition of unregistered liabilities exceeds (falls short of) the amounts implied by Table 2 below.

2.  External Sector Targets

a.  Performance criterion on external debt of the nonfinancial public sector¹

For any given quarter, the stock of debt² disbursed and outstanding is defined as the stock of debt disbursed and outstanding at the end of the previous quarter, plus gross disbursements that take place during the quarter in question, less the gross amortization payments made during the quarter in question.

The above limits will be adjusted upward to accommodate new external borrowing that is made in order to undertake a voluntary early or advance repurchase to the Fund. Should the authorities wish to make any early or advance repayments to other contributors to the exceptional financing package, they would make advance repurchases from the Fund on at least a proportional basis.

b.  Performance criterion on publicly guaranteed external debt of the private sector¹

For any given quarter, the stock of external debt guaranteed by the public sector is defined as the stock of external debt guaranteed by the public sector that is outstanding at the end of the previous quarter, plus the net addition to external debt guaranteed by the public sector during the quarter in question.

c.  Performance criterion on nonfinancial public sector short-term external debt¹

Short-term debt³ is defined as all debt with an original maturity of strictly less than one year. For any given quarter, the stock of short-term external debt (disbursed and outstanding) is defined as the stock of short-term external debt (disbursed and outstanding) at the end of the previous quarter, plus the net flows associated with the disbursements and amortizations of short-term debt that take place during the quarter in question.

The above limits will be adjusted upward to accommodate new external borrowing that is made in order to undertake a voluntary early or advance repurchase from the Fund.

d.  Performance criterion on net international reserves (NIR) in the BCB¹

The NIR in the BCB are equal to the balance-of-payments concept of net international reserves in the BCB (reservas internacionais líquidas ajustadas) and include gross official reserves minus gross official liabilities.

Gross official reserves are defined as liquid foreign currency denominated claims in the BCB. Gross official reserves include (i) monetary claims, (ii) free gold, (iii) holdings of SDRs, (iv) the reserve position in the IMF, and (v) holdings of fixed income instruments. Items (i) through (iv) will be valued at the end-period prices shown in Table 3 below. Item (v) will be valued marked to market. Gross official reserves will exclude participation in international financial institutions, the holdings of nonconvertible currencies, and the holdings of precious metals other than gold.

Gross official liabilities in foreign currencies include (i) foreign currency liabilities with original maturity of one year or less, (ii) the use of Fund resources extended in the context of the exceptional financing package, and (iii) any forward foreign exchange (FX) liabilities on a net basis—defined as the long position (posição vendida) minus the short position (posição comprada)—directly undertaken by the BCB or by other financial institutions on behalf of the BCB. Items (i) through (iii), will be valued at the prices shown in Table 3 below.

After January 31, 2001, any increases in foreign currency-denominated claims (both spot and forward) against residents, or against foreign branches or subsidiaries of Brazilian institutions, do not count toward NIR in the BCB.

e.  Performance criterion on the BCB's exposure in FX futures markets

The BCB will continue to refrain from entering into FX futures contracts, either directly or through any institution it uses as its financial agent. This constitutes a performance criterion under the program.

f.  Performance criterion on the BCB's exposure in FX forward markets

The BCB will continue to refrain from entering into FX forward contracts, either directly or through any institution it uses as its financial agent. This constitutes a performance criterion under the program.

3.  Monetary Targets

a.  Consultation mechanism on the 12-month rate of inflation

For March, June, and September 2001, the quarterly consultation bands around the target for the 12-month rate of inflation in consumer prices (as measured by the Indice de preços ao consumidor ampliado (IPCA)) are specified as follows:

Consultation bands for the 12-month rate of change of the IPCA (in percent)

The BCB will discuss with the Fund staff about the appropriate policy response should the 12-month rate of IPCA inflation exceed the upper limit of the inner band specified in the table above. Should the 12-month rate of IPCA inflation exceed the upper limit of the outer band specified above, the authorities will complete a consultation with the Executive Board of the IMF (henceforth the Board) on their proposed policy response.

III.  Structural and Statistical Benchmarks

A.  Structural Benchmarks

By end-March 2001

• Issuance of regulations for the implementation of a capital charge related to equity and commodity risks.

By end-June 2001

• Issuance of new investment regulations for complementary pension funds.

• Definition of a comprehensive strategy for strengthening the federal banks.

• Enactment of the remaining pieces of implementing legislation for the administrative reform.

• Presentation to congress of a draft constitutional amendment to introduce unified legislation for the states' value added tax (ICMS).

• Issuance of a regulation to reduce banks' portfolio exposure to individual clients.

• As part of the development of a new off-site banking supervision system, implementation of a new market monitoring system, including for public and private securities, operations in the futures exchange, and exchange-rate risk.

By end-September 2001

• Completion of a revision and upgrade to international standards of the plan of accounts for financial institutions, the rules for recording and evaluating assets and liabilities of these institutions, and the reporting to the BCB and the public of the financial statements of financial institutions.

• Presentation of enabling legislation to introduce an explicit taxation of oil products after enactment of the relevant constitutional amendment.

• Further progress in the privatization of the federalized state banks and the Brazilian Reinsurance Institute (IRB).

• Issuance of regulation to allow and develop credit derivatives.

By end-November 2001

• Development of a rating system for banks.

• Development of methodologies and programs to evaluate the performance of the banks' own internal risk measurement models for analyzing market risk.

• Design of the new off-site banking supervision system to be completed.

The above list of structural benchmarks will be reassessed and amended as necessary during the eighth review of the program.

B.  Statistical Benchmarks

By end-June 2001

• Begin publication of broad monetary aggregates as redefined on an internationally comparable basis.

By end-September 2001

• Begin regular publication of full quarterly demand-side national accounts at current and constant prices. The publication lag should be no longer than three months.

• To strengthen monetary accounts, broaden the financial and banking system surveys in line with international practice.

The above list of statistical benchmarks will be reassessed and amended as necessary during the eighth review of the program.

IV.  Disclosure of Specific Information

Specific data to continue to be provided by the authorities to the Fund staff include the following (at the indicated frequencies, and lags):

• Composition of gross international reserves under the cash concept (posição de caixa) and the liquidity concept (posição liquidez internacional) (weekly, the following week);

• The levels of gross international reserves and of net international reserves as defined under the NIR concept (daily, the next business day);

• The BCB's position in FX futures, including notional amounts of open-interest contracts, both bought and sold, in each contract for the next four months (daily, the next business day if this position should exceed zero);

• Outstanding stocks of US$-indexed federal debt by instrument, showing auction values (preço de lastro) and updated nominal values (valor nominal atualizado), as well as information on rollovers of these instruments, showing the face value of the amounts falling due, and new placements of this debt (following each auction, with a one-day lag);

• Quantitative results of the monitoring of the external credit lines of financial institutions (two business days after the deadline at which these institutions have to comply), and of external medium- and long-term bank claims on Brazilian nonbank debtors (once a week for the previous week).

All data will continue to be provided preferably in electronic format; the above list will be reassessed during the eighth review of the program.

V.  Program Assumptions for Selected Variables