Brazil—Letter of Intent, Memorandum of Economic Policies, and Technical Memorandum of Understanding

Brasília, March 4, 2002

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

Dear Mr. Köhler:

In its letters dated August 23, 2001 and November 30, 2001, the Government of Brazil provided Memoranda of Economic Policies (MEP) describing its economic program supported under the current 15-month stand-by arrangement (SBA). The MEP attached to this letter outlines recent progress and discusses additional policies and prospects for 2002. Also attached is a Technical Memorandum of Understanding (TMU) that sets out specific targets (in the form of performance criteria, indicative targets, and structural benchmarks) that are to be observed under the SBA. In addition to the policies outlined in the attached MEP, the Government stands ready to take additional measures as appropriate to ensure the achievement of its objectives. During the period of the SBA, the authorities of Brazil will maintain the usual close policy dialogue with the Fund.

As you are aware, a portion of Brazil's domestic public debt is foreign exchange indexed. To enhance the efficiency of the rollover of the relatively large volume of these bonds coming due in the next few months, we intend to begin issuing foreign exchange-indexed debt in two parts: a domestic currency denominated bond paying a floating interest rate, and a stripped foreign exchange insurance instrument. This change is of a technical nature, and would not increase the foreign exchange exposure of the public sector. However, by allowing the price of each component of the debt instrument to be determined separately, it would reduce the rollover costs of foreign exchange-indexed securities maturing in the coming months.

The Government plans to use this new procedure only to roll over the existing foreign exchange-indexed debt. In addition, it remains committed to unwind these transactions over time as market conditions permit, and to increase the stock of foreign exchange-indexed debt only in extraordinary circumstances. Based on these understandings, we request that the performance criteria regarding the non-utilization of foreign exchange futures or forward contracts be modified to accommodate this proposal, as in the attached TMU.

Yours sincerely,

Brazil—Memorandum of Economic Policies

The maintenance of disciplined monetary and fiscal policies and continued progress on the structural reform agenda enabled the Brazilian economy to withstand a series of economic shocks in 2001 while maintaining external confidence. Signs of an incipient recovery in domestic demand are emerging, and this recovery should accelerate over the course of 2002. However, the external environment remains volatile, and macroeconomic policies should therefore remain cautious.

I.  Recent Performance of the Brazilian Economy

1.  Data released since the preparation of the November 2001 Memorandum of Economic Policies (MEP) suggest that the deceleration of economic activity during the second and third quarters of 2001 came to an end late last year, with some indications that a modest recovery in demand may be underway. Industrial production increased by 1.5 percent in November (seasonally adjusted versus the previous month), marking the first such increase since February 2001, with durable goods production rising particularly sharply, and by 1 percent in December. For the year as a whole, the industrial production rose by 1.5 percent with capital goods rising by 12.8 percent. In addition, firm-level surveys indicate that inventories-which were at relatively high levels in the second and third quarters-declined in the fourth quarter to levels similar to those in the fourth quarter of 2000. Survey data (the Sondagem Industrial survey conducted by the National Industrial Confederation) also found that in the fourth quarter of 2001 the majority of entrepreneurs were optimistic about current economic conditions and future prospects, in both cases for the first time since the first quarter of 2001. Real retail sales in metropolitan São Paulo rose in November for the fourth consecutive month (in seasonally adjusted terms). In December, it fell 1.6 percent but preliminary numbers for January are indicating recovery. In addition, consumer confidence (as measured by the Índice de Intenções do Consumidor) grew sharply in January (the third consecutive monthly increase). Overall consumer sentiment now stands at its highest level since May 2001.

2.   Labor market developments have also been positive of late. The open unemployment rate in the six metropolitan areas surveyed by the IBGE fell to 5.6 percent in December from 6.4 percent in November, although it remained broadly constant in seasonally adjusted terms. Formal-sector employment continued its steady rise in November (seasonally adjusted), and increased by 2.9 percent over the first 11 months of 2001 compared to the same period of the previous year, representing an increase of 845,000 formal sector jobs.

3.  The successful operation of the government's energy-saving program, combined with improvements in the regulatory framework and substantial investments by private sector firms, have combined to minimize the impact of the energy crisis on economic activity. Expenditure reducing measures introduced by households and businesses are likely to result in permanent energy savings. The resulting reduced energy consumption, together with the satisfactory level of rainfall during the last few months and the more efficient reallocation of electricity across regions allowed for an increase in reservoir levels and the suspension of the rationing program on March 1st.

4.  A number of measures have been introduced to attract sufficient foreign investment to the energy sector and promote increased supply in the medium and long terms. In particular, the Government has entered into an agreement with generation and distribution companies to overcome major bottlenecks that hampered the efficient functioning of the electricity sector, to recoup losses associated with the rationing program, and to strengthen the financial positions of these firms and their capacity to invest. A new, more efficient system of energy supply and price determination will support the operation of the electricity system in the medium term. The national energy operator will periodically evaluate generation capacity over a rolling two-year horizon, thereby providing more accurate pricing signals. In addition, as a further step towards liberalization, a regulation has been issued indicating that energy generated by existing state owned hydroelectric generators, whose production costs are lower than those for newer plants using alternative sources, will be sold through competitive auctions. This will alleviate uncertainty about the future pricing and method of commercialization of the output of these companies. The revenues accruing to these state companies from the auction mechanism may be used in part to finance additional investment in the system or to subsidize electricity consumption of low-income families.

5.   Inflation was higher than anticipated in 2001, reaching 7.7 percent at end-year, above the 6 percent upper bound of the official target and the 6.8 percent bound established under the Stand-By Arrangement for consultations with IMF staff. More than one-third of end-year inflation (2.9 percentage points) is estimated to reflect the passthrough to prices of the nearly 20 percent depreciation (or 28.6 percent on average) of the real during 2001. An additional one-quarter (1.7 percentage points) arose from adjustments to administered prices (after excluding the impact of exchange rate passthrough and inertia from 2000 inflation on these prices). Increases in electricity and petroleum prices weighed particularly heavily on consumer prices last year.

6.  The external current account continued to strengthen in the fourth quarter, despite the modest recovery of demand and a significant appreciation of the real late in the year. The trade balance recorded a surplus of US$1.4 billion in the fourth quarter, including a record US$857 million surplus in December, pushing the annual surplus-Brazil's first in seven years-to US$2.6 billion, compared to a deficit of US$0.7 billion in 2000. Despite weakened global demand, exports grew by nearly 6 percent in nominal terms (and 9.6 percent in volumes), with most of the increase coming from exports of primary goods. Imports fell by about ½ percentage point in nominal terms (although they rose by about 3 percent in volume terms). The improved trade outcome led to a decrease in the overall current account deficit from US$24.7 billion in 2000 to US$23.2 billion in 2001, notwithstanding an increase in net remittances of profits and dividends (of US$1.6 billion).

7.   Capital account flows have improved significantly in recent months, despite developments in Argentina. Net FDI reached US$7.4 billion in the fourth quarter of 2001, including an exceptionally large inflow of US$3.9 billion in December. For the year as a whole, net FDI reached U$22.6 billion, down from the very strong US$32.8 billion level recorded in 2000 but still equal to nearly 98 percent of the annual current account deficit. Excluding privatizations, net FDI reached US$21.6 billion in 2001, compared to US$25.7 billion in 2000. A number of Brazilian firms have tapped international capital markets in recent months, and in January the Government accessed these markets for the first time since July 2001, raising US$1.13 billion (40 percent of the 2002 central government amortizations) through the issuance of 10-year bonds. Since September 2001 the rollover rate on interbank credit lines has averaged 96 percent, reflecting net payments of trade credits. Increased investor confidence in Brazil has led to an appreciation of the real from the lows reached in the aftermath of the September 11 attacks, and bond spreads have declined significantly, although they remain higher than at the start of 2001.

8.   Gross international reserves, which stood at US$40.1 billion at end-September, declined to US$35.9 billion at end-December, due mainly to the impact of pre-announced programmed sales of foreign exchange in the spot market. Interest and amortization payments on public debt were partially offset by the receipt in November of US$2.5 billion stemming from the liquidation of debt owed by the government of Poland. Also at end-December, gross reserves stood at 61 percent of short-term debt on a residual maturity basis, compared to 69 percent at end-September and 56 percent at end-2000. Net international reserves as measured under the program equaled US$27.8 billion at end-2001, US$7.8 billion above the program floor.

9.  At end-November, total external debt (excluding intercompany loans) amounted to US$211.7 billion (41.2 percent of estimated GDP), compared to US$216.5 billion at end-September. Its public sector component also declined, to US$94.7 billion at end-November from US$97.4 billion at end-September (although it was still higher than the US$92.4 billion at end-2000, due in part to borrowing from the Fund). The short-term component of the external debt, measured on an original maturity basis, decreased from US$27.4 billion at end-2000 to US$27.0 billion at end-September 2001 and US$26.1 billion at end-November, due to the lengthening of loan terms for Petrobrás and the net repayment of trade credits. Net of debt to the Fund, the external debt of the nonfinancial public sector stood at US$86.4 billion at end-November, while the short-term external debt of the nonfinancial public sector stood at US$0.5 billion. Both of these values are well-below the end-December ceilings established under the Stand-By Arrangement.

10.   Fiscal performance remained strong in the fourth quarter of 2001. For the year as a whole, the consolidated public sector recorded a primary surplus of R$43.7 billion (3.7 percent of GDP), well above the target of R$40.2 billion (3.35 percent of GDP) established by the Government. The public sector borrowing requirement, on a harmonized basis-excluding the impact of exchange rate-induced changes in the valuation of the debt stock accrued but not actually paid during the reference period-was about 3.6 percent of GDP¹. The net public debt rose to 53.3 percent of GDP at end-2001 from 49.4 percent at end-2000, although it remained below the indicative target ceiling for the net public debt. About 1 percentage point of this increase represents the recognition by the Government of previously unrecorded liabilities as part of the federal bank restructuring program implemented in mid-2001.

11.   All elements of the public sector contributed to the achievement of the primary surplus target for 2001. For the year as a whole, the central government posted a primary surplus of 1.9 percent of GDP; the states and municipalities recorded a combined primary surplus of 0.9 percent of GDP; and the public enterprises posted a surplus of 1.0 percent of GDP. Revenue performance at all levels was solid, and expenditure control also remained strong.

12.  Despite market turbulence last year, the government successfully lengthened the maturity and increased the duration of the public debt. The average maturity of competitively-placed outstanding securitized federal debt rose from 15.9 months at end-2000 to 25.5 months at end-2001 (from 29.9 months at end-2000 to 35.0 months at end-2001 for all securitized federal debt), while average duration grew from 6.4 to 10.5 months over the same period. Improvements in debt management allowed for a reduction in the share of short-term public debt, defined as the stock of debt maturing in less than 12 months, to 25.6 percent of the securitized public debt stock, compared to 42.4 percent at end-2000 and 27.1 percent as programmed by the Government at the beginning of 2001. As noted in the last MEP, the depreciation of the exchange rate and the additional sale of foreign exchange-indexed debt, particularly under the exceptional circumstances of September-October 2001, led to an increase in the share of this type of debt in the total debt stock during most of 2001. However, reflecting both the appreciation of the real that occurred late in 2001 and the fact that the rollover of these instruments has been limited to 100 percent since end-October, their share in the debt stock has fallen since the end of the third quarter of last year: at end-December 2001, foreign exchange-indexed debt accounted for some 28.6 percent of outstanding securitized federal debt, down from 32.9 percent at end-October. In recent months the Central Bank and the Treasury have sought to lengthen the average maturity of exchange rate-indexed debt and adjust its maturity profile, successfully swapping instruments falling due in the February-April 2002 for ones with tenors of two to three years.

13.  The Central Bank had maintained the overnight SELIC interest rate at 19 percent in the period since the November MEP, but with end-2002 and end-2003 inflation forecasted to be comfortably within their targets the Central Bank in its February meeting reduced the SELIC by 25 basis points. Average bank lending rates fell from 62.9 percent at end-September to 60.2 percent at end-December. Average spreads also fell, from 44.0 percent at end-September to 41.6 percent at end-December. Bank credit was flat in the fourth quarter, relative to its end-September level. For the year as a whole, newly granted credit rose by 11 percent. The share of loans with interest payments overdue for more than 120 days rose slightly in the fourth quarter, and total bank provisions rose to R$22.9 billion at end-December, more than fully meeting minimum provisioning requirements.

14.  The government continued to make progress on its structural reform agenda in the fourth quarter of 2001. The constitutional amendment introducing explicit taxation in domestic markets of petroleum products was approved by Congress in December, and regulations were issued to liberalize fully the domestic petroleum products market in 2002, fulfilling an end-December 2001 structural benchmark. The Central Bank is well-advanced in developing a rating system for banks, and intends to implement it in the second half of 2002. A revision and upgrade to international standards of the plan of accounts for financial institutions was also completed. As a result, two additional structural benchmarks under the Stand-By Arrangement have been satisfied. The design of the new off-site banking supervision system, which was not completed in time to meet an end-December structural benchmark under the Stand-by Arrangement, was finalized in January 2002 and the system is already in operation. Progress has been made as well in the privatization of federalized state banks, with the auctions of Banco do Estado de Goiás and Banco do Estado do Amazonas being completed in December 2001and January 2002, respectively, and preliminary steps for the auctioning of the four remaining federalized state banks have also been implemented.

II.  Policies and Prospects for 2002

15.  The macroeconomic framework for 2002 is based on real output growth of 2½ percent, due to exports and a rebound in private consumption and investment over the course of the year. Despite the pick-up in consumption and the still-weak external environment, the trade balance is projected nearly to double this year, to close to US$5 billion, and the current account deficit to narrow to US$20.6 billion, falling by about ¾ percentage point to 3.8 percent of GDP. FDI is projected to equal US$18.0 billion, well below last year's US$22.6 billion but still equal to 87 percent of the projected current account deficit. Overall, the balance of payments is projected to record a deficit of about US$2.5 billion, leaving gross reserves at US$33.4 billion and NIR at US$27.8 billion at year-end, US$7.8 billion above the floor under the Stand-By Arrangement.

16.  The Government aims at achieving a consolidated public sector primary surplus of 3.5 percent of GDP this year (as outlined in the attached TMU). Fiscal policy will continue to be guided by the parameters of the Fiscal Responsibility Law and the Budget Guidelines Law, supported by the debt restructuring agreements between the state and municipal governments and the Treasury. All elements of the public sector will contribute to the achievement of the primary surplus target. As in the past, the central government remains committed to monitor the fiscal performance of the subnational governments and to adjust its own fiscal targets, if necessary, to offset slippages at other levels. In December 2001 Congress approved the 2002 budget law in line with the consolidated primary surplus target of 3.5 percent of GDP, and on February 7 the government issued the budget execution decree spelling out spending plans for the year. The budget execution decree is consistent with the recently-passed changes in tax legislation updating the personal income tax brackets, deductions, and exemption threshold for the first time since 1996; modifying the taxation of enterprises in the services sector that opted for being taxed under the presumptive profit regime; and introducing equal treatment for the purpose of corporate income taxation of open and closed pension funds, following a Supreme Court ruling against the tax immunity of pension funds.

17.  With the exchange rate projected to remain broadly stable this year, the public sector borrowing requirement (on a nonharmonized basis) is projected to decline sharply to 4 percent of GDP. As a result, the net debt of the public sector is projected to stabilize at about 54 percent of GDP this year. The Government has issued its debt management plan for 2002, aiming primarily at improving the composition of the domestic public debt, with the shares in the debt stock of foreign exchange-indexed securities and floating-rate securities of, respectively, between 25-30 percent and 51-56 percent. Efforts to achieve reductions in the shares of these debt instruments last year were frustrated by external developments. Debt management will also seek to lengthen the average maturity of the securitized debt and new debt issuances, maintaining the current levels of short-term debt, defined as those securities maturing in less than 12 months, of between 26-29 percent of the debt stock, and reducing rollover rates, particularly towards the end of the year and at the beginning of 2003. The Treasury will maintain its efforts to increase transparency in debt management by continuing to pre-announce its schedule for auctions.

18.  Despite the limited time remaining on the congressional calendar before the October elections, the Government remains committed to achieving further progress on its structural reform agenda. Specifically, the Government will seek congressional approval of the remaining legislation for the establishment of complementary pension funds for public sector workers. In addition, it will seek approval of an extension of the bank debit tax (CPMF), along with measures to mitigate the impact of the tax on capital markets, including the exemption of stock market transactions. More generally, the important regulatory changes in the electricity sector that were announced in late January and early February will be implemented in the coming months.

19.   Monetary policy will continue to be guided by the inflation targeting framework. As noted earlier, the substantial shocks experienced last year led inflation to exceed the 6 percent upper bound of the target for 2001, but policies remain on track for achieving declining inflation rates within the target range this year and close to the midpoint in 2003. Midpoints and consultation bands established at the outset of the Fund program for March, June and September 2002 (which are based on 12-month inflation) will be maintained (see the attached TMU). The carry-over of inflation from the high 2001 outcome may result in inflation exceeding the upper band for consultation with the Fund staff, particularly in March. Inflation prospects will continue to be analyzed during the quarterly reviews of the program, and the Central Bank will maintain its regular exchange of views with the Fund staff about the evolution of monetary policy. The Central Bank remains ready to respond to changes in expected inflation, in accordance with the forward-looking nature of the inflation targeting framework.

20.  The experience of last year confirms the importance of the floating exchange rate regime in helping the economy respond to shocks. Nevertheless, the size and scope of the shocks experienced last year and the high volatility and low liquidity of the FX market required the Central Bank to intervene through the issuance of foreign exchange-indexed securities, as well as through pre-announced spot market sales of limited quantities of foreign exchange. With exchange rate pressures largely having abated, the Central Bank has ceased direct and indirect intervention in foreign exchange markets, confirming its belief that net increases in the stock of exchange rate-indexed debt should be limited to extraordinary circumstances. If market conditions allow, the Central Bank will seek to reduce the stock of these instruments in 2002.

21.  As in the fiscal sector, the Government will seek further progress in financial sector structural reforms during the remainder of the congressional calendar. The Government will work with Congress to achieve passage of a new bankruptcy law to reduce the social and economic costs of bankruptcy as well as to lower the cost of credit. The Central Bank will continue its efforts to enhance its off-site bank supervision system and to strengthen governance of financial institutions (see the attached TMU). It is worth mentioning in the context of current international concerns related to accounting, auditing and disclosure practices that Brazil has since 1996 required a change in the auditing company every four years for the financial system (and, since 1999, every five years for non-financial firms), a practice we believe is improving the quality of auditing standards. In addition, the process of auctioning the four remaining federalized state banks is expected to be completed by June of this year. In March, the first of two Financial Sector Assessment Program missions will begin its work in Brazil.

22.  The Government remains committed to Mercosul, and in recent months has worked with partner trade block members to resolve outstanding issues arising from the implementation of emergency trade measures in Argentina. In addition, the Government will strengthen its actions to reduce industrial country non-tariff restrictions on Brazilian exports, while working to further liberalize Brazil's own trade regime, both through bilateral and multilateral negotiations, as well as in the context of Mercosul. In this respect, in January the Mercosul tariff surcharge was reduced by 1 percentage point.

23.  In summary, firm management of macroeconomic policies in the context of the floating exchange rate regime has allowed Brazil to weather the substantial shocks that struck all emerging market economies last year. Conditions in financial markets have calmed considerably in recent months, and there are signs that domestic demand may be beginning to recover after the slowdown that started in the second quarter of last year. Nevertheless, the external environment remains volatile, and it is too early to declare that risks have faded. Continued disciplined monetary and fiscal policies and further structural reform as outlined in this MEP are therefore essential to safeguard economic stability, to protect the ongoing economic recovery, and lay the groundwork for an acceleration of growth and further improvements in the economic well-being of the population in the years ahead. In addition to the measures outlined in this MEP, the Government stands ready to adjust policies as needed to ensure the achievement of the objectives of its economic program, and looks forward to a continued close and constructive dialogue with the Fund.

Brazil—Technical Memorandum of Understanding

1. This Technical Memorandum of Understanding (TMU) sets out the specific performance criteria (PCs), indicative targets (ITs), structural benchmarks (SBs) and assumptions that will be applied under the Stand-by Arrangement during 2002.

I.  Phasing of Purchases and Reviews

2..  The general phasing of purchases and reviews for 2002 is shown in Table 1 below.

Table 1. Brazil: Phasing of Purchases and Reviews

Amounts Available (In millions of SDRs) and Sources	Earliest Availability Dates	Conditions and Remarks
358.625 from CT 3316.958 from SRF	March 22, 2002	Completion of the second review and observance of the relevant PCs under the arrangement (end-December, 2001).
358.625 from CT 3316.958 from SRF	June 14, 2002	Completion of the third review and observance of the relevant PCs under the arrangement (end-March, 2002).
379.513 from CT	August 30, 2002	Completion of the fourth review and observance of the relevant PCs under the arrangement (end-June, 2002).
379.513 from CT	November 29, 2002	Observance of the relevant PCs under the arrangement (end-September, 2002).

II.  Quantitative Targets

A.  Fiscal Targets

(i) Performance criterion for the primary balance of the consolidated public sector¹

3.  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).

4.  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.

(ii) Indicative target on the net debt of the consolidated public sector ¹

5.  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.

6.  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.

7.  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.

B. External Sector Targets

(i) Performance criterion on external debt of the nonfinancial public sector¹

8.  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.

9.  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.

(ii) Performance criterion on publicly guaranteed external debt of the private sector¹

10.  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.

(iii) Performance criterion on nonfinancial public sector short-term external debt¹

11.  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.

12.  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.

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

13.  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.

14.  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.

15.  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, and (iii) any forward foreign exchange (FX) liabilities on a net basis-defined as the short position (posição vendida) minus the long 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. 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.

(v) Performance criterion on the BCB's and the Treasury's exposure in futures markets

16.  The BCB and the Treasury will continue to refrain from entering into futures contracts (FX or otherwise), either directly or through any institution they use as their financial agent. This constitutes a performance criterion under the arrangement. This limitation does not apply to futures contracts issued by the BCB or the Treasury, either directly or through any institution they use as their financial agent, for transactions associated with the rollover of existing foreign exchange-indexed debt instruments described in the letter from the Minister of Finance and President of the Central Bank dated March 4, 2002.

(vi) Performance criterion on the BCB's and the Treasury's exposure in forward markets

17.  The BCB and the Treasury will continue to refrain from entering into forward contracts (FX or otherwise), either directly or through any institution they use as their financial agent. This constitutes a performance criterion under the arrangement. This limitation does not apply to forward contracts issued by the BCB or the Treasury, either directly or through any institution they use as their financial agent, for transactions associated with the rollover of existing foreign exchange-indexed debt instruments described in the letter from the Minister of Finance and President of the Central Bank dated March 4, 2002.

C. Monetary Targets

(i) Consultation mechanism on the 12-month rate of inflation

18.  The quarterly consultation bands 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)
			September 2001 (actual)	December 2001 (actual)	March 2002	June 2002	September 2002
	Outer band (upper limit)				7.8	7.3	6.2
		Inner band (upper limit)			6.8	6.3	5.2
		Central point	6.5	7.7	5.8	5.3	4.2
		Inner band (lower limit)			4.8	4.3	3.2
	Outer band (lower limit)				3.8	3.3	2.2

19.  Inflation prospects will be an important part of each review under the arrangement. In addition, the BCB will discuss with the Fund staff 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 2002

• Further progress in the auctioning of the four remaining federalized state banks.

• Develop a systematic monitoring system of operational limits, including the measurement of the Basle capital index, minimum net worth, foreign exchange exposure, and provisioning of the credit portfolio of banks with the data provided by banks to the Off-Site Banking Supervision Department of the Central Bank.

• The Central Bank to begin releasing on a more frequent basis consolidated analysis reports of banking system compliance with the fixed-asset limit and the Basle capital ratio.

By end-June 2002

• Further progress in the auctioning of the four remaining federalized state banks.

• Presentation of enabling legislation to Congress to create complementary pension funds for federal civil servants following the enactment of the relevant legislation.

By end-September 2002

• Completion of a review of differences between Brazilian and internationally-accepted practices for the use of independent external bank auditors, in order to evaluate the appropriateness of implementing such international practices.

• Develop a streamlined set of indicators from the financial data currently reported to the Off-Site Banking Supervision Department of the Central Bank to assess the economic and financial soundness of banks and non-banking financial institutions; and a registry of the largest borrowers in the financial system.

• Completion of the updating of existing regulations regarding licensing of firms and individuals to operate as or serve as officers of financial institutions, including the adoption of a multistage approach to the licensing process; the introduction of a requirement that firms present detailed operating plans before licensing, including information on corporate organization and structure, internal controls, and corporate governance; and the requirement that the licensing process include consideration of the impact of the proposed new financial institution on market concentration and competition.

• Develop a monitoring system to verify the quality of the accounting data provided to the Off-Site Banking Supervision Department of the Central Bank in terms of data consistency, and the accuracy of reported significant changes in key accounting data such as credit levels and composition, credit portfolio stress risks, and risk diversification.

IV.  Disclosure of Specific Information

20.  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).

V.  Program Assumptions for Selected Variables

The following Tables 2 and 3 set out program assumptions for selected variables.