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BRAZIL
Tighter economic policy and weaker external demand have helped to cool the economy from the rapid growth rates seen in 2010, but inflationary pressures have not receded and credit growth is still buoyant. Activity is expected to grow at below-trend rates over the next two years, notwithstanding support from large infrastructure programmes. Inflation may fall to about the middle of the central banks target band.

Domestic demand remains strong

The Brazilian economy has slowed, reflecting the withdrawal of some policy stimulus and a substantially less buoyant international environment. Domestic demand continues to be the main engine of growth, outstripping supply and resulting in robust import growth. Private consumption has been supported by credit expansion and increasing labour incomes. Investment has gathered pace but has been growing at a much slower rate than in most of 2010. By contrast, exports have been damped by past currency appreciation and recent weakness in export markets. Recent turmoil in financial markets has increased volatility of exchange-rate movements. Markets may also have reacted to an unexpected easing in the monetary stance. The monetary authorities have intervened to prevent disorderly movements in the currency. Inflation picked up to 6 per cent in 2011, with year-on-year inflation exceeding the ceiling of the official target range since June 2011, and inflation expectations have been on the rise. Weaker growth of economic activity will probably put downward pressure on prices although unemployment is low and average earnings have accelerated. The net

The real has been volatile

Inflation rose through 2011 but is set to fall through to 2013

Brazil
Domestic demand remains the main driver of growth
Contribution to annualised growth rate, seasonally adjusted % 4 $bn 20 15 2 10 0 5 0 -2
Domestic demand Net exports GDP

The real has been volatile

Index 2005 = 100
Real effective exchange rate Financial account balance

160 150 140 130 120 110 100

-5 -10

-4

2007

2008

2009

2010

2008

2009

2010

2011

1. Includes stockbuilding and statistical discrepancy. 2. The financial account balance includes net direct investment, net portfolio investments, net derivatives and other investments. Source: Central Bank of Brazil, IBGE and OECD Economic Outlook 90 database.

1 2 http://dx.doi.org/10.1787/888932541436

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Brazil: Macroeconomic indicators

2009 2010 2011 2012 2013

Real GDP growth Inflation (CPI)1 Fiscal balance (per cent of GDP)2 Primary fiscal balance (per cent of GDP)2 Current account balance (per cent of GDP)

-0.7 4.3 -3.3 2.0 -1.4

7.5 5.9 -2.5 2.8 -2.3

3.4 6.5 -2.7 2.9 -2.0

3.2 5.8 -2.8 2.5 -2.2

3.9 4.7 -2.6 2.5 -2.5

Note: Real GDP growth and inflation are defined in percentage change from the previous period. 1. End-year. 2. Takes into account a capital injection (0.5% of GDP) in the Brazilian Sovereign Wealth Fund in 2008, which was treated as expenditure, and excludes Petrobras from the government accounts. Source: OECD Economic Outlook 90 database.

1 2 http://dx.doi.org/10.1787/888932542937

effect is likely to be a fall in inflation to about the middle of the target range by 2013.

Monetary policy has eased

After having tightened the monetary stance earlier in the year, the Central Bank has cut the policy rate by a full percentage point to 11.5% since September 2011 and loosened restrictions on consumer lending in a context of increasing uncertainty regarding the global outlook. Assuming inflationary pressures clearly recede, there is room to lower interest rates further if the international environment continues to deteriorate. The fiscal support introduced during the 2008-09 crisis is being gradually reversed, and the authorities have announced new spending cuts relative to the 2011 federal budget. In addition, the government tightened the primary deficit target for 2011. On the current growth

Fiscal restraint has continued

Brazil
Public spending is falling
Central government % of GDP 19
Spending Primary balance

Inflation expectations have moved up

% of GDP 4 % 10 %
Consumer prices (IPCA) Short-term interest rate (SELIC) Expected inflation Tolerance band

20 18 16

8 3 18 6 17 2 4

14 12

16

1 2 10 8

15

2007

2008

2009

2010

2011

2007

2008

2009

2010

2011

1. Cumulated 12-month flows. 2. Year-on-year growth. 3. 12-months ahead. Source: Central Bank of Brazil, IBGE, National Treasury.

1 2 http://dx.doi.org/10.1787/888932541455

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Brazil: External indicators

2009 2010 2011 $ billion 2012 2013

Goods and services exports Goods and services imports Foreign balance Invisibles, net Current account balance Goods and services export volumes Goods and services import volumes Terms of trade
Source: OECD Economic Outlook 90 database.

178.2 179.8 - 1.6 - 22.7 - 24.3 - 10.2 - 11.6 - 3.4

233.3 254.0 - 20.7 - 26.6 - 47.4 11.5 36.2 12.7

297.2 316.9 - 19.7 - 29.1 - 48.7 4.3 12.6 10.3

330 357 - 27 - 29 - 56 8.2 13.8 3.5

371 412 - 41 - 30 - 70 10.2 13.0 0.1

Percentage changes

1 2 http://dx.doi.org/10.1787/888932542956

projection, the fiscal targets are expected to be achieved, despite the large minimum wage increase planned for 2012 and its ripple effect on pension benefits. Priority should, however, continue to be given to fiscal consolidation. In addition to putting the general government accounts onto a sustainable footing, a tighter fiscal stance would ease upward pressure on inflation and the exchange rate and make room for lower interest rates. Given the countrys needs in the short and medium term, infrastructure and social spending should continue to be protected from budget cuts. To more effectively achieve fiscal restraint, widespread revenue earmarking should be cut back and an expenditure ceiling introduced.

Structural reforms are needed to reduce Brazils cost disadvantage

The Greater Brazil Plan (Plano Brasil Maior) features a package of measures amounting to a total of some BRL 21 billion (0.6% of GDP) to boost competitiveness of domestic firms in key tradable sectors. Although some measures of the plan may provide short-term relief, they will not be sufficient to reduce the cost disadvantage of producing in Brazil, and further reforms to the tax system and to foster investment in infrastructure are urgently needed. Domestic demand is expected to continue to sustain economic growth. A recovery in investment should be supported by large infrastructure programmes. However, with exports held back by weakness abroad, GDP is projected to expand at sub-potential rates and the currentaccount deficit to deteriorate. Inflation may gradually diminish but remain in the upper part of the target range. The main downside risk is a continued wors ening of the international environment and a consequent shift in sentiment, which could reverse capital inflows and cut growth in the short term. On the positive side, spending on infrastructure could be faster than envisaged.

Activity is expected to grow at below potential rates

The risks are mostly on the downside

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Policy orientation should downside risks materialise

If the downside risks materialised, the OECD has identified, as part of its Strategic Response, key macroeconomic policies, as well as structural reforms which, while desirable in any case, would become essential to raise growth.

Brazil should first ease monetary policy to support the economy and has ample room to do so, but it has scope for discretionary fiscal stimulus if needed, in addition to allowing the automatic stabilisers to work. Any such fiscal action should, however, be couched in terms of a medium-term framework, which sets out a path for fiscal consolidation over time that would be needed to ensure long-term sustainability of the public finances, including social security. In general a policy mix that would combine a more restrictive fiscal policy with interest-rate cuts would ease upward pressure on the real and help to achieve the medium-term objective of reducing extremely high interest rates. The authorities should continue their efforts to secure support from state governments to simplify the tax system with a view to lowering firms compliance costs and boosting incentives to invest. The most beneficial change would be to introduce some payroll tax relief and harmonise state value-added taxes. Instead of the new industrial policy (see above) the authorities should focus on measures that can durably lower Brazils high production costs such as simplifying the tax system or developing infrastructure to lower transport costs.

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