OECD Economic Outlook November 2019 Country Note, Brazil by OECD

90 

Brazil The economy is recovering gradually. A pension reform has been approved, and better prospects for progress on structural reform are lifting confidence and supporting investment, which is also buoyed by easier financial conditions. Low inflation and easier withdrawal of funds in individual unemployment insurance accounts will underpin stronger consumption. On the assumption that the reform agenda continues to advance, growth is projected to gain momentum in 2020. However, high unemployment is falling only slowly, and newly created jobs are of low quality, including many informal jobs. Monetary policy has been relaxed, which is appropriate as inflation is expected to remain below target during 2020 and 2021. Some scope for additional easing remains. Ensuring fiscal sustainability and compliance with fiscal rules will require further adjustments on mandatory spending, while safeguarding effective social transfers and public investment. Raising productivity will hinge on improving the business climate through reforms in taxes, regulation and lower trade barriers. Preserving natural assets will require more determined enforcement efforts. The expansion is gaining momentum The recovery is gaining momentum on the back of domestic factors. Confidence is improving following progress on the approval of economic reforms in Congress, and investment has regained force after falling for two quarters. Private consumption and retail sales are strengthening. Inflation and core inflation are below target and financial conditions have eased. This, together with moderate wage growth, is supporting private consumption, although unemployment has yet to fall visibly. In particular, the composition of jobs created has been of low quality so far, with a disproportionate number of jobs created in the informal sector.

Brazil 1 Economic developments are improving Index Jan 2016= 100 110

Real interest rates have fallen and investment has edged up % of GDP 20

Real wage bill

% 10 ← Gross fixed capital formation

Retail sales Central Bank activity index

Ex-ante real interest rate¹ →

105 16

100

2016

2017

2018

2019

2016

2017

2018

2019

1. The ex-ante real interest rate is derived as the difference between the Selic rate and inflation expectations 12-months ahead (IPCA). Source: CEIC; and Central Bank of Brazil. StatLink 2 https://doi.org/10.1787/888934045050

OECD ECONOMIC OUTLOOK, VOLUME 2019 ISSUE 2: PRELIMINARY VERSION © OECD 2019

 91

Brazil: Demand, output and prices

2016

2017

Current prices BRL billion

Brazil GDP at market prices Private consumption Government consumption Gross fixed capital formation Final domestic demand Stockbuilding1 Total domestic demand Exports of goods and services Imports of goods and services Net exports1

2018

2019

2020

2021

Percentage changes, volume (2000 prices)

6 265.0 4 024.0 1 273.5 974.5 6 272.0 - 33.6 6 238.4 784.8 758.3 26.6

1.1 1.3 -0.9 -2.6 0.3 0.6 1.0 5.7 5.5 0.1

1.1 1.9 0.0 4.1 1.9 -0.4 1.5 3.4 7.6 -0.4

0.8 1.3 -0.3 2.9 1.3 -0.3 1.0 0.5 1.7 -0.2

1.7 1.3 0.6 5.2 1.8 0.1 1.9 2.4 4.1 -0.2

1.8 1.5 0.8 5.2 2.0 0.0 2.0 3.2 4.4 -0.2

_ _ _ _ _

3.5 3.4 2.8 -7.8 -0.7

3.0 3.7 2.8 -7.1 -1.2

3.9 3.7 3.6 -6.2 -2.4

3.1 3.1 3.0 -5.6 -2.5

3.5 3.6 3.4 -5.3 -2.6

Memorandum items GDP deflator Consumer price index Private consumption deflator General government financial balance (% of GDP) Current account balance (% of GDP)

1. Contributions to changes in real GDP, actual amount in the first column. Source: OECD Economic Outlook 106 database.

StatLink 2 https://doi.org/10.1787/888934046171

Brazil 2 Fiscal outcomes remain weak but are improving slowly % of GDP 4

Inflation is below target and interest rates have come down Y-o-y % changes 18

Interest balance Primary fiscal balance

← Core inflation¹

Headline fiscal balance

% 18

← Inflation (IPCA)

Policy rate (SELIC) →

-4

6 -8

Inflation target

3 -12

2016

2017

2018

2019

2016

2017

2018

2019

1. Core inflation is defined as the average of the three core inflation measures published by the Central Bank of Brazil. Source: Central Bank of Brazil; OECD Economic Outlook 106 database. StatLink 2 https://doi.org/10.1787/888934045069

92 

The fiscal outlook remains challenging, but monetary policy is supportive A pension reform has been approved by Congress and will help to contain rising pension spending. Nonetheless, the fiscal outlook continues to be challenging, leaving fiscal policy no additional room to support the incipient recovery. Gross public debt remains high at almost 80% of GDP and the primary deficit of 1.4% of GDP falls short of the estimated 1.5% surplus required to stabilise public debt. The deficit continues to be driven by mandatory expenditure items, including wages, pensions and other social security benefits. Discretionary spending has receded to achieve the necessary consolidation, but at only 6% of total spending it now has little scope for further reductions. Reforming mandatory spending and indexation rules has become crucial to ensure compliance with fiscal rules. So far, the expenditure rule adopted in 2016 has not generated the expected political momentum for such reforms. In particular, reducing the public sector’s high wage bill is instrumental, as is revisiting widespread tax expenditures. Recent expenditure trends have also reduced the quality of public spending. Indexed to the minimum wage, rising social security benefits have benefitted mostly middle-class households, leaving fewer resources for well-targeted social benefits to fight poverty, which is concentrated among children and youth. Raising income thresholds in the conditional cash transfer programme Bolsa Família, which costs only 0.5% of GDP, would broaden eligibility and raise benefit levels. This would lift more people out of poverty, reduce income inequality and strengthen incentives for school attendance and medical checkups, thus reducing inequalities with respect to education and health. Public investment has also been crowded out, but would potentially have high pay-offs. Scope for further monetary easing has arisen in the short term as inflation is projected to remain below target in 2020. Real interest rates have already reached a long-time low. Rising credit is improving household liquidity, and new rules to access individual unemployment insurance accounts will continue to reinforce this in 2020. However, corporate credit continues to decline. Current reform plans to strengthen competition in the financial sector are a promising step to reduce borrowing costs. Productivity growth will be the main engine of growth in the longer term, but is currently held back by low levels of competition in many sectors. More competition-friendly domestic regulation and closer integration into the global economy, including through a ratification of the EU-Mercosur trade agreement, could address this, while simultaneously reducing the cost of intermediate and capital goods. Improving contract enforcement by enhancing judicial efficiency and reducing tax compliance costs through a substantial overhaul of the fragmented indirect tax system, with a view towards a unified value added tax, would also raise productivity. Preserving valuable natural assets such as the Amazon rainforest for future generations will require stronger efforts to enforce existing laws, building on past progress in enforcement.

Growth is projected to gain momentum On the assumption of continued reform momentum, growth is projected to accelerate during 2020 and 2021. Unemployment will decline slowly, including through the creation of more formal jobs. Low inflation, stronger wage growth and improving liquidity conditions will support private consumption, while favourable financial conditions, growing confidence and productivity-enhancing structural reforms are projected to sustain investment.

 93 Risks are mainly related to the implementation of reforms. A fragmented political landscape makes it difficult to build political consensus for key reforms, which often require supermajorities in Congress. Without a retrenchment of mandatory spending items, the expenditure rule could be violated as early as 2020, likely resulting in higher financing costs, a loss of confidence, lower growth outcomes and possibly a return into recession. An aggravating crisis in neighbouring Argentina could reduce manufacturing exports. On the other hand, a stronger reform momentum could improve the business climate and accelerate growth. Worsening global trade tensions may divert trade to the benefit of Brazil in the short run, but at the cost of hurting future import demand from China and the United States, Brazil’s two major trading partners.