1 Henrique de Campos Meirelles Georgetown University, October 2004 The Central Bank and the Brazilian Economy: Potential and Challenges

2 I. Why to Care About Inflation? II. The Economic Policy of 2003/2004 a. Fiscal Policy b. Disinflation Policy c. External Adjustment III. Resuming Economic Growth IV. Strengthening Resistance to Shocks The Central Bank and the Brazilian Economy: Potential and Challenges

3 I. Why to Care About Inflation? The Central Bank and the Brazilian Economy: Potential and Challenges

4 Determinants of Growth Education Productivity Low Sovereign Risk Macroeconomic Stability  Low Inflation Savings and Fixed Capital Investment

5 Countries Have Grown with Low Inflation Source: IMF (avg. annual change) GDP (%) Singapore1,56,2 China5,49,2 Chile9,15,4 Thailand4,05,0 South Korea5,06,1 Brazil 1,8161,3 India 7,95,5 Mexico16,03,0 Inflation (%)

6 Inflation in Brazil  Brazil has a still short history of low inflation;  Maintaining inflation under control requires a continuous effort  Central Bank’s objective.

7 Inflation in Brazil ( ) Jan 76Jan 80Jan 84Jan 88Jan 92Jan 96Jan 00 Monetary Reform (Real Plan -1994) % p.m. Aug 04 A still short period of low inflation

8 II. The Economic Policy of 2003/2004 The Central Bank and the Brazilian Economy: Potential and Challenges

9 SUDDEN STOP Capital Flows to Brazil (US$ billion) US$ 28.0 billion GAP Background: The 2002 Confidence Crisis

10 Background: The 2002 Confidence Crisis Basis points Jan 01 May 01 Sep 01 Jan 02 May 02 Set 02 1,7 2,1 2,5 2,9 3,3 3,7 4,1 R$/US$ Brazil RiskExchange Rate Jan 01 May 01 Sep 01 Jan 02 May 02 Set 02

11 Confidence Rebuiding  New government committed to fiscal sustainability (target for consolidated primary surplus at 4.25% of GDP for 2003 and at 4.5% of GDP for 2004).  Government pursued agenda of reforms: social security, tax reform, new bankruptcy law, among others.  Consolidation of the external adjustment.  Maintenance of inflation targeting regime.

12 II. The Economic Policy of 2003/2004 a. Fiscal Policy The Central Bank and the Brazilian Economy: Potential and Challenges

13 Consolidated Public Sector Primary Surplus % of GDP Source: Bacen Jul 94 May 95 Mar 96 Jan 97 Nov 97 Sep 98 Jul 99 May 00 Mar 01 Jan 02 Nov 02 Sep 03 Jul 04 Aug 4.9% new target 4.5% previous target 4.25%

14 Debt-to-GDP Ratio % of GDP Jan 91 Jul 92 Jan 94 Jul 95 Jan 97 Jul 98 Jan 00 Jul 01 Jan 03 Jul 04 Aug % Source: Bacen

15 Debt-to-GDP Ratio Trend ( ) % of GDP Source: Bacen Median of Market Expectations

16 II. The Economic Policy of 2003/2004 b. Disinflation Policy The Central Bank and the Brazilian Economy: Potential and Challenges

17 IPCA Inflation Rate % p.m. Source: IBGE Jan 02 Apr 02 Jul 02 Oct 02 Jan 03 Apr 03 Jul 03 Oct 03 Jan 04 Apr 04 Jul 04

18 Market Inflation Expectations (IPCA): 12-Month % 6.2% Jan 03 Mar 03 May 03 Jul 03 Sep 03 Nov 03 Jan 04 Mar 04 May 04 Jul 04 Sep 04 Source: Bacen Survey

19 II. The Economic Policy of 2003/2004 c. External Adjustment The Central Bank and the Brazilian Economy: Potential and Challenges

20 Current Account: 1996/2004 US$ billion *2004: Accumulated in 12 months Aug 2004*

21 Trade Balance: 1996/2004 US$ bilhões * 30 *2004: Accumulated in 12 months

22 Trade Balance Source: Ministry of Development, Industry and Foreign Trade US$ billion 12-Month, Accumulated Exports Imports Jan 99 Jul 99 Jan 00 Jul 00 Jan 01 Jul 01 Jan 02 Jul 02 Jan 03 Jul 03 Jan 04 Jul 04

23 Trade Balance: Prices and Volumes ExportsImportsBalance Change % 21.1%2.2%89.1% Change in Prices % 4.7%6.1% Change in Volumes % 15.7%-3.7% 7M M %26.7%48.8% 10.4%6.0% 20.7%19.4% Change % Change in Prices % Change in Volumes % US$ billion Source: Funcex

24 Source: MDIC Last 12 Months (Sep 2003-Aug 2004) US 20.5% Argentina 7.4% China 6.1% Others 31.9% European Union 24.5% Chile 2.6% Japan 2.9% Mexico 4.0% Exports by Market

25 III. Resuming Economic Growth The Central Bank and the Brazilian Economy: Potential and Challenges

26 GDP Growth Seasonally adjusted, % 1Q032Q03 3Q034Q031Q042Q

27 Contribution of Domestic and External Demand to GDP Growth % Domestic DemandExternal Demand 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q042Q04 Decomposition of GDP growth (y-o-y)

28 Industrial Output s.a., 2002 = 100 Source: IBGE Jan 99 Jul 99 Jan 00 Jul 00 Jan 01 Jul 01 Jan 02 Jul 02 Jan 03 Jul 03 Jan 04 Jul 04

29 Source: IBGE Total Capital Goods Intermediate Goods Consumer Goods Durable Semi-Durable e Non-Durable % Jul 04 Jul 03 Jan-Jul 04 Jan-Jul 03 Industrial Output

30 Sources: IBGE, Banco Central Retail Sales Jan 01 Jul 01 Jan 02 Jul 02 Jan 03 Jul 03 Jan 04 Jul 04 Seasonally Adjusted, 3-Month Moving Average Average 2003 = 100

31 Jul 04 Jul 03 Jan-Jul 04 Jan-Jul 03 Total Furniture & Electronics Fuel and Lubricants Supermarket, Food, Beverage and Tobacco Vehicles & Autoparts Clothing Retail Sales % Source: IBGE

32 Industrial Employment Source: CNI s.a, Jun 2003 = Jun 03 Aug 03 Oct 03 Dec 03 Feb 04 Apr 04 Jun 04

33 The Role of the Labor Market Recovery 2003 = 100 Supermarket Sales left scale Labor Income right scale Jan 02 May 02 Sep 02 Jan 03 May 03 Sep 03 Jan 04 Jun = 100

34 Consumer Confidence Mar 99 Sep 99 Mar 00 Sep 00 Mar 01 Sep 01 Mar 02 Sep 02 Mar 03 Sep 03 Mar 04 Sep 04 Jun 03 = 100 Source: Fecomércio São Paulo

35 Business Confidence Source: FGV Industrial Survey Jul 03 Oct 03 Jan 04 Apr 04 Jul 04 GoodWeak Net Result %

36 Capacity Utilization Jan 97 Jan 98 Jan 99 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 s.a., 1992=100 Sources: CNI, Bacen

37 Fixed Capital Investment vs. Economic Cycle Sources: IBGE, FGV Q193Q194Q195Q196Q197Q198Q199Q100Q101Q102Q103Q104Q1 Capacity Utilization left scale Fixed Capital Investment right scale % 1990=100

38 Fixed Capital Investment vs. Brazil Risk Sources: IBGE, JP Morgan % Q003Q001Q013Q011Q023Q021Q033Q031Q043Q041Q Brazil Risk (Q-2) right scale Fixed Capital Investment left scale Basis Point

39 IV. Strengthening Resistance to Shocks The Central Bank and the Brazilian Economy: Potential and Challenges

40  Fast improvement in fundamentals enabled the Government to actively reduce public sector’s FX exposure;  Also, government started a process of international reserve accumulation. Strengthening Resistance to Shocks

41 FX-Linked and Fixed Domestic Debt as a Share of the Total Debt Source: Bacen % Jan 02 Jul 02 Jan 03 Jul 03 Jan 04 Jul Jan 02 Jul 02 Jan 03 Jul 03 Jan 04 Jul 04 FX-Linked Domestic Debt/Total DebtFixed Domestic Debt/Total Debt

42 FX-Linked Debt Outstanding in US$ US$ billion Source: Bacen US$ billion Jan 01 Sep 01 May 02 Jan 03 Sep 03 May 04 Since Jan/2003, FX-linked debt decreased US$31.6 billion

43 Impact of a 1% FX change on Debt/GDP ratio % Source: Bacen Jan 00 Jun 00 Nov 00 Apr 01 Sep 01 Feb 02 Jul 02 Dec 02 May 03 Oct 03 Mar 04

44 Net International Reserves US$ billion Source: Bacen Adjusted Net Reserves IMF Concept Net Reserves Jan 99 Aug 99 Mar 00 Oct 00 May 01 Dec 01 Jul 02 Feb 03 Sep 03 Aug 04

45 Interest Payments/Exports Ratio % * 2004 and 2005: BCB estimate *2005*

46 Net External Debt/Exports Ratio % *2005* * 2004 and 2005: BCB estimate

47 Net External Debt/GDP Ratio % *2005* * 2004 and 2005: BCB estimate

48 Henrique de Campos Meirelles Georgetown University, October 2004 The Central Bank and the Brazilian Economy: Potential and Challenges