1. 0 Brazil Economic Outlook Alexandre Bassoli May, 2007

2. 1 This presentation  What are the drivers of the exchange rate appreciation? What explains the resilience of exports?  New GDP methodology has important implications for risk perception and the economic activity outlook  Domestic demand is pushing economic growth  Interest rates, albeit still high, are converging to unthinkable levels  Fiscal policy: expenditures continue to soar, but the public debt dynamics remain healthy  Investment grade may be achieved in 2008

3. 2 In spite of the BRL strengthening, trade surpluses are approximately constant at USD 47bn

4. 3 Terms of trade gains explain the resilience of exports  Mainly as a result of soaring commodity prices, export prices accumulate an increase of 57% since Dec-02  The nominal exchange rate moved from 2.13 to 2.03 BRL/USD between Apr-06 and Apr-07, but the profitability of exports actually increased 1.0%  The increase of export prices has two important implications: –More Dollars for a given volume of exports –Since the profitability is improving, there are incentives to increase, not reduce, the export volume

5. 4 The improvement of sovereign risk boosts capital inflows

6. 5 Strong BRL is here to stay  Currency appreciation does not seem to reflect a bubble  Brazil has largely mitigated its sources of external vulnerability  Exchange rate volatility was structurally reduced  We forecast 1.95 BRL/USD in Dec-07

7. 6 New GDP methodology brought two fundamental changes  The GDP level is 11% higher than we previously thought  Average GDP growth is the last six years was 2.9%, while the previous methodology indicated 2.3%

8. 7 Growth is gaining momentum pushed by domestic demand…

9. 8 …and this process will continue

10. 9 The good news is that investments are growing…

11. 10 …but the expansion is likely to exceed potential growth in 2007

12. 11 Inflation remains very well behaved, thanks to the BRL appreciation and the deceleration of administered prices

13. 12 Interest rates, albeit still high, are converging to uncharted territory  Several factors point towards lower rates in upcoming quarters –A more robust balance of payments implies a lower sovereign risk and a less volatile currency –Administered prices now represent a positive shock –The BRL appreciation keeps tradable inflation under control –Terms of trade gains allow a fast increase of imports without damaging the current account surplus  Even after achieving the investment grade, however, it is not clear that interest rates will converge to levels observed in other countries such as Chile and Mexico (3.5%-4.0% in real terms)  The bad quality of fiscal policy implies, in our view a higher level of neutral interest rates and a lower level of potential growth  We expect nominal rates to stabilize at 11.0-11.25% in nominal terms  If terms of trade gains intensify, however, rates may stay below the equilibrium for a while

14. 13 Fiscal policy: more of the same  Public expenditures continue to grow at an extremely vigorous pace  The tax collection expansion is also outperforming GDP growth

15. 14 The primary surplus will fall, but the nominal deficit is likely to drop as well, thanks to lower interest rates

16. 15 From a solvency perspective, fiscal policy looks OK, but…  It has as expansionary impact on domestic demand and negative implications for potential growth  The bad quality of fiscal policy may imply higher interest rates in comparison to investment grade countries

17. 16 Conclusions  Brazil continues to benefit from terms of trade gains  We think that a stronger (and less volatile) BRL is here to stay  Thanks to the positive shocks, the expansion of domestic demand may outperform output growth  Due to stronger fundamentals and positive shocks, interest rates are converging to uncharted territory  Even after the investment grade, however, we think that interest rates will be above the average of our peers  From a solvency perspective, fiscal policy is OK, but its poor quality has negative implications for potential growth and interest rates  Thanks to extraordinarily benign external conditions and the new GDP methodology, the investment grade is likely to be achieved in 2008

18. 17 Macroeconomic forecasts