Summary: KEY ISSUES Context. Brazil is recovering gradually from the growth slowdown that started in mid- 2011, but the recovery remains uneven and inflation elevated. Output is estimated at potential with supply-side constraints, linked to tight labor market conditions and protracted weak investment since 2011, limiting near term growth. A monetary tightening cycle has started, following a period of easing. In staff’s view, excessive fine tuning of fiscal policy (including through public banks) has weakened the credibility of Brazil’s long-standing fiscal framework, while broader policy uncertainty has weighed on investment. Staff’s estimates of potential growth have been revised down and the challenges posed by eroding competitiveness and economic imbalances remain— notably low saving and investment. The Article IV consultation mission took place during May 13–24. Outlook and Risks. The recovery is expected to continue during 2013–14, supported by a pick-up in investment and resilient consumption. The near-term outlook envisages continued monetary tightening, broadly unchanged fiscal policy, and sustained implementation of infrastructure investment. Domestic risks are to the downside, linked to more sluggish investment and intensified inflationary pressures, worsening the growth-inflation tradeoff. Lack of timely policy tightening would exacerbate existing imbalances and weaken confidence in the fiscal framework. External risks are associated with global financial conditions and commodity prices. Over the medium term, a substantial scaling up of investment will be necessary to boost potential growth. Policies. With supply-side constraints restraining short-term growth, a tightening policy stance is needed to rebalance demand, including a steady fiscal consolidation, winding down policy lending, and continued monetary tightening. Strengthening Brazil’s longstanding fiscal framework to rebuild fiscal buffers and bolster confidence would entail adherence to a primary balance that puts gross debt firmly on a downward path; maintaining sub-national fiscal discipline; easing rigidities to increase public saving; and more fully recognizing contingent fiscal risks. The flexible exchange rate remains the main shock absorber for global turbulence, while intervention should aim to limit disorderly market conditions. The renewed focus on supply-side policies is welcome but in order to increase potential growth, decisive and comprehensive efforts are needed to enhance productivity and competitiveness, increase investment, and mobilize domestic saving. July 2, 2013
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