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

2. 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. 3 I. Why to Care About Inflation? The Central Bank and the Brazilian Economy: Potential and Challenges

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

5. 5 Countries Have Grown with Low Inflation Source: IMF 1990-2003 (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. 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. 7 Inflation in Brazil (1976-2004) 5 15 25 35 45 55 65 75 85 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. 8 II. The Economic Policy of 2003/2004 The Central Bank and the Brazilian Economy: Potential and Challenges

9. 9 SUDDEN STOP Capital Flows to Brazil (US$ billion) 52.8 24.8 20012002 US$ 28.0 billion GAP Background: The 2002 Confidence Crisis

10. 10 Background: The 2002 Confidence Crisis Basis points 650 850 1.050 1.250 1.450 1.650 1.850 2.050 2.250 2.450 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. 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. 12 II. The Economic Policy of 2003/2004 a. Fiscal Policy The Central Bank and the Brazilian Economy: Potential and Challenges

13. 13 Consolidated Public Sector Primary Surplus % of GDP Source: Bacen -2 0 1 2 3 4 5 6 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. 14 Debt-to-GDP Ratio % of GDP 27 32 37 42 47 52 57 62 Jan 91 Jul 92 Jan 94 Jul 95 Jan 97 Jul 98 Jan 00 Jul 01 Jan 03 Jul 04 Aug 04 54.1% Source: Bacen

15. 15 Debt-to-GDP Ratio Trend (2001-2008) % of GDP Source: Bacen Median of Market Expectations 20012002200320042005200620072008 48 51 54 57 60

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

17. 17 IPCA Inflation Rate % p.m. Source: IBGE -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 Jan 02 Apr 02 Jul 02 Oct 02 Jan 03 Apr 03 Jul 03 Oct 03 Jan 04 Apr 04 Jul 04

18. 18 Market Inflation Expectations (IPCA): 12-Month % 6.2% 5 6 7 8 9 10 11 12 13 14 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. 19 II. The Economic Policy of 2003/2004 c. External Adjustment The Central Bank and the Brazilian Economy: Potential and Challenges

20. 20 Current Account: 1996/2004 US$ billion *2004: Accumulated in 12 months -40 -35 -30 -25 -20 -15 -10 -5 0 5 10 -33.4 9.5 1996 1997 1998 1999 2000 200120022003 Aug 2004*

21. 21 Trade Balance: 1996/2004 US$ bilhões -10 -5 0 5 10 15 20 25 1996 1997 198 1999 2000 200120022003 2004* 30 *2004: Accumulated in 12 months

22. 22 Trade Balance Source: Ministry of Development, Industry and Foreign Trade US$ billion 12-Month, Accumulated Exports Imports 88.9 57.3 45 50 55 60 65 70 75 80 85 90 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. 23 Trade Balance: Prices and Volumes ExportsImportsBalance 2002 60.4 47.213.1 2003 73.1 48.324.8 Change % 21.1%2.2%89.1% Change in Prices % 4.7%6.1% Change in Volumes % 15.7%-3.7% 7M03 39.1 26.712.5 7M04 52.3 33.818.5 33.7%26.7%48.8% 10.4%6.0% 20.7%19.4% Change % Change in Prices % Change in Volumes % US$ billion Source: Funcex

24. 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. 25 III. Resuming Economic Growth The Central Bank and the Brazilian Economy: Potential and Challenges

26. 26 GDP Growth Seasonally adjusted, % 1Q032Q03 3Q034Q031Q042Q04 -1.1 1.7 0.4 -1.2 1.5

27. 27 Contribution of Domestic and External Demand to GDP Growth % -5 -3 1 3 5 7 Domestic DemandExternal Demand 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q042Q04 Decomposition of GDP growth (y-o-y)

28. 28 Industrial Output s.a., 2002 = 100 Source: IBGE 85 88 91 94 97 100 103 106 109 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. 29 Source: IBGE Total+9.6+7.8 Capital Goods+23.9+24.9 Intermediate Goods+9.9+6.8 Consumer Goods+7.5+6.0 Durable+27.3+24.5 Semi-Durable e Non-Durable+3.2+2.0 % Jul 04 Jul 03 Jan-Jul 04 Jan-Jul 03 Industrial Output

30. 30 Sources: IBGE, Banco Central Retail Sales 96 98 100 102 104 106 108 110 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. 31 Jul 04 Jul 03 Jan-Jul 04 Jan-Jul 03 Total+10.3+8.8 Furniture & Electronics+32.2+29.6 Fuel and Lubricants+3.4+6.7 Supermarket, Food, Beverage and Tobacco +7.3+5.2 Vehicles & Autoparts+27.0+16.5 Clothing+8.2+6.4 Retail Sales % Source: IBGE

32. 32 Industrial Employment Source: CNI s.a, Jun 2003 = 100 99 100 101 102 103 104 Jun 03 Aug 03 Oct 03 Dec 03 Feb 04 Apr 04 Jun 04

33. 33 The Role of the Labor Market Recovery 2003 = 100 Supermarket Sales left scale Labor Income right scale 98 100 102 104 106 108 Jan 02 May 02 Sep 02 Jan 03 May 03 Sep 03 Jan 04 Jun 04 98 100 102 104 106 108 110 1992 = 100

34. 34 Consumer Confidence 75 80 85 90 95 100 105 110 115 120 125 130 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. 35 Business Confidence Source: FGV Industrial Survey -50 -40 -30 -20 -10 0 10 20 30 40 50 Jul 03 Oct 03 Jan 04 Apr 04 Jul 04 GoodWeak Net Result %

36. 36 Capacity Utilization 75 76 77 78 79 80 81 82 83 Jan 97 Jan 98 Jan 99 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 s.a., 1992=100 Sources: CNI, Bacen

37. 37 Fixed Capital Investment vs. Economic Cycle Sources: IBGE, FGV 70 74 78 82 86 85 95 105 115 125 135 92Q193Q194Q195Q196Q197Q198Q199Q100Q101Q102Q103Q104Q1 Capacity Utilization left scale Fixed Capital Investment right scale % 1990=100

38. 38 Fixed Capital Investment vs. Brazil Risk Sources: IBGE, JP Morgan % 105 115 125 135 1Q003Q001Q013Q011Q023Q021Q033Q031Q043Q041Q05 400 700 1 000 1 300 1 600 1 900 Brazil Risk (Q-2) right scale Fixed Capital Investment left scale Basis Point

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

40. 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. 41 FX-Linked and Fixed Domestic Debt as a Share of the Total Debt Source: Bacen % 13.2 13 16 19 22 25 28 31 34 37 40 Jan 02 Jul 02 Jan 03 Jul 03 Jan 04 Jul 04 16.7 1 3 5 7 9 11 13 15 17 Jan 02 Jul 02 Jan 03 Jul 03 Jan 04 Jul 04 FX-Linked Domestic Debt/Total DebtFixed Domestic Debt/Total Debt

42. 42 FX-Linked Debt Outstanding in US$ US$ billion Source: Bacen US$ billion 34 38 42 46 50 54 58 62 66 70 74 78 Jan 01 Sep 01 May 02 Jan 03 Sep 03 May 04 Since Jan/2003, FX-linked debt decreased US$31.6 billion

43. 43 Impact of a 1% FX change on Debt/GDP ratio % Source: Bacen 15 20 25 30 35 Jan 00 Jun 00 Nov 00 Apr 01 Sep 01 Feb 02 Jul 02 Dec 02 May 03 Oct 03 Mar 04

44. 44 Net International Reserves US$ billion Source: Bacen Adjusted Net Reserves IMF Concept Net Reserves 10 15 20 25 30 35 Jan 99 Aug 99 Mar 00 Oct 00 May 01 Dec 01 Jul 02 Feb 03 Sep 03 Aug 04

45. 45 Interest Payments/Exports Ratio % * 2004 and 2005: BCB estimate 15 19 23 27 31 35 199619971998199920002001200220032004*2005*

46. 46 Net External Debt/Exports Ratio % 1.0 1.5 2.0 2.5 3.0 3.5 4.0 199619971998199920002001200220032004*2005* * 2004 and 2005: BCB estimate

47. 47 Net External Debt/GDP Ratio % 10 15 20 25 30 35 40 199619971998199920002001200220032004*2005* * 2004 and 2005: BCB estimate

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