Otaviano Canuto

1. THE BRAZILIAN ECONOMYThe Center for Latin American IssuesThe George Washington UniversityWashington, February 10, 2006 Otaviano Canuto World Bank - Executive Director forBrazil, Colombia, Dominican Republic,Ecuador, Haiti, Panama, Philippines,Suriname and Trinidad & Tobago

2. Brazil’s economy under President Luiz Inácio Lula da Silva has been more stable than many pundits foresaw when President Lula took office three years ago, even to the point that the country has been able to repay its IMF loan early. To what does the Brazilian economy owe its good fortune?

3. Macro stability: a remarkable journey Inflation 1976/2005 - CPI* – Monthly (%) Real Ex-post Interest Rate: a long, prudent transition Turning point * Consumer Price Index - IPC (FIPE) Source: IPEA. Until October 2005 Expected Inflation - CPI 25% drop in Real Interest Rates (premium on NTN-C*) Lower real interest rates have a major impact on investment decisions; many more projects are now affordable on a market basis than in the 1990s. 3 * Average rate of NTN-C auctions Source: Focus/Central Bank. Source: National Treasury

4. For the first time in 25 years, the external debt is not a concern in Brazil US$ billion For most of the last 25 years, the government external debt was a multiple of exports. Now the ratio is below one (close to 0,8) Total external debt/export ratio dropped by two thirds, from an average of 4 to historical lows of 1,4

5. Current indicators are the result of a clear strategy Prudent Fiscal Policy the main pillar of the economic policy • Stable inflationary expectations • Lower long-term interest rates • Improved debt dynamics • Greater fiscal flexibility • More credit,more jobs Cautious Monetary Stance Lead to... macro stability at the core of economic policies External Adjustment robust export growth and strong external accounts Sustainable Economic Growth Helps Improve Social Conditions 5

6. Fiscal Commitment: the main pillar of the economic policy Public Sector Primary Balance (in 12 months) Federal Revenue Service Receipts as % GDP Source: Internal Revenue Service – SRF/MoF Source: Central Bank Primary Balance by Government Level Public Sector Nominal Deficit % GDP (in 12 months) 6 Source: Central Bank Source: Central Bank

7. Robust export growth and strong external accounts Trade Balance (US$ billion - 12 months accumulated) External Accounts in US$ billion –20 year perpective Source: MDIC - SECEX Net Reserves – Excluding IMF Current Account (12 months accumulated) Source: Central Bank 7 Source: Central Bank

8. External Sector Evolution - limited downside risk • Increases in export volume explain a large part of the trade balance; • The improvement in the external performance is not just a “commodity prices” play; • Current commodities prices, especially agricultural prices, are close to 1990's levels, rather than in any historical peak; • Also, the volatility of the agricultural prices is smaller than that of minerals and, especially, of oil. Exports Price by Product Class (1996=100) Source: Funcex (Ipeadata) Volume-led growth of exports Oil and Other Commodities - Price Evolution Sep 04 – Aug 05 Sep 02 – Aug 04 70% 60% 50% 40% 30% 20% 10% 0% - 10% Prim. Semi. Manuf . Total Prim. Semi. Manuf . Total Price Volume 8 Source:Funcex

9. Broad-based exports: balanced growth across markets and products Brazilian exports by destination (as a % of total exports) Brazilian exports by type (as a % of total exports) 9

10. More production, more savings, more credit, more jobs GDP level (seasonally adjusted) Savings & Gross Capital Formation (% GDP) Source: IBGE * II Quarter 2005 Source: IBGE Credit to the private sector (Jan 2004=100) Job Creation (Net hiring in the formal sector) 10 Source: Ministry of Labor – Caged * 12-months accumulated until Nov/05. Source: Central Bank

11. … leading to a profitable, attractive private sector Primary and Secondary Issues of Stocks Profitability of 500 Top Firms (1981-2004) Source: Conjuntura Econômica - FGV - August 2005 Net Foreign Direct Investment (as % of GDP) Private Bonds Registers and Issuances BRAZIL Source:CVM

12. New Products: Mortgages. PIPS. securitization.private equity insurance... Higher GDP growth and more jobs Higher transparency Less vulnerability Business environment (tax system. regulatory framework. judiciary reform) Real Interest Rate with room to decline Fiscal Responsibility (macro stability) Micro reforms to fully reap the benefits of macroeconomic policies Reform of the housing & construction market Real Estate Credit (Jan-04 = 100)* • The construction sector grew by 5.7% in 2004 and 2.1% in 2005H1, after years of contraction; • Financing rates dropped from 12 % p.y. to 9 % p.y. on average; • The flow of new loans grew by 60% in 2005, comparing with 2004. A further 50% increase is projected for 2006 Source: Central Bank *Note: Private sector real state credit reached R$ 28.5 bn in Nov-05 The number of house loans in 2005 was the largest since 1994 Real estate is the next major market for the banking sector 12

13. 40.0 35.0 2002 2004 30.0 25.0 20.0 15.0 10.0 5.0 < 30 < 40 < 50 <60 < 70 < 80 55.0 2002 50.0 2004 45.0 40.0 3 35.0 30.0 < 70 < 80 <90 … and complement social policies Proportion of the Income for Income Decil (accumulated) % of total income Decil of population • The National Household Survey PNAD 2004 illustrates the progress in social indicators that can be obtained with a 4% annual GDP growth and targeted social policies that preserve fiscal responsibility • Programs such as Bolsa Família, together with more jobs and greater supply of utilities services, have an important impact on social welfare • Only the very top income level saw their income decreasing between 2002 and 2004 13

14. Social indicators on the move Gini index of the labor incomes A social safety net that avoids extreme poverty Drop in 1993-1995 reflects the impact of price stabilization in 1994 Source: IBGE Source: IBGE Aver. of schooling years of 10 y-old (or more) people Yearly Average Minimum Wage in US$/month 14 Source: IBGE

15. With Brazil facing presidential elections in October, does the economy face additional risks?

16. Should an election year always be a year of turbulence? Economic Indicators in the year preceding presidential elections

17. 51.0% 49.0% 47.0% 45.0% 43.0% 41.0% 40.2% 39.0% Basic scenario* GDP 4.0% Central Selic 38.5% GDP 3.5% Selic Path (-) GDP 4.0% Selic Path (-)** 37.0% 36.9% GDP 3.0% Selic Path (-)*** GDP 4.0% Selic Path (+)*** 35.0% 2006 2007 2008 2009 2010 2011 Source: Central Bank and National Treasury * According to Market Expectations – Focus ** It’s based on positive supply shock scenery (Reforms and more competition) *** It´s based on demand shock scenery. Three years of reduction in the Debt/GDP ratio brighten the fiscal outlook Net Debt/GDP scenarios based on the FOCUS survey Net Public Sector Debt / GDP ** Data of Central Bank – IGP-DI (wholesale price index)‘modified’ Scenarios are consistent with FOCUS Market Expectations, which project the primary balance at 4.25% of GDP and GDP growth at the 3.5% - 4.0% range  4 - 6 years: deficit zero & overall public sector debt at levels close to those of Mexico 17

18. International Reserves

19. Market Expectations for 2006-2010

20. Federal Public Debt DPF composition For the first time, the selic-linked LFT accounts for less than 50% of the domestic public debt DPMFi (and just above 40% of DPF) 20 Source: MorganMarkets, Broadcast

21. A steady level of public external debt with improved profile External Debt – National Treasury Average Maturity of Bonds at Issue (includes coupons) Source: National Treasury Source: National Treasury External Public Debt Profile – New Bonds and Bradies “Cleaning Up” of the External Debt Early payment of IMF and Paris Club Exchange of C-Bond Issuance in Reais - BRL 2016 Roll-over of 75% of the maturities in 2006-2007 Lengthening of the Maturity (11 years) and greater access to Asia 21 The outstanding amount between October and December for 2005 is US$ 15 million for principal and US$ 353 million for interest.

22. Lower yields and longer term bonds Yield of New Bonds – Global and Euro 2002 22 • Source: National Treasury • * Reopening Issuance • ** Real Bond

23. Economic and political outlook for 2006 and 2007 • Strong international liquidity and accelerated global growth create an environment which is still very positive for emerging markets and, in particular, for Brazil. • Slowdown in export growth, but trade surplus should remain very high. International reserves grow significantly, further improving Brazil’s external solvency indicators. The Real depreciates slightly. • Favorable balance of risks and continuity of inflation convergence process. There is a strong probability of inflation coming in below the annual target for the first time since the introduction of the inflation-targeting regime. • Cycle of monetary easing enables significant decline in nominal interest rates, without jeopardizing the convergence of inflation to its targets. Real interest rates decline gradually. • Monetary easing, lower inflation and a recovery in the confidence of businessmen and consumers should provide a fresh impetus to economic growth, making the current cycle the longest in the past 25 years. • Maintenance of primary surplus in line with its target allows for a continued decline in the net debt/GDP ratio. • 2006 presidential election should be a straight race between President Lula and the PSDB candidate. Opinion polls reveal a preference for low inflation, increasing the incentive to maintain current economic policy intact.

24. Pro-growth agenda will be a challenge for the next government Over the longer term, some measures that could raise Brazil’s potential GDP are: • Reduction in government spending, to reduce the public sector’s share of the economy and to increase the private sector’s contribution. • More efficient government spending (e.g. in education). • Tax reform with a lightening of the tax burden (reducing the advantages of the informal sector), mainly for investment and expanding the tax base. • Greater trade liberalization in the Brazilian market. • Expansion of negotiations of bilateral agreements, advances at the WTO, and resumption of negotiations under the FTAA and with the European Union. • Leverage investments in infrastructure that have major positive externalities (e.g. strengthening of regulatory agencies, advances in the Public-Private Partnerships, resumption of the privatization process, including concessions to operate public services). • Improving Brazil’s income distribution. • Continuing the process of improving credit and capital markets.