Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. P 7275 BR

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND

DEVELOPMENT

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED FISCAL AND ADMINISTRATIVE REFORM SPECIAL SECTORADJUSTMENT LOAN

IN THE AMOUNT OF $505.06 MILLION

TO THE

FEDERATIVE REPUBLIC OF BRAZIL

March 7, 2000

Poverty Reduction and Economic ManagementBrazil Country Managing UnitLatin America and the Caribbean Region

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not be otherwise disclosedwithout World Bank authorization

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CURRENCY UNIT - Real (Rs.$)US$1 = Rs.$1.77

WEIGHTS AND MEASURESMetric System

FISCAL YEARJanuary 1 - December 31

Abbreviations and Acronyms

ANATEL National Telecommunications (Agencia Nacional de Telecomunica,oes)ANEEL National Electric Energy Agency (Agencia Nacional de Energia Electrica)BCB Central Bank of Brazil (Banco Central do BrasilBIS Bank of International SettlementsBNDES National Development Bank (Banco Nacional de Desenvolvimento

Econ6mico e Social)CAS Country Assistance StrategyCEF Federal Housing Bank (Caixa Economica Federal)CLT Private Sector Labor Regime (Consolida,do das Leis TrabaIhistas)COFINS Financing Contribution for Social Security (Contribu,ao para o

Financiamento da Seguridade Social)CPMF Financial Transactions Tax (Contribu,ao Provisoria de Movimenta,ao

Financeira)GDP Gross Domestic ProductIBGE Brazilian Institute of Geography and Statistics (Instituto Brasileiro de

Geografia e Estatistica)ICMS Value Added Tax (Imposto de Circula,do de Mercaderias e Servi,os)IDB Interamerican Development BankIFI International Financial InstitutionIGP-DI General Price Index - Domestic Supply (Indice Geral de Pre,os -

Disponibilidade Interna)IMF International Monetary FundIOF Financial Operations Tax (Imposto de Operacoes Financeiras)MF Ministry of Finance (Ministerio da Fazenda)PME Monthly Employment Survey (Pesquisa Mensal de Emprego)PNAD National Household Survey (Pesquisa Nacional por Amostra de

Domicilios)RGPS General Social security Regime (Regime Geral de Previdencia Social)RJU Civil Service Employment Regime (Regime Juridico Unico)SARE State Secretariat of Administration and Patrimony (Secretaria de Estado

da Administra,do de Administra,do e do Patrim6nio)SOE State-owned EnterprisesS/SECAL Special Sector Adjustment LoanSTF Supreme Federal Tribunal (Supremo Tribunal Federal)

Vice President: David de FerrantiDirector: Gobind T. NankaniLead Economist: Suman BeryTask Manager: Mauricio Carrizosa

FOR OFFICLIL USE ONLY

States of Brazil

AC Acre PB ParaibaAP Amapa PE PernambucoAL Alagoas PI PiauiAM Amazonas PR ParanaBA Bahia RJ Rio de JaneiroCE Ceara RN Rio Grande do NorteDF Distrito Federal RO RondoniaES Espirito Santo RS Rio Grande do SulGO Goias RR RoraimaMA Maranhao SC Santa CatarinaMG Minas Gerais SE SergipeMT Mato Grosso SP Sao PauloMS Mato Grosso do Sul TO TocantinsPA Para

Tlis document has a restricted distribution and may be used by recipients only in theperformance of their official dufies. Its contents may not othierwise be disclosed withoutW'orld Bank authorization.

BRAZILADMINISTRATIVE AND FISCAL REFORM LOAN

Loan and Program Summary

Borrower: Federative Republic of Brazil

Implementing Agencies: Ministry of Finance and Ministry of Administration

Poverty Category: Not Applicable

Amnount: US$505.06 Million (including financing of the front-end fee)

Terms: Five-year term loan, with three-year grace period, a floatinginterest rate equal to 6-month US$ LIBOR plus 400 basispoints.

Commitment Fee: 0.75 percent on undisbursed loan balances, beginning toaccrue 60 days after signing.

Front-end Fee: 1 percent of the loan amount, to be financed under the loan.

Diescription: The operation would support the Government's program toimprove Brazil's fiscal performance in general and the fiscalperformance of the states in particular, with an emphasis onadministrative reform to reduce personnel costs and increaseefficiency.

The Program consists of policy actions to improve fiscalperformance chiefly through reducing the burden of the wagebill in the federal, state, and municipal governments, as wellas in the Federal District. The actions include introductionand initiation of the Government's Fiscal Stability Plan,approval and implementation of laws regulating the 19tl

Amendment to the Constitution (the Administrative Reform),refinancing of the state's debts, and establishment of afacility support states undertaking administrative reform.

Benefits and Risks: The main indicators of success include an increase in theoverall public sector balance, a reduction in net public sectordebt, an increase in primary balances and a reduction indebt/revenue ratios at the state level, and a reduction in thelevel of the personnel expenditures/revenue ratio at the statelevels. Related benefits include reduced real interest ratesand higher growth resulting from improved fiscalperformance, and efficiency gains from reallocating human

resources from the public sector to productive activities inthe private sector, from increased beneficiary participation inpublic sector service delivery, from undertaking performanceevaluations of the civil service, and from adopting amanagerial approach in public sector administration.

A first risk is that public sector balance and debt targets maynot be fully attained due to various reasons, includinghigher interest rates on the public debt and successfuldomestic pressures for additional expenditures. This risk ismitigated by the expectation, based on the Government'spolicy performance record, that any possible deviation fromattaining public sector balance and debt targets is likely totrigger additional actions by the Government. Second, thereis the risk that recession prevents a smooth transition ofdismissed public employees to private employment,generating some social costs. This risk is mitigated byongoing economic recovery, expected indemnities todismissed workers, and limited likelihood of dismissal ofdistressed employees. Third, there is the risk that debtagreements with the states weaken due to political pressurefrom sub-national governments. This is mitigated by theGovernment's strong commitment and need to enforce theprinciple that states must pay their debts to ensure fiscalsustainability.

Financing Plan: Not Applicable

Net Present Value: Not Applicable

Project Identification Number: BR-PE-P063341

This report is based on the findings of Bank missions headed by Mauricio Carrizosa (taskmanager, LCSPR) that visited Brasilia and several states during the period 1998-2000. Inputs tothe report were provided by Indermit Gill (LCSHD); Joachim von Amsberg (LCC5C); AlbertoChong (DECRG); Francisco Cameiro (consultant), Francisco Pereira (consultant), and AnnePillay.

FEDERATIVE REPUBLIC OF BRAZIL

PROPOSED FISCAL AND ADMINISTRATIVE REFORM SPECIALSECTORAL ADJUSTMENT LOAN

Table of Contents

1. RECENT ECONOMIC DEVELOPMENTS 1

MACROECONOMIC PERFORMANCE AND POLICIES 1POVERTY REDUCTION 2

2. THE FISCAL AND ADMINISTRATIVE REFORM PROGRAM 5

FISCAL REFORM ISSUES 5ADMINISTRATIVE REFORM ISSUES 7THE REFORM AGENDA. 9EXPECTED IMPACT OF THE REFORM PROGRAM 21SUSTAINABILITY OF THE REFORMS 28

3. THIE PROPOSED LOAN 30

BANK ASSISTANCE STRATEGY 30PROGRAM OBJECTIVE 30PROGRAM DESCRIPTION 31DESCRIPTION OF FINANCIAL ASSISTANCE 32PROGRAM IMPLEMENTATION AND SUPERVISION 34DISBURSEMENT AND AUDITING 34PROGRAM BENEFITS 35LESSONS LEARNED 35RISKS AND RISK MITIGATION PROVISIONS 36

4. RECOMMENDATION 38

5. ANNEXES 39

ANNEX 1: LETTER OF SECTOR DEVELOPMENT POLICY 40ANNEX 2: ACTIONS PRIOR TO BOARD PRESENTATION 47ANNEX 3: KEY ECONOMIC INDICATORS 49ANNEX 4: KEY EXPOSURE INDICATORS 51ANNEX 5: STATUS OF BANK GROUP OPERATIONS 52ANNEX 6: STATEMENT OF IFC'S HELD AND DISBURSED PORTFOLIO 54ANNEX 7: IFC: APPROVALS PENDING COMMITMENT 57ANNEX 8: BRAZIL AT A GLANCE 58

MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THEINTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENTTO THE EXECUTIVE DIRECTORS ON A PROPOSED SPECIAL SECTOR

ADJUSTMENT LOAN TO THE FEDERATIVE REPUBLIC OF BRAZIL FORBRAZIL'S FISCAL AND ADMINISTRATIVE REFORM PROGRAM

1. This report proposes a special sector adjustment operation, in the amount ofUS$505.06 million (including front-end fee), to support a Fiscal and AdministrativeReform Program in Brazil. This is the first of an expected program of two adjustmentoperations in support of Brazil's fiscal and administrative reforms. The operations arepart of a proposed Bank package of adjustment loans totaling $2.5 billion that alsosupports reform in the areas of social security and social protection expenditures. Thefirst loans in the latter two areas were approved in January 1999. The Bank package is anintegral part of a broader support initiative by the IFIs, including the IMF and the IDB,together with selected bilateral governments, directly and through the BIS to help Brazilmeet its external financing requirements in support of key structural and social reforms.

2. The objective of the Program is to improve Brazil's fiscal performance in generaland the fiscal performance of the states in particular, with an emphasis on administrativereform to reduce personnel costs and increase their efficiency. The first loan supportsmeasures and actions that have already enacted and are being implemented, includingBrazil's Fiscal Stability Program, the State Debt Refinancing Law, the State Debtrefinancing agreements, the Sub-national Public Indebtedness Regime, andAdministrative Reform. The expected outcomes from these measures and actions includean increase in the overall public sector fiscal balance and a reduction in the ratio of publicsector net debt to GDP; an increase in the aggregate fiscal surplus at the state level; areduction in the ratio of personnel expenditures to net current revenues at all levels; areduction in the ratio of state debt to net state revenues; and additional privatization at thestate level. The second loan would support additional measures to be enacted, includingBrazil's new fiscal code (the Fiscal Responsibility Law) and a pending bill that willcomplete the regulation of Administrative Reform.

1. RECENT ECONOMIC DEVELOPMENTS

MACROECONOMIC PERFORMANCE AND POLICIES

3. Since the early 1990s, Brazil has been engaged in a major reform of its economy,moving away from import substitution and state-owned enterprises towards greateremphasis on private initiative, competition and international integration. Considerableprogress has been made in controlling inflation and creating an improve economicenvironment for private enterprise, fiscal adjustment and reform of the public sector.From 1992 to 1997 Brazil experienced a very successful growth performance. Annualgrowth averaged 4.2%, a major improvement over the average for the previous five-yearperiod (0.0%). Factors contributing to this positive outcome include a trade liberalization

2

during the early 1 990s and a well-designed and implemented economic stabilizationprogram initiated in mid-1 994 (the Real Plan), together with a favorable internationaleconomic environment. By contrast, the last two and a half years (mid- 1997 to end- 1999)have seen a much more volatile international economic environment with a series ofcrises in international markets. These crises adversely affected growth in Latin Americaand Brazil was no exception. The average rate of growth during 1998-99 was only 0.3%,but by the end of 1999, recovery of industrial output was firmly established.

4. As a result of the stabilization plan introduced in 1994, annual inflation declinedfrom over 2000% in 1993 to less than 2% in 1998. Even the large currency depreciationof January 1999 had a fairly limited small pass-through impact on inflation. Inflation in1999 was contained to about 20% on broad price indices and 8% on consumer priceindices. This was the result of sluggish aggregate demand and continued monetary tightness. Following the change in the exchange rate regime in 1999, from a crawling band toa floating rate, Brazil introduced a sophisticated inflation targeting framework. Targetswere set at 8%, 6% and 4% respectively for 1999-2000, with a margin on each side oftwo percentage points. With an improved fiscal framework (see para. 14 ) and assumingan absence of external shocks, the inflation targets for 2000-01 are realistic. The inflationtargets provide the anchor for monetary policy.

5. Policy performance has also improved substantially. As early as 1995, theGovernment attempted to address the structural fiscal deficit unmasked by price stability.However, lack of legislative consensus meant that fiscal adjustment lagged behind otherparts of the economic reform program. As a result, Brazil has been dependent on largecapital inflows. This dependence coupled with the prevailing exchange rate regimeimplied vulnerability to sentiments in international markets. The Government respondedcompetently and effectively to the loss of market confidence in late-1 998 and early-1 999with a combination of tightened monetary policy and fast-acting fiscal adjustmentmeasures coupled with a new drive for structural fiscal reforms. Throughout 1999, fiscaladjustment has been carried out with tremendous effort and remarkable discipline and hasachieved the ambitious targets that were set. These measures, taken together with theshift to a floating exchange rate in January 1999 have been successful in preservingeconomic stability and regaining market confidence. Provided the external environmentremains benign, Brazil can look forward to a return to steady, non-inflationary growth.Brazil's remaining economic vulnerability results from its continuing, though declining,fiscal and current account deficits. As fiscal deficits are closely correlated with currentaccount deficits, fiscal adjustment at both national and sub-national levels are critical forreducing vulnerability and restoring growth.

POVERTY REDUCTION

6. Following a period of increasing poverty from 1987-1994, the Real Plansignificantly reduced poverty levels during the period 1994-1998. The national headcountratio (using a poverty line of R$65 per capita per month at 1996 prices) declined from

3

34% in 1993 to 22% in 19981. This beneficial effect was due to: (i) economic growth andrising real wages; (ii) the end of inflation (salary erosion and inflation tax); (iii) asignificant appreciation of the local currency shifting relative prices toward the servicesectors in which most poor work; and (iv) a significant increase in the minimum wage towhich important income sources, such as pensions, are tied. Despite these advances,Brazil continues to be a country with high income inequality and a high level of povertyfor its level of per-capita income. The average 1998 headcount ratio of 21.7% masksimportant regional differences, with regional headcount ratios ranging from 8.5% in theSouth East to 47.3 in the North-East.

7. The succession of economic crises since 1997 has affected the poor mainlythrough reduced labor demand and the resulting reduction in employment and/or realwages. Nevertheless, since economic performance in 1999 has been much better thanfeared at the time of the devaluation in early 1999, the negative poverty impact of thecrisis has also been much less severe than expected. According to availablemeasurements of labor incomes 2 , the headcount poverty rate in six metropolitan areasdropped from a peak of 35.3% in July 1994 to a low of 24.6% in October 1997. The rateincreased continuously from November 1997 until March 1999, when it reached 30.0%.The latest data through September 1999 shows a slight improvement in poverty ratesindicating a reversal in the negative crisis impact. Country-wide indicators show a trendof slowly reducing labor income inequality continuing through 1998. The rate of openunemployment reached a high of 8.2% in March 1999 but since then has declined againto 6.3% (December 1999).

8. Government support for the poor during the difficult 1998-99 period has beenincreasingly effective. Supported by the Bank's Social Protection S/SECAL and a paralleloperation by the IDB, the Federal Government has effectively protected the expendituresfor a core set of 22 selected priority social programs in the areas of education, health,labor, and social assistance, considered to be particularly effective in reaching the poor.Despite the drastic overall cuts in the 1999 budget, allocations for these programs(totaling about R$12 billion) were protected near or above their 1998 levels. Total actualspending for these protected programs in 1999 has slighly exceeded the Governmentcommitments. The Government's budget proposal for 2000 implies an increase in fundingfor the total of the 22 programs of 20% over the 1999 budget proposal and 12% over theapproved 1999 budget, including very significant increases for relatively new andpromising programs that link transfer payments to poor families to children's schoolattendance (Child Labor Eradication Program, and Bolsa Escola). SubnationalGovernments have also contributed to social protection in the crisis period, for examplethrough workfare programs implemented by several states and municipalities. At thesame time, the Federal Government is proceeding with a program to improve the qualityand targeting of spending in the social area. The remaining second and third tranches of

1 Poverty data here come from a forthcoming urban poverty report based on the 1998 PNADhousehold survey and a food-only poverty line.2 Data from the Monthly Employment Survey, PME, undertaken by IBGE. This survey most likelyexaggerates the negative impact of the crisis since it is limited to six metropolitan areas (most likely thehardest hit areas) and excludes income from transfer programs which would have compensated for some ofthe loss of labor income.

4

the IDB's Social Protection Loan are linked to physical performance indicators of theprotected programs and a program of studies and steps to improve targeting and qualityof these programs. In addition, the Bank would follow with particular interest thestrengthening of the implementation framework (monitoring and evaluation, technicalassistance, training, and capacity building for participating municipalities, etc.) for thetransfer programs linked to school attendance discussed above.

9. Increased public and political attention toward poverty problems, together withpolicy reforms undertaken in recent years, strongly suggest an improved outlook forBrazil's poor. The remarkable rise of poverty reduction into the top of Brazil's agenda ofpublic debate (over the last year in particular), is reflected in congressional initiative toformulate concrete proposals for additional poverty reduction efforts and by a proposal tocreate a new Poverty Alleviation Fund that has the Government's support and is currentlybeing debated in Congress. Structural reforms of the economy have laid the groundworkfor economic stability that would protect the poor from income fluctuations related tofailed stabilization attempts. The impact of renewed growth on poverty reduction, thoughgradual, will be important. The major drive for improved education access and quality isstill recent but will yield significant poverty reduction results in the medium term. Theimpact of other structural social policies including land reform, urban upgrading,professional training, labor market reforms, and others, is difficult to quantify butqualitatively important and expected to continue, including the social assistancecomponent of Social Security (which is protected under the Social Security Reform beingsupported by the Bank). The poverty reducing impact of transfer programs has been largein recent years and is also expected to continue, especially if measures for better targetingare successfully implemented. The Government's stated goal is to reduce the poverty rateby 50% by the year 2015. This target could be accomplished with annual average growthof 3.5%, with the joint effect of other structural social policies and improved socialprotection, and if recent improvements in outcomes from educational policies continue.3

3A detailed discussion is provided in the CAS.

5

2. THE FISCAL AND ADMINISTRATIVE REFORMPROGRAM

10. The proposed operation has been designed to support improvements the fiscalperformance of Brazil's public sector. Improved fiscal performance is closely linked toadministrative reform: increased efficiency in the delivery of public sector services isregarded as one of the key components of fiscal adjustment. This is particularly so withregard to most sub-national administrations, where personnel costs (wages andretirement/survivorship benefits) have become unduly high with respect to revenues. Anadjustment of these costs through administrative and social security reforms is arequirement for improving Brazil's sub-national and overall fiscal performance. Theproposed loan supports policies for federalfiscal adjustment as well as federal policyincentives for sub-nationalfiscal adjustment, particularly through administrative reform.

FISCAL REFORM ISSUES

11. Fiscal Imbalance. At present, fiscal adjustment is Brazil's most challengingmacroeconomic policy issue. Brazil's public sector borrowing requirement in 1998,which amounted to 8 percent of GDP, increased the debt/GDP ratio from 34.4 to about 42percent of GDP (Chart 1). The inadequate fiscal performance contributed to theconsiderable amount of turbulence that Brazil's financial and foreign exchange marketssuffered in the aftermath of the Asia crisis in October 1997. Faltering confidence in thecrawling exchange rate band coupled with policy-led declines in interest rates (from43.3% in November 1997 to 19.2% in August 1998, prior to the Russia crisis4) led to adecline in liquid international reserves from the exceptional peak of $73.8 billion attainedin April to a more normal level of $40.3 billion in November of 1998. In late 1998, theGovernment introduced a Fiscal Stability Program, supported by the IMF. Reserve lossesled to a change in the exchange rate system in January 1999, from the crawling exchangerate band introduced at the onset of the Real plan to a floating rate. The resulting 64%devaluation (from R$1.21 to R1.98 to the dollar) raised the debt/GDP ratio to about 52%in January 1999, reflecting the dollar-denominated and dollar-indexed federal debt(which comprised about 28% of total debt in late 1998). Furthermore, the Governmentraised interest rates again to defend the currency, to 45% by February 1999, making fiscaladjustment even more difficult and discouraging growth. The January 1999 devaluationoccurred as confidence faltered in the aftermath of a debt moratorium declared by one ofthe major states in Brazil, underscoring the fragile state of sub-national finances in Brazil.Conditions improved following the announcement of a revised agreement with the IMFthat introduced a stronger fiscal adjustment program. Since January 1999, the exchangerate has ranged from about 1.7 to 2.1 (the rate at the end of February 2000 was 1.77),overnight rates have returned to a level below 20 percent p.a., net public debt haddeclined to 47% of GDP by end-99, and GDP growth in 1999 was about 0.8%, muchbetter than the -4.0 percent predicted at the beginning of the year. In November, 1999 theIMF Board approved the fourth review under the Stand-by arrangement.

4 Over-Selic Rate

6

12. Incentives on Expenditures. Much of the inadequate fiscal performanceoriginated in excessive incentives for public expenditures, including un-fundedconstitutional mandates (e.g., universal access to health care) and decentralization ofrevenues (but not of responsibilities5). On the expenditure side, the main structuralproblems have been:

* expenditure rigidities: the limited scope for expenditure policy, as most expenditure ispredetermined by constitutional or legal provisions, including constitutional transfers,constitutional social security benefits, health expenditures, and many others (it isestimated that the federal government has control over only 10 percent of its budget);* a lack offiscal balance targets: budgets are mainly driven by expenditure mandatesand not by fiscal balance objectives; and* weak sub-national budget constraints: weakness of the budget constraints that havebeen faced by sub-national governments, leading to excessive expenditures at the sub-national level.

Some progress has been achieved in addressing expenditure rigidities, including a 20%reduction in earmarking and an increased ability to reduce excessive public employmentThe lack of fiscal balance targets is being achieved by the Government's Fiscal StabilityPlan and, more systematically, by the new fiscal code that is presently being discussed byCongress, the Fiscal Responsibility Law. The Fiscal Responsibility Law will alsostrengthen budget constraints at all levels. Reforms to strengthen the sub-national budgetconstrain are discussed in the next section. The main structural reforns with a bearing onpublic expenditures, including the Fiscal Responsibility Law and Social SecurityReforms are discussed in the next section.

Chart 1- Brazil Net Debt1GDP: 1974-1999

° 30.0%E 0.0h_ * __*l

1 20.0%IL 30.0%

10.0%/

O~~~~ - D - - - - -

C 3.. CD cD 2 0 , > g X m288jD88Ea8r

u o PGoP oi lo

13. Sub-national Finances. Until 1998, states financed their excess expendituresthrough increasing debt levels.6 As a result, many states have unduly high levels of debtin relation to their revenues. Their primary balances have been inadequate to contain

5 See Rigolon, Francisco and Giambiagi, Fabio, "A Renegocia9do das Dividas e o Regime Fiscal dosEstados", BNDES, Textos para Discuss&o, No. 69, 1999 (July).6It is argued that sub-national govermments in Brazil have not faced a sufficiently hard budget constraintdue to existing political incentives. An analysis of the impact of political incentives on sub-national fiscaldisequilibrium is found in Mendes, Marcos Jose, "Incentivos Electorais e Desequilibrio Fiscal de Estados eMinicipios", Instituto Femand Braudel de Economia Mundial (1999).

7

those debt levels. As of September 1999, state gross debt/revenue ratios exceeded 2.0for 12 of the 27 states and exceeded 1.0 for 21 of the 27 states. In 1999 (January-November) the primary surplus for the 27 states was 3.5% of net disposable currentrevenues. While this is an improvement over 1998, when states had a deficit of 6. 1% oftheir net disposable revenues, the present surplus is still insufficient to reduce the ratio ofdebt to revenues. With normal parameters (e.g., 6.6% real interest rate, 4% real growth inrevenues, and a debt/revenue ratio of 2.2), the minimum primary balance required toreduce debt would be above 5.5% of current revenues. A larger real interest rate (broughtabout, for example, by indexation exceeding general inflation) or sluggish revenuegrowth would raise these requirements, as they did in 1999. The required surpluses willbe higher than the likely 1999 surplus. To achieve higher surpluses, many states willneed to deepen control of personnel costs, which are critical for successful adjustment.The major focus of the Program is on reversing the overallfiscal performance of thestates by encouraging and assisting in their fiscal adjustment and in administrativereforms.

14. The Government's Approach to Fiscal Reform. The authorities regard fiscalreform as a central component of the Government's program, with a bearing onconfidence, growth and public sector efficiency. In 1998, the Government introduced aFiscal Stability Program to improve Brazil's fiscal performance (the primary balance),reduce public sector debt to more comfortable levels and reduce real interest rates. Lowerpublic debt and interest rates will improve confidence and encourage growth. Under theGovernment's program, supported by the IMF, the specific aim is to bring down debt to46.5% of GDP by the year 2001 through public sector primary surpluses exceeding 3% ofGDP. In 1999, the programmed surplus of 3.1% was comfortably met. The authoritiesexpect to continue obtaining the programmed surpluses chiefly through measures thathave been enacted to raise federal taxes and to control federal expenditures and throughdebt refinancing agreements to encourage fiscal adjustment at the sub-national level.However, the Government has for long realized that, over the longer tern, sustained fiscalpolicy improvements require deeper structural changes in fiscal institutions, taxes,intergovernmental relationships, public administration, and social security. These changeswill contribute to sustain fiscal adjustment and enhance public sector efficiency. They arepart of the Government's far-reaching public sector reform agenda discussed furtherbelow.

ADMINISTRATIVE REFORM ISSUES

15. Public Administration. Brazil's public sector administration and service deliveryhas been affected by a number of factors that can be summarized as follows:

* Bureaucratic Public Administration: Brazil's public sector, as in many othercountries, has suffered from a excessive reliance on procedures. The bureaucraticapproach to public administration is being addressed through Administrative Reform,which places an increased focus on management and outcomes.

* Public Enterprises: The bureaucratic approach to administration led to rigidities onpublic enterprises, which had to follow the same procedures adopted by the central

8

government (e.g., rules of government procurement were extended to publicenterprises). The poor performance of public enterprises is being addressed throughthe Government's aggressive privatization program (para. 43).Mandatory tenure for civil servants. The 1988 Constitution made it mandatory forthe public sector to hire with tenure. This has made it difficult for Governments at alllevels to address labor redundancies and to adopt more effective managerialapproaches. Administrative Reform has abolished mandatory tenure for the civilservice (paras. 33-36).

* Decentralization: Although decentralization is expected to have a positive effect onpublic sector efficiency and service delivery, the experience thus far in sectors such ashealth and education is mixed, with much progress still to be made. To fully reap thebenefits of decentralization, administrative reform needs to reach the sub-nationallevel.

16. Brazil's Approach to Administrative Reform. The Government's approach toadministrative reform, as in several other parts of the world, is that the public sectorshould move from a bureaucratic state to a managerial state7. This shift implies arethinking of the role of the private sector and of public sector administrative andinstitutional approaches. The changes are based on a classification of state activities intofour sectors: strategic core8, which defines law and policies and ultimately ensures theirenforcement; exclusive activities9 , which guarantee that laws and policies are followedand financed; excludable services'(, which are provided both by the public and privatesectors; and production of goods by public commercial enterprises. Privatization of thelater is viewed as a major action to achieve efficiency. Increased private sectorinvolvement in excludable services is also seen as having a positive impact on efficiencyand service delivery. Hence, Brazil has adopted privatization and other forms of privatesector involvement as major policies with regard to these state activities.

17. The scope of privatization being limited to SOEs and, less so, to the so-calledexcludable service sector (e.g., health services), public sectors normally have an interestin direct management of a share of excludable services and dominate the strategic coreand the exclusive activities' . It is particularly in regard to these services and activitiesthat the proposed managerial approach entails an effort to have public administrationfocus more on the outputs or outcomes of the public sector and on its clients --thecitizenry -- rather than exclusively on procedures. This requires a new administrative andinstitutional approach, largely inspired by public sector reforms that took place in Britain,New Zealand, Australia, and Sweden. Basic instruments to achieve it include

7This approach is well described by the views developed by former Administration Minister Luiz CarlosBresser Pereira. See, Bresser Pereira, Luiz Carlos, "Managerial Public Administration: Strategy andStructure for a New State", in Journal of Keynesian Economics", Fall 1997, Vol. 20(1), pp. 7-23.a Includes parliament, the courts, the presidency, and ministers, as well as the corresponding localauthorities in a federal system.9 Includes the armed forces, the police, tax collection, regulatory agencies, and the agencies that financeand control social services, including social security.'0 Includes education, health, culture, and research.1l One may note, nevertheless that the private sector has a limited role in these activities, including self-regulation and private protection.

9

decentralization, delegation of authority and responsibility (i.e., management contracts),and control of achievement of results. Even in the case of core services, where proceduralcharacteristics remain important, a focus on service delivery is to be enhanced bystronger civil servants (i.e., competent and well-paid). In exclusive activities,decentralization, delegation, and monitoring become paramount. In excludable activities,autonomy, with civil society playing a role in their control, must be added. Brazil'sAdministrative Reform contemplates institutional instruments to enhance the focus ofexclusive and excludable activities on management and outcomes. The reform will alsoencourages efficiency by permitting the dismissal of employees that performinadequately.

18. Brazil's Administrative Reform also seeks to assist fiscal adjustment throughcontainment of personnel expenditures. Brazil is today in a "cutback management" phase,where public spending cuts, including cuts in personnel spending, and improvedefficiency are required to meet fiscal constraints in an economy where the tax burdenalready appears too high. The Administrative Reform serves this aim by allowingdismissal of civil servants when personnel expenditures are excessive.

THE REFORM AGENDA.

19. Based on the approaches described above, the Government has developed and isimplementing a Fiscal and Administrative Reform agenda that can be classified into thefollowing key components:

* Public Sector Fiscal Reform, as contained in the Government's Fiscal StabilityProgram and in Fundamental Structural Reforms with a Fiscal Impact;

* State Fiscal Reform, as provided in the State Debt Refinancing Law and the StateDebt Refinancing Agreements;

- Administrative Reform, as established by a 1998 reform to civil service andinstitutional provisions in the Constitution and by the regulation of those provisions;

* Privatization, as implemented through the National Privatization Plan.

20. Figure 1 links these reforms to expected outcomes. Public sector fiscal reform isexpected to increase the overall primary balance of the public sector and reduce theburden of public sector debt. State Fiscal Reform is designed to encourage fiscaladjustment at the state level. Administrative Reform is expected to facilitate fiscaladjustment through reductions in personnel expenditures and to improve public sectorefficiency. The following paragraphs discuss the reforms.

21. Public Sector Fiscal Adjustment Under the Government's Fiscal StabilityProgram, the planned surpluses for 1999-2001 are 3.10%, 3.25%, and 3.35% of GDP. In1999, the authorities exceeded the target by attaining a public sector surplus of 3.13% ofGDP. To achieve the targets, the authorities are undertaking short term fiscal measures aswell as implementing reforms to address structural sources of the fiscal deficit, includingtax reform, the fiscal code, social security reform, and sub-national finance. As discussedbefore, the Government's objective is to reduce the public sector's debt/GDP ratio to

10

Figure 1: Relationship Between Policy Measures and Outcomes

POLICY MEASURES OUTCOMES

1~~~lb v.4 A lb

84

~~ 4~ ~

11

around 46.5% by the end of the year 2001, with the expectation that a sustainable stableor declining ratio will help Brazil withstand external shocks with less disruption of thedomestic economy and that fiscal stability will help improve confidence, reduce realinterest rates, and encourage growth.

22. Short Term Fiscal Measures. The short term fiscal measures that are beingundertaken comprise actions to both reduce expenditures and raise revenues during 1999-2001. The short terrn fiscal measures were announced first in October 1998, in theaftermath of the Russia crisis, and second, in March, in the aftermath of the chanRe in theexchanpe rate system. Measures to increase revenues included increases in taxes and oilprices , collection of previously accrued taxes (including a vigorous defense againstjudicial challenges to some taxes). In 1999, these measures increased the tax/GDP ratio to31% of GDP. Measures to contain expenditures cover lower wage adjustments,suspended hiring and promotions, and cuts in non-labor costs and investments.

23. Tax Reform. The authorities are also aiming at longer term measures to improvethe level and quality of fiscal outcomes. Fiscal performance has been undermined both bythe inefficiency of the tax system and by rigidities in the control of expenditures. The taxsystem relies on taxes that are clearly distortionary in that their non-neutral tax rates andcascading effects make for widely differential impacts across economic activities. Manyof the cascading taxes at the federal level were enacted chiefly to help meet federalexpenditure commitments. This required containing the amount of constitutional transfersto the sub-national governments, which would have occurred by raising, for example, theless distorsionary income tax. The Government is thus presently working with Congresson a tax reform that will seek to modify taxes and tax assignment to arrive at a simplerand more efficient tax system based on the income tax, a value added tax, and sales taxon key high-yield goods and services, with reduced cascading of taxes and reducedincentives for predatory tax competition among states. The tax reform will becomplemented by a reform of the fiscal code discussed further below that aims atstrengthening fiscal responsibility at all government levels.

24. The Fiscal Responsibility Bill. Moreover, Congress is presently considering a newfiscal code (Law of Fiscal Responsibility, already approved by Brazil's House ofDeputies) that will seek to further strengthen fiscal discipline at the federal and sub-national level, including the mandatory establishment of fiscal targets. The new proposed

12 The CPMF, a tax on checking account debits, was increased from 0.2% to 0.38% (after being suspendedform January to June). The COFINS, a business tax on gross receipts, was increased from 2% to 3%, andextended to the financial and infrastructure sectors (telecommunications, petroleum, electric energy andmining). The IOF, a tax levied at various rates on loans and other financial operations, was extended toinvestments in investment funds, and the tax rate on loans was raised by 0.38 percentage points temporarily(from January to June) while the CPMF was suspended . The withheld income tax on investment incomewas extended to cover income from hedging through swap operations.13 The authorities increased oil prices by an average exceeding 60%. This improved government incomefrom the difference between domestic oil product prices and prices of oil imports (the petroleum account),which had deteriorated as a result of rising international oil prices.

12

fiscal code will regulate Article 163 of the Constitution'4. The highlights of this complexcode are:

* Fiscal Planning and Fiscal Targets: All Governments will need to determine andimplement fiscal targets with regard to debt, deficits, receipts, and expenditures.The planning and implementation for these targets is formalized throughout thethree stages of the budget cycle: the four-year multi-annual plans, the yearlybudget directives laws, and the yearly budget laws;

* Tax collections: Governments are responsible for establishing, projecting, andcollecting assigned taxes in a consistent fashion and to ensure that tax expendituresor subsidies be consistent with established fiscal targets;

* Expenditures: Governments are prohibited from undertaking a level ofexpenditures that is inconsistent with fiscal targets;

* Personnel Expenditures: Limits are set for personnel expenditures and for theirdistribution across government branches;

* Public Debt: Senate and Congress are responsible for setting limits, respectively,on the consolidated public sector and the federal bonded debt.;

? Privatization Proceeds: Governments cannot use privatization proceeds forfinancing current expenditures;

* Disclosure, Reporting, Enforcement and Control: Law sets obligations with regardto ample disclosure to the public, accounting, reporting, and review.

* Penalties: the law restricts transfers and credit to Governments incurring in variousevents of non-compliance. A separate law will also establish penalties that willapply to officials that do not comply with the provisions of the code.

Under this law, states would have stronger institutional constraints on expenditures.Therefore approval of this bill is likely to increase the incentive to improve fiscalperformance in general and meet legal debt and personnel expenditure limits inparticular. The bill is presently being considered for final approval by the Senate.

25. Social Security Reform. Social security reform seeks to reduce imbalancesbetween contributions and benefits for both public sector and private sector retirees. The1988 Constitution established a 100% replacement rate rule for the (i.e., retirees earn atleast their last salary) on retirement benefits for the civil service (RJUI15), with noeffective provision for actuarial balance. Social security reforms have started to addressthis difficult issue. In social security reform, the expected sources of improved financialbalance are:

* Increased contribution time and reduced retirement time due to (i) gradualintroduction of a minimum required period of contribution prior to retirement (in lieuof time of service in both the RGPS and the RJU); (ii) longer time in service (in the

14 Article 163 of the Constitution provides for the issuance of a law regulating public finance, debt,guarantees, bonds, surveillance of financial institutions, and exchange rate operations.5 The federal social security system is comprised by (i) the Regime Geral de Previdencia Social (RGPS),

for private and public employees hired under private sector labor legislation and (ii) by the Regime JuridicoUnico (RJU), for the tenured civil service.

13

RJU) through minimum tenure (10 years in Government service, 5 years in thecurrent position) and minimum retirement age (53/48 for men/women with gradualincrease to 60/55, only for the RJU); (iii) elimination of most special pensionregimes;

* Reduced pension benefits or higher effective contributions/tax collection through (i)new benefit formula for the RGPS which adjusts benefits to time of contribution andlife expectancy at time of retirement, with a monthly benefit ceiling of R$ 1255; (ii)introduction of ceilings on RJU pension benefits equal to highest civil service salarypermitted; (iii) increased and progressive contribution rates and coverage (extensionto retirees in the RJU) through possible constitutional reform;'6 (iv) extension ofincome tax on pension and survivor benefits to persons over 65 years old (RJU andRGPS); (v) expansion of contribution obligation to all work related earnings (RGPS);(vi) elimination of multiple pensions or simultaneous pensions and salaries (RJU);(vii) obligation to raise contributions when the difference between benefits andcontributions or when the ratio of employer to employee contributions exceed givenlimits (General Public Pension Law).

While these changes will reduce the path of deficits in the RGPS and RJU, social securitybenefits remain too high to be financed only from contributions. Further reforms,including a removal of the RJU benefit fornula from the Constitution remain a primerequirement to attain financial balance in Brazil's social security system. A possibleconstitutional reform (the Hanly Amendment) being considered by Congress would makeit mandatory for the public sector to hire new workers under the RGPS, thereby loweringthe retirement benefit cost of the flow of new entrants to the public sector. Existingemployees would continue to benefit from RJU retirement benefits. The companionreport on a Proposed Second Social Security Special Sector Adjustment Loan provides amore detailed discussion of social security issues.

26. Reform of State Finances. Brazil has already put in force debt refinancingprovisions, debt agreements with the states, and indebtedness regulations that havestrengthened the financial constraints faced by sub-national governments. These are:

* Law 9496 of 1998, which provides debt relief to the states subject to compliancewith fiscal targets (with regard to the primary surplus, debt, revenues, personnelexpenditures, investment expenditures and privatizations) and enforces debtagreements through access to constitutional transfers as well as the states' ownrevenues17.Debt agreements with 25 states have been signed. The Government is nowseeking to achieve similar agreements with indebted municipalities;

16 Introduction of these changes by law last year was rejected by the Supreme Court. The Governmentsubmitted a new draft Constitutional Amendment to permit the changes, now under consideration byCongress.17 State bonded and contractual debts have been renegotiated under very favorable financial terms thatincluded rescheduling to a 30 year term, a real interest rate of 6 percent, and a cap on the debtservice/revenue ratio of about 11-13 percent. The agreed interest rate is much lower than current realmarket interest rate, which exceeds 15 percent. Nevertheless, the agreements guaranteed collection of

14

* Senate Resolution 78/98, which places fiscal and financial prerequisites and limitsfor submission or Senate approval of new state debts; and

* Complementary Law 96 of 1999, which suspends federal grants and disallowsfederal loan guarantees and loans from federal financial institutions to those states ormunicipal Governments that do not meet personnel expenditure limits established bythis law.

Establishing and enforcing these provisions will strengthen intergovernmental financialrelations in Brazil. Coupled with the strong Government commitment to stronger overallfiscal performance, the debt agreements and indebtedness constraints are likely to revertthe recent trend toward ever larger sub-national debts. The agreements provide a partialnew debt reduction (in that the present value of the rescheduling is below its face value)in recognition of the states' financial distress at the accumulated debt levels. But moreimportantly, the agreements re-establish the principle that states should service their debt,leading to an interruption of the indefinite accumulation of debts that led them toinsolvency.

27. The Government expects that the debt agreements, together with constraints andprohibitions on other sources of indebtedness, will finally force states into fiscalresponsibility. States are facing a menu of options in undertaking fiscal adjustment toincrease primary surpluses and reduce debts. This menu could include: i) reduction of tax(ICMS) evasion; ii) reduction of subsidies; iii) raising social security contributions; iv)privatizing/concessioning enterprises/public services v) containment of investments; vi)containment of non-labor costs; vii) reduction of special wage benefits; viii) reduction oftemporary labor contracts; ix) audit/re-negotiation of service contracts; x) introduction ofnew voluntary departure programs; xi) dismissals under the new administrative reform;xii) placement of some employees under partially paid mandatory leave; xiii) dismissal ofnon-tenured employees; xiv) elimination of existing vacancies; xv) establishment of abinding salary ceiling; xvi) establishment of a sustainable pension benefit financingscheme. The guaranteed debt collection andfinancing constraints comprise the basicpolicy incentive that is presently expected to encourage sub-nationalfiscal adjustment.

28. Administrative reform, discussed in detail below, will also have a fiscal impact.The sources of fiscal savings stemming from the reform are:

* the obligation to reduce personnel expenditures to a maximum limit established byLaw;

* the ability to dismiss employees when personnel costs become excessive; and

scheduled repayments through access to the portion of revenues that are constitutionally shared with thestates as well as with the states' own revenues. This implies that states now have to pay more than beforethe agreements. Before the agreements, the accrued debt service was higher, but states could alwayscapitalize debt by not paying, without fear of a punitive remedy. Today, the federal government is applyingthis remedy to states that do not meet their debt obligations and sates are current on their debt serviceobligations.

15

the ability to hire under the private sector labor regime, where social security benefitprovisions are much less onerous and where the ability to reduce redundantemployment is available.

29. Administrative Reform. Administrative (institutional and civil service) reformaims at reducing the burden of the wage bill on public sector expenditures and to improvethe efficiency in the delivery of public services. The Administrative Reform is chieflybased on Constitutional Amendment 19, issued on June 4, 1998, which modified keyconstitutional provisions on the civil service. The key changes in the civil service regimeincluded enforceable maximum limits on personnel expenditures, the abolishment ofpermanent tenure for existing and new civil servants, and introduction of provisions forreducing public sector employment when personnel expenditures are excessive or whenemployee performance is inadequate. Regulation by law of these constitutional changesis almost complete. They will allow Brazil's public sector to bring down the fiscal burdenof the wage bill. The following paragraphs discuss these laws as well as other reforms(privatization, institutional reform, and public sector wage setting) that have a bearing onpublic sector administration.

30. Maximum Limits on Personnel Expenditures. A major source of fiscal imbalanceis the large burden of personnel expenditures, particularly at the sub-national level. Acentral objective of the administrative reform is to reduce the burden of the wage bill onpublic sector expenditures. On the average, state personnel expenditures (including wagesand retirement benefits) amounted to 55.2% percent of net current revenues in May 1999,the latest date for which data is publicly available. The ratio of personnel expenditures torevenues ranges from 26.% (Roraima)" to 80% (Rio Grande do Sul). Eighteen of the 27states had wage revenue ratios exceeding 60%, the legal limit established in 1995 (the LeiCamata, named after Congresswoman Rita Camata) to which states would have to adjust.The Lei Camata limits have been reaffirmed and strengthened in the new law regulatingArticle 169 of the Constitution, which provides for the issuance of limits on personnelexpenditures. 19 In the case of the Federal Government, the limit established in the newlaw (50%) is above the present ratio (46%). In the case of states, the limit established inthe new law (60%) will allow nineteen states to dismiss tenured civil servants to reducethe burden of wages. The new law is stronger in that it will prohibit federal credit andguarantees to those states not meeting the limits. To attain the limits, states have theoptions listed in para. 27. Reducing the burden of wages is a necessary component of anyprogram to improve fiscal performance. A Bank review of employment and wages in thepublic sector indicates that there are opportunities to reduce this burden, includingemployment reductions, particularly at the state level, and reduction of wages and/orbenefits in some categories of government employment where current wage levelssignificantly exceed private sector comparators20.

18 In the case of Roraima, personnel expenditures are relatively low because some of the public employeesbelonged to the corresponding former territories and are thus paid by the federal government.19 The limits are also included in the Fiscal Responsibility Bill under consideration by the Senate.20 Te World Bank, Brazil, From Stability to Growth through Public Employment Reform, Report No.16793-BR

16

31. High personnel expenditures, including wages and social security benefits, is oneof the key factors contributing to fiscal distress in many states. Together with otherexpenditures, it explains why so many states have large primary deficits. As indicatedbefore (para. 13), another factor contributing to fiscal distress is the large level ofindebtedness. Chart 2 ranks states by the debt/revenue ratio in December 1998, and alsodepicts the change in the debt/net revenue ratio between Dec-98 and October-99 and theratio of personnel expenditures to revenues in May-99. The ranking of Chart 2 indicateswhich states are most in need of fiscal adjustment. It also shows that many of the highlyindebted states also have high labor expenditures (while states with debt/revenue ratios of1.5 and above have an average personnel expenditure ratio of 0.71, states with debtrevenue ratios below 1.5 have an average personnel expenditure ratio of 0.58), suggestingthat high personnel expenditure may have contributed to deficits and indebtedness andthat lowering these expenditures may be part of the solution. Chart 2 also shows that thehighly indebted states did not generally reduce their debt/revenue ratios during 1999,indicating the point stressed before that these states will need stronger adjustments toapproach fiscal sustainability. Wage bill reduction targets need to be part of a broaderprogram that covers revenues, expenditures, fiscal reform, tax reform, privatization,administrative reform, and social security reform.

Chart 2: Brazil - State Indebtedness and Personnel Expenditures4.0

3.5

3.0

2.5

2.0

145 - - - -.- -.- -_

1.5!

1.0 I

o hDebVRevenues (Dec-98) E Personnel Exps./Revenues (May-99) C Change in DebtVRevenues (Dec 98-Oct-99)

Source: Staff estimates based on data published by the Central Bank and the Administration Secretariat at the Ministryof the Budget.

32. Under the new regulation of Article 169 of the Constitution, limits on personnelexpenditures were strengthened chiefly through introducing penalties on non-compliancewith the limits. The preceding legislation only had the target (wage expenditures, net ofemployee contributions to pension schemes, could not exceed 60% of receipts, net oftransfers), with no enforcement mechanism. Despite the lack of an enforcementmechanism, some adjustment occurred due to revenue constraints. Average personnelexpenditure ratios declined from 70.2% in 1995 to 55.2% in May 1999. Under the newlegislation, states and municipalities will be granted an extension through the year 2001

17

to meet the limit, with two thirds of the gaps closed by May, 2000 and the remainder byMay 2001. Non-compliant states will be barred from:

* granting salary increases or benefits;* creating new jobs or replacing vacancies;* obtaining federal guarantees on external loans;* voluntary transfers from the federal government;* loans from official credit institutions: senate resolution 78-98 instructs the Central

Bank not to forward to the senate any borrowing request (for IBRD, IDB, CEF,BNDES, etc.) from a state or municipality not in compliance with legal personnelexpenditure limits or the fed-state debt agreements (25 states have signed debtrefinancing contracts thus far).

Fiscal constraints are likely to continue encouraging states and municipalities to furtherraise revenues and reduce wage and other expenditures. Implementation of the newenforcement instruments listed above is likely to strengthen the pressure on sub-nationalgovernments to undertake the adjustments. Together with the instruments provided by thedebt agreements, the above remedies, if implemented, should provide a strong incentivefor adjustment. The analysis of how this adjustment can happen is presented furtherbelow.

33. Tenure in Public Sector Employment. The Administrative Reform introducedimportant changes in public employment provisions. The most significant is the abolitionof universal tenure in the public sector. Universal tenure was introduced by the 1988constitution, through the so called Unified Juridical Regime (Regime Juridico Unico, orRJU). Prior to the RJU, civil servants obtained tenure through competitive civil-servicecontests or concursos (with a five year trial period where it was virtually impossible todismiss an employee having won a concurso). However, the public sector could stillrecruit under the Consolidated Labor Regime (Consolida,do das Leis Trabalhistas, orCLT), the private sector labor law. About 55,000 employees of the federal labor force of596,192 are covered by the CLT regime, hired either prior to the 1988 Constitution orunder exceptions to the Constitutional provision for hiring short term employees. UnderLaw 9962 of February 2000, which regulates the 19th Amendment, the CLT Regime canbe used to hire civil servants. Employees hired under this regime can be dismissed due topoor performance or redundancies.

34. The impact of this Constitutional amendment will be to increase the flexibility ofthe public sector to adjust its labor force as well as on retirement costs of public servants.Increased flexibility will come over time as the share of CLT employees in the publicsector work force increases due to the ability to hire all employees through the CLT laborregime. The impact on retirement costs will occur even later when employees hired underthe CLT retire and receive the much less onerous social security benefits that apply underthe public social security system for private employees.

35. Dismissal of Public Employees. Constitutional Amendment 19 establishesprovisions whereby a public sector agency can dismiss employees. One situation is wherea government's personnel expenditures exceed legal personnel expenditure limits. In this

18

case, a government (federal, state or municipal) can use a redundancy arrangement todismiss employees. This arrangement provides that a government not meeting the legallimits will first reduce at least 20 percent of expenses on special high level andmanagerial appointments (cargos em comissdo efun,oes de confian,a) in the functionsor agencies to be downsized, then dismiss non-tenured employees (servidores ndoestaveis), and finally dismiss tenured employees, with dismissal of core employeesallowed only after 30% of other employees have been dismissed. The last step should bebased on a normative act by any of the powers (executive, legislative or judiciary) thatjustifies where (i.e., in which function or agency) the dismissals will need to take placeand indicates the savings from the dismissals. Severance for dismissed tenured civilservants is established by the amendment at one month per year of service. The lawregulating this matter establishes that dismissals should be based on highestcompensation, lowest age, or lowest number of years of service.

36. A second situation for dismissal of a tenured employee arises when theemployee's performance has been found inadequate. This new constitutional provision isapplicable to the direct administration at all levels (federal, state, and municipal) and willbe regulated by a new complementary law (presently at the final stages of considerationby Congress) that indicates the assessment criteria, the evaluation process, remedialtraining, and criteria for dismissal (two continuous unsatisfactory marks or a total of threenon-continuous unsatisfactory marks in five years). The complementary law will also listthe core public sector positions that are relatively protected from dismissal. Definition ofthese positions is required to allow dismissals due to excessive expenditure or poorperformance. The dismissals would follow an administrative process where the employeewould be fully entitled to challenge and defend against a dismissal decision. Althoughperformance evaluations could well improve efficiency, it is doubtful that they will resultin a large amount of dismissals. More likely, dismissals from performance evaluationswill be spread in time and amount to a minor fraction of the public sector labor force inany given year.

37. Public Sector Wage Setting. There is some evidence of differences betweencompensation of public employees and market wages of private employees with similarqualifications. For the federal level, on the average, managerial and technical positions(Cargos Executivos, Cargos de Nivel Superior and Cargos de Nivel Thcnico) earn lessthan market wages while the lower operational positions (Cargos Operacionais) earnmore than market wages.21 A Bank Study that adjusted comparisons for several workercharacteristics (age, sex, race, tenure, and education) found above market wages at thefederal level and in the judicial and legislative sectors, and below market wages at thesub-national (specially municipal) level and in the education and health sectors. Thefinding implies that an improved wage structure could be achieved by reducingcompensation of the overpaid categories and raising compensation of the underpaidactivities.22

21 This is based on 1995 data reported in SARE, Boletin Estatistico de Pessoal, Novembro 1999, Table 4.5.22 See World Bank, Brazil, From Stability to Growth through Public Employment Reform, Report No.16793-BR (February 1998), Vol. 1, Table 3..5, p. 38; and Vol. 2, Table 5.1, p.35 .

19

38. Federal wage policy has been ruled by two criteria: consistency with fiscal policyobjectives and increased consistency with market wages. Consistency with fiscal policiespresently requires minimization of average wage growth. This has been restricted both bywage drift, by court awards on wage increases, and by higher wage increases in thelegislative and judicial branches. Since 1995, the Federal Government has not grantedacross-the-board increases in wages. Nevertheless, some wages have increased due tocourt awards and adjustments by the Government in specific areas. The wage freezeresulted in a decline in average real wages in the executive branch from 1995 (when realwages increased sharply as a result of stabilization) to 1998, with some recovery in 1999.An index of real wages for a small sample of occupations in the executive branchdeclined by 15.6% between 1995 and 1999.23 At present, Federal policy is to continuewith the wage freeze, with possible changes in wage structure to correct some wage gaps.In contrast, real wage levels of the federal legislative and judicial branches increasedbetween 1995 and 1998, with some decline in 1999. All in all, the annual nominalincrease in the federal wage bill averaged 8% from 1995 to 1999, with wage levelsincreasing faster, as the number of public servants declined during the period.

39. Further adjustment of wage levels, particularly for the Legislative and Judicialbranches, will depend on further regulation of the 19 Amendment to the Constitution.The new Article 37 indicates, in its Paragraph XI, that the maximum total compensationin the public sector cannot exceed the compensation level of the member of the SupremeFederal Tribunal (SFT, today at R$12.720 per month). The reform introduced an all-encompassing concept of remuneration (subsidio) that includes all monetary benefitsderived from public employment. The concept is to be used in the determination of theremuneration ceiling indicated above, which is to be set by a law jointly proposed by thePresident, the Senate, the Chamber of Deputies and the Supreme Federal Tribunal (STF).The ceiling is also the basis for setting remuneration for legislators and federal judges.

40. After considerable debate, the presidents of the three branches agreed recently(March 2, 2000) to submit a bill setting maximum monthly government compensation atR$11.500.24 The bill would also set a governor's compensation as the ceiling on his state'scompensation, and states and municipalities would be allowed to establish sub-ceilings(i.e., ceilings below the compensation of members of the STF) for their ownadministrations25 . The Government has indicated that the ceiling on the federal executivebranch will remain unchanged at R$8.000. If so, the impact of the new bill would belimited to the judiciary and the legislature, which accounted for 14.2% of the total federalwage bill in 1999. As with other recent developments with a fiscal impact (e.g., courtrulings on salaries or taxes), the Government is likely to offset the fiscal impact of thenew ceiling or other pressures on salaries with additional measures to contain otherexpenditures or raise revenues.

41. The Federal Government has also issued a decree (No. 3151 of August 1999) thatwill allow a partial reduction of wages by mandatory administrative leave. That is,

23 See SARE, Op. Cit., Table 4.3, p.6 1.24 The ceiling will exclude indemnities (ajuda de custo) to members of parliament, a bonus received bythree members of the STF, and retirement benefits on one prior job.25 Salaries of state magistrates would remain linked to salaries of the SFT president.

20

employees may be excused from work, but would still earn a salary equal to a fraction(years of service/35, where 35 is the number of years required for retirement). From thepurely financial perspective, this measure would encourage dismissals of the youngeremployees. Civil servants on mandatory administrative leave would of course be allowedto seek alternative employment.

42. Institutional Reform. In institutional reform, Brazil is attempting to improve theeffectiveness of exclusive services and excludable activities. Executive agencies-- anadministrative qualification to be provided to that part of the state in charge of exclusiveactivities (autarquias andfundaq6es publicas) -- and social organizations -- non-stateautonomous entities established as non-profit civil institutions in charge of deliveringexcludable services such as education and health -- are the institutional venues that theauthorities expect will improve service delivery. In both cases, the state will use aninstrument -- the management contract -- to link the budget it spends on these activitiesand services to results. It is expected that executive agencies will develop financialautonomy through their own charges (e.g. fees). Such is the case of the agencies that arebeing developed in Brazil to regulate infrastructure activities. While social organizationsare expected to remain dependent on the budget, they would be entitled to charge forservices, hopefully decreasing the degree of financial dependency. Although the legalframework for these institutions is already in place, progress in the implementation of thisarea will only be gradual. Examples of these new kinds of institutions are ANEEL(Agencia Nacional de Energia Electrica) and Anatel (Agencia Nacional deTelecomunicaqoes).

43. Privatization. A central tenet of Brazil's public sector reform is that, to improvepublic sector and general economic efficiency, public commercial enterprises should besold to private operators. The privatization program, begun in 1991, has already advancedsignificantly, with $89.6 billionsold (including debt transfers of Table 1: Brazil - Privatization Program: 1991-1999

$16.5 billion) from 1991 to 1999 US$ Billion(Tale1) ndan ddtioal$10 Debt(Table 1) and an additional $1 0 Program Receipts Transfers Total

billion likely to occur this year. Federal Privatizations 46.6 11.3 58.0Of the assets already sold, $58.0 Telecommunications 27.0 2.1 29.1

billion were federal assets and PND 19.7 9.2 28.9the remainder were sub-national State Privatizations 25.2 6.6 31.6assets. One half of the federal Total 71.8 17.8 89.6

assets sold ($29.1 billion) were Source: BNDES

telecommunications assets orlicenses. But the privatized assets cover several other sectors, including steel, mining,petrochemicals, railroads, banking, gas, and power. The program is expected to continueduring 2000, led by new power privatizations, but also including state banks, gas, andwater and sanitation. Although there are still some important privatizable assets, thefederal and state governments have made much progress on the plan to turn commercialpublic enterprises into private hands. While this has responded to a large extent to thefinancial constraints that the public sector has been experiencing, privatization is likely toimprove service delivery - a central aim of administrative reform -- to reduce fiscalexpenditures and debt accumulation to cover public enterprise losses, and to reallocate

21

public sector employees to the private sector. Privatization and concessions are changingradically the structure of Brazil's public sector, from one with a dominating and largelymoney-losing corporate component to one more focused on the more typical public sectorcore, exclusive and excludable functions described before. The Government's Programalso supports this policy focus by requiring that states meet privatization targetsestablished in the debt agreements.

EXPECTED IMPACT OF THE REFORM PROGRAM

44. Fiscal and administrative reform aims at increasing the overall public sector fiscalbalance, reducing the ratio of public sector net debt to GDP, increasing the aggregatefiscal surplus at the state level, a reducing the ratio of personnel expenditures to netcurrent revenues at all levels, reducing the ratio of state debt to net state revenues, andadditional privatization at the state level. The reform would increase federal revenues andreduce federal expenditures through the measures indicated before (para. 21-25). Stateswould be encouraged to adjust through several measures (para. 26). This would include areduction of the wage bill through better public sector wage policies (closer adjustment tomarket wages) and a reallocation of the labor force from the public to the private sector.This reallocation would also improve economic efficiency to the extent that there existredundancies both prior to the reforms as well as because of the reform (e.g., as aconsequence of improved evaluation and monitoring of the civil service). Economicefficiency would also be positively affected by improved management of the publicinstitutions and of the civil service. Finally, efficiency gains would be reaped from theresults-oriented focus of institutional reformns, which would raise the quantity or improvethe quality of public services.

45. Impact of Public Sector Fiscal Reform. The expected impact of theGovernment's Public sector Fiscal Adjustment program on fiscal performance has beendiscussed before (para. 21-25). The authorities are committed to achieving primarybalances of 3.25% and 3.35% in 2000 and 2001 (Table 2). The outcome in 1999 was3.13%. The overall impact on sub-national finances thus far has been an increase in theprimary balance from -0.3% of GDP in 1998 to 0.2% of GDP in 1999. The impact on thestates has been to increase the primary balance from -0.4% in 1998 to 0.2% in 1999. Theauthorities are projecting state primary balances of about 0.5% of GDP in 2000 and 2001.These would be equivalent respectively to state primary balances of about 5.5% of netstate revenues. These surpluses are being achieved through several measures, asdiscussed before.

22

Table 2: Brazil - Consolidated Public Sector Balance: 1991-2001 - (Percent of GDP)

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000" 2001i

Total Nominal Balance -28.25 45.75 -64.74 44.22 -7.05 -5.87 -6.14 -8.06 -10.01 -3.49Fed. Govt. and BCB -6.90 -16.31 -23.87 -16.80 -2.27 -2.56 -2.65 -5.49 -7.05State & local govts. -10.32 -16.90 -27.12 -19.02 -3.50 -2.71 -3.04 -2.04 -3.01

States -1.82 -2.57Municipalities -0.22 -0.44

State-Owned Enterprises -11.03 -12.54 -13.75 -8.40 -1.29 -0.61 -0.45 -0.52 0.05Total primary Balance 2.86 1.57 2.26 4.40 0.40 -0.08 -0.95 0.01 3.13 3.25 3.35Fed. Govt. and BCB 1.04 1.10 0.88 3.05 0.57 0.39 -0.27 0.57 2.29 3.15State and local govts. 1.47 0.06 0.62 0.46 -0.11 -0.55 -0.74 -0.19 0.22 0.1

States 0.19 0.46 -0.31 -0.52 -0.41 0.16 0.5 0.5Municipalities 0.27 -0.57 -0.24 -0.22 0.22 0.06 0.0

State-Owned Enterpnses 0.35 0.41 0.76 0.90 -0.06 0.08 0.06 -0.36 0.62 -0.2Net Public Sector Debt 35.5 38.9 35.0 33.3 30.3 33.4 34.4 42.3 47.0 46.5

Sources: Central Bank of Brazil, IMF, and Bank staff calculations.

46. Impact of the Reform of State Finances. As discussed before, the statesimproved their primary balance from a deficit of 4% of net current revenues 1998 to asurplus of 2% of net current revenues in 1999. This level of surpluses is still inadequateto reduce debt burdens. The authorities are projecting a primary surplus for the states ofabout 0.5% of GDP in 2000 and 2001 (5.5% of net current revenues). This level will helpstabilize the ratio of debt to net real current revenues To reduce it to manageable levelsin the foreseeable future, the states will need to generate even higher surpluses. Chart 3illustrates with a projection of the ratio of net debt to net current real revenues. Theprojection assumes a real interest rate of 6.6% (the average estimated for the states debt),growth of 4% per year, and a primary surplus of 5.5% in 2000, 5.5% in 2001, 10% in2002, and 13% in 2003 and beyond. The assumption of a 13% primary corresponds to thetypical debt service cap condition in the debt refinancing agreements. Under thoseassumptions, the debt/revenue ratio stabilizes this year at about 1.9 and begins to declinein 2001. Higher real rates (say, because the price index used in the debt refinancingcontracts (the IGP-DI) increases faster than other indices), lower growth, or lower

Chart 3 - Brazil - Projected Debt of Chart 4 - Brazil - Projected Debt ofthe States: 2000-2011 the States: 2000-2011

2.0 2.01.8 1.81.6 6 1.61.4 % 1.4

iz c 1.2 z 1.2eX 1. _ __ _ _ _ _ _ _ _ _ _ _ .| ..0 a-.

E- 10.8 0o 0.6 -0 0.60 0.4 ; 00.4

a:0.2 Q:0.2l

0.0 _ 0.0

(D ( C) CO a O 0 O a tD O O O O(D oC 0 0 0 0 0 o (D CD 0 0 0 c 0I4s ED - X m 4 (D _ 4 <O - C, n 4 <D

in,: d(t) l Year d( Year

Primary Surplus: 13% of Revenues Primary Surplus: 10% of Revenuesafter 2002. after 2001.

23

primary deficits would lead to a slower adjustment.2 6 Chart 4, for example, projects thedebt/revenue ratio based on the same assumptions of Chart 3, except that the primarysurplus on 2002 and beyond is 10% instead of 13%.

47. Impact of Administrative Reform. To control the growth of the wage bill, after1995, federal and sub-national authorities exercised chiefly a control of wage levels.Apart from the impact of court decisions on some categories of wages, the FederalGovernment froze wages from 1995 to 1997 (a 10% increase was granted in 1998 andwage drift continues to push wages upward). The wage freeze continued through 1999and could be extended to 2000. In addition, there have been some efforts at reducingemployment through voluntary departure programs, with mixed results. Towards thefuture, financing restrictions, including the need to contain debt growth, are likely toencourage both the federal and the state Governments to exercise further control of wageexpenditures. As discussed before, financing restrictions for sub-national governmentshave now become more binding. The Federal Government has cut most sources offinancing to the states. Furthermore, the Federal Government completed debtrescheduling agreements with most states. These agreements require that the statesservice their debt obligations with the federal government, which can now be enforcedwith recourse to constitutionally mandated transfers as well as to the governments' ownrevenues. The agreements will require states to generate primary surpluses that in turnwill necessitate reductions in their wage bills. The new law setting limits on personnelexpenditures (wages plus social security benefits) also strengthens the budget constraintand fiscal discipline, by putting further constraints on financing, transfers, wage increasesand new hires.

48. Administrative reform at the Federal Level. The federal government will not beable to dismiss tenured employees because the legal personnel expenditure limit (50percent) exceeds the personnel expenditure ratio achieved by the federal governmentNevertheless, a decline in employment at the federal level will occur as a result ofattrition of tenured employees27 . This will imply that benefit payments to retirees willrise. The federal authorities expect a continued decline in the number of employeesduring 1999-2000. Declines in nominal wage growth have been constrained by the factthat, constitutionally, wages cannot be reduced and that the courts awarded wageincreases to the military. Furthermore, there is the possibility that wages in the judicialand legislative branches increase as a result of new possible legislation on salary ceilings(paras. 39-40). Nevertheless the Government's present stance is to continue the wagefreeze for the executive branch, at least through 2000. With 8% inflation in 1999, thispolicy reduced real wages and the ratio of wages to revenues. All in all, nominal wageand benefit payments increased from R$47.3 billion in 1998 to about R$49 billion in1999. They are expected to increase to about R$51 and R$53 billion respectively in 2000-

26 Mathematically, the ratio of debt to net real current revenues in year t, dt = d. 1. [(I+ rt)/(l+ g,) - sJI, whered,.1 is the ratio of debt to net real current revenues in year t-l, r, is the real interest rate in year t, g, is the realgrowth of revenues in year t, and s, is the ratio of the primary surplus to net real current revenues in year t.27 Assuming that the population of retirees/survivors remains constant, attrition of tenured employees has afavorable fiscal impact (to the extent that it is not offset by new hires).

24

01, maintaining the ratio of personnel expenditures to net current revenues at about 45%-46% (Table 3).

Table 3 - Brazil - Federal Employment, Retirees and Survivors and Total Personnel Expenditures:1995-2001

Year 1995 1996 1997 1998 1999* 2000* 2001*Federal Employees (000) 1022 1005 982 925 895 866 837Retirees (000) 501 516 516 534 545 557 569Survivors (000) 300 342 355 372 400 429 461Total Personnel (000) 1823 1863 1853 1831 1840 1852 1868Wages and Benefits (Million R$) 35497 40505 42848 47296 49000 51000 52630Net Current Revenues (Million R$) 67298 89353 97041 104491 107000 111555 116304Personnel Expenditures/Net Current 52.7% 45.3% 44.2% 45.3% 45.8% 45.7% 45.3%RevenuesSource: 1995-1998: Ministry of Finance and SARE. 1999-2001: *Staff projections based on past growth.

49. Administrative Reform at the State Level. The average wage expenditure ratiodeclined from 71% in 1995 to 68% in 1998 (Table 4). This decline was probably due tothe fact that the sharp real wage hike of 1992-1995 in the public sector left many states inincreased fiscal and financial distress. Rising debt levels reduced the states capacity fornew indebtedness (except for accumulation of unpaid interest to the federal government).Higher wage ratios left little for other expenditures of at least a comparable priority.Furthermore, high real wages reduced civil service pressure for further increases.Incentives were thus in the direction of reversing the somewhat involuntary rise in realwage levels that had occurred through 1995 (partly due to the unexpected decline ininflation). In sum, the decline in the personnel expenditure to net revenue ratio after 1995reflects some correction of the unexpectedly high prior real wage increases. Some stategovernments implemented voluntary departure programs to help bring down the burdenof personnel expenditures.

50. Table 4 also shows the savings in the wage bill that would be obtained if the statesadjust as required by the new law on personnel expenditure limits. The total adjustmentin 1999, 2000 and 2001 is equal respectively to 0.3%, 0.8%, and 1.0% of GDP (aboutR$3.0 billion, R$8.0 billion and R$10.0 billion respectively).2 8 This is respectively 5%,12% and 15% of the total personnel bill paid by the states in 1997. The adjustment wouldtake place partly through growth in revenues of about 4% per year, partly through areduction in the real wage (albeit less so than during 1999, when inflation was relativelyhigh), and partly through some declines in employment (e.g., one state governmentdismissed 1/3 of the civil service in early 2000).Y

2S These are the savings that would be obtained if states with personnel expenditures exceeding 60% of netcurrent revenues adjusted down to 60% by 2001, when compared to the hypothesis that these statesmaintain the 1997 ratio of personnel expenses to current revenues (69% on the average). It is furtherassumed that those states that met the limits maintain their 1997 personnel expenditure ratios.29 Mathematically, the ratio of personnel expenditures to net current revenues in year t, C, = Ct . (1+w,).(I+nt)/(l+gt), where C, I is the ratio of personnel expenditures to net current revenues in year t- l, wt is realwage growth in year t, n, is employment growth in year t, and gt is real growth in net current revenues inyear t.

25

Table 4 - Brazil - Possible Savings from Application of Personnel ExpenditureLimits at the State Level: 1999-2001

Year 1995 1996 1997 1998 1999* 2000* 2001*Personnel Expenditures/Net CurrentRevenues 71.0% 70.8% 69.0% 68.1% 65.2% 60.5% 58.1%Savings over 1997/Net CurrentRevenues -2.0% -1.8% 0.0% 0.9% 3.8% 8.5% 10.9%Savings over 1997/GDP -0.2% -0.2% 0.0% 0.1% 0.3% 0.8% 1.0%Source: Ministry of Finance and Staff Estimates

51. With the new law on expenditure limits and with the debt agreements finalized,adjustment of personnel expenditures is likely to be stronger than before, particularly inthose states that are not meeting legal personnel expenditure limits. Under the personnelexpenditure limits law, these states cannot raise wages (wage growth would then belimited to wage drift, which is below inflation) and cannot hire new employees (thenumber of employees would then decline by attrition and dismissals). States that do notmeet the legal limits and expand wages or employment will need to find additionalrevenues or financing. As financing is restricted by legal provisions and by the debtagreements, there is a strong chance that these states are indeed being forced intocontaining personnel expenditures. To do so, states have a variety of options (para.27).These include dismissal of tenured employees already approved by the 19t Amendmentand regulated by Law 9801 of 1999.3°

52. States meeting legal personnel expenditure limits face a situation more similar tothat of the federal government. Although pressures for real wage increases will continueto come, debt service obligations will encourage these states to contain wage and otherexpenditures. These states are also having opportunities and tools for adjustment. First,public-private sector wage gaps still provide an opportunity for restraint, although wagegaps appear to be lower at the state level than at the federal level. Second, inflation in1999 and residual inflation in 2000 provide these states with an opportunity to containreal wage growth. And third, these states can still decrease employment numbers byattrition, voluntary departure programs, and dismissal of non-tenured personnel. But thepressure on adjusting personnel expenditures for these states is lower, particularly inthose states that have expenditures well below limits and enjoy a manageable debtsituation.

53. For those states in which the fraction of their personnel expenditures paid toretirees is high, adjustment will be more challenging. Chart 5, which shows the splitbetween wage expenditures and retirement benefits, indicates that wage bill to revenueratios are not as high or as different across states as the total personnel expenditure ratiosindicate. For example, a state with a high total personnel cost/revenue ratio as Rio Grandedo Sul (80%) has a wage bill ratio below 50 percent, which is typical of other states inBrazil. This means that for a state like Rio Grande do Sul to bring personnel expendituresof 80 percent net revenues down to 60 percent would mean bringing salary expenditures

I' To be operational, Law 9801 needs approval of a companion bill, the Inadequate Performance Dismissal]3ill, which defines a small set of civil service careers that are relatively (but not fully) protected fromdismissal. This bill is now in the final stages of approval.

26

from about 50% of net income to 30 percent of net income, the level attained by the stateswith lowest wage expenditure/revenues ratios. This simply reflects the widelyacknowledged fact that the fiscal problem in Brazil is in large measure a social securitybenefits problem. This problem is now being addressed through various measures (para.25). Options to address the high burden of retirenment benefits will need to include highersocial security contributions (including contributions by retirees and survivors, whichwould be enabled by possible constitutional reform currently under consideration byCongress).

54. The extent of the effective downsizing will also be strengthened by the FederalGovernment's resolve to enforce legal personnel expenditure limits and the debtagreements. Strong federal resolve for enforcement is being indicated by theGovernment's commitment .to its fiscal program and its strong record of collecting debtservice under the debt agreements. This resolve will continue to be tested by localpolitical opposition to the required adjustments. States unable to receive transfers orcredit due to non-compliance with legal limits and the debt agreements may face enoughlocal disruption to possibly force extraordinary financial assistance from the federalgovernment. But the Federal Government's own financing constraints will limit theamount of any extraordinary assistance. Hence enforcement of the legal provisions willcontinue to strengthen. As a result, personnel expenditure ratios are likely to declinefiurther.

Chart 5 - Brazil - State Wage and Pension Benefit Expenditures - 199790.0%

80.0%

0X

70.0%0o 5.0%

Z 40.0%

30.0%

IL 1 0.0%

0.0% > >> > 0 wo Dm C -- a--aa i9o -a 4 > m " o ->) co > u w 0 - o z Xco m om0

State

[Wage Expenditures rPension Benefits

55. Finally, past experience suggests that fiscal responsibility and adjustment haspolitical rewards. During the 1998, the parties of affiliation of those Governors thatachieved good fiscal performance won the gubernatorial elections, with very fewexceptions. This suggests that fiscal responsibility is supported, perhaps as a proxy forgood administration in other areas as well. With the prospect of political reward, theother incentives discussed before - Federal commitment, the debt agreements, andexpenditure limits -, the chances for deeper fiscal and administrative adjustment at thesub-national level are likely to increase.

27

56. Social Impact of Dismissals. Any adverse impact of dismissals on low incomepublic employees is likely to be small. There are several reasons for this. First, labormarket conditions will improve with renewed growth and reduce the time needed fordismissed employees to find alternative employment in the private sector. Second, anydismissed employees will receive indemnities that typically have averaged around ayear's salary (the Administrative Reform prescribes on month salary per year of service).Third, dismissed employees, under the Administrative Reform, are more likely to behigher income than lower income employees; one of the criteria for dismissal under thereform is the level of income (the others are age and length of service). Finally, stateswill use dismissals as a last resort to adjust their finances. As discussed before, some ofthe adjustment to larger surpluses and lower personnel expenditures will take placethrough increased revenues. States are also likely to first reduce excessive benefits in thehigher compensation levels.

57. Impact on Economic Efficiency. Fiscal and administrative reform is having animpact in five areas with a bearing on economic efficiency. First fiscal adjustment is i)helping reduce real interest rates to encourage more rapid and efficient growth and ii)encouraging better use of limited public sector resources. Second, privatization isimproving the efficiency of former public enterprises as well as of the services grantedunder concessions. Third, there will be efficiency gains from reallocation of humanresources from the public to the private sector through dismissals or voluntary departureprograms. These efficiency gains come to the extent that labor productivity would behigher in the private sector not only because of the possible larger value of additionalprivate output compared with the decline in public sector output but also because humanresources may be more efficiently managed and monitored by private firms. There is awidely-accepted perception of absenteeism and multiple jobs in the public sector fromwhere one can surmise that some human resources in the public sector are not wellmonitored and possibly not needed. Fourth, there is a potential long term impact ofstronger beneficiary participation in monitoring and assessing public services on publicsector productivity (the performance of the privatized enterprises is already being closelymonitored). Fifth, the new inadequate performance dismissal bill (expected to beapproved shortly) may encourage better performance by the civil service; the impact willdepend on how rigorously and how effective this law is in dismissing those thatrepeatedly perform poorly. The adequacy of the evaluation methods and dismissalprocesses will play a critical role. Finally, the reform seeks to strengthen the use ofperformance contracts with public sector service providers to achieve a stronger focus onoutputs and public sector delivery. International experience suggests that the impact ofthese contracts is limited or takes several years to materialize.

58. Together, the effects listed above will be of significance. The decline in realinterest rates that fiscal adjustment is making possible is widely regarded as the criticalmacroeconomic development that is necessary for resumed long term growth. TheFederal Government's successful efforts to deliver its services with a reduced labor forceare an indication of improved efficiency. Privatization of many services (e.g.,telecommunications) has improved quality and/or coverage. The effects of bettermonitoring and of a results oriented administration are also potentially large in that thereis much room for improvements of service delivery, particularly at the sub-national level.

28

SUSTAINABILITY OF THE REFORMS

59. The fiscal and administrative reform impacts discussed above are short termimpacts. These emerge from the 1999-01 targets of the Fiscal Stability Program, thefiscal targets for the same years that have been written into the debt refinancing contractswith the states, and the personnel expenditure limits that have been defined for 2000 and2001. The reforms discussed above will also have an impact over the next several years.The Fiscal Stability Plan of the Federal Government provides the example of whatgovernments will need to do on a permanent basis as a result of the Fiscal ResponsibilityLaw. The debt refinancing agreements will have an impact on state fiscal behavior overthe next several years. The fiscal impact of the Social Security Reform will bedistributed over a long period of time. The personnel expenditure limits will also becomea permanent parameter for fiscal behavior at all levels. The law authorizing dismissals tocontain excessive personnel expenditures is likely to be invoked in the short term, whenrendered operational by the pending legislation, by those states with an extreme burden ofthese expenditures. It will also be invoked over the long term by states that need to adjusttheir expenditures. Other components of the Administrative Reform will likely havetheir main impact over the long term. Dismissal provisions for inadequate performers willhave a combined effect on dismissals and performance over a longer period of time thanthe two year horizon that was quantified above. The approved law that allows hiring allpublic employees through the private sector labor regime will not have a significant shortterm impact; over the long term, however, it will have a fundamental effect on enhancedflexibility to manage personnel expenditures, including retirement benefits.

60. Privatization is generally regarded as a sustainable reform in the sense that it isnot easy, albeit not impossible, to reverse. Employment and wage cuts are not sustainableby themselves. Unlike privatization, both can easily be and often are reversed by marketor political reasons. Nevertheless, employment and wage cuts in the public sector can besustained when they have been triggered by a framework that makes governments'budget constraints sufficiently binding. As discussed above, Brazil's expectedcontainment of labor costs in the public sector is taking place in a context of economicconditions and fiscal reform that could make states and municipalities more fiscallyresponsible. In fact, the reason why the adjustment are taking take place at all in the statesis because new fiscal conditions now impose a tougher budget constraint to Brazil'spublic sector.

61. At the state level, the budget constraint that would have been imposed byfinancial markets some years ago was relaxed in Brazil when the federal governmentreplaced high yield state bonds with its own lower yield securities. Left on their own, thestates would probably have already been forced by financial markets into fiscaldiscipline, albeit with a possible adverse impact on delivery of basis services. As fiscaldiscipline did not materialize in many states, the federal government absorbed lowquality state assets, lowering the quality of its own net worth. This ultimately deterioratedthe federal government's access to finance and is now forcing a fiscal adjustment at alllevels. With restricted access to finance, and the remarkable track record of theGovernment in strengthening reforms over the last 4-5 years, there is today a much

29

greater possibility that state fiscal adjustments remain in place over the number of yearsneeded to bring their debt stocks to manageable levels.

30

3. THE PROPOSED LOAN

BANK ASSISTANCE STRATEGY

62. The Framework Paper: Special Program of Support for Brazil (SecM98-943) ofNovember 25, 1998, outlined the Bank's overall Special Support Program for Brazil. Itproposed a US$4.5 billion package of sector adjustment loans to Brazil until end FY2001at special pricing and maturity, plus 1 % front-end fee. The Framework Paper noted thatthe 1997 CAS (discussed in the Board on June 12, 1997) and the 1998 CAS ProgressReport (discussed on June 2, 1998) acknowledged that Brazil could be subject to externalshocks. In such an eventuality, if the Government responded with corrective policymeasures, the CAS proposed to respond quickly with financial support for reforms invarious areas, including administrative reform, privatization, social security, and safetynets. The external shock materialized in late 1998, and the Government responded with astrong fiscal and administrative reformn program help strengthen public finances andcontain excessive personnel expenditures.

63. The first two S/SECALs were presented to the Board on January 6, 1999, one forSocial Protection Reform (US$250 million) and the other for Social Security Reform(US$757.57 million). The Framework Paper indicated that a Second Social SecurityS/SECAL of US$757.57 million and a follow up social protection loan would bepresented to the Board at a second stage. Furthermore, an additional US$757.57 millionS/SECAL would support the enacted fiscal and administrative reforms supported by theproposed loan (para. 65), with a follow up loan to support completion of theadministrative reforms, enactment of a new Fiscal Code presently under considerationand continued improvements in Brazil 's fiscal and administrative performance. Brazilhas successfully met the IMF targets and has made substantial drawings from the Fund,the bilaterals and IDB. Also, social protection is now being efficiently addressed byother instruments. The Bank and the Authorities have agreed to draw only a furtherUS$1.5 billion under the special support program, and let the remaining US$2 billionlapse. Accordingly, the current plan is to proceed with special S/SECALs in tworemaining areas: Administrative and Fiscal Reform (two single tranche loans areenvisaged) and Social Security Reform. The following paragraphs indicate the reformssupported by the Fiscal and Administrative Reform Loan proposed by this report.

PROGRAM OBJECTIVE

64. Given the background discussed in the previous chapter, the operation describedbelow would support a program with the following objective: to improve Brazil's fiscalperformance in general and the fiscal performance of the states in particular, with anemphasis on administrative reform to reduce personnel costs and increase efficiency. Thisobjective falls within the CAS objectives of development and implementation of

31

structural reforms and fiscal improvement. Pursuit of these objectives is now more urgentto sustain the gains that Brazil has achieved by reducing inflation.

PROGRAM DESCRIPTION

65. The Program consists of policy actions to improve fiscal performance chieflythrough reducing the burden of the wage bill in the federal, state, and municipalgovernments, as well as in the Federal District. The actions include introduction andinitiation of the Government's Fiscal Stability Plan, approval and implementation of lawsregulating the 1 9th Amendment to the Constitution (the Administrative Reform),refinancing of the state's debts, and establishment of a facility support states undertakingadministrative reform. The key provisions include:

* Constitutional Reform of Public Administration: Removes mandatory tenure forthe civil service, facilitates control ofpersonnel expenditures, rationalizes thecompensation regime ofpublic sector employees, and introduces other provisionsfor increased efficiency ofpublic administration; 19t Amendment to theConstitution, issued June 19th 1998.

* Establishment of limits on personnel expenditures: 50% for the federalGovernment and 60% for states and municipalities. Non-complying governmentswould be unable to obtain federalfinancing or guarantees, would not be allowedto hire or raise wages, and would not obtain voluntary transfers; Allowingdismissals when personnel expenditures exceed the legal limits; ComplementaryLaw No.96/May 1999. Regulates Article 169 (1 and 2) of the Constitution, aschanged by the 19kh Amendment.

* Regulation of dismissals when personnel expenditures exceed the legal limits;Law 9801/June 1999. Regulates Article 169 (4) of the Constitution, as changed bythe 199 Amendment.

+ Allowing public sector to hire under private sector law; Law 9962/February2000. Establishes the public sector's employment regime, as allowed by Article 39of the Constitution, as changed by the 19th Amendment.

* Allowing dismissals when employee performance is inadequate; Draft Law248/1998. Regulates Article 41 (1;III) of the Constitution, as changed by the 19thAmendment. Status: Passed by the House; Senate consideration scheduled forMarch 2000.

* Allowing salary reductions to tenured workers that are put on administrativeleave (allowed by Article 41 (2&3) of the Constitution, as changed by the l9thAmendment; does not require a law). Decree No. 3151, 1999.

* Refinancing of the States' bonded and contractual debts; Law 9496/97 providesthe framework; contracts with 25 states finalized in 1999 establish the specificconditions with each state in regard to amounts refinanced, debt service ceilings,and fiscal targets.

* Establishing restrictions on public sector indebtedness; Senate Resolution 78 of1998.

* Supporting states efforts to reduce their personnel expenditures; Provisionalmeasure No. 1977, 2000 established a federal facility whereby the states can

32

allocate up to 4% of their debt service to pay indemnities to dismissed employees.Debt service on the amount paid is postponed under the same financial conditionsof the debt refinancing agreements. The facility is regulated by an administrativeorder (Portaria).

66. While lowering the wage bill is probably the most important form of adjustrnent,other actions would also be undertaken. These could include, in particular, control ofnon-labor expenditures, additional contributions to finance social security benefits,further privatization of investments, and better tax collection. These are incorporated intothe Program as described below.

DESCRIPTION OF FINANCIAL ASSISTANCE

67. The Bank's assistance would be comprised of two SSECALs in the amount of$505.06 million each. The first loan will disburse after effectiveness, as all of thesupported measures have been approved. These measures, listed above, are described inmore detail in Annex 4. The second loan will be considered when the InadequatePerfornance Dismissal Bill and the Fiscal Responsibility Bill are put into effect.Although there is some uncertainty with regard to the time when this will occur, there is areasonable prospect that the first bill will be put into effect during the current legislativesession.31 The bill has already been approved by the House, where its criticalcontroversial issues were resolved.

68. The Bank's financial assistance will help Brazil meet its external financingrequirements, while the proposed reform program supports medium-term fiscaladjustrnent. During the year 2000, Brazil's current account deficit balance is expected toamount to about $23 billion dollars, of which $3.5 billion are expected to come frommultilateral institutions. Moreover, the loan will also help meet the federal government'sfinancing requirement of about R$16 billion, and will also help lengthen the termstructure of the public sector's debt, which would reduce vulnerability to financial shocks.

69. The Federal Government would implement actions to achieve its public sectorprimary surplus and debt targets and contain the growth of the Federal wage bill,including employment and average wages. It would also enforce legislation dealing withstate fiscal, debt performance, and personnel expenditure performance, includingLaw 9496, Senate Resolution 78/98, and the new Camata Law (which regulates personnelexpenditure limits). Law 9496 contains a policy-based state debt service reductionprovision in that states that meet a set of adjustment targets (regarding debt, primarybalance, personnel expenditures, revenues, privatization, and investment) benefit from aninterest rate of 6 percent (over IGP-DI, or 8.5% today), well below the cost of the publicdebt. Senate Resolution 78/98 contains provisions establishing limits on borrowing by thestates. Under the new Lei Camata the federal government must refrain from providing

31 The Inadequate Performance Dismissal Bill was approved by its Senate Committee in February and isexpected to be considered by the Senate plenary in March. If approved, it will return to the House ofDeputies for approval or rejection of changes made in the Senate, and then submitted for presidentialsanction or rejection.

33

credit, guarantees, or voluntary transfers to non-compliant states, and wage raises or newhiring is prohibited for those states. Some of the latter remedies (credit, guarantees, andtransfers) can apply only 12 months after approval of the law (i.e., in May 2000), whenstates must meet the first adjustment (2/3 of the gap from the maximum Camata ratio).

70. The Federal Government has established a financial facility (covering up to 4%of a state's monthly net current revenues to cover part of the indemnity payments toseparated state employees, under satisfactory employment reduction and wagerestructuring programs32 . Under the financial facility, a state is allowed to postpone up to4% of its monthly debt service to the Federal Government. The states would use thisamount for partial financing of indemnities to dismissed employees. Own financing bythe states would provide complementary funds. Under the facility, states' paymentswould be added to their debt to the federal government and refinanced on the same termsas those of the refinancing agreements.

71. The facility provides a financing opportunity for those States that need to dismissemployees to meet personnel expenditure limits or primary balance targets. As discussedbefore, however, states are first taking less painful measures to reduce the ratio ofpersonnel expenditures to revenues or even letting revenue growth achieve theadjustment. Nevertheless, a selected number of states are dismissing employees on fiscalor efficiency grounds. Thus far, four states have used the facility. To illustrate possibledemand for the facility, it is assumed that real wages remain constant and that realrevenues grow 4% in 2000 and 2001. Under those assumptions, about 8 states wouldneed dismissals to meet personnel expenditure limits. These dismissals would reduceexpenditures by about R$2 billion and require indemnities of a similar amount.33 It wouldbe less if those states implement a reduction of real wage or benefits. Low demand for thefacility in 1999 was surely helped by inflation. In the absence of nominal wage increases,inflation would have reduced real wages by about 8%, while low growth would havekept current real revenues at about the same level.

72. Access to the facility occurs on a first-come first-served basis. The amounts arelimited to 4% of the state's debt service. The measure is presently available throughMarch 31, 2000 and the Government has indicated that it will extend the facility throughJune 2001 by means of a new provisional measure to be enacted on March 14, 2000.

73. The mechanics of the facility are as follows: i) a state deposits at NationalTreasury the amounts it intends to use for severance payments (up to 4% of the states' netrevenues); ii) the Federal Government deducts the deposited amount from the states' debtservice so that said arnount remains capitalized into debt; iii) the state provides evidenceand documentation on the indemnity payments that it needs to make; iv) the FederalGovernment deposits the funds at an agreed federal financial institution for payment ofindemnities to the dismissed employees.

32 This facility has already been created by the Provisional Measure No. 1977/99.33 Legal indemnities amount to a month per year of service.

34

PROGRAM IMPLEMENTATION AND SUPERVISION

74. The implementing agencies include the Ministry of Finance (MF) and theSecretariat of Administration (SARE). The Ministry of Finance would implement:

* Public sector fiscal and debt targets;* Federal wage bill policy (jointly with SARE, at the Budget Office);* Remedies (transfers and official finance to states; prohibition to raise salaries or

employment at non-complying states) under the Personnel Expenditures Limits Bill;* Monitoring and remedies under the Federal/State debt rescheduling agreements;* Monitoring of personnel expenditure savings and compliance with legal personnel

expenditure limits at the state level;

The Secretary of Administration (SARE) would implement:

* Federal wage bill targets (jointly with MF);* Presentation of Inadequate Performance Dismissal to Congress;

Program supervision will consist of monitoring progress towards meeting the Programobjective of improving overall public sector and state fiscal performance and reductionof personnel expenditures. Three bi-annual Bank supervision missions are projectedbeginning about September 2000 to review and discuss these matters. The finalsupervision mission would be in September 2001 and would include preparation of theImplementation completion report.. To permit such supervision the Government (MF andSARE) would furnish the Bank with required information regarding the matters related tothese conditions, including public sector fiscal and debt performance, federalemployment and wage statistics, state and municipal fiscal and debt statistics, compliancewith state debt rescheduling agreements, federal official credit flows and stocks to states,hiring by skill and legal regime, changes in personnel expenditures (salaries andretirement benefits) by state, compliance with debt/revenue and primary surplus targetsby state, compliance with personnel expenditure limits, and privatized and state ownedenterprises by state.

75. Specifically, supervision missions will focus on assessing performance withrespect to projections of the key outcome variables aimed by the program. These includethe Public sector deficit, public sector debt, the federal wage bill, and the statesperformance with regard to the primary deficit, the debt/revenue ratio, the ratio ofpersonnel expenditures to net current revenues, and privatization.

DISBURSEMENT AND AUDITING

76. The loan would disburse under the Bank's provisions for fast disbursingoperations, which require no procurement of goods or services. The flow of the proceedsform the loan would be as follows:

35

* The Bank deposits the proceeds in a Government's account at Banco do Brasil, NewYork;

* The proceeds enter into the Central Bank of Brazil's International Reserves Account,denominated in dollars;

* The Central Bank enters the counterpart proceeds, denominated in domestic currency,into the Government's account at the Central Bank (the Conta Unica do Tesouro).This account earns the average yield of Treasury bills at the Central Bank;

* The Conta Unica do Tesouro has a classification of funds by revenue source. Thedomestic currency proceeds at the Government's account at the Central Bank (ContaUnica do Tesouro) are classified as Resources from Foreign Credit (account item No.148);

* Expenditure of the proceeds from the loan at the Conta Unica do Tesouro isearmarked, in the Federal Budget, for repayment of federal external debt;

* To repay debt, the Government uses the earmarked domestic currency proceeds in itsCentral Bank account to purchase the required dollars from a bank;

* The procedures described above are subject to Ministry of Finance internal controls(Secretaria Federal de Control) and to external controls by the Accounts Tribunal.

The Bank may require audits of the account into which the proceeds of the loan will bedisbursed.

PROGRAM BENEFITS

77. The Program seeks to help improve fiscal performance, particularly at the statelevel. The main indicators of success include the path of the overall public sector balanceand net public sector debt, the path of primary balances and debt/revenue ratios at thestate level, and the level of the personnel expenditures/revenue ratio at the federal andstate levels. Related benefits include reduced real interest rates and higher growthresulting from improved fiscal performance, and efficiency gains from reallocatinghuman resources from the public sector to productive activities in the private sector, fromincreased beneficiary participation in public sector service delivery, from undertakingperformance evaluations of the civil service, and from adopting a managerial approach inpublic sector administration.

LESSONS LEARNED

78. The Bank developed an initial experience through the State Reform/PrivatizationOperations to three Brazilian states (Rio de Janeiro, Rio Grande do Sul, and MatoGrosso) during 1996-1999. These operations focused on supporting chiefly privatizationand, to a lesser extent, fiscal adjustment at the state level. The early assessment is thatthese operations were successful in achieving irreversible privatizations that havecontributed to efficiency and service delivery. The operations for Rio de Janeiro and RioGrande do Sul were not successful in improving fiscal performance. The chief reasonswere: (i) Brazilian states were unable to adjust personnel expenditures, their majorexpenditure, due to rigid civil service legislation; (ii) Brazilian states have not had strongincentives to adjust, given the availability of federal financing. Conditions regarding

36

these constraints have improved. The debt agreements between states and the federalgovernment, together with Senate regulations, have strengthened constraints onindebtedness and enforcement of debt repayments. These will encourage fiscaladjustment at the state level. Furthermore, administrative reform will soon allow stateswith unduly high personnel expenditures to dismiss redundant employees.

RISKS AND RISK MITIGATION PROVISIONS

79. Three short term program risks should be underscored:

* First, public sector balance and debt targets may not be fully attained due to variousreasons, including higher interest rates on the public debt and successful domesticpressures for additional expenditures (e.g., salary increases due to an excessive salaryceiling), and insufficient adjustment of personnel expenditures at the state level. TheGovernment is making every effort, thus far successful, to ensure that targets are metbut these efforts could be undermined by factors outside of its control. The proposedProgram is one of the efforts that have been put in place to help the public sectorattain its financial targets. The Government has a good track record of reacting tocrises. It is expected that any possible deviation from attaining public sector balanceand debt targets is likely to trigger additional actions by the Government (e.g.,mandatory administrative leave, dismissals of non-tenured employees) includingstrong enforcement of remedies for non-compliance with personnel expenditurelimits at the sub-national level.

* Second, there is the risk that recession prevents a smooth transition of dismissedpublic employees to private employment, generating some social costs. This risk iscontained because (i) labor market conditions will improve with expected renewedgrowth; (ii) any dismissed employees will receive indemnities that typically haveaveraged around a year's salary; (iii) dismissed employees, under the AdministrativeReform, are more likely to be higher income than lower income employees; (iv) stateswill use dismissals as a last resort to adjust their finances, after actions to reduceexcessive benefits and raise revenues. (see para. 56).

* Third, there is the risk that debt agreements weaken due to political pressure fromsub-national governments. This would undermine perhaps the most importantinstrument to presently impose a strong budget constraint on state governments.although repayment under the new state-federal debt agreements has only now begun,thus far the federal govermment has held steadfastly to its legal obligation to collect.Although there is scope for negotiation upon review of selected targets built in intothe debt agreements, the principle that states' should repay their debts (as opposed tosimply accumulating debt service into the debt stock) has been re-established within aframework of reducing the states' level of indebtedness over time.

80. Long term risks are linked to the expected long term impacts of the program(para. 59). These risks include softened public sector balance an debt targets in theaftermath of the Government's Stability Program and, again, insufficient enforcement ofthe debt refinancing agreements. These risks are contained by the likely approval and

37

implementation of the Fiscal Responsibility Law, which prescribes fiscal planningdiscipline at all levels on a more permanent basis. Moreover, these risks are likely to becontained by governments' increasing awareness of the benefits deriving fiscaldiscipline.

All in all, the benefits of the project are important and the mitigating factors to the statedrisks are strong.

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4. RECOMMENDATION

81. I am satisfied that the proposed loan would comply with the Articles ofAgreement of the Bank, and recommend that the Executive Directors approve it.

James D. WolfensohnPresident

Washington D.C.April 6, 1998Attachments

39

5. ANNEXES

40

ANNEX 1: LETTER OF SECTOR DEVELOPMENT POLICY

Brasilia, March 7, 2000

Mr. James D. WolfensohnPresidentThe World BankWashington, DC

Dear Mr. Wolfensohn:

This letter of sector policy discusses progress in the economic stability program ofthe Brazilian Government, including developments in its fiscal policy framework and inpolicies with regard to administrative reform. We are writing to request financialassistance from IBRD, in the form of a special sector adjustment loan and in support ofthe implementation of these policies. Brazil's Fiscal and Administrative reforms arecentral components of the Government's structural reform program. We believe theyshould be a part of the reforms supported by the Bank's package of special adjustmentloans that was initiated last year in response to the adverse effects on Brazil of the 1997-98 international shocks.

Macroeconomic Outcomes and Prospects

Following the international commercial and financial shocks that swept emergingmarkets worldwide during the second semesters of 1997 and 1998, Brazil strengthened itsstrategy of reducing the country's main macroeconomic imbalances. It decided to float itscurrency, accelerate the adjustment of the public sector and speed up major structuralreforms designed to put the economy on a better footing. The positive outcomes from thestronger policy stance are already in evidence, notwithstanding the pessimistic growth,unemployment and inflation forecasts in the afterrnath of the devaluation. The followingparagraphs discuss these outcomes in 1999 as well as the outlook for the year 2000.

The Economy in 1999

Preliminary figures indicate that GDP growth was 0.8% in 1999, well aboveprojections at the beginning of the year. The open unemployment rate, although at a highlevel of 7.6 %, did not increase on average during the year. The exchange rate, afterreaching a peak of over 2 reais per dollar, from 1.2 real at the end of 1998, stabilizedbelow 1.8 real at end-1999. Inflation, as measured by the main consumer price index,reached 8.9%, well within the target band established for the whole year by thegovernment. The limited pass-through of the exchange rate devaluation to domesticprices was due to the tight monetary and fiscal policy, a sizable output gap in thepresence of a weak demand, and the previous formal de-indexation of the economy. Withless volatility in the foreign exchange market and with inflation under control, the CentralBank, after increasing short nominal interest rates to above 40% per year in early March,gradually reduced its rates to 19% by the end of the year.

41

The major economic imbalances were clearly reduced in 1999. The primarysurplus of the public sector - which in the case of Brazil encompasses the federalgovernment, the Central Bank, states, municipalities, social security and state enterprisesof all three levels of government - increased from 0% in 1998 to 3.1% of GDP. Thefiscal adjustment together with the exchange rate stabilization and the reduction of realinterest rates, put the net debt of the whole public sector expressed in terms of GDP on adownward trend. Net public sector debt, which had risen to 51.7% in January 1999 afterthe float of the real, came gradually down to 47.0% of GDP in December.

The current account deficit of the balance of payments showed a significantreduction. The deficit fell from US$ 33.6 billion to US$ 24.3 billion in 1999, thanks to asmaller trade deficit - which fell from US$ 6.6 billion to US$ 1.2 billion - andimprovements in the balance of important services, including international travel andprofits and dividends. The current account deficit was more than financed by directinvestment, which reached a record level of US$ 30 billion in 1999. The larger size offoreign investment gives a good picture of increased international investor confidence inthe long term perspectives of the Brazilian economy.

Despite the significant overall cuts in the 1999 budget, the Government hassuccessfully protected key social expenditures. These include the 22 priority programs ineducation, health, labor, and social assistance supported under World Bank and IDBspecial loans. In these programs, 1999 budget allocations were near or above their 1998levels and indications are that full budget execution occurred. Furthermore, theGovernment's budget proposal for 2000 implies an increase in funding for the total of the22 programs of 20% over the 1999 budget proposal and 12% over the approved 1999budget, including very significant increases for relatively new and promising programsthat link transfer payments to poor families to children's school attendance (Child LaborEradication Program, and Bolsa Escola). Subnational Governments have alsocontributed to social protection in the crisis period, for example through workfareprograms implemented by several states and municipalities. At the same time, the FederalGovernment is proceeding with a program to improve the quality and targeting ofspending in the social area.

Prospects for 2000

Prospects for 2000 indicate a clear improvement in Brazil's general economicperformance. Annual growth is projected to pick up moderately and stay at about 4%.This increase in growth is likely to contain unemployment. Inflation has already started adownward trend and the official objective to limit consumer inflation to about 6% seemswell within reach. Under the Government's Fiscal Stability Program, the primary surplusof the whole public sector is projected to increase to 3.25% of GDP in the year 2000 (andto 3.35% of GDP in 2001). As stabilization proceeds, real interest rates are expected todecline further.

Exports are expected to gain momentum in a more favorable external environmentand following an increase in the quantum of basic exports in 1999. In spite of theresumption of growth, the current account deficit is expected to be lower than the 1999number. Even though a reduction in foreign direct investment is foreseen, it is expectedthat FDI will still be sufficiently large - about US$ 25 billion - to cover the current

42

account deficit. If the privatization program is fully implemented in 2000, privatizationproceeds are expected to amount approximately to US$ 12 billion ( R$ 22,2 billion ) ofwhich around 20% will come from privatization of State companies, and to surpass, on anaccumulated basis (1991-2000), the threshold of US$ 100 billion which puts the Brazilianprivatization program among the largest in the world.

The Government's Fiscal and Administrative Reform Program

Behind the encouraging results achieved so far by the Brazilian economy lieimportant policy changes. As indicated, Brazil has been operating a floating exchangerate regime since mid-January 1999, leaving behind a long tradition of administeredexchange rate policy. In line with the shift in the exchange rate regime, the Governmentdecided to establish, beginning in July 1999, a formal inflation targeting framework formonetary policy. This means that the monetary authority is not pursuing an exchangerate objective anymore. Targets for inflation, within a tolerance interval of about 2percentage points, have been set for three years: 8% for 1999, 6% for 2000, and 4% for2001.

Besides shifts in exchange and monetary regimes, there have also been significantchanges in fiscal policy. Central to the present fiscal program is a sharp increase of theprimary surplus designed to bring the net public debt to GDP ratio on a downward trend.The government's 1999-2001 program aims at bringing the net public debt down to 46%of GDP at the end of 2001. In order to achieve this objective, the Government adoptedmeasures to cut expenditures and raise revenues in the short run and decided to pushforward with structural reforms to improve the sustainability of the fiscal position in thelong run. These structural reforms cover social security, a new fiscal code, the tax reform,debt management, privatization, intergovernmental relations, and administrative reform.

Social security possibly remains the most important policy challenge from thefiscal viewpoint. The constitutional amendment on social security, approved in December1998, represented an important step towards the improvement of the system and thereduction of its deficit. The major changes were the removal of the benefit formula fromthe Constitution for the General Social Security Regime (RGPS), the adoption of years ofcontribution instead of years service as the criterion for retirement, the incorporation ofthe concept of actuarially fair and fiscally balanced pension regimes, the phasedelimination of early retirement programs, and the imposition of a minimum retirementage for the civil service regime (the RJU). Law 9876, enacted on November 26, 1999,established new rules for retirement in the private sector, including among them, the"fator previdenciario", a new benefit formula for the general social security regime(RGPS) that extends the worker's reference wage to eventually include the worker's entireworking life. The new formula is actuarially fair and fiscally balanced.

The government recognizes, however, that the reforms enacted to date are notsufficient to ensure the financial viability of the social security system over the mediumterm. Therefore, it continues working with Congress on new measures, including aproposal for a constitutional amendment regulating the contribution of retired publicsector workers as well as a bill providing for a complementary pension plan for suchworkers.

43

A Fiscal Responsibility Bill was approved by the Lower House of Congress inJanuary of 2000, and will soon be ready to be voted by the Senate. The main objective ofthis law is to firmly establish fiscal planning throughout the full budget cycle (the multi-annual plans, the fiscal directives laws, and the budget laws), to strengthen theconsistency between revenue projections and collections, to ensure that increases inexpenditures be consistent with fiscal targets, to promote fiscal transparency, and toimprove fiscal sustainability through a stricter control on public finances at all threelevels of government. The law indicates that quantitative limits must be set onindebtedness and includes limits on personnel expenditures. It also prohibits the use ofnew borrowings to finance current expenditures and the further refinancing of debts ofone level of government by another.

A major tax reform is also presently under discussion in Congress. The taxreform does not seek to increase revenues. It aims to streamline the present cumbersomeindirect tax system and to improve the efficiency impact of the tax system. The mainobjective of the reform is to consolidate the existing indirect Federal, State and Municipaltaxes into a national value added tax, to be shared among all levels of government. Thereform aims also at eliminating the scope for "fiscal wars" among states, reducingevasion, and minimizing distortions due to cascading taxes.

With the easing of the financial crisis, the Government has given renewedattention to improving its debt management. The central objective of this effort has beento extend the maturity of domestic debt issues, to increase the proportion at fixed interestrates and to reduce the range of instruments so as to increase their liquidity and theirmarketability. Through these efforts, the Treasury recently made domestic placementswith a maturity of one months, extending the prior benchmark of three months. Ininternational placements, a successful thirty- year issue was made in February. This willhelp establish a benchmark for private borrowers.

The privatization program has been a landmark in the fundamental changes thathave been occurring in the economy. The proceeds from the sale of companies ofvarious sectors have permitted a major repayment of public debt. Further more,privatization has led to reduced production costs, increased investment, and improvedcompetitiveness. For the year 2000, the program encompasses privatization ofcompanies in the electricity sector (Furnas, COPEL, CELPE and CEPISA) and in thefinancial sector (BANESPA and IRB - RE), and progress in the privatization of water andsewerage.

A major component of the Government's program has been to promote and assistfiscal adjustment at the sub-national level. The state debt refinancing law (Law 9496of 1997) provided the legal framework for the refinancing of state debts. Agreementshave been signed with 25 out of the 27 Brazilian States. As a result of these agreementsStates are expected to generate a primary surplus of 0.5% of GDP in 2000 and 2001. Acomplementary provision is Senate Resolution 78 of 1998, which establishes conditionsfor Senate approval of new credit operations by sub-national governments.

The refinancing agreements intend to induce long term financial and economicequilibrium at the state level. As a general rule, State debts were refinanced on a 30-yearmaturity basis, an interest rate of IGP-DI plus 6% per year (IGP-DI is the general price

44

index for domestically supplied goods), and with monthly payments ceilings within arange of 11,5% to 15% of the States' real net revenue. In case of noncompliance withdebt repayments, the federal government may withhold transfers to States or collect fromthe state's own revenues. New borrowings were also restricted. Additionally, a ceilingwas established for the ratio of debt to net revenues. In addition, specific targets forprivatization and for personnel expenditures were set. As a result of the privatizationtargets, privatization at the state level, is expected to amount to about US$2,5 billion inthe year. In relation to personnel expenditures, the States must abide by ComplementaryLaw 96 of May 31, 1999, which limits payroll expenditures to a maximum of 60% of netrevenue. Under this law, States will need to reduce their excess personnel expendituresby two thirds by May 2000 and the remaining third by May 2001.

An important component of the reform process initiated in Brazil is the reform ofthe State. A landmark in this process was the approval of the l9'h Amendment to theConstitution (the Administrative Reform). The reform improved the public sector'sflexibility in the hiring and dismissal of public employees and in the reduction ofpersonnel expenditures when these expenditures are excessive. It also changed the regimefor setting maximum limits on civil service remuneration, introduced the principle ofefficiency into constitutional criteria for public administration, and strengthened theautonomy of the public sector's indirect administration. Other provisions aim to achievehigher levels of transparency and efficiency in budget management, to establishregulatory agencies in areas where the State is not the sole provider of services such astelecommunications and oil, and to streamline public administration.

Most of the key laws regulating the Admninistrative Reform are already into effect.On May 31, 1999, President Cardoso sanctioned a law establishing that States andmunicipalities cannot spend more than 60% of net current revenue on personnelexpenditures. The ceiling for the Federal government is 50% of its net current revenue,but expenditures have been maintained and are expected to remain below that level. Thishas been possible due to a decline in the number of federal civil servants, from 567,7thousand in 1995 to 497,7 thousand in 1999, resulting from the Government's policy ofeliminating public positions and containing new hires. Further declines are expected asnew departures continue to exceed hires. If the ceilings are not met, a precise sequencingof measures to be taken is defined in the legislation. Law 9801 of June 14, 1999established provisions for the dismissal of public employees in case of excessivepersonnel expenditures.. Law 9962 of February 22, 2000 established the public sector'semployment regime. Under this law, the public sector has been enabled to hire for allcareers under the private sector labor regime. This will improve the flexibility of publicsector employment and reduce future pension liabilities of the public sector. Finally, anew bill governing the dismissal of public officials due to inadequate performance anddefining a group of "exclusive state careers" (a limited set of core public sector careersthat are relatively protected from dismissal) is presently under discussion in Congress. Itwas approved by the House and a Senate Committee. Approval by the full Senate is stillpending. The amendments introduced by the Senate will have to be subject to a new voteby the House.

At the Federal level, a number of specific measures has also been taken tostreamline public service, increase efficiency levels and improve the quality of

45

regulation. They cover, inter alia, a 20 per cent reduction in special appointments(Cargos em Commissdo) and an extension of the probation period for new publicemployees from two to three years. A new redundancy program was implemented in1999. As a result, 5733 public officials were declared redundant, resulting in savings ofR$ 88 million per year. In August 1999, the Federal government offered Federal publicofficials the choice of a four-hour workday (instead of the usual eight hours) with aproportional reduction in salaries. It also offered the possibility of a three-year leavewithout pay, renewable for three more years.

Furthermore, reference must be made to the Government's four-year developmentplan, entitled Avanca Brasil - Plano Plurianual /PPA 2000/3, which currently awaits finalapproval in Congress. Based on an earlier study of investment priorities, the PPA 2000/3represents a shift in public management approach toward professional programadministration. It coordinates Government spending for the next four years andaddresses the main challenges faced by Brazil, including the achievement of sustaineddevelopment and growth, the fight against poverty, and the consolidation of economicstability and of democracy. It also serves as a basis for the elaboration of the annualbudget proposal.

States and municipalities have also been engaged in reducing the public machineryand reforming public administration at large. Many States have carried out redundancyprograms, established salary ceilings, initiated audits in the payment system, and reducedspecial appointments. In an effort to create the conditions for States to make use of theopportunities opened by the Administrative reform, the Federal government has issued aprovisional measure and supporting regulation allowing States to allocate, until June 30,2001, 4% of their debt payments owed to the Federal Treasury to finance indemnities todismissed employees.

Request for Financial Assistance

The Government - including the Executive, Congressional and Judicial branches -remains firmly committed to its program of fiscal adjustment and administrative reformas outlined above, and would welcome World Bank financial assistance. We appreciatethe prompt consideration that the World Bank management and staff have given to theProgram of Support for Brazil and would particularly welcome the inclusion of the firstUS500 million Fiscal and Administrative Reform Special Sector Adjustment Loan in theprogram, in support of the measures that have been enacted and are underimplementation. We look forward to working together with the Bank on a proposedfuture loan as further fiscal and administrative reforms take place.

Dr. Amaury Bier Dr. Martus TavaresActing Minister of Finance Minister of Planning

Budget and Administration

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ANNEX 2: ACTIONS PRIOR TO BOARD PRESENTATIONPage 1 of 2

Actions Prior to Board PresentationPolicy Area I' loan 2' loan

Overall Fiscal Framework Fiscal Stability Program in place: A. Fiscal Stability Program in place:* Public Sector Primary Surpluses to increase to 3.1%, 3.25%/o, and 3.35% of GDP respectively in 1999, 2000, 2001. * Public Sector Primary Surpluses to increase to 3.1%,

Target exceeded in 1999. 3.25%, and 3.35% of GDP respectively in 1999,2000,* Net Public Sector Debtto decline to 46.5% of GDP by the year2001 2001. Target exceeded in 1999.

* Net Public Sector Debt to decline to 46.5% of GDP by theyear 2001.

B. Continued progress in improving fiscal performance atthe state level.

Sub-National Debt Agreements A. State Debt Refinancing Criteria Approved (Law 9496/98): A. Law of Fiscal Responsibility Passed.and Sub-National Borrowing * Determines Six Fiscal Adjustment Variables (debt/revenue ratio, primary balance, personnel expenditures, own B. Implementation of Executive actions allowed by

revenues, privatization/adm. Reform, investment expenditures). Federal/State debt agreements:* Establishes debt refinancing conditions (rate of interest-6%; indexation of principal=IGP-DI; amortization=30 years * Enforce collection of debt service, including execution of

(Tabela Price); Maximum Debt Service=determined in individual contracts as a percentage of net revenues, with guarantee provided by revenues and constitutionalexcess accruals automatically refinance on the same terns. transfers.

* Determines that States not meeting targets with regard to the fiscal adjustment variables will: (i) pay a rate of interest * Enforce the adjustment targets of the agreements throughequal to the cost of federal debt + I percentage point; (ii) increase maximum debt service by 4 percentage points charging federal debt cost rates to non-complying states.

* Prohibits States with debtlrevenue>l from issuing Bonds Implementation of Senate Resolution 78/98, whereby sub-* Allows a state to bonrow only if it meets debt/revenue target. national governments cannot undertake borrowing that:* Requires debt contracts to include the following guarantees: i) state taxes; ii) constitutional transfers from the income C. Implementation of Senate Resolution 78/98, whereby sub-

and industrial products tax. national governments cannot undertake borrowing thatfB. Refinancing of States' Debt Completed: * Violate debt refinancing agreements* Law 9496 of 1997, provides for a 30 year refinancing of the states' bonded and contractual debt, at a 6% real rate, with * Violate limits on the ratios of new borrowing, debt service

debt service caps, and targets with respect to the primary surplus, debt, investment and personnel expenditures, and total debt to net revenues,revenues and privatization; * Exceed budgeted investments (except if such investments

* Agreements finalized with 25 states. are targeted to a senate-approved program for improvingC. Sub-national Borrowing Conditions Established (Senate Resolution 78/98): fiscal/financial administration).* New borrowing must meet debt refinancing agreement limits and cannot exceed capital expenditure or 18% of net Furthermore the Central Bank cannot submit for senate

revenues; approval credit operations to sub-national governments with* Total Debt service cannot exceed 13 percent of revenues primary deficits or loans in default to domestic financial* The total Debt/revenue ratio cannot exceed two in 1998 and 1/10 less each year to reach unity in 2008. institutions.* Primary balance cannot be negative;* Borrower cannot be in default with any domestic financial institution.

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ANNEX 2 (Cont.)Page 2 of 2

Annex 3: Actions Prior to Board PresentationPolicy Arez V loan 2- loanFiscal and Administrative A. Constitutional reform of Public Administration Approved: 19' Amendment to the Constitution. Key provisions cover: A. Complementary Administrative Reform Legislation Approved:

Reform Actions * Removal of mandatory tenure from public sector employment; Inadequate Performance Dismissal Bill:* Permits dismissals and expenditure reductions when personnel expenditures exceed legal limits; * Establishes Evaluation Criteria and Process;* Regulates the setting of salary ceilings and introduces the concept of an all-encompassing salary (subsidio) covering e Establishes Dismissal Process

all sources of compensation; * Defines civil service careers relatively shielded from+ Introduces various other provisions to increase public sector efficiency; dismissal ( "Servidor Estavel que Desenvolve AlividadeB. Complementary Administrative Reform Legislation Approved: Exclusiva de Estado ")

(i) Excess Employment Dismissal Bill (Regulation of Constitutional Provision 169 (4)). Dismissals will require: B Implementation of enforcement remedies by the National* An executive act by any of the three powers; Treasury to those states not meeting personnel expenditure limits.

* A general criteria of dismissal (lowest number of years of service; highest remuneration; or lowest age);In addition, dismissal of core tenured employees (Servidor Estavel que Desenvolve Atividade Exclusiva de Estado) willrequire dismissal of at least 30 percent of other employees. Each executive act cannot reduce more than 30 percent of coreemployees.(ii) Limits on Personnel Expenditures to Net Revenue Ratios:* Federal (50 0%) and Sub-National Govermments (60%).* Permit wage bill reductions in the following order: a) At least 20 percent of expenses on special appointments

(cargos em comiss.ro efunc6es de conflanca); b) Dismissal of non-tenured employees; and c) Dismissal of tenuredemployees.

* Govemments would need to achieve two thirds of the required adjustment in 2000 and one third in 2001.Enforcement actions would include: a) No new credit operations from federal financial institutions (Year 2000); b)No new Federal Guarantees (Year 2000); c) No voluntary transfers (Year 2000); d) Prohibition to increaseemployment or positions; e) Prohibition to raise wages or benefits;

(ii) Civil Service Legal Regime Bill: extends the private sector labor regime to new hiring in the public sector(iii) Issuance of Decree allowing partially paid mandatory leave (servidores em disponibilidade);

Assistance Fund A. Facility established to cover severance payment by adjusting states (presently regulated by Medida Provisoria 1977-121/00. Federal Govemment authorized to finance state severance payments, up to 4% of their net revenues. On March 14,2000, the Govemment will extend the faculty through June, 2001.B. Regulation of Facility to be re-enacted on March 14, 2000.

49

ANNEX 3: KEY ECONOMIC INDICATORSPage I of 2

Brazil - Key Economic Indicators

Actual Estimate ProjectedT.Adr t., I LJQA 1 oosI acuQ 1 07 102 I 1000 QQQ 90(11 9009

National accounts (as % of GDP)Gross domestic produ& 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Agriculture 9.9 9.0 8.3 7.9 8.4 8.7 8.3 8.2 8.2Industry 40.0 36.7 29.4 29.7 28.8 29.7 28.4 28.1 28.0Services 50.2 54.3 62.3 62.4 62.8 61.6 63.2 63.7 63.8

Total Consumption 77.5 79.5 81.4 81.4 81.4 80.2 79.0 77.4 76.8Gross domestic fixed investment 20.7 20.5 19.1 19.6 19.9 19.9 21.1 22.4 22.5

Government investment 3.6 2.5 2.3 2.2 2.2 1.9 2.1 2.1 2.7Private investment 18.5 19.8 18.4 19.0 19.1 19.1 20.0 21.4 20.8(includes increase in stocks)

Exports (GNFS) 9.5 7.7 7.1 7.6 7.4 9.9 10.7 11.5 12.2Imports(GNFS) 9.2 9.5 9.2 10.2 10.1 11.1 11.8 12.3 12.6

Gross domestic savings 22.5 20.5 18.6 18.6 18.6 19.8 21.0 22.6 23.2Gross national savings 21.3 19.5 17.3 16.9 16.3 16.6 17.8 19.4 19.7

Memorandum itemsGross domestic product 546230 704168 774869 804113 775356 564946 570878 579508 593768(US$ million at current prices)GNP per capita (US$, Atlas method) 3060 3690 4340 4790 4570 4666 4540 4541 4629

Real annual growth rates (%, calculated from 1995 prices)Gross domestic product at market prices 5.9% 4.2% 2.8% 3.2% 0.1% 0.8% 3.7% 4.0% 4.0%Gross Domestic Income 5.6% 4.9% 2.4% 3.7% 0.8% 0.6% 3.6% 4.0% 4.0%

Real annual per capita growth rates (%, calculated from 1995 prices)Gross domestic product at market prices 4.4% 2.8% 1.4% 1.8% -1.2% -0.7% 2.2% 2.5% 2.5%Total consumption 4.3% 5.0% 2.3% 2.5% 0.0% -1.4% 0.8% 0.7% 2.1%Private consumption 7.7% 15.2% 0.3% 1.0% -0.3% 2.1% 3.5% 4.3% 2.0%

Balance of Payments (US$ miHions)Exports (GNFS) 46702 49544 51853 56831 55479 55981 61103 66747 72429

Merchandise FOB 43545 46506 47747 52990 51120 46930 51408 56461 61506Imports (GNFS) 40131 58749 64958 74147 70517 62679 67255 71425 74573

Merchandise FOB 33079 49858 53286 61347 57558 48310 52176 55743 58178Resource balance 6571 -9205 -13105 -17316 -15038 -6698 -6152 -4678 -2144Net currenttransfers 2588 3973 2899 2216 1886 -647 806 1063 1064Current account balance -1689 -17972 -24347 -33430 -34946 -25090 -24721 -23711 -23111

Net private foreign direct investment 2356 4778 9644 17879 26110 30000 25140 15000 15000Long-term loans (net) 4421 6547 12681 18409 26342 -16874 2846 9212 3796Official -2134 -1576 -533 -1533 4850 -1077 1173 5505 1121Private 6555 8123 13214 19942 21492 -15797 1673 3707 2675

Othercapitatnet,incl.effors&oonanissions) 7851 20127 11039 -10659 -25997 288 6029 7830 8031Changeinreserves -12939 -13480 -9017 7801 8491 11676 -9293 -8331 -3715

Memorandum itemsResource balance (% of GDP) 1.2 -1.3 -1.7 -2.2 -1.9 -1.2 -1.1 -0.8 -0.4Real annual growth rates ( YR95 prices)Merchandise exports (FOB) 6.6 -2.0 35.8 1.8 4.0 6.9 6.5 6.2 5.8Primary 17.6 -1.9 5.6 6.1 13.8 1.0 4.0 3.0 3.1Manufactures 2.7 -2.0 5.3 0.0 2.2 11.1 8.0 8.2 7.3

Merchandise imports (CIF) 25.5 38.7 6.1 14.5 8.3 -15.7 3.3 3.2 1.6(Continued)

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ANNEX 3Page 2 of 2

Brazil - Key Economic Indicators(Continued)

Actual Estimate ProjectedIndicator 1994 1995 1996 1997 1998 1999 2000 2001 2002

Public finance (as % of GDP at market prices)eNonfinancial revenue 18.6 19.6 17.8 18.6 20.4 21.1 20.7 20.5 20.5Current expenditures 15.9 18.9 17.6 18.0 18.9 18.4 17.4 17.3 17.3Primary Balance 3.1 0.6 0.4 -0.3 0.6 2.4 2.7 2.7 2.7Capital expenditure 1.0 0.8 0.8 0.9 1.1 0.5 0.7 1.0 1.1Foreign financing .. .. .. .. .. ..

Monetary indicatorsM2/GDP 41.7 29.7 27.7 29.4 28.7 29.4 29.4 29.4 29.4GrowthofM2(%) 1211.9 31.9 12.2 18.4 1.4 12.6 10.1 8.6 8.6Privatesectorcreditgrowthl 81.6 115.9 9.3 42.6 59.8 -82.3 382.6 299.3 -45.3total credit growth (%/.)

Price indices( YR95 =100)Merchandise export price index 120.3 127.7 127.2 122.8 116.8 109.6 112.8 116.6 120.1Merchandise import price index 114.8 124.1 127.3 118.1 104.8 110.1 115.1 119.2 122.5Merchandise terms of trade index 104.8 102.9 99.9 104.0 111.5 99.5 97.9 97.8 98.0Real exchange rate (LCU/US$f 97.3 110.5 112.2 118.0 120.8 1.4 1.5 1.6 1.6

Real interest rates 23.3% 12.2% 14.8% 28.6% 24.6% 14.0% 13.3% 12.6% 12.0%Consumerprice index (%change) 2075.9 66.0 15.8 6.9 2.7 8.6 6.0 4.0 4.0GDP deflator (% change) 2239.1 77.6 17.2 7.8 3.6 9.0 6.2 4.4 4.4

a. GDP at factor costb. "GNFS" denotes "goods and nonfactor services."c. Includes net unrequited transfers excluding official capital grants.d. Includes use of IMF resources.e. Consolidated central government.£ "LCU" denotes "local currency units." A decrease in LCU/US$ denotes appreciation.

51

ANNEX 4: KEY EXPOSURE INDICATORS

Brazil - Key Exposure Indicators

Actual Estimate Proiectedlndicator 1994 1995 1996 1997 1998 1999 2000 2001 2002

Total debt outstanding and 151209 159037 180785 194882 236058 221791 223987 228085 231232

disbursed (TDO) (US$mj

Net disbursements (US$ml 1909 9097 15242 18276 23309 -11389 2198 4122 3145

Total debt service (TDS) 16212 21681 25078 38243 40226 73694 54732 49000 44143

(US$m)a

Debt and debt service indicators

(%)TDO/XG§' 296.4 280.6 300.7 293.5 362.9 369.2 344.6 321.6 301.5TDO/GDP 27.7 22.6 23.3 24.2 30.4 39.3 39.2 39.4 38.9TDS/XGS 31.8 38.2 41.7 57.6 61.8 122.7 84.2 69.1 57.6Concessional/TDO .. .. .. .. .. 0.7 0.8 2.1 0.8

IBRD exposure indicators (%)IBRD DS/public DS 20.8 14.0 12.7 8.5 8.1 3.5 5.4 5.5 10.0Preferred creditor DS/public 28.8 18.7 17.6 12.2 12.0 17.9 48.8 33.0 29.3DS (%)'IBRD DS/XGS 3.7 3.3 2.7 2.2 2.1 2.5 2.3 2.3 2.5IBRDTDO(US$mf 6311 6038 5876 5743 6298 7116 8294 9666 10859

Of which present value ofguarantees (US$m)

Share of IBRD portfolio (%) 5.5 5.6 5.5 5.1 5.3 5.7 6.1 6.8 7.5IDA TDO (US$m)f 0 0 0 0 0 0 0 0 0

IFC (US$m)Loans 464 567 328 402 430 141Equity and quasi-equity /c 123 166 56 44 106 51

MIGAMIGA guarantees (US$m) 95 129 164 201 195

a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short-term capital.

b. "XGS" denotes exports of goods and services, including workers' remittances.c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the

Bank for Intemational Settlements.d. Includes present value of guarantees.e. Includes equity and quasi-equity types of both loan and equity instruments.

52ANNEX 5: STATUS OF BANK GROUP OPERATIONS

Status of Bank Group Operations (Operations Portfolio)Closed Projects 173

Difference BetweenBoard I acqt PSRR Expected and Actual

Date Supervision Rating b/ Original Amnaint In I[S$ Millinng nighijrqPmPntc'

Fiscal navainpmant LmplampntatinnYear Active Projects IBRD IDA Cancel. Undisb. Orig. Frm Rev'd

OnNjattias Prgrass

1989 P006370 NE IRRI JAIBA S S 71.0 0.0 0.0 0.2 0.2 0.01990 P006453 NE IRRIG I S U 210.0 0.0 0.0 14.8 83.8 52.11992 P006505 MATO GROSSO NAT RES U U 205.0 0.0 0.0 48.4 48.4 0.01992 P006454 RONDONIA NTRL RES. M U U 167.0 0.0 0.0 27.4 27.4 0.0

1992 P006368 WATER SECTOR MODERNI S S 250.0 0.0 0.0 1.1 1.1 0.01993 P006541 BR WTR Q/PLN(SP/PR/FED) S S 245.0 0.0 9.3 15.5 24.8 15.51993 P006547 METRO TRANSP. RIO S S 128.5 0.0 0.0 0.3 0.3 0.01993 P006540 WTR Q/PLN(MINAS GERA S S 0.0 0.0 0.0 0.0 0.0 0.0

1994 P006524 BR MINAS MNC.DEVELOPMT S S 150.0 0.0 9.7 24.7 34.4 29.41994 P006558 BR PARANA BASIC EDUC S S 96.0 0.0 0.0 15.4 15.4 0.01994 P006522 ESP.SANTO WATER U U 154.0 0.0 4.0 68.3 72.3 68.31994 P006543 M. GERAIS BASIC EDUC S S 150.0 0.0 0.0 19.7 19.7 0.01995 P006564 BELO H M.TSP S S 99.0 0.0 0.0 35.0 28.4 0.01995 P006436 Ceara Urban Development & Water R&,ource S 140.0 0.0 0.0 47.5 47.5 2.11995 P038882 RECIFE M.TSP S S 102.0 0.0 0.0 66.0 53.8 0.01995 P035717 RURAL POV. (BAHIA) S S 105.0 0.0 0.0 35.1 20.7 0.01995 P038884 RURAL POV.- CEARA S S 70.0 0.0 0.0 10.9 0.3 0.01995 P038885 RURAL POV.-SERGIPE S S 36.0 0.0 0.0 5.5 0.1 0.01996 P037828 BR (PR)R.POVERTY S S 175.0 0.0 0.0 128.8 98.8 0.01996 P006512 BR ENV/CONS(CVRD) U U 50.0 0.0 0.0 16.5 12.1 0.01996 P006554 HLTH SCTR REFORM S S 300.0 0.0 0.0 209.5 169.5 0.01996 P040028 RAILWAYS RESTRUCTURG S S 350.0 0.0 50.0 37.4 69.1 37.41997 P043871 (PIAUI)R.POVERTY S S 30.0 0.0 0.0 6.8 -0.6 0.01997 P043873 AG TECH DEV. S S 60.0 0.0 0.0 45.3 22.5 0.01997 P006562 BAHIA MUN.DV S S 100.0 0.0 0.0 89.9 49.2 2.31997 P046052 CEARAVWTR PILOT S S 9.6 0.0 0.0 6.4 6.4 0.51997 P006532 FED HWY DECENTR S S 300.0 0.0 0.0 234.3 154.3 0.01997 P006475 LAND RFM PILOT S S 90.0 0.0 0.0 55.1 30.5 0.01997 P048870 MT STATE PRIV. HS S 45.0 0.0 0.0 13.2 13.2 1.1

53

Difference Between

I at PSR. Expected and ActualBoard

-^ - ISupivalon Rating .. OR"a"'i Amnn in US; Miliuii fighurqpmAntg

Fiscal nvlpAtIpannalnYear Active Projects D Im tstion IBRD IDA Cancel. Undisb. Orig. Frm Rev'd

1997 P042566 R.POVERTY(PE) S S 39.0 0.0 0.0 11.8 3.9 0.01997 P038896 R.POVERTY(RGN) S S 24.0 0.0 0.0 11.0 5.0 0.01997 P034578 RGS HWY MGT S S 70.0 0.0 0.0 62.6 34.3 4.01997 P043868 RGS LAND MGT/POVERTY S S 100.0 0.0 0.0 86.9 31.0 0.01998 P006559 (BF-R)SP.TSP S S 45.0 0.0 0.0 45.0 34.3 0.01998 P035728 BAHIAWTR RESOURCES S S 51.0 0.0 0.0 36.7 23.3 0.01998 P050762 BR Fundescola I S 5 62.5 0.0 0.0 19.3 -13.6 0.01998 P006474 BR LAND MGT 3 (SAO PAULO) S S 55.0 0.0 0.0 55.0 16.1 0.01998 P038947 BR SC. & TECH 3 S S 155.0 0.0 0.0 131.7 50.9 0.01998 P048357 CEN.BANK TAL S S 20.0 0.0 0.0 14.3 14.3 0.01998 P038895 FED.WTR MGT S S 198.0 0.0 0.0 159.4 67.8 1.21998 P006549 GAS SCTR DEV PROJECT HS HS 130.0 0.0 0.0 88.9 88.9 0.01998 P051701 MARANHAO R.POVERTY S S 80.0 0.0 0.0 51.5 0.3 0.01998 P042565 PARAIBA R.POVERTY S S 60.0 0.0 0.0 44.7 5.0 0.01998 P057910 PENSION REFORM LIL HS S 5.0 0.0 0.0 4.7 4.7 0.01998 P043421 RJ M.TRANSIT PRJ. S S 186.0 0.0 0.0 178.1 126.8 0.01998 P043420 WATER S.MOD.2 S S 150.0 0.0 0.0 150.0 72.6 19.01999 P054120 AIDS 2 S S 165.0 0.0 0.0 128.9 38.9 0.01999 P055388 ANIMAL&PLANT DIS. CO S S 44.0 0.0 0.0 44.0 4.2 0.01999 P058129 BR EMER. FIRE PREVENTION U U 15.0 0.0 0.0 15.0 5.3 0.01999 P043874 DISEASE SURVEILLANCE S S 100.0 0.0 0.0 96.5 34.9 0.01999 P048869 SALVADOR URBAN TRANS S S 150.0 0.0 0.0 150.0 14.6 0.02000 P006449 BR CEARA WTR MGT 136.0 0.0 0.0 136.0 0.0 0.02000 P039200 BR ENERGY EFFICIENCY 43.4 0.0 0.0 43.4 0.0 0.02000 P035741 BR NATL ENV 2 S S 15.0 0.0 0.0 15.0 0.0 0.02000 P039199 PROSANEAR 2 30.3 0.0 0.0 30.3 0.0 0.0

TOTAL 6017.3 0.0 73.0 3089.6 1766.9 232.9

- No rating established yet.

54

ANNEX 6: STATEMENT OF IFC'S HELD AND DISBURSED PORTFOLIO

CAS Annex B8 (IFC) for Brazil

BrazilStatement of IFC's

Held and Disbursed PortfolioAs of 12/31/1999

(In US Dollars Millions)

Held Disbursed

FY Approval Companv Loan Equity Ouasi Partic Loan Equity Ouasi Partic

1995 AEF Comp Avicole 0.27 0.00 0.00 0.00 0.27 0.00 0.00 0.001999 AEF FasoMine 1.00 0.45 0.00 0.00 0.00 0.00 0.00 0.001992 AEF Growela 0.15 0.00 0.00 0.00 0.15 0.00 0.00 0.001993 AEF Htl Tropico 0.52 0.00 0.00 0.00 0.52 0.00 0.00 0.001996 AEF Notacam 0.69 0.00 0.00 0.00 0.69 0.00 0.00 0.00

1994/96 AEF Proleg 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.001999 AEF Saicam 0.00 0.00 0.38 0.00 0.00 0.00 0.00 0.00

1994/96 AEF United Trspt 0.28 0.00 0.00 0.00 0.28 0.00 0.00 0.001979 Alucam 0.00 0.93 0.00 0.00 0.00 0.93 0.00 0.001998 Arteb 20.00 7.00 0.00 20.00 20.00 7.00 0.00 20.001999 BAC Bank 0.00 0.00 5.00 0.00 0.00 0.00 0.65 0.001993 BACELL 6.00 15.70 0.00 16.20 6.00 15.70 0.00 16.20

1990/91/92 Bahia Sul 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.001996 Banco Bradesco 15.51 0.00 0.00 22.36 15.51 0.00 0.00 22.361999 Bank of Shanghai 0.00 21.76 0.00 0.00 0.00 21.76 0.00 0.001996 Beijing Hormel 4.28 0.50 0.00 4.40 4.28 0.50 0.00 4.401997 Bompreco 25.00 0.00 5.00 0.00 25.00 0.00 5.00 0.001991 Bradesco-Bahia 3.00 0.00 0.00 0.00 3.00 0.00 0.00 0.001991 Bradesco-Eucatex 7.50 0.00 0.00 0.00 7.50 0.00 0.00 0.001995 Bradesco-Hering 7.50 0.00 0.00 0.00 7.50 0.00 0.00 0.001991 Bradesco-Petrofl 7.50 0.00 0.00 0.00 7.50 0.00 0.00 0.001991 Bradesco-Romi 0.79 0.40 0.00 0.00 0.79 0.40 0.00 0.001995 Brahma- BRA 17.50 0.00 5.00 36.90 17.50 0.00 5.00 36.901981 Brasilpar 0.00 0.04 0.00 0.00 0.00 0.04 0.00 0.001998 BSC 13.18 0.00 0.00 7.06 13.18 0.00 0.00 7.061998 Caltex Ocean 21.00 0.00 0.00 45.00 21.00 0.00 0.00 45.001995 Cambuhy/MC 15.00 0.00 0.00 0.00 15.00 0.00 0.00 0.001999 Celhart 13.90 1.50 0.00 0.00 13.90 1.50 0.00 0.00

1993/96 CEVAL 0.00 10.00 0.00 0.00 0.00 10.00 0.00 0.001994/96 CHAPECO 15.00 0.00 0.00 5.00 15.00 0.00 0.00 5.00

1998 Chengdu Chemical 0.00 3.20 0.00 0.00 0.00 0.00 0.00 0.001998 Chengxin-IBCA 0.00 0.36 0.00 0.00 0.00 0.36 0.00 0.00

1987/92/94 China Bicycles 0.00 0.95 0.00 0.00 0.00 0.95 0.00 0.00

55

Held Disbursed

FY'Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic

1994 China Walden JV 0.00 5.40 0.00 0.00 0.00 5.40 0.00 0.001994 China Walden Mgt 0.00 0.01 0.00 0.00 0.00 0.01 0.00 0.001986 CICAM 1.93 0.00 0.00 0.00 1.93 0.00 0.00 0.001998 CIG Port Holding 0.00 1.50 0.00 0.00 0.00 1.50 0.00 0.00

1973/78/83 CODEMIN 0.00 0.40 0.00 0.00 0.00 0.40 0.00 0.001997 Copesul 35.00 0.00 0.00 154.29 35.00 0.00 0.00 154.29

1993/97/00 Coteminas 0.00 0.53 0.00 0.00 0.00 0.53 0.00 0.001992 CRP-Caderi 0.00 0.68 0.00 0.00 0.00 0.68 0.00 0.001994 Dalian Glass 19.36 2.40 0.00 36.89 19.36 2.40 0.00 36.89

1980/92 DENPASA 0.00 0.00 0.12 0.00 0.00 0.00 0.05 0.001998 Devnya Cement 29.98 0.00 0.00 0.00 23.22 0.00 0.00 0.001998 Dixie Toga 0.00 15.00 0.00 0.00 0.00 15.00 0.00 0.001999 Dujiangyan 25.59 0.00 0.00 30.00 0.00 0.00 0.00 0.001995 Dupont Suzhou 20.25 4.15 0.00 36.40 20.25 4.15 0.00 36.40

1987/96/97 Duratex 22.00 0.00 0.00 66.33 22.00 0.00 0.00 66.331994 Dynamic Fund 0.00 12.35 0.00 0.00 0.00 10.70 0.00 0.001997 Ecobank-Burkina 0.00 0.25 0.00 0.00 0.00 0.25 0.00 0.001999 Eliane 32.00 0.00 13.00 0.00 0.00 0.00 0.00 0.001998 Empesca 5.00 0.00 10.00 0.00 5.00 0.00 10.00 0.001990 ENGEPOL 0.66 0.00 0.00 0.00 0.66 0.00 0.00 0.001994 Euromerchant FND 0.00 5.00 0.00 0.00 0.00 4.50 0.00 0.001998 Fosfertil 20.00 0.00 0.00 45.00 15.08 0.00 0.00 33.921998 Fras-le 10.00 0.00 10.00 0.00 10.00 0.00 6.70 0.001994 GAVEA 8.75 0.00 5.50 0.00 8.75 0.00 5.50 0.00

1995/96/98 Globocabo 0.00 9.91 0.00 0.00 0.00 9.91 0.00 0.001994 GP Capital 0.00 14.04 0.00 0.00 0.00 14.00 0.00 0.001997 Guilmana-Amorim 28.92 0.00 0.00 81.42 28.92 0.00 0.00 81.421999 Hansom 0.00 16.10 0.00 0.00 0.00 16.10 0.00 0.001998 Icatu Equity 0.00 30.00 0.00 0.00 0.00 1.80 0.00 0.001999 Innova SA 20.00 5.00 0.00 60.00 0.00 5.00 0.00 0.001996 Interlease Inc. 3.21 0.30 0.00 0.00 1.71 0.30 0.00 0.00

1980/87/97 Ipiranga 40.00 0.00 0.00 150.00 40.00 0.00 0.00 150.001996 Jingyang 40.00 0.00 0.00 100.00 40.00 0.00 0.00 100.002000 Kronospan Bulgar 12.62 0.00 0.00 9.08 8.22 0.00 0.00 5.911995 LATASA-Brazil 11.67 0.00 0.00 1.50 11.67 0.00 0.00 1.501998 Leshan Scana 6.10 1.35 0.00 0.00 3.50 1.35 0.00 0.00

1996/97 Lightel 0.00 8.17 0.00 0.00 0.00 8.17 0.00 0.001995 Lojas Americana 22.00 0.00 5.00 10.00 22.00 0.00 5.00 10.001993 Macedo Alimentos 9.04 0.00 5.00 0.00 9.04 0.00 5.00 0.001996 Mallory 6.55 0.00 0.00 0.00 6.55 0.00 0.00 0.00

1987/92/96 MBR 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

56

Held Disbursed

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic1996 NanjingKumho 11.68 3.81 0.00 33.22 11.68 3.81 0.00 33.221995 Newbridge Inv. 0.00 5.44 0.00 0.00 0.00 2.13 0.00 0.001997 Ningbo 0.00 2.00 0.00 0.00 0.00 2.00 0.00 0.00

1980/88 OPP 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.001997 Orient Finance 13.33 0.00 0.00 16.67 13.33 0.00 0.00 16.67

1975/96 OxitenoNE 20.00 0.00 0.00 0.00 20.00 0.00 0.00 0.001996 Pacific Ports 0.00 3.64 0.00 0.00 0.00 3.64 0.00 0.001994 Para Pigmentos 29.66 0.00 9.00 27.55 29.66 0.00 9.00 27.55

1992/94/97/98 Pecten Cameroon 45.47 0.00 0.00 144.00 17.46 0.00 0.00 55.291987/96 Perdigao 26.25 0.00 0.00 12.00 26.25 0.00 0.00 12.00

1982/84/86 PISA 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.001989/95 PolitenoInd. 11.69 0.00 0.00 0.00 11.69 0.00 0.00 0.00

1994 Portobello 10.93 5.00 0.00 0.00 10.93 5.00 0.00 0.001997 PTP Hubei 12.63 0.00 0.00 25.38 12.63 0.00 0.00 25.38

1994/97 PTP Leshan 3.60 0.00 0.00 0.00 3.60 0.00 0.00 0.002000 Puras 4.00 0.00 1.00 0.00 4.00 0.00 1.00 0.001998 Rabobank SHFC 2.03 0.00 0.00 2.03 2.03 0.00 0.00 2.031998 Randon 7.00 0.00 3.00 0.00 7.00 0.00 3.00 0.001995 Rhodiaco/PTA 17.50 0.00 0.00 15.00 17.50 0.00 0.00 15.001991 Rhodia-Ster 4.29 5.95 0.00 0.00 4.29 5.95 0.00 0.001990 Ripasa 1.43 5.00 0.00 0.00 1.43 5.00 0.00 0.001997 Rodovia 35.00 0.00 0.00 79.50 33.07 0.00 0.00 75.13

1994/96 S.A.I.C.C. 0.00 2.85 0.00 0.00 0.00 2.85 0.00 0.001994/95/97 Sadia 27.00 0.00 9.00 144.00 27.00 0.00 9.00 144.00

1997 Samarco 15.30 0.00 0.00 12.00 15.30 0.00 0.00 12.001998 Saraiva 15.00 3.00 0.00 0.00 15.00 3.00 0.00 0.001999 SEF Britagem 1.25 0.00 0.19 0.00 0.00 0.00 0.00 0.001998 SGBB 0.00 0.38 0.00 0.00 0.00 0.38 0.00 0.001998 Shanghai Krupp 30.00 0.00 0.00 68.80 0.00 0.00 0.00 0.001993 Shenzhen PCCP 3.76 0.99 0.00 0.00 3.76 0.99 0.00 0.001997 Sofia Hilton 10.80 0.00 2.00 9.50 3.27 0.00 2.00 0.00

1987/97 SP Alpargatas 23.33 0.00 5.00 0.00 23.33 0.00 5.00 0.001997 Sucorrico 13.50 0.00 0.00 0.00 13.50 0.00 0.00 0.001995 Suzhou PVC 22.00 2.48 0.00 22.20 22.00 2.48 0.00 22.201998 Tecon Rio Grande 7.50 0.00 5.50 18.00 5.25 0.00 5.50 12.611996 TIGRE 21.15 0.00 5.00 14.95 21.15 0.00 5.00 14.95

1992/93 TRIKEM 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.001993 Votorantim 10.43 0.00 0.00 0.71 10.43 0.00 0.00 0.711999 Vulcabras 20.00 0.00 0.00 0.00 20.00 0.00 0.00 0.001996 Weihai Weidongri 4.13 0.00 0.00 0.00 4.13 0.00 0.00 0.001997 Wembley 0.00 10.00 0.00 0.00 0.00 10.00 0.00 0.001999 Wiest 9.00 0.00 8.00 0.00 0.00 0.00 8.00 0.001998 WIT 5.00 0.00 0.00 0.00 0.00 0.00 0.00 0.001993 Yantai Cement 12.47 1.95 0.00 6.66 12.47 1.95 0.00 6.661998 Zhen Jing 0.00 2.00 0.00 0.00 0.00 2.00 0.00 0.00

Total Portfolio: 1134.31 249.82 111.69 1590.00 950.57 212.47 90.40 1308.98

57

ANNEX 7: IFC: APPROVALS PENDING COMMITMENT

Approvals Pending Commitment (In US$ Thousands)FY Approval Company Loan Equity Quasi Partic

1999 AutoBAn 35000 0 0 460001997 CTBC 35000 0 0 1500001999 Cibrasec 0 7500 0 01998 Cima Hermosillo 7000 0 0 01998 FSA 35000 0 10000 450002000 Fleury 9000 0 6000 01998 Fras-le 0 0 0 150002000 Frutera 7000 0 0 01996 GlobocaboII 0 0 0 380001999 Growth Fund 0 5000 0 01998 Guinea Seguros 0 134.73 0 01999 Innovative HS 0 0 6250 02000 InverCap 0 1000 0 01998 Ipiranga-RI 2 0 92.07 0 01999 JOSAPAR 13000 0 7000 01999 MBRLTDP 20000 0 5000 1150001996 Oxiteno/Ethylo 0 5000 0 01998 Randon 0 0 0 150002000 Rio Bravo 50000 0 0 650001997 SP Alpargatas II 0 0 0 300001997 Safari Intl. 2000 750 0 02000 Saltillo S.A. 35000 0 0 450001999 Saradar Equity 0 998 0 01998 Unibanco 40000 0 0 2500001997 Unipak-Nile 0 0 0 5000

Total Pending Commitrnent: 288000 20474.8 34250 819000

58 ANNEX 8

Annex A2: Brazil at a glanceLatin Upper-

POVERTY and SOCIAL Ameica middle- -......

Bjaj B & Carib. ncomo Development diamond1998Pooulabtion. mid-vear (millions) 165.9 502 S88 Life expectancyGNP aer cooita (Atls meftOd, US$) 4.570 3.940 4.860GNP (Atlas method, US$ billons) 758.0 1,978 2.862

Average annual growth, 1992-98

Populationr (%) 1.4 1.6 1.4Labor force (%) 1.7 23 2.0 GNP Gross

EE ~~~ ~~per primaryMoat wrcent eatimte (laest year available, 11248) 1capita enrlment

Poverty (% of DoDulaefon below natfonal Dovertv line) 117Urban oDulation (% of totalaoultffon) 80 75 77Life exDectancv at birth (vears) 67 70 70Infant mortalitv (Der 1O 0 ve birhs) 34 32 27Child malnutrition 1% of children under 5) 6 a Access to safe waterAccess to safe water (% of pooulebton) 69 75 79Ilfiteracv(%oftooulationao&15+) i16 13 11Gross primarv enroliment (% of school-aoe Poulonl i 7 123 1131 108 -Brazil

Male .. . .* Upper-middleincome groupFemale

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1977 1987 1997 1998Economic ratios'

GDP (USS biffions) 176.2 294.1 820.4 750.8

Grossdomesticinvestrent/GDP 221 22,3 21.3 21.2Exports of goods and services/GDP 7.3 9.5 7.6 6.9 TradeGross domestic savings/GDP 21.4 25.6 15.6 188Gross natonal savings/GDP 19.7 21.8 16.9 16.6

Current account balance/GDP -2.9 -0,5 -4.1 -4.7Interest payments/GDP 1.2 2.1 1.2 1.4 Domestic InvestmentTotal debt/GDP 23.9 40.7 23.6 28.2 SavingsTotal debt service/exports 42.5: 41,7 57,4 67.7Presentvalueof debt/GDP ,. 22.5 vPresent value of debt/exports .. 277.4

Indebtednessi19747 198-98 1997 :1998 11999'3

(average annual growth)GDP 3.0 2.4 3.2 0.2 3 0 BrazilGNP per capita 0.5 0.5 1.9 -1.4 1.0 Upper-middle-income groupExports of goods and sevices 10.1 4.8 1.8 0.2 6,2

STRUCTURE of the ECONOMY1977 1987 1997 1998 Growth rates of output and Investment (%)

(X of GDP) 1Agriculture 14.7 10.0 8.1 8.6 12T

Industry 38.6 45.9 35.2 37.5Manufacturing 29.3 32.0 22.8 243 4

Services 46.7 44.1 56.7 539 o _ _____ _ 0

Private consumption 69.2 62.3 63.2 68.5 4 93 94 55 96 97 98General oovemmentconsumotion 9.4 12.2 181 127 GDI -GDPImports of goods and services 7.9 6.2 10.2 9.2

(average annual growth) 197747 1988-98 1997 1998 Growth rates of exports and Imports (%)

Agriculture 3.5 2.5 1.9 0.5 4Industry 2.7 1.8 5.5 0.5

Manufacturing 2.3 0.7 3.8 0.5 20

Services 3.2 2.6 3.5 1.2

Private consumption 3.6 5.3 2.4 -3.4 9

General oovemment consumoton 4.0 -1.5 8.0 214 95 96 97 98Gross domestic investment -1.3 2.1 6.2 0.1 20Imports of goods and services -2.6 13.4 13.9 8.9 Exports -*ImportsGross national product 2.7 2.0 3.3 0.0

Note: 1998 data are preliminary estimates.

The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond willbe incomplete.

59

Brazil

PRICES and GOVERNMENT FINANCE1977 1987 1997 1998 Inflation (%)

Domestfc prices 3,000

(% change)Consumer prices 228.3 6.9 2.7 2,000Implicit GDP deffator 46.2 204.1 7.8 0.0 1,0004

Govemment flnance __(% of GDP, includes cunent grants) 93 94 95 9s 97 9a

Current revenue 10.4 18.6 21.2 a1,0m0 -Current budget balance -1.4 -1.8 -4.6 - GDP deflator CPIOverall surplus/deficit -2.8 -2.7 -5.7

TRADE1977 1987 1 1997 98 Export and import levels (USS millilons)

(US$ millions)

Total exports (fob) 26,225 52,990 47,176 ao,000Coffee 2,185 3,094 2,505Soybeans 2,325 5,729 4,580 00,oo0

Manufactures 14,331 32,736 27,601Total imports (d) 15,053 81,354 53,012 40,000

Food 500 3,290 2,961 i -L -

Fuel and energy ,, 4,674 3,220 3,903 ,,3.000Capital goods 3,958 26,232 25,282 o O N E S

Exoort orice index (1995=100) 78 96 92 s2 93 94 Ds 9a 97 sa

lmDort Doce index (1995=100) 81 95 84 *Exports EIlmports

Terms oftrade (1995=100) 97 101 108

BALANCE of PAYMENTS1977 1987 1997 1998 Cunent account balance to GOP rato (%)

(US$ millions)

Exports of goods and services 13,003 28,073 56,831 55,479 2 TImports of goods and services 14,646 17,749 74,147 70,517Resource balance -1,643 10,324 -17,316 -15,038 0o

92 93 9Net income -3,469 -11,699 -18,331 -21,794Netcurrenttransfers 4 -43 2,216 1,886 -2

Current account balance -5,108 -1,418 -33,430 -34,946 E u-IFinandng items (net) 5,629 363 25,629 28,455Changes in net reserves -521 1,055 7,801 8,491 4

Memo:Reserves includina cold (US$ millions) 7.256 6.420 51.729 43.366Conversion rate (DEC, locaUUSS) 5.14E-12 1.43E-8 1.1 1.2

EXTERNAL DEBT and RESOURCE FLOWS1977 1987 1997 1998

(US$ millions) ComposIton of total debt, 1998 (USS millions)

Total debt outstanding and disbursed 42,037 119,820 193,683 212,069 6298IBRD 1,371 9,384 5,743 6,298 5310IDA 0 0 0 0 49229 5284

Total debt service 5,737 11,956 38,091 44,049 12844IBRD 204 1,555 1,428 1,373IDA 0 0 0 0

Comoosition of net resource flowsOfficial grants 5 35 63 80Official creditors 415 10 -1,820 -2,571Private creditors 5,708 -690 19,890 -28,999Foreign direct investment 1,833 1,225 19,652 23,737Portfolio equity 0 78 5,300 -1,852 133324

World Bank programCommitments 319 1,394 1,104 1,291 A-IBRD E-BilateralDisbursements 299 915 1,416 1,240 B - DA D - Other multlateral F - Private

Principal repayments 101 887 1,049 995 C - IMF G -Short-termNet flows 198 48 368 245Interest payments 104 688 380 378Net transfers 95 -841 -12 -133

Development Economics