FROM THE OFFICE OF PUBLIC AFFAIRS

I would like to thank the Council for inviting me here today.  It’s my pleasure to provide comments to this distinguished group alongside Assistant USTR Chris Padilla and Otaviano Canuto, whom I’m happy to welcome to Washington as Brazil’s new Executive Director at the World Bank.

The overriding objectives of U.S. economic policy—whether domestic or international—are maintaining macroeconomic stability and increasing economic growth.  It is useful to think about what has happened in Brazil over the last year and what the priorities are for the upcoming year in this context.

Improving Macroeconomic Stability:  President Lula’s First Year in Office

When I spoke at this event last year, President Lula had been in office less than one month.  While early indications were very positive, many Brazil observers and Brazilians themselves were still uncertain regarding the direction of a Lula presidency, especially with regard to economic policy.  I noted at the time that we in the U.S. Treasury were encouraged by President Lula’s balanced economic agenda— anchored in the maintenance of macroeconomic stability and driven by a focus on economic growth to achieve the social objectives laid out by President Lula in his inaugural address.  Today, more than one full year President Lula’s term, I’m pleased to report that our optimism was well-placed. 

President Lula and his Administration were quick to implement disciplined economic policies aimed at achieving economic stability.  The components of Brazil’s economic agenda are well-known to this audience, but I think they merit review because it is easy to forget just how far we have come over the last year.  Sound policy choices—and strong Brazilian ownership of these policies—have been the decisive factor in restoring financial market confidence in Brazil.
 
To begin, President Lula sought to control spending by committing Brazil to a primary surplus aimed at achieving sustainability of Brazil’s public debt.  Brazil over-performed on its IMF primary surplus target throughout 2003.  President Lula made good on his promise to reform the public pension system and to reduce the deficit stemming from public pension payments.  Reducing poorly-targeted spending in areas like pensions helps the government protect spending for priority areas such as sanitation and key social initiatives such as Bolsa Familia.  The Administration has also started down the road to much-needed tax reform, it successfully passed tax measures necessary to ensure Brazil’s fiscal sustainability in the near and medium-term.  There is recognition that important reforms to correct inefficiencies in Brazil’s tax code must be addressed in the context of fiscal stability.  This is a fiscal reform record that demonstrates the Lula Administration’s ability to build consensus on tough issues.  We know it will need to sustain this consensus as it pursues other elements of the growth agenda.

In the area of monetary policy, the Central Bank demonstrated its commitment to the inflation-targeting regime and withstood significant pressures to prematurely relax monetary policy.  This policy has resulted in a steady reduction of inflation expectations in 2003, which peaked at 12.6 percent in March 2003.  Statistics released last week show that consumer inflation for 2003 was 9.3 percent.  Expectations for 2004 have followed a similar declining trend and currently stand at less than 6 percent, close to the Central Bank’s target of 5.5 percent.  Locking-in a lower inflationary path will be amply rewarded in the form of lower borrowing rates and higher economic growth.  Granting the Central Bank formal autonomy will be an important next step to increase transparency and further reinforce expectations of low inflation. 

Brazil also took tangible steps to reduce vulnerabilities to future shocks.  One example is Brazil’s concerted effort to accumulate international reserves in a manner consistent with Brazil’s floating exchange rate and inflation-targeting monetary policy.  Net international reserves—that is reserves excluding IMF disbursements—increased from $14 billion at end-2002 to $17 at end-2003, while the real appreciated 15 percent over the course of the year. 

Another example is the government’s strategy to aggressively reduce its reliance on foreign currency-linked debt.  In one year, the Treasury reduced the amount of foreign currency-linked debt as a percent of Brazil’s internal public debt outstanding from 22.4 percent at the end of 2002 to 10.8 percent at the end of 2003.  This result exceeds the government’s most optimistic target for reducing Brazil’s direct fiscal exposure to currency swings.  Finally, the government is making a concerted effort to deepen domestic financial markets by introducing the direct auction of public securities through the internet, which should both diversify Brazil’s sources of funding and help increase potential sources of funds for the private sector.

Markets have reacted to this concerted progress.  After approaching nearly 4.0 to the dollar in October 2002, the real rebounded strongly in 2003 and has been relatively stable in a range of 2.8 to 3.0 to the dollar since last April.  Let us not forget that Brazil’s sovereign risk spread soared to 2,400 basis points over U.S. Treasuries during the fall of 2002.  Today, that sovereign risk spread stands at about 400 basis points.  Just last week Brazil issued its first global bond of 2004—a $1.5 billion, 30-year bond that priced at just 376 basis points over the benchmark U.S. Treasury.  Brazil has now completed $3 billion in external placements out of a planned $5.5 billion for 2004, having pre-financed $1.5 billion at the end of 2003.
 Beyond the government, the lower sovereign spread has positive implications for Brazilian companies, who can and have returned to international markets to raise capital in 2003 and 2004.

The official community has also signaled its confidence.  Brazil has entered a new phase in its relations with the IMF.  Late last year, Brazil and the IMF extended the program on a precautionary basis through early 2005.  The program extension is designed as an exit strategy to unwind Brazil’s obligations to the IMF in a way that won’t undermine Brazil’s reserve position or damage market confidence.  It is clear that Brazil is moving away from reliance on official finance and has taken control of its own reform strategy.  The United States supported this exit strategy as it has supported Brazil’s consistently strong performance in meeting IMF commitments.

Increasing Economic Growth:  The Agenda Ahead

Having achieved such substantial progress in restoring economic stability, it is natural that the focus in Brazil should now turn to increasing economic growth.  This means addressing some of the key microeconomic impediments to higher rates of economic growth.

One priority is reducing the cost of credit and expanding access to capital.  According to a recent World Bank report on Brazil, less than 20 percent of small enterprises have access to outside sources of financing.  Nearly one-third of entrepreneurs cite the lack of credit as a major obstacle to business growth.  The Brazilian government’s 2004 agenda includes a number of measures designed to reduce the cost and expand the availability of credit, including: the passage and implementation of pending bankruptcy reform; implementation of measures to allow workers to pledge a portion of their wages as loan collateral; and giving borrowers and lenders access to a centralized credit rating system in order to encourage competition in the banking sector. 

Deregulation also has to be a priority.  Entrepreneurship is encouraged by eliminating unnecessary administrative procedures.  In Brazil, the cumbersome process of starting a business, which includes separate licensing and tax registration at various levels within the government, serves as a disincentive to business creation.  The government has indicated its plans to examine measures to simplify and reduce registration requirements for business and address overlaps and redundancies between different agencies and levels of government.

A clear and transparent regulatory environment is critical to attracting new investment in key industries such as energy and telecommunications.  The government recently unveiled plans to boost investment in key infrastructure projects through Public Private Partnerships. 

Eliminating distortions in labor markets and bringing more workers into the formal labor market will also encourage investment as well as create jobs.  Today, millions of workers in Latin America are forced into the informal labor sector, as employers find hiring employees through formal channels prohibitively expensive.  By one estimate, more than half of the Brazilian labor force is employed in the informal sector.  Addressing this problem requires action to address disincentives, such as high payroll taxes, that discourage job creation in the formal sector.

Changes to put in a place a simpler, more efficient tax system are also essential for getting incentives right for production and investment.  The Lula Administration has committed to pursuing tax reform designed to make the tax system simpler, more efficient and socially just.  Conversion of the cascading turnover tax, which disadvantages certain activities with long production chains, into a value-added tax is one example of this.

U.S.-Brazil Engagement

Raising economic growth is critical to combating poverty, promoting social development, and strengthening democracies throughout the Western Hemisphere.  This was an important theme that emerged from last week’s Special Summit of the Americas in Monterrey, which provided a broad endorsement of the kinds of sound economic policies needed to bolster economic growth across the Hemisphere.  The Summit also provided the opportunity to launch specific initiatives to address the microeconomic impediments to higher growth.  The United States proposed specific initiatives to triple IDB-catalyzed credit to small businesses, reduce the time required to start a business, and halve the cost of sending remittances from migrant workers to their families. 

The U.S.-Brazil Group for Growth was inaugurated last year following the meeting between President Bush and President Lula.  It provides a venue for advancing discussions on ways to increase economic growth in Brazil and the United States.  We view it as a new model for engaging on economic policy in this region. We meet as two, large, sophisticated economies with much to teach each other on accelerating growth and reducing poverty.  The inaugural meeting of the Group in August provided an opportunity to examine and compare the how productivity is measured in Brazil and the United States, and how such measurements are used in the conduct of economic policy.  We also considered the relationship between investment and productivity growth over long periods of time in both countries.  We plan to build on this discussion at the next meeting of the Group due to be held in Brazil in the first quarter of this year.  This and future meetings will take up concrete policies for encouraging entrepreneurship, job creation and investment.

Again, I thank the Council for inviting me to speak with you today and I welcome your views on the outlook for Brazil and the kinds of issues we should focus on in the Group for Growth.