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					Brazil Economic Outlook

                        Alexandre Bassoli



            May, 2007




                                            0
This presentation

 What are the drivers of the exchange rate appreciation? What explains the
  resilience of exports?
 New GDP methodology has important implications for risk perception and the
  economic activity outlook
 Domestic demand is pushing economic growth
 Interest rates, albeit still high, are converging to unthinkable levels
 Fiscal policy: expenditures continue to soar, but the public debt dynamics
  remain healthy
 Investment grade may be achieved in 2008




                                                                               1
In spite of the BRL strengthening, trade surpluses are approximately
constant at USD 47bn

                                                12-month trade balance
                  150.000

                  130.000

                  110.000                    Exports

                   90.000                    Imports
    USD million




                                             Trade balance
                   70.000

                   50.000

                   30.000

                   10.000

                  -10.000

                         90 90 91 92 92 93 94 94 95 96 96 97 98 98 99 00 00 01 02 02 03 04 04 05 06 06
                       n/ et/ ai/ an/ et/ ai/ an/ et/ ai/ an/ et/ ai/ an/ et/ ai/ an/ et/ ai/ an/ et/ ai/ an/ et/ ai/ an/ et/
                     ja s m j s m j s m j s m j s m j s m j s m j s m j s


                                                                                                                                2
Terms of trade gains explain the resilience of exports
                                                                                                                                EXPORT PRICES
                                                                         120
 Mainly as a result of soaring commodity                                115

  prices, export prices accumulate an                                    110

  increase of 57% since Dec-02                                           105




                                                           1996 = 100
                                                                         100

 The nominal exchange rate moved from                                       95

  2.13 to 2.03 BRL/USD between Apr-06 and                                    90

                                                                             85
  Apr-07, but the profitability of exports
                                                                             80
  actually increased 1.0%                                                    75


 The increase of export prices has two




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  important implications:                                                                Real exchange rate and export profitability index
                                                                 160
 – More Dollars for a given volume of exports
                                                                 140
 – Since the profitability is improving, there are                                                                                                           RER


   incentives to increase, not reduce, the export volume         120                                                                                         EPI




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                  0,8
                        1,0
                              1,2
                                    1,4
                                          1,6
                                                1,8
                                                      2,0
                                                            2,2
                                                                  2,4
                                                                        2,6
                                                                              2,8
      /1 02
         1/
     26 200
        /2 2
          /
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          /
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        /8 3
    26 /20
      /1 03
         1/
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        /2 3
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         1/
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        /2 4
          /
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          /
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    26 /20
      /1 05
         1/
                                                                                Embi Brasil / Embi +




     26 200
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          /
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          /
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        /8 6
    26 /20
      /1 06
         1/
     26 200
        /2 6
          /2
            00
              7
                                                                                                       The improvement of sovereign risk boosts capital inflows




4
Strong BRL is here to stay

 Currency appreciation does not seem to
  reflect a bubble
 Brazil has largely mitigated its sources of
  external vulnerability                                                 Real exchange rate
                                                                  4,30
 Exchange rate volatility was structurally                       4,05
  reduced                                                         3,80
                                                                  3,55




                                                BRL of May 2007
                                                                  3,30
 We forecast 1.95 BRL/USD in Dec-07                              3,05
                                                                  2,80
                                                                  2,55            .

                                                                  2,30
                                                                  2,05
                                                                  1,80
                                                                  1,55
                                                                  1,30
                                                                  1,05


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                                                                                              5
New GDP methodology brought two fundamental changes
         2006 GDP level (BRL mn) - old vs new methodology
  2200                                                             Average GDP growth (2001-2006) - old vs new methodology
                                                            3,5%
  2150                                                                          2,9%
                                                            3,0%

  2100                                                      2,5%                                              2,3%

                                                            2,0%
  2050
                                                            1,5%
  2000
                                                            1,0%

  1950                                                      0,5%

  1900
                                                            0,0%
                   Old                         New                              New                           Old



 The GDP level is 11% higher than we previously thought
 Average GDP growth is the last six years was 2.9%, while the previous methodology
  indicated 2.3%




                                                                                                                             6
     19
       9




                                         0,0%
                                                1,0%
                                                       2,0%
                                                              3,0%
                                                                     4,0%
                                                                            5,0%
                                                                                     6,0%
                                                                                                                         7,0%




                 -3,0%
                         -2,0%
                                 -1,0%
    19 6 -
      96 I
     19 - III
       9
    19 7 -
      97 I
         -
      19 III
        9
     19 8-I
       98
     19 -III
       9
    19 9 -
      99 I
     20 - III
       0
    20 0 -
      00 I
                                                                               GDP




     20 - III
       0
                                                                                                           Net exports




    20 1 -
      01 I
                                                                                     Domestic Absorption




     20 - III
       0
    20 2 -
      02 I
     20 - III
       0
    20 3 -
      03 I
     20 - III
       0
    20 4 -
      04 I
     20 - III
       0
    20 5 -
      05 I
     20 - III
       0
                                                                                                                                GDP growth: contribution of domestic absorption and net exports




    20 6 -
      06 I
                                                                                                                                                                                                  Growth is gaining momentum pushed by domestic demand…




         -I
            II
7
                    9,0
                               12,0
                                              15,0
                                                             18,0
                                                                       21,0
                                                                                24,0
                                                                                          27,0
                                                                                                        30,0
                                                                                                                 33,0
    jan/00
    mai/00
    set/00
    jan/01
    mai/01
    set/01
    jan/02
    mai/02
    set/02
    jan/03
    mai/03
    set/03
    jan/04
    mai/04
    set/04
    jan/05
    mai/05
                                                                                                                        1-year ex ante real interest rate




    set/05
    jan/06
    mai/06
    set/06
    jan/07
    mai/07
                                                                                                                                                               …and this process will continue




    m
      ar
                                                                               1,0%
                                                                                       3,0%
                                                                                                 5,0%
                                                                                                          7,0%
                                                                                                                 9,0%




                             -9,0%
                                      -7,0%
                                                     -5,0%
                                                               -3,0%
                                                                       -1,0%




                    -11,0%




        /0
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    m
                                                                                                                            Real growth of total wages (YoY)




      ar
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           6
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          06
    m
      ar
        /0
           7
8
The good news is that investments are growing…

             Annual growth of gross fixed capital formation
    25,0%

    20,0%

    15,0%

    10,0%

     5,0%

     0,0%

     -5,0%

    -10,0%
       Q 92

       Q 93

       Q 94

       Q 95

       Q 95

       Q 96

       Q 97

       Q 98

       Q 98

       Q 99

       Q 00

       Q 01

       Q 01

       Q 02

       Q 03

       Q 04

       Q 04

       Q 05
             06
          19

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          20
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        1

        4

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        2

        1

        4

        3

        2

        1

        4

        3

        2
    Q




                                                              9
                77%
                          78%
                                        79%
                                                  80%
                                                                  81%
                                                                                82%
                                                                                            83%
     jan/03
     mar/03
     mai/03
      jul/03
     set/03
     nov/03
     jan/04
     mar/04
     mai/04
      jul/04
     set/04
     nov/04
     jan/05
     mar/05
     mai/05
      jul/05
     set/05
     nov/05
                                                                                                Industrial capacity utilization




     jan/06
     mar/06
     mai/06
      jul/06
     set/06
     nov/06
     jan/07
     mar/07




     m
        ai
                 9,0%
                        9,5%
                                10,0%
                                          10,5%
                                                  11,0%
                                                          11,5%
                                                                        12,0%
                                                                                12,5%
                                                                                        13,0%




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     no 5
                                                                                                Unemployment rate (s.a.)




         v/
            0
                                                                                                                                  …but the expansion is likely to exceed potential growth in 2007




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                 -1%
                          4%
                                       9%
                                                    14%
                                                                           19%
          9 8
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           99
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                                                                           Tradables
             0
     ja




                                                           Non-Tradables
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                                                                                                IPCA - tradables and non-tradables




         l/0
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     de
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           9
                 0,0%
                        5,0%
                               10,0%
                                            15,0%
                                                          20,0%
                                                                                       25,0%




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          9
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                                                                                                                                     and the deceleration of administered prices




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                                                                                               Regulated prices




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                                                                                                                                     Inflation remains very well behaved, thanks to the BRL appreciation




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Interest rates, albeit still high, are converging to uncharted territory

 Several factors point towards lower rates in upcoming quarters
 – A more robust balance of payments implies a lower sovereign risk and a less volatile currency
 – Administered prices now represent a positive shock
 – The BRL appreciation keeps tradable inflation under control
 – Terms of trade gains allow a fast increase of imports without damaging the current account surplus

 Even after achieving the investment grade, however, it is not clear that interest
  rates will converge to levels observed in other countries such as Chile and
  Mexico (3.5%-4.0% in real terms)
 The bad quality of fiscal policy implies, in our view a higher level of neutral
  interest rates and a lower level of potential growth
 We expect nominal rates to stabilize at 11.0-11.25% in nominal terms
 If terms of trade gains intensify, however, rates may stay below the equilibrium
  for a while


                                                                                                        12
Fiscal policy: more of the same


        Real annual growth - central government revenues           Real annual growth - central government expenditures
                                                           12,0%
14,0%
                                                           10,0%
12,0%
                                                           8,0%
10,0%
                                                           6,0%
8,0%
                                                           4,0%
6,0%

4,0%                                                       2,0%

2,0%                                                       0,0%

0,0%                                                       -2,0%

-2,0%                                                      -4,0%

-4,0%                                                      -6,0%
  ag 0




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                                                            de
 Public expenditures continue to grow at an extremely vigorous pace
 The tax collection expansion is also outperforming GDP growth



                                                                                                                          13
The primary surplus will fall, but the nominal deficit is likely to drop as
well, thanks to lower interest rates

                   12-month nominal deficit as a % of GDP
     14,0%

     12,0%

     10,0%

      8,0%

      6,0%

      4,0%

      2,0%

      0,0%
       ja 7


       ja 8


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       ja 0


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             97


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             07
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                                                                              14
From a solvency perspective, fiscal policy looks OK, but…

 It has as expansionary impact on
  domestic demand and negative
  implications for potential growth
 The bad quality of fiscal policy may imply                                                Net public debt/GDP ratio
                                               57%
  higher interest rates in comparison to
                                               52%
  investment grade countries
                                               47%


                                               42%


                                               37%


                                               32%


                                               27%




                                                    91

                                                          92

                                                                   93

                                                                         94

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                                                                                                 97

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                                                                                                                99

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                                                                                                                                                                        15
Conclusions

 Brazil continues to benefit from terms of trade gains
 We think that a stronger (and less volatile) BRL is here to stay
 Thanks to the positive shocks, the expansion of domestic demand may
  outperform output growth
 Due to stronger fundamentals and positive shocks, interest rates are
  converging to uncharted territory
 Even after the investment grade , however, we think that interest rates will be
  above the average of our peers
 From a solvency perspective, fiscal policy is OK, but its poor quality has
  negative implications for potential growth and interest rates
 Thanks to extraordinarily benign external conditions and the new GDP
  methodology, the investment grade is likely to be achieved in 2008


                                                                                    16
Macroeconomic forecasts

     External accounts (USD bn)                 2002    2003    2004    2005    2006    2007
     Exports                                     60,4    73,1    96,5   118,3   137,5   151,0
     Imports                                     47,2    48,3    62,8    73,5    91,4   107,0
     Trade balance                               13,2    24,8    33,7    44,8    46,1   44,0
     Current account                             -7,6    4,0     11,6    14,3    13,5   11,7
     Medium and long term amortizations         -29,7   -27,8   -33,3   -32,8   -44,1   -31,0
     External sector borrowing requirement      -37,3   -23,8   -21,7   -18,5   -30,6   -19,3
     Net direct investment                       14,1    9,9     8,7     12,6    -8,5   14,0

     Economic activity
     GDP                                        2,7%    1,1%    5,7%    2,9%    3,7%    4,3%
     Industrial production (IBGE)               2,7%    0,1%    8,3%    3,1%    2,8%    4,8%

     Inflation
     IPCA                                       12,5%   9,3%    7,6%    5,7%    3,1%    3,5%
     IGP-M                                      25,3%   8,7%    12,4%   1,2%    3,8%    2,9%

     Public sector
     Public sector primary surplus (% of GDP)    3,6%   3,9%    4,2%    4,4%     3,9%   3,6%
     Public sector nominal deficit (% of GDP)    4,2%   4,7%    2,4%    3,0%     3,0%   1,9%
     Debt to GDP ratio                          50,5%   52,4%   47,0%   46,5%   44,9%   43,9%

     Interest rate and exchange rate
     FX (average of period, BRL/USD)             2,92    3,07    2,93    2,43    2,18    1,99
     FX (end of period, BRL/USD)                 3,53    2,90    2,65    2,34    2,14    1,95
     SELIC interest rate (average)              19,5%   23,3%   16,3%   19,0%   15,2%   12,2%
     SELIC interest rate (end of period)        25,0%   16,5%   17,8%   18,0%   13,3%   11,25%

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posted:6/29/2012
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