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Promoting Economic Growth in Brazil

Randal K. Quarles
Assistant Secretary of Treasury for International Affairs
Remarks at the Brazilian-American Chamber of Commerce
New York City, July 17, 2003

Thank you very much for inviting me here today. It's a pleasure to speak with you about Brazil, especially at a time of growing optimism about Brazil's future.

The name of this event - "Brazil: From Stabilization to Growth" — could not be more appropriate. Less than a year ago, the market was weighed down by uncertainty in the lead-up to an election that would provide Brazil new leadership after eight years of solid and stable policies under President Fernando Henrique Cardoso. This uncertainty, and a somewhat turbulent global environment at the time, combined to drive spreads on Brazilian bonds to more than 2,400 basis points over U.S. Treasuries and the real to nearly four to the dollar. Since then, there has been rebound in market confidence and greater stability: the real has strengthened 20 percent and spreads on Brazilian bonds have narrowed to 800 basis points over U.S Treasuries.

This return of market confidence can be credited to the bold and far-sighted policy choices of the Lula Administration in its opening months in office. President Lula rightly recognized the importance of macroeconomic stability to the achievement of the social goals he articulated in his inauguration speech. As the government implements its program to forge a better life for all Brazilians, economic policies will continue to be integral to the achievement of this vision. The current period of rising confidence and stability creates a window of opportunity for looking beyond short-term financial concerns and focusing on the long-term priority of economic growth.

Today I would like to say a few words about developments in recent months, before turning to the opportunities that lie ahead.

The Start of the Lula Administration

President Lula and his economic team came into office committed to continued fiscal responsibility, and to a monetary policy that makes long-term price stability the top priority. They have delivered on their commitments: fiscal performance so far this year has exceeded formal targets established in Brazil's IMF program. And Brazil has formally committed to achieving similar primary surplus targets in 2004. Thanks to the Central Bank's continuing efforts to meet inflation targets, inflation is falling rapidly. Consumer prices declined in June for the first time in more than four years and inflation appears to be on the desired path.

Brazil's export sector has outperformed even the most optimistic expectations: June's trade surplus measured $2.4 billion, generating a record high trade surplus of $21 billion for the last 12 months. Even more compelling is the fact that these results have been achieved largely through export expansion rather than import compression. Brazil's impressive trade performance partially derives from expanding trade with non-traditional trading partners such as China. Diversifying its export markets not only increases total exports but also reduces vulnerabilities to volatility in any single market.

Finally, the Lula Administration submitted to Brazil's Congress key pension and tax legislation that goes to the heart of Brazil's long-term fiscal position. Passage and implementation of these reforms will lay the foundation for the reduction of Brazil's debt levels and free up future government resources for productive investment. While more vigorous legislative debate lies ahead, we commend the government's efforts to build broad support for reforms while maintaining the key reform objectives.

Laying the Basis for Sustained Growth

In Brazil, as elsewhere, the ability of an economy to deliver rising standards of living depends upon increasing the amount of goods and services that each worker produces -- or, in the language of economists, increasing productivity. Labor productivity in turn depends upon (1) the amount of capital that each worker has to work with, and (2) the technology and efficiency with which the factors of production are used. The goal of government policy should be to create an environment that increases productivity growth by encouraging investment (capital accumulation) and rewarding innovation, entrepreneurship and competition (technological progress and increased efficiency).

There is great potential for improving productivity growth in Brazil. Productivity declined dramatically during the crisis years of the 1980s. Market-oriented reforms in the 1990s were pivotal in reversing this trend. But productivity growth remains modest, and international experience suggests that more can be achieved.

Good economic policies can unleash Brazil's potential for substantial productivity gains. In Brazil, priority areas include tax and labor market policy, industrial regulation, the financial sector, health and education, and trade.

The Lula Administration's proposed tax reform provides a good example of a reform to improve Brazil's business and investment environment and enhance the incentives for capital accumulation and economic activity. The proposal seeks to replace the remaining major cascading tax with a value-added tax. This would prevent double taxation on inputs and lower production costs-and that has an obvious positive impact on the competitiveness of Brazilian goods at home and abroad.

Another key component of the legislation would reduce the payroll tax burden. High payroll taxes that keep labor costs high discourage job creation and push employment into the informal sector. Reduction of the payroll tax burden provides an incentive to bring Brazilian workers into the formal labor market. 

The importance of incentives is also prominent in the area of regulatory policy. Attracting investment in Brazil's domestic infrastructure is essential to supporting activity throughout the economy. Clear and transparent regulation is needed to attract new investment to key industries such as energy and telecommunications, so that investors can be confident in the long-run viability of business plans. The United States knows from experience the complexities inherent in the regulation of key industries. We look forward to sharing our experiences with the Brazilian government as it continues its dialogue with investors, government entities, and consumers on regulatory reform.

Many observers have commented on the high cost of credit in Brazil as a constraint on investment. The government's continued progress in containing inflation will allow for further reductions in the benchmark Selic rate, which will have a direct impact on lowering borrowing costs. Beyond this, a number of factors contribute to high bank lending rates that make credit prohibitively expensive to most Brazilian businesses.

Banks hold large amounts of Brazilian government debt, rather than loans, on the asset sides of their balance sheets. Continued progress with sound fiscal policies ought to allow a reduction in the total amount of government debt and thus a reduction in this "crowding out" of bank credit, thus increasing the availability of credit to the private sector. On the microeconomic side, high bank operating costs and weak creditor rights also keep borrowing costs high. Government policy matters here, too. Passage of bankruptcy legislation that has been pending in Brazil's Congress for nearly ten years would represent significant progress toward addressing the issue of creditor rights.

Experience from around the world has demonstrated that investing in people through health and education is needed to build a capable and industrious labor force.

President Lula's Zero Hunger initiative is a good example of what the new administration is doing to provide for such basic needs. In education, we hope that the Lula administration is successful in building on the progress of the 1990s that increased primary school enrollment and reduced the adult illiteracy rate. Passage of social security reform and other efforts to maintain sound public finances will free up government resources for additional investments in these areas.

Finally, the area of trade presents a tremendous growth opportunity for Brazil. The reduction of trade barriers encourages the growth of exports, enhances the competitiveness of domestic industry, and lowers the cost of goods to consumers. While Brazil has liberalized substantially in the last decade, total trade (exports plus imports) as a share of GDP remains relatively low by middle-income country standards, at approximately 29 percent of GDP in 2002. By way of comparison, trade equals roughly half of Mexico's and Turkey's gross domestic products, two-thirds of Korea's GDP and more than 100 percent of Thailand's GDP in 2002. Brazil's trade performance over the past year, which resulted in an accumulated trade surplus through the first half of the year of $10 billion and a rolling 12-month surplus of $20 billion, demonstrates the importance of trade to the overall health of the Brazilian economy.

Important multilateral initiatives to reduce trade barriers-globally through the World Trade Organization, regionally through the Free Trade Area of the Americas (FTAA)-are now underway. Brazil is positioned to take a leadership role in these initiatives.

Ambassador Zoellick was recently in Brazil to discuss next steps on the FTAA.

While much work remains to be done, the United States remains committed to achieving the January 2005 deadline. As co-chairs of this effort, Brazil and the United States bear a significant responsibility for bringing the FTAA to fruition. Our goals are ambitious, but achievable.

U.S.-Brazilian Cooperation

The first months of the Lula administration provide a good indication of its seriousness in addressing Brazil's key economic challenges. Such a process is never easy. But for each obstacle, there is also an opportunity.

In this spirit, it was announced during President Lula's visit to Washington last month that the United States Treasury Department and Brazil's Finance Ministry will initiate regular consultations on accelerating economic growth in both countries. This dialogue -- the Group for Growth -- will facilitate in-depth discussions on growth strategies. It will enable us to share experience and best practices for addressing common challenges. It will provide a forum for discussions lessons learned in such areas as reforming fiscal and tax policies; reducing impediments to the creation and expansion of small and medium-sized companies; increasing investment and business credit; promoting trade; developing infrastructure; and strengthening domestic competition.

Through this and other areas of engagement, the United States looks forward to working with our Brazilian partners to advance growth and poverty reduction strategies in our two countries and throughout the hemisphere.

Thank you very much, and I look forward to this morning's discussion.

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July 21, 2003

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