BRAZIL – ECONOMY AND TRADE

ECONOMY

Brazil's economy, aided by a benign international environment, grew approximately 2.3% in 2005 and 4.9% in 2004. Sustained growth, coupled with booming exports, healthy external accounts, moderate inflation, decreasing unemployment, and reductions in the debt-to-GDP ratio. President Lula and his economic team have implemented prudent fiscal and monetary policies and have pursued necessary microeconomic reforms.

Brazil has made progress but significant vulnerabilities remain. Despite registering its first year-on-year decline in 2004, Brazil's (largely domestic) government debt remains high, at 51% of GDP. Total foreign debt, while falling, is still large in relation to Brazil's export base. Over time this concern will be reduced by healthy export growth, which has anchored the positive trade and current accounts. Personal incomes improved in 2004 and 2005 after a significant decline over the previous decade. Income and land distribution remains skewed.

Sustaining high growth rates in the longer term depends on the impact of President Lula's structural reform program and efforts to build a more welcoming climate for investment, both domestic and foreign. In its first year, the Lula administration passed key tax and pension reforms to improve the government fiscal accounts. Judicial reform and an overhaul of the bankruptcy law, which should improve the functioning of credit markets, were passed in late 2004, along with tax measures to create incentives for long-term savings and investments.

Legislation promoting public private partnerships, a key effort to attract private investment to infrastructure, also passed in 2004. Labor reform and proposals to increase autonomy for the Central Bank are pending. Despite this well-considered reform agenda, much remains to be done to improve the regulatory climate for investments, particularly in the energy sector; to simplify tax systems at the state and federal levels; and to further reform the pension system.

Trade Policy

President Lula has made economic growth and poverty alleviation top priorities. Export promotion is a main component in plans to generate growth and reduce what is seen as a vulnerability to international financial market gyrations. To increase exports, the government is seeking access to foreign markets through trade negotiations and increased export promotion as well as government financing for exports.

To increase its international profile (both economically and politically), the Lula administration is seeking expanded trade ties with developing countries, as well as a strengthening of the Mercosul (Mercosur in Spanish) customs union with Uruguay, Paraguay and Argentina. In 2004, Mercosul concluded free trade agreements with Colombia, Ecuador, Venezuela and Peru, adding to its existing agreements with Chile and Bolivia to establish a commercial base for the newly-launched South American Community of Nations. Mercosul is pursuing free trade negotiations with Mexico and Canada and has resumed trade negotiations with the EU. The trade bloc also plans to launch trilateral free trade negotiations with India and South Africa, building on partial trade liberalization agreements concluded with these countries in 2004. In July 2006, Venezuela was admitted to the trade bloc as a full member China has increased its importance as an export market for Brazilian soy, iron ore and steel, becoming Brazil's fourth largest trading partner and a potential source of investment.

Reform Agenda

In 2003, Congress passed Lula's key reforms of the public sector pension system and the tax code. The 2004 legislative season was not very productive, in part because of a political scandal early in the year followed by campaigning for the October municipal elections. In December 2004, several key bills passed into law, including a reform of the judicial system, a modern bankruptcy law, and Public Private Partnerships to fund infrastructure projects. In March 2005, a law to legalize biotechnology crops and stem cell research passed. The domestic political scandal, which surfaced in June 2005 and led to multiple congressional investigations, sidetracked most reform legislation for the remainder of the 2005 and 2006 sessions.

Agriculture

Agriculture is a major sector of the Brazilian economy, and is key for economic growth and foreign exchange. Agriculture accounts for 10% of GDP (30% when including agribusiness) and 40% of Brazilian exports. Brazil enjoyed a positive agricultural trade balance of U.S. $38 billion in 2005. Brazil is the world's largest producer of sugar cane, coffee, tropical fruits, frozen concentrated orange juice (FCOJ), and has the world's largest commercial cattle herd (50% larger than the U.S.) at 170 million head. Brazil is also an important producer of soybeans (second to the United States), corn, cotton, cocoa, tobacco, and forest products. The remainder of agricultural output is in the livestock sector, mainly the production of beef and poultry (second to the United States), pork, milk, and seafood.

Other Aspects

Forests cover half of Brazil, with the largest rain forest in the world located in the Amazon Basin. Recent migrations into the Amazon and large-scale burning of forest areas have brought international attention. The government has reduced incentives for such activity and is implementing an ambitious environmental plan that includes an Environmental Crimes Law with serious penalties for infractions.

Brazil has one of the most advanced industrial sectors in Latin America. Accounting for one-third of GDP, Brazil's diverse industries range from automobiles and parts, other machinery and equipment, steel, textiles, shoes, cement, lumber, iron ore, tin, and petrochemicals, to computers, aircraft, and consumer durables. Most major automobile producers have established production facilities in Brazil.

Brazil has a diverse and sophisticated services industry as well. Mail and telecommunications are the largest, followed by banking, energy, commerce, and computing. During the 1990s, Brazil's financial services industry underwent a major overhaul and is relatively sound. The financial sector provides local firms a wide range of financial products. The largest financial firms are Brazilian (and the two largest banks are government-owned), but U.S. and other foreign firms have an important share of the market.

Privatization triggered a flood of investors after 1996. The yearly investment average in the telecom sector the 4 years prior to the start of privatization was R$5.8 billion, and the annual average for the four years following privatization was R$16.3 billion, nearly tripling. Investment in the electrical power sector increased from R$5.3 billion annually in the pre-privatization era to R$7.2 billion. U.S. companies provided a great deal of this influx of cash. After 2000, many of these investors suffered huge losses in the face of adverse regulatory decisions and especially the sharp depreciation of the real. The energy sector was especially hard hit.

In 2001, Brazil experienced an electricity crisis due to inadequate rainfall for its hydroelectric system and insufficient new investment in the sector. Mandatory rationing and price hikes were sufficient to prevent blackouts. The rationing system officially ended on March 1, 2002. Lula’s then-Energy Minister unveiled an energy plan in July 2003, which left many vital details undefined and most investors dissatisfied.

The Government of Brazil has undertaken an ambitious program to reduce dependence on imported oil. In the mid-1980s, imports accounted for more than 70% of Brazil's oil and derivatives needs; the net figure is nearing zero. Brazil is expected to become a net exporter of oil by the end of 2006 as output from the Campos Basin continues to increase. Brazil is one of the world's leading producers of hydroelectric power. Of its total installed electricity-generation capacity of 90,000 megawatts, hydropower accounts for 66,000 megawatts (74%).

Proven mineral resources are extensive. Large iron and manganese reserves are important sources of industrial raw materials and export earnings. Deposits of nickel, tin, chromite, bauxite, beryllium, copper, lead, tungsten, zinc, gold, and other minerals are exploited. High-quality, coking-grade coal required in the steel industry is in short supply.

FOREIGN RELATIONS

Brazil has traditionally been a leader in the inter-American community and played an important role in collective security efforts, as well as in economic cooperation in the Western Hemisphere. Brazil supported the Allies in both World Wars. During World War II, its expeditionary force in Italy played a key role in the Allied victory at Monte Castello. It is a member of the Organization of American States (OAS) and a party to the Inter-American Treaty of Reciprocal Assistance (Rio Treaty). Recently, Brazil has given high priority to expanding relations with its South American neighbors and is a founding member of the Latin American Integration Association (ALADI), the Community of South American Nations (CASN) and Mercosul, a customs union including Argentina, Uruguay, Paraguay, Venezuela and Brazil, with Chile, Bolivia, Peru, Colombia, and Ecuador as associate members.

Along with Argentina, Chile, and the U.S., Brazil is one of the guarantors of the Peru-Ecuador peace process. Brazil is a charter member of the United Nations and participates in its specialized agencies. It has contributed troops to UN peacekeeping efforts in the Middle East, the former Belgian Congo, Cyprus, Mozambique, Angola, East Timor, and most recently Haiti. Brazil is currently leading the UN peacekeeping force in Haiti. Brazil served as a non-permanent member of the UN Security Council from 2004-2005. Prior to this, it had been a member of the UN Security Council four times. Brazil is lobbying for a permanent position on the Council.

As Brazil's domestic economy has grown and diversified, the country has become increasingly involved in international economic and trade policy discussions. For example, Brazil has been a leader of the G-20 group of nations in the WTO Doha Round talks. The U.S., Western Europe, and Japan are primary markets for Brazilian exports and sources of foreign lending and investment. China is a growing market for Brazilian exports. Brazil also has bolstered its commitment to nonproliferation through ratification of the nuclear Non-Proliferation Treaty (NPT), signing a full-scale nuclear safeguard agreement with the International Atomic Energy Agency (IAEA), acceding to the Treaty of Tlatelolco, and joining the Missile Technology Control Regime (MTCR) and the Nuclear Suppliers Group.