OECD Economic Outlook, Volume 2023 Issue 2

Brazil

Real GDP is projected to grow by 3.0% in 2023, 1.8% in 2024 and 2.0% in 2025. Economic activity rebounded strongly in the first half of 2023 driven by an exceptional agriculture harvest and resilient household consumption. Despite tight financial conditions, household spending will remain strong due to buoyant employment growth, declining inflation, and higher social transfers. Private investment will recover slightly throughout 2024 as monetary policy eases. Though commodity prices are declining, agricultural products will drive a continued expansion of exports. Inflation has declined markedly over 2023 and will converge toward the target band during 2024.

Monetary policy easing started in August 2023. Real interest rates remain high, leaving room for continued reductions in policy rates over 2024 and 2025. Fiscal policy remains expansionary, but a gradual consolidation is expected in 2024 to achieve the 1% of GDP primary surplus target required by the new fiscal framework. Implementing the new fiscal framework will help to restore confidence and achieve a more consistent macroeconomic policy mix. Stronger infrastructure investment and the planned adoption of a unified value-added tax can boost potential growth. Expanding access to early childhood education would facilitate labour market participation for women and reduce gender disparities.

Economic activity has picked up

The economy grew robustly in the first two quarters of 2023, with an annualised quarter‑on‑quarter expansion of 7.5% in the first quarter and 3.7% in the second quarter. The first quarter saw exceptional agricultural production, and early estimates project a new record in agricultural output for the upcoming second harvest. While industrial production improved in August, it remains 1.8% below the pre-pandemic level of February 2020. The services sector contracted consecutively by 0.3% in September 2023 and by 0.9% in August compared to July, following a 2.1% gain in the May-July period. Advanced indicators suggest a progressive slowdown in the second half of the year. The labour market has been strengthening, with the unemployment rate falling to 7.7% in September, the lowest recorded since June 2015. Job creation is predominantly being propelled by the services sector, including domestic services.

Brazil: Activity and confidence indicators

Source: CEIC; Banco Central do Brasil; and OECD calculations.

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Brazil: Demand, output and prices

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Brazil: Inflation and trade indicators

1. Core inflation excludes energy and food products. The shaded area corresponds to the inflation tolerance band.

2. Moving average.

Source: OECD Economic Outlook 114 database; and Banco Central do Brasil.

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Inflation declined to 4.8% in October after a rebound to 5.2% in September, and a significant drop to 3.2% in June. The recent uptick is primarily attributable to higher fuel prices during September. In contrast, food and beverages, which have a strong weight in household consumption, experienced deflation for the fourth consecutive month in October. Furthermore, core inflation is declining, reaching 5.5% in October, down from 6.1% in August.

Monetary policy easing has started

Despite the recent increase, the declining inflation trend throughout the year has allowed the central bank to ease monetary policy, reducing the policy rate from 13.75% in July to 12.25% by November 2023. With expectations of continued inflation declines and high real interest rates, further policy rate cuts are expected, lowering the rate to 9.2% by the end of 2024 and 7.8% by the latter half of 2025.

In 2023, fiscal policy was expansionary, driven by an increase in social transfers. The primary fiscal deficit is projected to be 1% of GDP. In August 2023, Congress approved a new fiscal framework, enhancing medium-term predictability while adding flexibility, especially for investments. To meet the primary balance target under this framework, the government plans to implement additional tax revenue raising measures equivalent to 1.5% of GDP in 2024, while spending would increase by 1.0% of GDP. Additionally, the lower Chamber of Congress has approved an indirect tax reform, currently under discussion in the Senate, aiming to create a unified value-added tax. This tax reform has strong potential to simplify the tax system and boost economic growth.

Growth will remain strong

Growth is projected at 3.0% in 2023, slowing to 1.8% in 2024 and 2.0% in 2025. Domestic demand remains the primary driver of economic activity. Job creation continues to bolster household income, stimulating strong household consumption growth. Investment is set to improve due to more favourable financial conditions. Agricultural exports will boost growth in 2023 but this boost is expected to fade in the following years, amid lower commodity prices. Inflation, down from an average of 9.3% in 2022, is expected to decrease to 4.5% in 2023, 3.2% in 2024, and 3.0% in 2025, aligning with the target band as of 2024. The decline in inflation is the result of an early monetary policy response and the normalisation of earlier supply chain disruptions.

Economic risks are balanced. On the upside, another exceptional agricultural harvest could spur growth. Additionally, successful implementation of the tax reform could boost confidence and economic activity, with the effects potentially exceeding expectations. On the downside, slower growth in China, a key trading partner of Brazil, could weigh on external demand. Sustained increases in inflation could delay further policy rate reductions, leading to reduced investment and consumption. Additionally, any further increases in policy rates in advanced economies could exert pressure on the exchange rate.

Adopting the tax reform and improving competition will boost growth

Implementing the new fiscal framework and meeting the primary balance targets will be key to ensure debt sustainability and restore confidence in the public finances. Implementing a unified value‑added tax system will simplify the taxation of goods and services and reduce administrative burdens on businesses. Beyond consumption taxes, there is also scope to reform income taxes and improve the progressivity of the tax system. A current personal income tax deductibility of expenditures for private health and education expenses has regressive distributional effects, as 90% of Brazilians have incomes below the threshold where they would pay income taxes and only 25% of Brazilians are subscribed to private health plans, while most of the population relies on the public health system. Recent increases in conditional cash transfers have been well-targeted, reducing poverty and inequality, but further improvements in the effectiveness and targeting of social benefits are needed. Expanding access to early childhood education, especially for low-income households and single parents, can enhance equal opportunities and encourage more women to participate in the labour market. Streamlining regulations and lowering market entry barriers would strengthen long-term growth. Addressing infrastructure gaps in transportation, water, and sanitation can enhance the competitiveness of Brazilian firms in international trade. Deforestation is the leading source of gross greenhouse gas emissions. Stronger enforcement of environmental protection laws including the Forest Code will be crucial to combat deforestation. The agriculture sector is the second‑largest direct source of greenhouse gas emissions in Brazil. A better targeting of agricultural credit to low‑carbon practices can be effective to combat deforestation and reduce emissions. Introducing carbon pricing mechanisms can complement these efforts and promote fair competition between sectors.