Fiscal policy reacted forcefully to the COVID-19 crisis, dedicating around 9% of GDP to emergency support measures, including income support to households and firms. Most of these measures have been withdrawn by now. Fuel tax exemptions introduced to cope with high inflation have also been mostly withdrawn. Higher income transfers for Bolsa Familia recipients have been made permanent.

Inflation has receded, mostly explained by lower food and energy prices. Russia’s war of aggression against Ukraine and the resulting global price surges fuelled inflationary pressures which then became more widespread (Figure 1). Inflation has declined since mid-2022, supported by lower fuel taxes, and core inflation has also declined. Slower credit growth and lower wage increases will reduce household income and contribute to lower inflation.

Risks to economic activity are balanced. Weaker growth in China, Brazil’s main trading partner, could reduce exports, while faster disinflation could allow lower policy rates and boost investment.

Public debt remains high compared to other emerging market economies. Ensuring its sustainability requires a credible fiscal framework and better spending efficiency. A planned reform of the fragmented system of consumption taxes will reduce compliance costs substantially.

Previous fiscal rules have not addressed widespread budget rigidities such as constitutionally mandated spending items, revenue earmarking and automatic indexation mechanisms (Figure 2). Therefore, fiscal space for policy priorities declined until becoming very small, and the rules were changed frequently to avoid breaching them.

The new fiscal framework, adopted in August 2023, is meant to address these challenges by combining more medium-term predictability with added flexibility. The framework establishes multi-year targets for the primary balance until 2026 and defines limits on real spending growth. The new framework also contains a mechanism to bring the primary balance back to target when deviations occur.

Brazil’s tax system is highly complex and distorts production decisions. Five different taxes on the consumption of goods and services are levied on sometimes overlapping bases and at different levels of government, with incomplete credits for intermediate inputs and substantial legal uncertainty, giving rise to long tax disputes.

A proposal currently discussed in Congress aims to consolidate the different consumption taxes into a unified value-added tax (VAT). This VAT would have simple rules and a common, broad tax base harmonised across states, full tax credit on all inputs and zero-rating for exports. The government has made this tax reform a key priority. Political challenges include the distribution of revenues across states, but a gradual transition and transfer mechanisms between states should help build a consensus for the tax reform.

Potential growth and productivity gains have declined. Reforming regulatory policies, a stronger engagement in international trade, increasing female labour participation and a stronger education and training system would boost potential growth.

Stringent regulations and high administrative burdens on markets for goods and services restrict competition and the entry of new firms, hampering productivity growth. Recent reforms have reduced unnecessary bureaucracy and regulations. However, barriers in services sectors are still higher than the OECD average.

Access to foreign markets and deeper integration into global value chains could be facilitated by lowering existing trade barriers. Average import tariffs are about eight times higher than in Mexico, for instance. Non-tariff barriers are also relatively high, including widespread local content requirements (Figure 3).

Female labour force participation and employment are about 20 percentage points lower than for men. Limited access to early childhood education is one barrier to women’s access to the labour market. Only about a third of all children under the age of three in Brazil have access to day care.

The pandemic has worsened the educational attainments of children from disadvantaged backgrounds. Despite high public spending on education relative to GDP, resources are not always targeted towards improving inequalities of opportunities. Moreover, participation in vocational education programmes remains low and post-secondary vocational education opportunities are limited.

Strengthening the enforcement of the Forest Code, developing rural economies and incentivising the adoption of new technologies can help to reduce greenhouse gas emissions.

Deforestation, a major source of greenhouse gas emissions, has risen since 2019, although early indicators now suggest a decline in 2023. Stricter enforcement of the Forest Code, coupled with more adequate resources for enforcement agencies, are now expected to support national efforts towards reducing deforestation. The Brazilian government has recently committed to reach zero deforestation by 2030 in its nationally determined contribution to the Paris Agreement under the UNFCCC, as defined by Brazil’s Action Plan for the Prevention and Control of Deforestation in the Legal Amazon. Emissions from agriculture, the second-largest contributor to GHG emissions, come mostly from livestock (Figure 4). Better regulations and incentives for more sustainable production have substantial scope for reducing them. Carbon pricing mechanisms will also be key for emission reductions.

Better planning, including tighter coordination across the federal and subnational governments, could strengthen infrastructure investment. Reducing risks associated with long-run infrastructure projects has the potential to attract more private and international financing.

The infrastructure damages caused by climate events are already detrimental to growth and represent approximately 1.3% of GDP in annual losses. Public infrastructure is particularly vulnerable to climate shocks amid a rapid, unplanned, and uncontrolled urbanisation. Frequent droughts and rising temperatures will create challenges for energy supply, particularly from hydroelectric sources.

Infrastructure investment has been low in international comparison and has even declined (Figure 5). Public spending on infrastructure has delivered results that have often fallen short of expectations over the last decades. Improvements in planning and project execution could substantially improve the performance of public infrastructure investment. Each year, more than 30% of public infrastructure projects are interrupted and either temporarily or permanently paralysed.

Most public sector investment is executed by subnational governments. States and municipalities often lack the technical capacities needed for infrastructure project preparation and procurement. In addition, local infrastructure plans are not always aligned with federal priorities and a consistent monitoring of infrastructure spending across different levels of government is difficult.

Opening up additional sources of private investment will be essential for filling infrastructure financing gaps in the medium run. Creating the appropriate framework conditions for private investment will require rethinking current risk sharing mechanisms and minimising risks related to changing policy settings and judicial uncertainty.