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Brazil Economic Outlook & Challenges when Normalization begins

IMF-World Bank Spring Meetings 2014 Washington DC
Luiz Awazu Pereira da Silva*

April 2014

(*) Deputy-Governor, International Affairs and Financial Regulation, Banco Central do Brasil.
personal and do not necessarily reflect the opinions of the Banco Central do Brasil (BCB)

These remarks are
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Outline
• Global Economy • EMEs • Brazil
– Fundamentals, Differentiation, Policy Reaction – Inflation – Growth – Challenges

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Main Messages (1)
• Global economy a bit better (e.g., US recovery, less tail risks/false positive in EuroZone, China) • Normalization has begun, it’s a net positive; better coordination, FED’s communication on UMP exit (e.g., separation, spillovers, caution); repricing underway of EMEs assets w/ some volatility • Nothing really new in challenges faced by EMEs (Impossible Trinity, Mundell-Fleming) during GFC (e.g., transmission of K flows into inflation, asset prices, exchange rate, credit market, etc.), except for unprecedented speed+intensity + simultaneity of UMP (ZIF+QE+FG) in 3 major monetary areas
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Main Messages (2)
• EME monetary policy frameworks (IT or not) had to address challenges posing significant risks to monetary and/or financial stability (e.g., typical “boom” & “feel good” moment, followed by “sudden stop”, reversal); but not only an EME bp (e.g., EZ periphery, Baltics, East-Asia) • Good news: many EMEs had experienced, more prepared are always riding some global financial cycle (local MP in AE have global effects), we are always into some kind of “beauty contest”, especially deficit-savings countries • Bad news (in a while): UMP unprecedented, AEs’ exit not synchronized (FED, BoJ, ECB), “New Normal”’ equilibria?
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Main Messages (3)
• Brazil’s textbook response in this transition is working well: flexible ER, AD management (FP+MP) with sizeable buffer of self-insurance (reserves); MaPs worked well for financial stability and complemented MP in upswing; FX buffer is important to reduce volatility during “tapering” and help financial stability (FS) • Brazil’s took early action (MP), prepared the reversal, addressed inflation pressure (early 2013), put in place FX hedge program, but challenges remain: ST highpersistent inflation, sticky expectations, supply shock food prices, growth-confidence nexus; MLT rotating growth from C to I, more TFP through increasing physical & human K stocks
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Slightly Better but Complex, Why?
• UMP unprecendented policy framework, despite the FED’s much improved FG for exit there are the Known Unknowns and the Unknown Unknowns, like what? • AEs: NAIRU, labor market & wage, transmission into inflation, neutral rate, risks of new bubbles, potential growth & “secular decline”, etc. Issue: anxiety about “control” over slope of yield curve & timing of future changes in monetary conditions (anticipation?) • EMEs: life after “easy money” and the commodity supercycle? “Decoupling” or “middle-income growth traps”? Issue: anxiety about how local political economy conditions would allow necessary & timely adjustments
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Different Studies for Nairu, Phillips Curve and STLT Unemployment & Inflation wages in the US

Source: Krueger, Alan B. Cramer, Judd, and Cho. Are the Long-Term Unemployed on the Margins of the Labor Market?, Brookings Panel on Economic Activity, March 20–21, 2014, Princeton University & NBER 7

US-Nairu

Source: Deutsche Bank. U.S. Employment Outlook. Sep., 2013.

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US-Do you look by duration?

Source: Krueger, Alan B. Cramer, Judd, and Cho. Are the Long-Term Unemployed on the Margins of the Labor Market?, Brookings Panel on Economic Activity, March 20–21, 2014, Princeton University & NBER

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US-Do you look by skills?
Unemployment Rates by Education
18 16 14 12 % 10 8 6

4
2 0

mar-10

mar-00

mar-02

mar-04

mar-06

mar-08

mar-12

Less than a high school diploma Less than a bachelor's degree

High school graduates, no college College graduates

10

Source: US Bureau of Census for the Bureau of Labor Statistics - Current Population Survey (CPS)

mar-14

nov-00

nov-02

nov-04

nov-06

nov-08

nov-10

nov-12

jul-01

jul-03

jul-05

jul-07

jul-09

jul-11

jul-13

Do you look at slope Phillips curve?

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Do you look at slope Phillips curve?

Source: IMF, Monetary Policy In the New Normal, SDN April 2014

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US-Which Unemployment Projects Better Wage Growth?

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US-Which Unemployment Measure Projects Better CPI?

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US-Unskilled Labor Wage Moderation
Weekly and hourly earnings data from the Current Population Survey
115 110 média de 2008 = 100 105 100

95
90 85 80 75 70 mar 00 set 00 mar 01 set 01 mar 02 set 02 mar 03 set 03 mar 04 set 04 mar 05 set 05 mar 06 set 06 mar 07 set 07 mar 08 set 08 mar 09 set 09 mar 10 set 10 mar 11 set 11 mar 12 set 12 mar 13 set 13 Less than a high school diploma Some college or associate degree High school graduates, no college* Bachelor's degree or higher
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Source: US Bureau of Census for the Bureau of Labor Statistics - Current Population Survey (CPS)

US: No inflationary surprises
3,0% 2,5% 2,0% YoY

1,5%
1,0% 0,5%
Jan 12 Feb 12 Mar 12 Apr 12 May 12 Jun 12 Jul 12 Aug 12 Sep 12 Oct 12 Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Oct 13 Nov 13 Dec 13 Jan 14 Feb 14

0,0%

PCE

PCE - Core

Dallas FED - trimmed mean
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Sources: US Bureau of Economic Analysis (BEA), FED and Bloomberg

Similar Nairu Changes – selected AEs

Thin line: unemployment rate; bold line: tv-Nairu; dotted lines: 95%-confidence interval; dashed line: unemployment gap.
Source: la Serve, M.E.; Lemoine, M. 2011. Measuring the Nairu: a complementary approach. Document de Travail 342. Banque de France.

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And Great Moderation Neutral interest rate?

Source: The Neutral Interest Rate and the Stance of Monetary Policy in Brazil. Anpec 2013
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And Great Moderation Neutral interest rate?

Source: THE EFFECTIVENESS OF MONETARY POLICY SINCE THE ONSET OF THE FINANCIAL CRISIS ECONOMICS DEPARTMENT WORKING PAPER No. 1081. OECD

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And Policy Rates in EMEs? My Taylor is Poor?

Sources: IMF, International Financial Statistics and World Economic Outlook; Bloomberg; CEIC; Consensus Economics; Datastream; national data; BIS calculations.

Baseline for Exiting UMP in the US
• Net positive for the rest of the World, despite ST volatility that will also depend on local policy stances and conditions • FED communication is working, separation “tapering” & “tightening”, cautious approach, mindful of spillovers • Labor market conditions, different Studies for Nairu, Phillips Curve and ST-LT unemployment & inflation wages in the US  nominal wage rigidity in downturn might moderate and/or delay wage adjustment in upturn • Neutral interest rates different studies for AEs  levels after Great Moderation and GFC might have changed • For the moment: despite these uncertainties, stick to Baseline, as the most likely scenario
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Chronicle of a Death Foretold: EME
• As the Story goes: EMEs benefitted from “easy money” and allowed excessive relaxation of policy stances • Local political economy favored counter-cyclical policy (especially the expansionary bit) • Fundamentals deteriorated (e.g., asset-credit bubbles, higher current account deficits, inflationary pressure, fiscal stance-debt-to-GDP ratios, external financing for both corporates and sovereigns, etc.) • No structural reforms in good times: lower growth prospects in the future • Perfect storm in the making: higher vulnerability to “sudden stops”  crisis looming
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Our Answer in Brazil: No Quite So..

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Brazil: Fundamentals
• Floating ERR, repricing of assets and depreciation is part of the solution and is not vulnerability • Financial Sector has proven resilience, strong capital, provision and liquidity indicators • Ratios of external financing (stocks and flows) are strong & sustainable • Hedge program is contributing to reduce volatility, including after “perfect storm” events (e.g., tapering, EME January sell-off, Brazil’s downgrading)

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External Financing
External Debt/GDP
Turkey Turkey

Short Debt/Total External Debt

Chile
South Africa Peru Mexico Brazil Indonesia Colombia

Indonesia
India Mexico Chile

South Africa
Peru Colombia Brazil 0 10 20 % 30 40 50 0 10 % 20
25

2013* 2012

India

30

Source: IIF e Datastream

External Debt Ratios
140 120 120,6%

100
80 63,4% 60 40 38,8% 19,9% 27,8% 13,9%
%

20
0

short term debt/intl. debt external debt/GDP reserves services/exports Dec 03 Feb 14* *estimate
Source: BCB

Sound financial system
Regulatory Capital to Risk-Weighted Assets
Germany
Brazil United Kingdom Mexico Turkey South Africa Japan Canada United States France South Korea Italy 19,1

( Provisions – NPL) / Capital
Brazil Mexico
10,6 7,7 -3,2 -3,9

Liquid Assets to Short Term Liabilities
Brazil Germany South Korea Italy 160,0 140,3 121,4 96,9 82,0 76,4 72,5 49,9 46,7 45,0 44,9 40,0 36,1 26,1 0 50 100 150 200

17,1
16,4 16,1 15,7 14,8 14,7 14,4 14,4 14,3 14,0 13,9 13,4

Turkey
South Korea Canada Russia

-6,0
-10,9 -13,6 -13,6

Russia
United States Turkey Japan Mexico Australia Canada United Kingdom South Africa India

India
United States United Kingdom Australia Japan South Africa Spain Italy -86,3

-14,5
-14,7 -19,2 -22,2 -31,9

Russia
India Spain Australia 10

13,3
12,0 11,6 12 14 16 18 20

-120

-20

80

Source: IMF (FSI – latest available data)

Banks: Low Share of External Funding
Origin of Bank Funding 100% 4,4 11,3 8,8 14,4

80%
95,6 88,7 91,2 85,6

60%
public-owned private-owned foreign-controlled total
Feb 14

Domestic
Source: BCB

External

UMP exit brought higher volatility
BRL Volatility
(3-Months At-the-money Implied)

17,5

15,0

Chairman BB May 22 Speech

12,5

10,0

7,5

5,0 mar 13 fev 13 set 13 ago 13 mai 13 abr 13 out 13

jun 13

jul 13

nov 13

dez 13

jan 13

Source: Bloomberg

jan 14

But FX hedge program effect
-6000 -5000 -4000 -3000 -2000 2,3 -1000 0 2,25 2,2 2,15 2,1 USD millions 2,5 2,45 2,4 2,35

1000
2000 3000

Swap

Repo FX

USD.BRL 30

Brazil: Resulting Differentials
10 5

NEER (chg %) *

0
-5 -10 Since 2 Weeks May 22,2013 2014

10 8 6 4 2 0 -2 -4 -6 -8

USD/Currency (chg %) *

Since May 2 Weeks 22,2013

2014

* Positive sign indicates appreciation of the country's currency / group.

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Brazil: Resulting Differentials
CDS (chg bps)
40 30 20 10 0 -10 -20 -30 -40
Since May 2 Weeks 22,2013 2014

10 5 0

Equity (chg %)

-5 -10
-15 Since May 22,2013 2 Weeks 2014

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Brazil: Reversal of Sentiment?
Monthly Avg. USD Millions

Portfolio Investment - Net Flows (USD Millions)

500

IOF on fixed income at 6%
400

IOF on equities at 2%

IOF on equities at 0%

IOF on fixed income at 0%

300

200

100

0

-100

-200

Equities

Bonds

Other Flows

Source: Central Bank of Brazil. Inflows from forex contracts.

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Brazil: Policy Anticipation & Reaction
• We knew that reversal of market sentiment would eventually come and prepared ourselves, accumulated sizeable reserves to be used as buffers (alternative strategy: less reserves and more reliance on multilateral support like IMF-FCL) • Preventive measures during upswing (MaPs for tightening excessive credit growth); keep strong capital, provisions & liquidity in our financial system, cautious reliance on external sources of funding • Took early and sizeable action on Monetary Policy, complemented by Fiscal Policy
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Brazil: Why Then Such Variance?
Because there are legitimate albeit difficult analytical challenges everywhere and in particular in Brazil: • Where is our NAIRU? Effects on wage bargaining process? • Where is our Neutral interest rate? Down and MP more effective in an environment of less confidence • How long would our J-Curve take? And then to affect domestic absorption and growth? And in addition: • Inflation headline hit by temporary supply shock, headline inflation impacts expectations, issue of persistence (see Roache, IMF (2014)) • Growth: confidence indicators in transition; supply policies (investment in infrastructure underway) 35

Skilled Wage Moderation?
Are we in the opposite symetric of the US case? Would it also affect unskilled wage cycles?
150 140 130
2008 Average+100

120 110 100 90 80

fev 06

fev 03

fev 04

fev 05

fev 07

fev 08

fev 09

fev 10

fev 11

fev 12

fev 13

ago 07

ago 02

ago 03

ago 04

ago 05

ago 06

ago 08

ago 09

ago 10

ago 11

ago 12

Without formal education 4 to 7 years of schooling

1 to 3 years of schooling 8 to 11 years of schooling 36

Source: Ministry of Labor and Employment/CAGED.

ago 13

fev 14

Real Actual Interest Rate
25
20 15 10 5 0
Apr 4th 4.9%

% annual

abr 06

abr 12

abr 02

abr 03

abr 04

abr 05

abr 07

abr 08

abr 09

abr 10

abr 11

abr 13

360-day market rate discounted by the IPCA expected for the next 12 months (Focus)

Sources: BM&FBovespa / BCB

abr 14

Neutral interest rate - literature review shows large variation

Source: The Neutral Interest Rate and the Stance of Monetary Policy in Brazil. Anpec 2013

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Compared to our Region?

Source: Nicolas E. Magud and Evridiki Tsounta. To Cut or Not to Cut? That is the (Central Bank’s) Question. IMF Working Paper. October 2012

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Brazil: Headline Inflation
• Inflation has been high and resistant, reflecting the elevated services inflation inertia and administrated prices realignment • BCB has acted to secure the convergence of inflation to the target. • MP effects on inflation are cumulative and take place with lags. In this sense, significant part of prices response to the tightening cycle is yet to materialize. • At this moment, there are renewed external and domestic food price pressure, but in a much tighter monetary conditions environment
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Producer Price Indexes
10

8.24%
IPP Feb 14

8.05%
IPA-DI Mar 14

8 % in 12 months

6.25%
IPA-10 Nov 11

6

4

2

3.22%
jul 12 mar 12 mar 13 jul 13 mar 14

IPP Nov 11

0 nov 11
mai 12 nov 12 mai 13 nov 13 jan 12 set 12 jan 13 set 13 jan 14

IPP
Sources: IBGE / FGV

IPA (10, M and DI)

Consumer Price Indexes
7,5 7,0
IPCA = 6.15%
Mar 14

6,5
% in 12 months 6,0 5,5 5,0 4,5 4,0 3,5 out 12 ago 12 ago 13 abr 12 abr 13 out 13 dez 12 dez 13

IPC-DI = 6.09%
Mar 14

INPC = 5.62%
Mar 14

IPC-Fipe = 5.12%
1st/Apr 14

IPCA-15 and IPCA
Sources: IBGE / Fipe / FGV

INPC

IPC-Fipe

IPC (10, M and DI)

abr 14

fev 12

jun 12

fev 13

jun 13

fev 14

IPCA and Food Prices Component
27 Variation (%) 12 months accumulated 24 21 June/2008 15,8

May/2003 27,0

18
15 12 9 6 3 0 -3 jan 01 jan 02 jan 03 jan 04 jan 05 jan 06 jan 07

Abr/2013 14,0

6,31 5,68 5,47

jan 08

jan 09

jan 10

jan 11

jan 12

jan 13

IPCA
Source: IBGE

Alimentação e bebidas Food and Beverages

IPCA Alimentação e bebidas IPCA exceto ex-Food and Beverages

jan 14

Headline Dependent Expectations?
Change in Expected Annual IPCA anual after a Surprise in Monthly IPCA (in m+1, v-a-v m-1)

Change in Expected Annual IPCA anual after a Surprise in Monthly 5,0 IPCA 4,0 3,0 2,0
y = 1,7299x + 0,0106 R² = 0,79

1,0
0,0 -1,0 -2,0 -3,0 -1 -1 m-1
y = 3,0765x + 0,0661 R² = 0,50 y = 1,527x - 0,0011 R² = 0,81

m

0

m-2

1

1

Surprise in monthly IPCA mensal (v-a-v expected IPCA of each period)

Source: BCB/DEPEC.

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Inflation – Convergence to Target
10 8
reference scenario*

6

% yoy
4 2
target (4.5%)

0 mar 05 mar 06 mar 07 mar 08 mar 09 mar 10 mar 11 mar 12 mar 13 mar 14 mar 15 mar 16

*Central Bank of Brazil Forecast (Inflation Report – Mar 14)

Sources: BCB / IBGE

J – Curve Lags, about one year?
Number of citations

South Africa Argentina Austr alia Chile China Colo mbia Ec uador Indon esia Japan Malaysia Me xico Peru Thailand Tur key Uruguay

No evidence / partial evidence (p) 1 1 p

Not specify the lag

Lag (quarter s)

3,5

1 1 1
1 4 p 4 1 1 1 1

4

4

46

Sources: MOURA, GUILHERME and SERGIO DA SILVA, (2005) "Is There a Brazilian J−Curve?", Economics Bulletin, Vol. 6, No. 10 pp. 1−17, July 2005.

HSING, Y. “A Study of the J-Curve for Seven Selected Latin American Countries”, Global Economy Journal, 2008, 8(4). KALYONCU, H., OZTURK, I., ARTAN, S., KALYONCU, K. “Devaluation and trade balance in Latin American countries”, Zb. rad. Ekon. fak. Rij., 2009, vol. 27, sv.1, 115-128. ONAFOWORA, OLUGBENGA, (2003) "Exchange rate and trade balance in east asia: is there a J−curve?." Economics Bulletin, Vol. 5, No. 18 pp. 1−13, 2003. BAHMANI-OSKOOEE, M. and GOSWAMI, G. G. “A Disaggregated Approach to Test the J-Curve Phenomenon: Japan versus Her Major Trading Partners” Journal of Economics and Finance, Volume 27, Number 1, Spring 2003. AHMAD, J. AND YANG, J. “Estimation of the J-Curve In China”, East-West Center Working Papers”, Economic Series, nº 67, March 2004. HALICIOGLU, F. “The Bilateral J-curve: Turkey versus her 13 Trading Partners”, Munich Personal RePEc Archive Paper No. 3564, 15. June 2007. BAHMANI-OSKOOEE, M., GOSWAMI, G. G. and TALUKDAR, B. K. “The Bilateral J-Curve: Australia Versus her 23 Trading Partners”, Australian Economic Papers, Blackwell Publishing Ltd/University of Adelaide and Flinders University, June 2005 and Moodley, S. “An estimation of the J-Curve effect between South Africa and the BRIC countries”, University of Pretoria, nov. 2010.

Growth since the Global Financial Crisis
Cumulative Real GDP Growth
120
118.0 117.7 117.7

115
Index Dec 07 = 100 110 105 100
97.9

110.2 106.3

95

90 4Q 07 1Q 08 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 3Q 11 4Q 11 1Q 12 2Q 12 3Q 12 4Q 12 1Q 13 2Q 13 3Q 13 4Q 13
Poland Brazil South Korea Mexico US Euro Area
Source: Bloomberg

Brazil - Leading destination for FDI
2010
US China Belgium Hong Kong UK Singapore 114,7 85,7 82,7 50,6 48,6 48,5 46,9 43,3 42,8 40,8 35,2 197,9 US China Belgium Hong Kong Brazil Australia 124,0 103,3 96,1 66,7 65,8 64,0 52,9 51,1 41,4 40,9 40,4

2011
226,9 US China Hong Kong Brazil UK France

2012
146,7 119,7 72,5 65,3 62,5 58,9 54,4 48,5 47,2 44,1 39,6 27,3

Brazil
Germany Russia Ireland Spain Australia Switzerland France Saudi Arabia 0

Singapore
Russia UK Canada France Germany Italy India Spain 0

Singapore
Australia Canada Russia Ireland India Chile Luxembourg Belgium 0

32,5
30,6 29,2 50 100 150 200 Thousands

34,3
31,6 29,5 50 100 150 200 Thousands

26,4
22,6 19,3 50 100 150 Thousands

Source: UNCTAD

Global CEO Survey 2014: Key Countries
Which 3 countries, excluding the country in which the CEO is based, do they consider most important for their overall growth prospects over the next 12 months? *

China US Germany
17% 12% 10% 7% 7% 7% 7% 5% 30%

33%

Brazil UK
% India Russia Indonesia Japan Mexico

0

5

10

15

20

25

30

35

Source: PwC 17th Annual Global CEO Survey

*Base: 1,344 respondents

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Model Rotation: GFCF / GDP (%)

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Brazil: Prospects & Challenges
• Brazilian economy is also passing through a transition, with investment expansion and families’ consumption moderation. • Brazil has been conducing a structural reform agenda to qualify work force, amplify investments and boost productivity, as well as improving business environment.

• Concerning investments, it is noteworthy the ample concessions program, which includes the transfer of airport, road, railroad and port management to private sector.
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Brazil: Prospects & Challenges
• Brazilian economy faces a transition period pursuing new engines to growth: productivity gains and investment expansion. In 2014, economic activity should be somewhat lower than in 2013.
• Industry – recovery, but not very strong signs of support. • Services – lower growth rates than previous years.

• Agribusiness – record harvest year after year, besides bad weather in 2014.
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Brazil: Prospects & Challenges
• Investiment started to grow again in 2013 (~6% more than the ~2% for private consumption) – continuity will depend on confidence and tends to gain traction led by infrastructure projects and oil fields exploration.
• Reform agenda – more efficient allocation of production factors of the economy and productivity gains.

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Thank You!

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