MW Technics

- operates as an international consulting agency focusing transfer and joint-ventures between South-America and Europe

- promotes direct transfer of know-how, opening of markets and marketing of products in partner countries

- support you in planning, raising or reconstructing production plants

- help you to find appropriate partner to market and enhance your products

- assist you in finding producers/products in the country you need

- examine and inform you about legislation and patents for your product

- assess you concerning conditions of market and possibilities of production

- assess and deal with you and your partner in the respective languages

- mail us or get in contact directly:

MW TECHNICS Ltd
Parque Petrópolis Paulista
Al. das Sibipirunas 300
CEP: 07600-000 Mairiporã S.P.
BRASIL

Engineering Consulting

MW TECHNICS  LTDA

is located in Brazil, in the centre of the industrial metropolis São Paulo. This provides short routes, since 80 % of the enterprizes either produce or run branches in São Paulo.

Companies or branches in Brazil may be assisted directly by MW Technics starting with the examinationtion of the production, support in personal-planning and developing of marketing-structures.

Take advantage of our experiences to optimize your production in Brazil, including its special circumstances. Let us assist you in your language.

Stuff Management

MW TECHNICS  LTDA

offers a head-hunting service for your branch in Brazil.

Since we are located in the industrial heart of Brazil our partners take the advantage of a high level knowledge about conditions and legal questions of the MERCOSUL and perfect conditions to acquire qualified personal to improve the resources of their branch.

Take use of our experience to optimise your branch in Brazil according to the local conditions. We are prepared to assist you in your language.

MW Technics acquires its business partners qualified personal from Brazil to develop interaction and transfer of information between your enterprise and your branch.

Take use of our experience to arrange your enterprise according to the requirements of the MERCOSUL. We will assist you.

References

MW TECHNICS ltd.,  Director : Max B. R. Wolff, P.E.

Max B. R. Wolff studied management and worked for Dutch,
German, Swedish, Swiss and American companies as well as
in Brazil as general manager for multinational companies.

MW TECHNICS  LTDA

Member of the most important South American Chamber of Industry and Commerce (AHK Brasil - Alemanha, São Paulo)

Consultant of TEGEL-TECHNIK Conveyors, Germany

Consultant of STEMAC GRUPOS GERADORES, Porto Alegre

Consultant of C&S INTERPATENTS, São Paulo

Consultant of CRUZEIRO/NEWMARC  Patentes e Marcas LTDA

Consultant of the Dierkes & Stephan Solicitor’s Office, Dresden/Germany

Contato

MW TECHNICS  LTDA

e-mail: info@mwtechnics.com

Fax: + 55 - 11 - 44 85 18 85
Phone: + 55 - 11 - 44 85 10 40
Mobil: + 55 - 11 - 99 78 14 20

MW TECHNICS  LTDA

Parque Petrópolis Paulista
AL. das Sibipirunas 300
CEP: 07600-000 Mairiporã S.P.
BRASIL

MW TECHNICS  LTDA

CAIXA POSTAL / PO-BOX : 17053
CEP: 02399-970/ São Paulo
BRASIL

MW TECHNICS  LTDA

A Political and Economical Sphere

Overview

Brazil is considered to be one of the ten largest nations in the world with regard to area, population and GDP (gross domestic product). Over a third of all South-American economic power relies on this country, which has considerable reserves of raw materials, a broad base of production and a partly highly developed industrial structure.

On January 1, 2003, President Lula da Silva assumed control of a country that - to a great extent - was politically and economically stable and following the reforms introduced by his predecessor Cardoso, which focused on a free economic order, the protection of human rights and close international cooperation. However, other extensive political, social and economical reforms will be necessary to eliminate the existing structural problems posed to development and to the achievement of a wide modernization of the country, in which the entire population can participate.

Brazil is a federal presidential republic. The head of state and also head of government is the President, who is elected through direct ballot by the people for a four-year mandate(and is eligible for reelection only once). The Vice-President is elected at the same time. At the federal level, the Legislative Power is exercised by the National Congress, which is composed of two houses. The Chamber of Deputies has 513 members and the Senate has 81 (three from each state and the Federal District). At the state and municipal levels, the Executive Power is exercised by governors and mayors and the Legislative Power by the Legislative Assemblies respectively. Most political parties are much more people-oriented than program-oriented. Therefore, political alliances and coalitions can change rapidly and it is not rare that elected officers switch parties. The Judicial Power is divided between the federal and the state court. Those courts have jurisdiction over civil, commercial, administrative and public matters, which are normally resolved in up to three steps. There are also specific courts for labor, electoral and military matters and federal courts for disputes involving the federal government and its institutions. The Supreme Federal Court (Supremo Tribunal Federal) is the highest judicial body and is responsible particularly for federal and constitutional disputes, and for proceedings related to foreign countries. It also judges all litigation brought against members of the federal bodies (such as the President, Ministers, Congress members), whereas cases involving state governors and members of the legislative assembly are under the responsibility of the Superior Court of Justice (Superior Tribunal da Justiça), which is the highest federal judicial body and is composed of three courts. The Brazilian judicial system specifically the Constitution of 1988, is characterized by its complexity and lack of clarity. The courts are known to be overburdened and slow, and qualified attorneys are expensive. Under these circumstances, reaching a common agreement without involving law procedures may be sensible alternative.

The traditional Brazilian political culture is changing. Despite the significant differences that exist between the South and North regions regarding economical and social development, today people involved in politics, mostly the young, push for reforms in economy and society to promote a better-balanced social structure and the modernization of the country in all fields. Civil society with its numerous organizations plays an important role in this respect.

Foreigners might have difficulty to understand the Brazilian scenario. Successful business relationships require knowing the political culture and the potential contradictions between political rights and actual conditions. This includes being particularly aware that, although it is defined by century-old traditional structures, the country is going through rapid changes, both politically and socially.


The Role of the Brazilian Government in the Economy

In the past, the Brazilian government participated on a large scale in the economy with government owned companies and exercised great control over privately owned enterprises. Therefore, excessively detailed and frequently changing regulations where often a reason for complaint in the Brazilian economy, particularly with respect to the monetary and price policies, the rules on import, license regulations and labor law.

There have been significant changes in this regard since 1990. Within the context of a comprehensive privatization program almost all considerable industrial holdings belonging to the Federal Government have been privatized, with very few exceptions. Since 1995 the Brazilian Federal Government and increasingly also its states have become involved in the privatization of infrastructure (transport, energy and telecommunications) and financial services. State monopolies(i.e. telecommunications and petroleum) and restrictions against foreign capital (i.e. mining and financial services) were mostly eliminated.

The privatization that started in 1991 yielded US$ 105.3 billion in proceeds for the state treasury until the end of 2002. This sum was used for the debt relief of enterprises and banks being privatized and to settle the states debts. At the end of Cardoso's era, the state-owned development bank BNDES (Banco Nacional de Desenvolvimento) still had a list of outstanding privatizations that included several energy distributors and generators, water and wastewater companies, telecommunication licenses in several states, the state reinsurance IRB, as well as some state-owned banks.

The BNDES generally has a comprehensive overview of the present situation in all sectors of the Brazilian economy and should be consulted when making investment decisions. Furthermore, it is an important financing resource, since it extends long-term credits, even to foreign investors.

Contrary to other European and American enterprises, the German economy participated very little in the privatization. In order to remedy the matter, in February 2002, German Chancellor Schröder and President Cardoso created a German-Brazilian Workgroup of Infrastructure and Energy, whose objective is to attract German investors, particularly to the still to be privatized segments of the Brazilian economy.

However, privatization came to a standstill in 2002. In the case of the biggest Latin-American energy distributor, Eletropaulo, it even came to a temporary partial nationalization, since BNDES took over 50% of Eletropaulo's shares during a debt restructuring from its head office, the North American AES, in order to pay off credits taken on at BNDES for the purchase. The devaluation of the real, the changes in the behavior of consumes as a result of the 2002 energy crisis and the slow economic growth pattern put energy enterprises which had been privatized to foreign businesses in a difficult position. BNDES wants to take energy enterprises out of the red by restructuring their debt.

The Lula administration thinks that the State should play a more significant role in the economy At the same time, even the Lula administration needs private investors in order to make the investments foreseen in the government's multiannual plan (2004-2007) (www.planobrasil.gov.br). For this reason, the regulation of segments such as energy, telecommunications, transport, etc. will have to be clarified. The intent of the Lula administrations inspect the regulatory authorities created by the previous government for the privatized segments put the investors into a state of uncertainty and provoked a drop in foreign investments Also, the decision made still under the Cardoso administration to suspend the ratification of 14 bilateral investment protection and incentive treaties, among them the one signed with Germany in 1995 and already ratified by the German Bundestag, was not very helpful.

The Lula administration also intends to sell the last four regional banks that were taken over by the Federal Government still under the Cardoso administration and whose debts were relieved. However, first it is necessary to mediate litigation between the Federal Government and the four affected state governments regarding the privatization proceeds. So far, the privatization of the three major federal banks, Banco do Brasil, Caixa Economica and BNDES, has not been planned.

Despite the liberalization, openness and deregulation, the tradition to intervene in the way businesses are conducted through rapid and detailed measures remains. The country's enormous area, regional diversity and social problems represent a challenge to the state administration Problems, such as the lack of personnel continuity or parallel authority structures with unclear competences and insufficient coordination also interfere by posing insecurity to investments planning and showing that often even in well-organized parts of the country the administration can still be improved. The Brazilian government is aware that these are big challenges that need to be faced.


Mercosur

The creation of the Common Market of the South (Mercosur) on January 1st, 1995, brought a new dimension to the development of Brazil. Mercosur goes back to 12 bilateral protocols between Brazil and Argentina dated of 1986, which in 1988 were transformed in an agreement on integration, cooperation and development with the objective of creating a common market between both countries within 10 years. After Paraguay and Uruguay joined, all four countries signed an agreement in 1991 on the creation of the Mercosur in order to obtain a free trade area of goods and services, a common customs tariff and a unified commercial policy towards other countries. The agreement also had the purposed of coordinating these country's economic policy.

Since January 1st, 1995, the internal duty has been abolished for more than 90% of all goods produced in the member countries and the remaining internal duties are supposed to be completely abolished by the year 2006. Also, a common customs tariff was introduced for the majority of goods.

Chile, Bolivia and Peru have also joined, and negotiations are being held with other Latin American countries.

Until 1997, Mercosur's success led to a significant expansion of the trade between its member countries and influenced the economic planning and investment behavior of enterprises in all South America.

Since then, however, the integration process has been very slow. First, the different monetary and exchange rate policy of large member countries, such as Brazil and Argentina led to strong tensions. After the devaluation of the Brazilian currency real in January 1999, Argentina introduced protective duties in order to defend itself against the cheap imports from Brazil. Also, Argentina undermined the common customs tariff through numerous special regulations.

However, since the Argentinean peso has no longer been pegged to the dollar (end of 2001), the conflict regarding the monetary policy was eliminated. Once again, Argentina bets on the cooperation in the Mercosur. Although the severe 2002 economic crisis in Argentina provoked a significant drop in the Mercosur trade, the revival of the Argentinean economy reconsolidated the Mercosur trade in 2003. Moreover, the foreign policy of the Lula administration is geared towards the Mercosur and Latin America. In order to further the regional integration even resources from the state-owned development bank, BNDES, have been made available.

The Brazilian industry - including large German companies - is pressuring the Brazilian government to sign agreements with countries outside the Mercosur in order to open new export markets. Brazil has already negotiated free trade agreements with Chile and Mexico, which can come into force with the authorization of the other Mercosur members.

Mercosur has an office in Montevideo. In February 2002, as a first step in creating supranational structures, a (virtual) court of arbitration was established. This complies with what Brazil, as a Mercosur member has been demanding for many years.

Since November 1999, the EU is conducting negotiations with Mercosur regarding an association agreement that, besides a trade segment, should also include political and cooperation segments. On July 5th, 2001, the Commission handed a comprehensive proposal for the gradual elimination of tariff and non-tariff hindrance to trade over to the Mercosur. In November, Mercosur made a counter offer. In February 2003, both parties improved their original offers, and negotiations are to be concluded by 2005. Until then, a Free Trade Agreement of the Americas (FTAA/ALCA) is supposed to be signed, whereas particularly Brazil and USA disagree with its structure.


Further questions ?
send us an e-mail or write directly to:

MW TECHNICS Ltd
Parque Petrópolis Paulista
AL. das Sibipirunas 300
CEP: 07600-000 Mairiporã S.P.
BRASIL

MW TECHNICS  LTDA

Economic Indicators for Mercosur

Economic Perspectives

Overview

Since the Brazilian economy recovered quite fast from the 1999 devaluation crisis and already presented a significant growth in 2000, everyone was led to believe that the largest national economy in Latin America had returned to a stable growth. In the following years, however, internal and external factors prevented a longer-lasting recovery period. In 2001, the energy crisis, the political and economical collapse in neighboring Argentina, as well as the beginning of an international conjunctural contraction resulting from the terrorist attacks on September 11th dampened the economic recovery. In the election year 2002 the conjunctural situation worsened once again. The lack of trust the financial markets had in the country's future capacity due to the probable victory of the Labor Party's presidential candidate, Luiz Inacio "Lula" da Silva, led to turbulence in the exchange rates, to an increase in the interest rates, and consequently high inflation, not to mention the decline in consumption and investments by consumers and enterprises, respectively.

Through the continuation of a market-oriented economic policy, courageous cuts in the budget, an uncompromising battle against inflation and the presentation of decisive structural reforms, the new President Luiz Inacio "Lula" da Silva quickly turned the negative expectations of the financial markets into positive ones, right after his inauguration on January 1st, 2003. The national currency, the real, regained value, the interest rates on foreign loans fell below pre-crisis levels, and due to the granting of two government loans, Brazil returned to the international capital markets.

Although 2003 will still close with rather slow general growth patterns, there were more indicators in the 3rd quarter that the Brazilian development will soon restart. The year 2004 should bring a decisive reversal in trend and introduce a significant economic upturn.


Gross Domestic Product

The new government under President Lula's leadership surprised nearly everybody by following a strict stability policy since its inauguration. In the first months in office, it was able to control indicators that had been dangerously out of balance, such as the inflation rate, the foreign exchange rate and the country risk ratings. However, the Brazilian scenario is still affected by the results the lack of trust and the currency devaluation played in the election year 2003. The intensification of the austerity policy and the restrictive monetary policy, which were necessary to restore confidence in investments and stabilize the currency, slowed down growth in the first semester of 2003. So far, the modest growth of the gross domestic product (GDP) shown in the first semester was mostly sustained by the extraordinarily dynamic export development and the booming agriculture.

The still high interest rates, despite repeated reductions of the benchmark interest rate Selic, the population's loss of buying power due to inflation and the only moderate salary adjustments do not allow for a far-reaching development of the domestic demand in 2003.

The weak private consumption (end consumer) has a particularly negative effect on the retail trade of durable consumption goods. Retail sales publications for the first half of 2003 indicate, however, that consumer confidence is slowly being reestablished.

Thanks to the reduction in the interest rates performed by the Central Bank and the decrease in inflation, the private consumption should recover in 2003.

The same also applies for the enterprises investment activities that in the first semester were very cautious in regards to new acquisitions. But here there are also signs of a revival that indicates an increase in the investment activities until the end of the year.

All these factors probably will allow the Brazilian GDP to grow only by moderate 1.5% this year. Should the prices and the foreign exchange rate stabilization be successful in the long run, opening space for further interest rate reductions, then the Brazilian economy might pick up speed and grow by about 3.5% in 2004. If the Brazilian government sets the course properly in terms of the economic policy and if the world economy recovers, then a path for a longer-lasting period with high growth rates could be opened.

Despite the currency devaluation, with a gross domestic product of US$ 456.5 billion, Brazil is still one of the ten largest national economies of the world. Almost 60% of the net product is allotted to the so-called Southeast, one of the five largest regions, which includes the states of Sao Paulo, Rio de Janeiro, Minas Gerais and Espirito Santo. The state of Sao Paulo alone produces almost 35% of the Brazilian GDP. 300 of the 500 largest Brazilian enterprises have their headquarters in the Greater Sao Paulo, the state's capital.

However, in the last few years it has become visible that there is a tendency for the economic power to slightly decline in the Southeast. Numerous companies are increasingly opening or transferring their production sites to the country's South, Mid-West and Northeast regions.

Several branches of industry, including the short-lived consumption goods, the petrochemical and automotive industry, are establishing their facilities in those regions because there they find cheaper labor and better production conditions (for example, tax benefits, lower land prices or investment aids). Also, the southern states are the ones that profit from the process of economic integration brought by the MERCOSUR, which favors the execution of projects in the southern part of the country.

In 2002, the processing industry produced about 22% of the GDP. Aside from the basic industries (steel, petrochemistry, aluminum production, cement and fertilizers), the manufacturing of motor vehicles, the electro-electronic industry, the aircraft construction, mechanical engineering, and the chemical, textile and leather industry are Brazil's most important branches of industry. Due to the market opening in the 90's the industry sector was widely modernized and today can even stand international competition. Also, through a comprehensive privatization program the government's participation in the economy diminished considerably.

The agricultural sector contributes with about 8% to the GDP. In addition to export, agriculture is today the success story in Brazil. In 2002, a new record harvest was brought in. For 2003, another maximum value with a harvest of over 115 million tons, which would represent an increase of 19% compared to 2002, is expected. The agricultural segment is responsible for 25% of Brazil's total exports. Right after coffee, cocoa, sugar, soy, orange juice, chicken meat and tobacco are the country's most important agricultural export products.

The mining industry contributes with about 3.5% to the GDP. Brazil has many mineral resources and is the world's biggest exporter of iron ore.

Contributing with slightly more than 60% to the Brazilian GDP, the service industry holds the largest participation. In addition to the financial sector, particularly the telecommunications segment has had a boom in the last couple of years, as a result of the restructuring and deregulation processes, which occurred between 1997 and 1998. Due to elevated private investments in the IT- sector Brazil has today the most advanced information technology in South America.


Per Capita Income

Brazil's stagnated economical situation in the 80's caused the yearly per capita income to experience almost no real increase until 1995. On the other hand, the turning to a stability policy through the concept introduced by "Plano Real" and the corresponding political-economic measures led to a significant increase in people's buying power, which in 1997 for the first time brought a national per capita income of more than US$ 5,000. Due to the repeated devaluations of the real, the per capita income - expressed in US$ - has been steadily declining since 1999. In 2002, it came to only a bit more than US$ 2,800. That means that it was clearly below the Mexican (US$6,200) and Chilean (US$ 4,100) levels.

Aside from a thin upper class, Brazil has a relatively broad middle class for the South American standards. In the Federal District Brasilia, the yearly per capita income is more than US$ 5,500 and in the state of Sao Paulo more than US$ 4,600, by far the higher ones in the country. In Rio de Janeiro it amounts to about US$ 3,900, in Rio Grande do Sul to about US$ 3,300 and in Minas Gerais and Parana to about US$ 2,800, respectively.


Inflation and Exchange Rates

Since Brazil abandoned its dollar-peg in January 1999, the exchange rate of the real to the North- American currency was exposed to several strong fluctuations. Particularly in the period from June2002 to the first semester of 2003 the real went through a rollercoaster. While in June 2002 the exchange rate to the US-dollar was still at 2.80 reais, in the period that encompassed the run-up to the elections until the election of the new President it increased to almost 4 reais per US-dollar. After several ups and downs of the exchange rate fluctuations, as of spring 2003 the Brazilian currency has registered constant revaluations. In September 2003 the real fell back to below the 3- US-dollar limit and this positive development is a consequence of the restrictive monetary-fiscal policy that has been pursued by the government ever since its inauguration, when president Lula finally managed to convince financial markets and investors.

The exchange rate turbulences also affected the development of inflation. For the first time, the consumer price index IPCA (Indice de Preços ao Consumidor Amplo) reached a two-digit figure —12.5% in 2002. Imports, whose prices had gone up significantly due to the currency devaluation and US-dollar-dependent electricity and fuel tariffs forced prices up.

In 2003, the government and the Central Bank were able to control inflation. Since February, price increases have clearly been reversing trend, and in June the IPCA even indicated a deflation. Therefore, the Central Bank had enough leeway to reduce the benchmark interest rate Selic four times in a row in mid 2003-from 26.5% to the currently 20% per year. Thereby, it expects significant positive impulses for the Brazilian scenario.

As a consequence of basic effects from fall 2002 the inflation rate for 2003 will probably close at a two-digit value. In 2004 the IPCA-index should be 6.5%.


Direct Foreign Investments

For years Brazil has been considered one of the most preferred destinations for foreign investments. Only between 1997 and 2002 almost US$ 145 billion flew into the country. The continuous liberalization of the economy, the participation in the economic agreement with Mercosur and the comprehensive privatization efforts during the last few years led to an increased interest in Brazil as an investments location.

With almost US$ 33 billion in direct foreign investments, the year 2000 has scored a record so far. Because of that, Brazil once again belongs - as in 1999 - to the group of the ten main recipient countries of foreign investments. Among the emerging markets, besides China/Hong Kong and Mexico, Brazil is one of the most preferred destinations of international investors.

In 2001 and 2002 foreign investment flows slightly slowed down. In 2002, direct foreign investments(US$ 16.6 billion) dropped by about 26% in comparison to the previous year. However, considering the almost concluded privatization phase in Brazil, the weak conjuncture of the global economy and the globally declining direct investment flows, this foreign engagement can still be considered significant.

Since the global investment environment diminished its pace once again in 2003, this year Brazil will probably receive only about US$ 10 billion in direct foreign investments. An influx of US$ 13 billion is expected for 2004.

In 2002, the USA had to hand over its longstanding leading position as the most important foreign investor to the Netherlands. In the entire year, about US$ 3.4 billion flew from this middle European country to Brazil (USA: US$ 2.6 billion). Compared to the previous year, the Spanish investments experienced the biggest deficit since they went from US$ 2.8 billion (2001) to US$ 0.6 billion (2002).

In the service sector, the main objects of direct foreign investments were the areas of telecommunications, energy and financial industry, and in the industrial sector these investments were geared to motor vehicles, food and beverages, and chemicals.


Job Market

The current weak conjuncture reflects on the job market, which since 2001 shows to be very tense. The official unemployment rate went from 6.2% (yearly average 2001) to 11.1% in 2002.

In the first semester of 2003 unemployment rates continued to grow. A similar average to that 2002 is expected for the entire year.

Unemployment did not only increase due to the weak economical development. Another reason is the sharp increase of the employable population in Brazil. Because of the demographical development there are more employable people pushing on the job market than job openings are created.

With an attractive situation the perspectives for the job market should become less tense in 2004.

Since the official indicators do not consider the informal job market we can assume that the actual unemployment in Brazil is considerably higher.

The average monthly real income has been dropping for a couple of years. In April 2003 it was R$ 857. At the beginning of the year, as one of its first actions the new government increased the monthly minimum wage from R$ 200 to R$ 240.


Foreign Trade

Right now, there is no other area that experiences such a booming phase as the Brazilian export sector. Although Brazil's global share is only about 0.8%, the country is working at full stretch to build an export culture. Not only the Brazilian government, but also the entrepreneurs realized that foreign markets can bring in foreign currency and offer a commercial balance regarding fluctuations in the domestic market.

In 2001, for the first time since 1994, the Brazilian foreign trade was able to close with a surplus. Due to the fact that while in the 80's and early 90's the trade balance showed an export surplus, a trade balance deficit has been developed since 1994 as a consequence of the political-economical reorientation. The opening of the economy (liberalization of import regulations and reduction of import duties) and additionally the policy practiced by the Brazilian Central Bank to overrate the national currency have also contributed to this result. If on one hand exports increased steadily/ on the other imports grew rapidly. Even the gradual devaluation of the real by 0.6% per month since 1995 could not avoid a trade balance deficit until 1997. This development only stopped once the economical growth slowed down. In 1998, a decrease of the deficit could be observed for the first time, and continued in 1999, turning into a surplus in 2001.

Aside from the mentioned new export culture/ Brazil is currently profiting particularly from last year's strong currency devaluation and the rising prices of international raw material. Thanks to these factors, the country was able to close 2002 with an export surplus of 3.7% and total exports in the amount of almost US$ 60.3 billion. With total imports of US$ 47.2 billion the trade balance surplus came to impressive US$ 13.1 billion.

In 2003 the good export scenario has also been maintained. In the first semester, the export of goods had increased by more than 20%. Since there has been a clear revaluation of the real in relationship to the US-dollar, this value will probably not be sustainable until the end of the year. However, with an estimated value of US$ 68.7 billion, new record proceeds might be achieved, which in turn should be surpassed in 2004 with a forecasted US$ 72.1 billion.

Brazil also owes the export success to the strategy of opening new markets. Because of the bad conjuncture in some of its traditional trade partners, such as the neighboring Latin American countries or the EU-countries, Brazil was engaged in finding increasingly more alternative markets in Asia, Eastern Europe and the Middle East. That way, exceptional growth rates could be achieved in 2002, especially with exports to Russia and China, who this way ascended to the group of Brazil's main trade partners. With an export growth of more than 200%, in the first semester 2003 China even became the second market after the USA. Trade with the "new markets" should continue being the driving force of the Brazilian export in 2004.

The import situation is completely different. The devaluation of the currency, as well as the weak domestic conjuncture led to a sharp decrease in imports. Compared to the previous year, the Brazilian imports went down to US$ 47.2 billion in 2002, falling by 15%. Furthermore, we notice the tendency that, due to a better quality competitiveness of the Brazilian industry, more and more higher-end import products are being replaced by local ones.

With the revaluation of the real it seems that the rock-bottom phase has been overcome. For 2003, we count on a slight increase of imports to US$ 49.3 billion. With the expected scenario revival, the import activities should increase significantly in 2004 and return to the 2001 levels of US$ 54.8 billion.


Foreign Exchange Reserves

The US$ 30 billion loan package granted by the International Monetary Fund (IMF) during the trust crisis in August 2002 proved the confidence that international financial experts have in Brazil and in its economic policy. Contrary to what happen in Argentina, for example, in the case of Brazil the IMF was immediately ready to offer the country its support. So far, the Brazilian government has complied with or even surpassed almost all the conditions imposed by the IMF without any problems, which the IMF has acknowledged several times. Right now, the Brazilian government and the IMF are verifying if the agreement, which expires at the end of 2003, should be extended once again. The existing foreign exchange reserves suffice to honor the external debt within the stipulated period in 2003.


Domestic Debt

Aside from external debts, the domestic debt traditionally represents a weakness in the Brazilian economic policy. At the end of 2002, the public debt was R$ 881.1 billion, which according to the exchange rate at that time represented US$ 185 billion and 56.5% of the gross domestic product. The Lula administration seems to be determined to take serious and lasting measures to fight the state debt problem. It submitted several draft bills to the Congress, which should allow for a midterm budget consolidation. The suggestions also include an extensive tax and pension reforms. The latter was already approved by the Parliament and now has only to be approved by the Senate. Furthermore, from 2003 to 2005, the government aims at a yearly primary surplus (surplus of the consolidated budget before deduction of interest payments) of at least 4.25% of the GDP. Thanks to the federal government's strict expenditure control there are strong indications that in 2003 the aimed primary surplus will probably be surpassed.


Interest Rates

In order to counteract the danger of the inflation dynamics that arose in the fourth quarter of2002, the Brazilian Central Bank increased the benchmark interest rate Selic in November 2002 to 22%.

In early 2003, the looming inflation development did not leave the new Central Bank Head another choice but to carry on the previous administration's orthodox monetary policy. The already elevated benchmark interest rates were increased to 25.5% in January 2003, and to 26.5% in March.

In the middle of 2003 with declining interest rates, the desired new trend began. In order to give the Brazilian situation a boost, the Central Bank - with the government's support - decided to lower the Selic-rate four times — from 26.5% to 20% per year.

If the price development continues subsiding, in the next couple of months the Central Bank should have enough leeway to significantly lower the benchmark interest rate in the mid-term.


External Debt

To reduce the high external debt is another challenge that the Lula administration will have to face during its mandate. After the debt rate was reduced from 1998 to 2001, it increased again slightly in 2002 to US$ 210.7 billion (2001: US$ 209.9 billion) compared to the previous year. Foreign liabilities were slightly more than 46% of the GDP, due to the strong devaluation of the real. Because of the restricted access to foreign credits there was limited increase, which can be explained mostly by additional credits from international organizations. However, the level of the private sector's indebtness decreased.


Further questions ?
send us an e-mail or write directly to:

MW TECHNICS Ltd
Parque Petrópolis Paulista
AL. das Sibipirunas 300
CEP: 07600-000 Mairiporã S.P.
BRASIL

MW TECHNICS  LTDA

Current Economic Perspective

Overview

According to many market observers, a year ago Brazil was still at the verge of insolvency, but today it is once again one of the preferred options among the emerging markets. The ups and downs in the country risks and in the foreign exchange rate make that particularly clear. Temporarily, the real ratio to the dollar was at 4 real/US$, but in the meanwhile it had a considerable revaluation (3 real/US$). In October 2002, the country risk on government bonds was over 2,000 base points and currently it is around 700 base points. Above all, it was the upcoming change of government that made many doubt if the fundaments of the Brazilian economic policy (austere fiscal policy and stable price levels) would be carried on. Right now, there are only a few indications of a new destabilization of the macro economical balance. However, despite all the progress Brazil has made, strengthening its institutions, there are still some structural weak points that have to be mentioned.

With 173 million inhabitants and a GDP of about US$ 450 billion, Brazil is one of the 10 largest national economies in the world. The domestic product is mostly concentrated in large centers in the South. For example, with 22% of the population, the state Sao Paulo, the most important industrial region, produces 36% of the GDP. Aside from a relatively high percentage of industry, Brazil's economical structure is characterized by an internationally very competitive agricultural sector. In Latin America, except for Mexico, economically and politically speaking Brazil is one of the heavyweights. Despite its substantial natural resources (including oil, iron ore and agricultural products) and a relatively well-qualified population, in the last decades Brazil was not able to exhaust its growth potential. The strategy to substitute imports that started in the 50's ended in a debt crisis and was finally abolished in the late 80's. The adjustments that came with the opening of the country's democratization (since 1985) were followed by profound crisis and phases of hyperinflation.

The external debt and the public debt are some of the most urgent problems of the country. The external debt must become sustainable by further opening the national economy and increasing exports. The high public debt has to be faced with the continuation of an austere fiscal policy, but particularly through structural reforms. All these measures that lead to a productivity improvement, also mean that Brazil can partially "outgrow" its debt.


Achieved Progress

• Stability-oriented Monetary and Financial Policy

After recurring phases of hyperinflation and economical crisis in the 80's and early 90's, it was possible to significantly improve the institutional basic conditions for a stability- monetary oriented and fiscal policy, and that way bring inflation back to an acceptable level. With the law of fiscal responsibility (that also foresees a maximum limit for new debts on all levels of government), a very efficient instrument was created to control the management of public finances of the otherwise to a large degree autonomous federal states. In the financial policy, transparency increased because the primary surplus objectives for the public sector stipulated in the budget (objectives for the budget balance before interest) can be continuously controlled. In the monetary policy, the instrument of inflation targeting proved to be a transparent and efficient way to fight inflation. The last rise of inflation was obviously a temporary phenomenon, which can be confirmed by last months' inflation data. Another contribution to improving the transparency in the monetary and financial policy was certainly made by the IMF, who has verified the budget and inflation objectives on a quarterly basis through several agreements (since 1988 there have been five agreements).

• Flexible Exchange Rate System and Liberalization of Capital and Goods Traffic

After the introduction of "Plano Real" in 1994, the Brazilian currency was pegged to the US$, which led to a real overvaluation of the currency and severely limited the capacity to adjust to external shocks. Under the pressure of the markets, in 1999 the government decided to decontrol the currency. A free exchange rate system has an important role in the financial stabilization, as last year proved. The decrease in capital influx could be partially compensated through a clear exchange rate-linked (2002: 34% devaluation) increase of the balance of trade surplus.

A prerequisite for the clear adjustment in the balance of trade, which largely depends on a clear export growth, is the liberalization of the foreign trade carried out since the late 80's. While in1990 the average import customs tariff was 32%, until 1995 it had dropped to 14% (it has hardly fallen since). Not to mention the immediate benefits of the trade liberalization, the opening means mainly a clear increase in competitiveness and the possibility to import modern technologies. Both factors contributed significantly to the improvement of productivity in the Brazilian economy. However, there is still a large potential for further liberalization of the foreign trade, especially because not only customs barriers but also non-tariff trade obstacles hinder the import of many goods.

Apart from the foreign trade, capital transfer was also liberalized. Direct investments benefited from that, since they were rare until the early 90's due to the discrimination against foreign capital. With extensive privatizations (see below) and generally improved basic conditions direct investments became an important source of long-term foreign capital. In average, over the last 10 years direct investments amounted to about US$ 15 billion or 3% of the GDP, which is comparable to what Asian countries, like South Korea, attract.

• Extensive Privatizations

Due to the extensive privatization process that started in the early 90's, the role of the Federal Government in the economy was significantly reduced. While in 1990 38% of the 100 largest enterprises were still state-owned, in 1998 this percentage went down to only 12%. The sale of steel and telecommunication companies and of state-owned banks was basically successful. Particularly, a transparent regulatory context was created for each sector, which gave the enterprises more security when planning. At the end though, the privatization process came to a standstill. We believe that the inclusion of the private industry is particularly necessary for the electricity sector in order to expand its capacities and avoid bottlenecks like the ones that were observed during the energy crisis in 2001.


Mature Democratic Institutions

After Luiz Inacio Lula da Silva won the presidential elections in October 2002 there was a political change due to the exemplary respect of democratic rules. We see that as a proof of the stabilization of democratic institutions.


Structural Weaknesses

Structural Weaknesses at the Public Finances Level

Not only the amount of the public debt, but also its structure have made Brazil vulnerable towards shocks. About 25% of the public debt is external debt. About 35% of the domestic debt is pegged to the US$ and 45% pay variable interest (linked to the overnight-interest Selic). The average term of traded domestic bonds is currently 22 months. In the past, because of these relationships one could often observe negative spirals that questioned the macro economical stability of the country: devaluations of the real led to an increase of the public debt in a % of the GDP. The devaluation went hand in hand with a heightened inflation and accordingly higher interests, which in turn worsened the debt situation. The consequence was a stronger withdrawal of foreign capital (out of fear of insolvency), an increased devaluation of the currency, etc. The government set the extension of the terms and the increase of the percentage of fixed-interests and inflation-linked bonds as objectives. Compared to the early 90’s there has been progress in this respect, but lately this progress has been only slow and followed by drawbacks.

The targeted decrease of public debt is hindered by a deficient pension system, which every year represents a burden of 5% of the GDP to the budget, mostly due to the pension system for public servants. While the pension system for private employees was already revised by the Cardoso administration and there are no indications of dangerous dynamics in this regard, the privilege- loaded pension system for public servants has hardly been touched. This April, the Lula administration submitted a reform package to Congress concerning this issue. In the meanwhile, a large part of the legislative process has been overcome without any significant cuts to the reform and we believe that the government stands a good chance of passing this law until the end of the year. The reform foresees, among other things, the rising of the retirement age for men and women in 7 years, i.e. to 60 and 55 years, respectively. Also, in the future pensions will be taxable and a maximum limit for pensions (R$ 2,400. -) will be introduced. These measures will offer a long-lasting relief for the public budget.

From the fiscal point of view, with its 25% tax bracket (2002), the tax system can become more favorable if compared to that of other emerging markets, but from the macro economical point of view it is worth mentioning that the value of the tax bracket (considering the relatively low level of public services the population receives in return), as well as the complexity of the tax system and the multitude of seemingly distorting taxes, significantly limit the country's growth potential. The value-added tax ICMS (main income source of the federal states) is the one that most needs a reform. The ICMS-brackets differ from state to state and from one product group to another. There are also taxes on financial transactions that, by nature, seem distorting. Last, one would have to mention the several social security contributions that are basically levied on almost all levels of the production process as a type of value-added tax, without the possibility of deducting previously paid taxes. This April, the Lula administration submitted a tax reform to Congress that shall address the above-mentioned problems (the core is the simplification of the value-added tax ICMS). Here negotiations prove to be a bit complicated because the interests of federal states and communities are directly affected. However, even in this concern important progress has been achieved in the legislative process and the reform stands a good chance of passing still this year Overall, it can only be regarded as an important first step.


• Social Problems

Brazil has one of the most uneven income distributions in the world. According to the World Bank, 20% of the population with higher income concentrates 63.8% of the total domestic product. The lower 20% of the population is entitled to only 2.5% of the domestic product. For sake of comparison, in the USA the values are 46.4% and 5.2%, respectively.

Having an uneven income distribution as a background, it is not surprising that criminality has increased in the last decade. The murder rate in Brazil went from 19.1 per 100,000 inhabitants in1992 to 26.2 in 1999. In Sao Paulo, only in 1999, it reached the figures of 57.8 murders per 100,000 inhabitants. There are no indications that the situation might have improved since. The number of kidnappings has also increased severely. And to make matters worse, in addition to the social problems, an inefficient justice and police apparatus also facilitate the situation. The precarious security situation is a decisive obstacle that hinders mostly foreign investors to invest (more heavily) in Brazil. The tourism industry is also directly affected by the situation.


• Insufficiently Developed Banking Systems

The Brazilian banking system barely fulfils its original function - to channel the population's savings to the most productive activities. With 28%, the intermediation degree in Brazil is considerably lower than, for example, that of the relatively well-developed banking market of Chile (68%). Long-term loans are hardly ever granted (it is basically the state-owned development bank BNDES that grants long-term loans). Another indicator of the bank sector's underdevelopment are the high interest rates. At the end of 2002, the interests charged for credits to consumers were above 70% p.a. and for enterprises over 40% p.a. The main reason for that is the high demand of this sector by the Federal Government (about 30% of all bank assets are government bonds). Another reason is the bankruptcy law that also needs an urgent reform, since it makes the collecting of collateral a very difficult process. The Lula administration plans to reform the bankruptcy law still during this legislative period. Despite the previously mentioned problems, the banking systems in Brazil are very profitable and - due to the strict regulation - a stable sector/ which will not be a source of financial crisis.


Will the Situation Change?

Currently the Brazilian national economy is in recession. In the first two quarters, the GDP fell compared to the previous quarter. However, the path is properly set for a quick revival of the good scenario. The new government's political-economical course reestablished the macro economical stability, which seemed to have gotten lost last year. Excluding the austere fiscal policy and a clever inflation-fighting monetary policy, the structural reforms (including pension and tax reforms) are the ones that - through a great deal of political skill - already overcame important obstacles in the legislative process. Another factor for the macro economical stabilization is the exemplary adjustment of the balance of payments to the reduced flows of capital without leading to a significant recession. While in 2001 the balance of payments deficit was still at 4.6% of the GDP, in the last year it came to 1.7% of the GDP. This year we are even counting on a surplus, the first one since 1992. This development strengthened the Brazilian currency. All that partially reestablished the investors' confidence, which they had lost last year. The risk on Brazilian government bonds, which in October were stratospheric 2,400 points, fell below 700 points. Brazilian enterprises were accordingly able within the last months to place longer-term loans at the international capital market with acceptable spreads. The Federal Government also became active at the international capital market. On the other hand, the granting of private foreign loans is still relatively low, what can be seen in the slowly recovering lines of credit for the foreign trade. This year, direct investments will probably amount to US$ 9.4 billion, while last year they were still almost US$ 17 billion. We believe that it can be explained by the globally weak direct investments and the fact that the decisions about direct investments are made months in advance and at the beginning of the year investors were still haunted by the ghost of a Brazilian default. However, since July we have been noticing a clear revival of direct investments. For the next year we expect it to increase to US$13 billion. Another good prerequisite for the revival of the favorable situation is the reduction in the interest rates. Since the end of last year, we have observed a clear decrease in the domestic interest rates for one to three-year contracts. Since June, the Central Bank has followed suit reducing the overnight-interest Selic, which defines consumer credits (decrease of 450 base points to 22%). Further interest reductions are on their way, so for the end of the year we can count on a Selic- interest of 19%. The extremely interest-dependent consumption (durable consumption goods in Brazil are almost always bought on credit) that has been dropping since last year should experience a revival in the next couple of months due to the reduction of the interest rates. This should reflect on a higher industrial production, which should also benefit from the revival of the global development.

This mid- to long-term development depends on Brazil bringing its external and public debts to a sustainable level, and consequently becoming less vulnerable to internal and external shocks.

In the case of the external debt, a definite positive trend can be observed. Since 1998, it went from 380 %f exports of goods and services to 282%. We assume that the export growth will continue at a slower pace in the next years and that until 2010 the external debt will be reduced to 170% of exports. This way, the debt seems to be bearable.

The public net debt, however, increased over the last years from 42% of the GDP in 1998 to almost55% of the GDP this year. The prerequisites to bring the public debt to a sustainable level are a lasting growth of the national economy and other finance-political structural reforms that would allow the generation of a long-lasting high primary surplus (budget surplus before interests), without having to make further social cuts, which would become increasingly more difficult to implement politically. The pension and tax reforms created good conditions in this respect.


Conclusion

By setting the right priorities, the new Brazilian government was able to address the structural reforms that are indispensable for a long-lasting growth in productivity, since they relieve the burden placed on the enterprises and offer a bigger macro economical stability. The continuation of this stability-oriented economic policy - reflected in these reforms - that could already be observed in the last administration, is an important reduction policy. That and the revived capital flows should shortly bring a moderate upswing. prerequisite for the Central Bank to continue its interest- Next year, there should be a solid growth of 3.5%.


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Max Wolff