Public Disclosure Authorized. Public Disclosure Authorized. Public Disclosure Authorized. Public Disclosure Authorized. Report No.

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Project Name Region Sector Project ID Borrower Implementing Agencies Report No. PID9869 Brazil-Programmatic Fiscal Reform Structural Adjustment Loan Latin America and de Caribbean Economic Management BRPE60575 Federative Republic of Brazil Date PID Prepared January 16, 2001 Appraisal Date December 4, 2000 Board Date January 18, 2001 COUNTRY AND SECTOR BACKGROUND Ministerio da Fazenda Nacional: Esplanada dos Ministerios, Bloco P Brasilia D.F. Brazil. Dr. Marcos Caramuru de Paiva Tel: Ministerio do Planejamento, OrOamento e Gestao: Esplanada dos Ministerios, Bloco K , Brasilia D.F. Brazil. Dr. Jose Guilherme Almeida dos Reis; Tel: Recent Macro Economic and Fiscal Performance. Since the early 1990s, Brazil has been engaged in a major reform of its economy, moving away from import substitution and state-owned enterprises towards greater emphasis on private initiative, competition and international integration. Considerable progress has been made in controlling inflation and creating an improved economic environment for private enterprise, fiscal adjustment and reform of the public sector. From 1992 to 1997 Brazil experienced a very successful growth performance. Annual growth averaged 4.2w, a major improvement over the average for the previous five-year period (0.0%). Factors contributing to this positive outcome include a trade liberalization during the early 1990s and a well-designed and implemented economic stabilization program initiated in mid-1994 (the Real Plan), together with a favorable international economic environment. By contrast, the two and a half years from mid-1997 to end-1999 saw a much more volatile international economic environment with a series of crises in international markets. These crises adversely affected growth in Latin America and Brazil was no exception. The average rate of growth during was only 0.3%. However, by the end of 1999, recovery, led by the industrial sector (particularly consumer durables and capital goods), was firmly established. GDP growth rates between the last quarter of 1998 and the last quarter of 1999 and between each of the first two quarters of 1999 and the first two quarters of 2000 averaged 3.9%, close to the 4.0% consensus estimate of Brazil's likely average growth over the next several years. 2. As a result of the stabilization plan introduced in 1994, annual inflation declined from over 2000% in 1993 to less than 2% in Even the large currency depreciation of January 1999 had a fairly limited small passthrough impact on inflation. Inflation in 1999 was contained to about 20% on broad price indices and around 8% on consumer price indices. This was the result of sluggish aggregate demand and continued monetary tightness.

2 Following the change in the exchange rate regime in 1999, from a crawling band to a floating rate, Brazil introduced a sophisticated inflation targeting framework. Targets were set at 8%, 6%, 4% and 4% respectively for the IPCA index duringl , with a margin on each side of two percentage points. Inflation in 1999 was 8.9%. Inflation during the 12-month period through November, 2000 was 6%, which is exactly the mid-point of the governments 2000 target. In its September 2000 inflation report, BCB expected an inflation below 4% for 2001 (somewhat lower than the market's median expectation in September of 4.3% for 2001). With an improved fiscal framework and assuming an absence of external shocks, the inflation targets for remain realistic. These targets provide the anchor for the Government's monetary policy. 3. Fiscal policy performance has also improved considerably. As early as 1995, the Government attempted to address the structural fiscal deficit unmasked by price stability. However, lack of legislative consensus meant that fiscal adjustment lagged behind other parts of the economic reform program. As a result, Brazil has been dependent on large capital inflows. This dependence coupled with the prevailing exchange rate regime implied vulnerability to sentiments in international markets. The Government responded competently and effectively to the loss of market confidence in late-1998 and early-1999 with a combination of tightened monetary policy and fast-acting fiscal adjustment measures coupled with a new drive for structural fiscal reforms. Throughout 1999 and 2000, fiscal adjustment has been carried out with tremendous effort and remarkable discipline and is achieving the ambitious targets that were set. These measures, taken together with the shift to a floating exchange rate in January 1999 have been successful in preserving economic stability and regaining market confidence. Provided the external environment remains benign, Brazil is now approaching steady, non-inflationary growth. Brazil's remaining economic vulnerability results from its continuing, though declining, fiscal and current account deficits. As fiscal deficits are closely correlated with current account deficits, fiscal adjustment at both national and sub-national levels are critical for continuing to reduce vulnerability and restore growth. 4. The Government's Fiscal Reform Program. Following the Fiscal and Administrative Reform Loan approved last March, the operation proposed here is being designed to support a deepening of Brazil's fiscal reforms. These reforms are aimed at improving economic efficiency through macroeconomic stability, restructuring of taxes and expenditures, and better choices of risks and return in assets and liabilities. Brazil's present fiscal reform efforts can be classified in four closely related areas, as discussed below. Fiscal Balance 5. The Fiscal Stability Program for , introduced by the Federal Government in October 1998 and strengthened in March 1999, responded to the considerable financial turbulence that Brazil experienced in 1998, as a result of the adverse international financial environment and Brazil's expansionary fiscal policy through The program originally called for public sector primary surpluses of 3.1%, 3.25%, and 3.35% of GDP respectively for 1999, 2000, and The target for 1999 was met (3.13%) and the target for 2000 (revised to 3.4% of GDP due to revised GDP) is likely to be met as well (the primary surplus through October was 4% of GDP). The target for 2001 has been revised to 3.0% and the target for 2002 was set at 2.7%. By October 2000, the Government had reduced the debt/gdp ratio to 49.0% of GDP (from 53.4% in January 1999, its highest point after the floating of the exchange rate) of GDP. The debt/gdp ratio by the end of 2000 is likely to be within 49%-50%. The Government now expects that the Debt/GDP ratio will fall within - 2 -

3 46W-48t by end The Fiscal Stability Program discussed above introduced a consistent framework for fiscal sustainability. The key issue with aggregate fiscal planning in Brazil has been the weakness of the link between expenditure and revenue flows, on the one hand, and net public debt levels, on the other. That is, expenditure levels more often than not were set without adequate consideration of the implications of those levels on debt, the burden of which falls on subsequent administrations. As a result, the burden of interest costs increased the stock of debt. 7. In May of this year, Congress approved a new fiscal code (Complementary Law 101, known as Law of Fiscal Responsibility (Lei de Responsabilidade Fiscal), or LFR. This Law firmly establishes fiscal sustainability planning and implementation to governments at all levels, as introduced by the Federal Government through its Fiscal Stability Program, described above. The new law, based on Article 163 of Brazil's Constitution (requiring the regulation of public finances), covers (i) fiscal targets; (ii) mechanisms to correct deviations from fiscal targets; (iii) a mechanism to encourage accurate revenue projections; (iv) limits on permanent expenditure increases, personnel expenditures, net debt, gross bonded federal debt, and borrowing; (v) prohibition of intergovernmental lending, except through guarantees or by public financial institutions; (vi) transparency (disclosure of fiscal laws, accounts and reports); and (vii) federal consolidation of overall public sector accounts and a federal registry of public sector debt. Enactment of the Law represents a major breakthrough in terms of addressing Brazil's structural fiscal problems: it will allow Brazil to complete the transition from a past where a disregard for the impact of expenditures on debt led to an unsustainable fiscal stance, to a new environment in which sustainability comes to the forefront in determining aggregate expenditures and indebtedness. 8. Furthermore, Congress approved a Fiscal Crimes Law, which includes dismissal (with possible reparation payments), prison, and fines as possible penalties to those responsible for various fiscal crimes. The new law (Law No of October 19, 2000), added non-compliance with key LFR provisions to Brazil's Penal Code (Decree-Law 2848 of 1940), to Law 1079 of 1950 (covering misconduct by federal and state authorities, including the president, the attorney general (procurador geral), ministers, governors, and state secretaries), and to Decree-Law 201 of 1967 (covering misconduct of municipal elected officials). Structure, Assignment And Earmarking Of Taxes 9. Four key issues have been raised by Brazil's tax system. First, the tax burden varies widely across economic activities because value added tax rates vary widely and because the burden of the cascading taxes, on which the tax system relies extensively, varies widely across economic activities. Second, assignment of an origin-based value added tax to states is believed to encourage an inefficient location of economic activity, as states extend tax subsidies to attract industrial investments. A related problem is that the origin based tax tends to concentrate revenues in the large producing states and against exporting states. While this is partly corrected by applying a lower tax rate on interstate trade, the resulting distribution of the valued added tax remains inequitable across states. Third, earmarking of revenues has introduced considerable rigidity to fiscal policy, as the earmarking in effect puts a floor on certain expenditures, possibly limiting efficient choices in fiscal adjustment and in budget programming. Constitutionally mandated earmarking of revenues occurs chiefly through the federal social security budget, which earmarks about a third of public sector taxes to -3 -

4 social expenditures (education, health, retirement and severance benefits). Constitutional mandates earmark about half of total public sector taxes to public expenditures in the social sector. While these earmarking provisions may improve the stability of financing of some areas of expenditures, they have also proved to be a constraint on budget management. As a result of this constraint, Brazil established the Fiscal Stabilization Fund (now the DRU Desvincula6ao das Receitas da Uniao ), which "taxes" 20t of the earmarked proceeds to improve the flexibility of the budget. Nevertheless, remaining earmarking and expenditure rigidities have continued to make it difficult to contain expenditures when fiscal considerations require it. Fourth, sharing of federal revenues has possibly inhibited tax collection effort at the state and local levels. States received 20t of its revenues from federal constitutional transfers in 1998, but spent 25t on transfers to municipalities. At the state level, transfers in the form of debt forgiveness have been the main factor discouraging efforts at better collection of their value added tax. Municipalities received 71- of their revenues as transfers from the federal government and the states; this may explain weak efforts to collect the taxes assigned to them (chiefly the services tax and the urban real estate tax). 10. A reform to simplify the complexity of the tax system and improve tax assignment has been extensively discussed in Congress, although consensus with the executive has not been achieved yet. The most recent tax proposal submitted by the Government would (i) establish national legislation for the value added tax (in lieu of independent state-level legislation); (ii) shift the value added tax from an origin-based tax to a destination based tax over a seven-year transition period; (iii) and replace the existing cascading federal taxes by non-cascading taxes over a period of three years. This reform has not been included among the actions to be supported by the Programmatic Sector Adjustment operation. The reason is that, despite strong interest on all sides, the reform remains controversial and the proposal will require two rounds of votes, with qualified majority, in each house of Congress. Therefore, given the political cycle, with a change in administration in 2003, there is a significant likelihood that approval of the reform will not take place within the horizon envisaged by the proposed operation Allocation and Technical Efficiency of Expenditures 11. In Brazil's budget, the four-year plan (the Plano Pluriannual, or PPA) is the fundamental document that aims to establish public sector priorities. A major fiscal reform underway is comprised by the actions to make the PPA relevant, operational, and effective. The Government began development of a new PPA framework with the previous PPA ( ; Brasil en AOao), a program that identified a number of key regional investments within a new planning framework. The distinguishing characteristics of the new PPA approach, as implemented thus far, are as follows: 12. The new PPA, entitled AvanQa Brasil, is based partially on an earlier diagnostic study (Estudo dos Eixos Nacionais de Integra6ao e Desenvolvimento, or Study of National Axes for Integration and Development) that, based on the geographic and economic characteristics of each of Brazil's region, identified priority investments of R$317 billion to be undertaken by the public and private sector over eight years. 13. The PPA is also based on other fiscal reforms, including setting a multi-year spending framework, and introducing program and performance budgeting. Specifically, in Avan6a Brasil, all Federal Government expenditures are grouped in 388 Programs, each with a performance indicator and clear 2003 target (e.g., infant mortality levels). Each program is - 4 -

5 comprised of set of activities or actions deemed relevant for achieving the target. A program manager was appointed for each of the 388 programs, and is responsible for coordinating the actions to achieve the PPA objective. The 2001 Budget was submitted on a program basis. In budget formulation, resources (calculated by the Planning Ministry, not by the line ministries) are allocated by program and objectives, rather than to administrative units (Ministries). Avan6a Brasil also integrates capital and current expenditures under the same Program categories, thus reinforcing the objective-based programmatic approach to public expenditure management. 14. The PPA also has strategic aspects. Of the 388 programs, 87 have been designated as strategic programs of the Government, meaning these program objectives are top Government priorities with a preference in budget execution over other discretionary programs. Further, the PPA explicitly acknowledges the means of program implementation, or ways the goals would be attained. Specifically, the federal PPA is more aware and explicit of the partnerships with sub-national governments and with the private sector in the implementation of PPA goals. For example, in the delivery of health outcomes, a strong interface between federal transfers and sub-national implementation is critical for success. In infrastructure investment with a public interest, strong private sector ownership, financing, and/or management are also necessary for attaining the goals. In this regard, the Government is establishing the Brazilian Network of Investment Promotion (Invest in Brazil), which will disseminate investment opportunities with the expectation of attracting investors to the infrastructure and social projects envisaged in the PPA. 15. A manager for each program has been appointed, with a view to promote better results through management and accountability. In terms of management, appointed managers are presently responsible for monitoring programs to identify problems in implementation and for promoting coordination among relevant actors to exploit potential synergy from related activities. In terms of accountability, there is a program performance monitoring system in place (the SIG) and outcomes are reported to the Ministry of Planning, where a team of 40 professionals is using an evaluation framework developed by the Government to assess each of the 388 PPA programs and report to the President by the end of March The assessment is to be used to adjust PPA implementation and determine proposed priorities under the next draft LDO to be submitted to Congress on April The Government also plans to review its general program evaluation framework during 2001 with Bank cooperation under the possible technical assistance loan. To further promote transparency and accountability, the SIG is available on the internet, with the name and phone number of each manager included, in addition to budget execution and performance data. 16. A fundamental requirement to achieve fiscal efficiency is that the budget reflect strategic priorities and expenditures be made and tracked accordingly. Asset and liability management is also an important component for the achievement of fiscal efficiency. Effective monitoring and evaluation of expenditures, assets and liabilities, are key components of efficient fiscal policies and operations. The planning and management of government programs on a multiyear basis, discussed above, further supports the achievement of targeted budgetary outputs and outcomes. An Integrated Financial Management System (IFMS) facilitates the administration of the relevant information flows, tracking revenues and expenses, and providing managers with comprehensive information on the financial and physical execution of the budget required for planning, decision making and evaluation. -5-

6 17. In 1987, Brazil's federal government established an IFMS, known as SIAFI. The system was placed under the responsibility of the Natural Treasury Secretariat (STN) at the Ministry of Finance (MOF). Through an extensive telecommunications network, SIAFI outreaches to approximately 4,650 spending units under the federal government's and the social security budgets. It is also used for the consolidation of the financial statements of the federal, state and municipal governments, to produce the consolidated financial statements of the Union. Through SIAFI, the SNT performs the financial planning of the federal budget; centrally processes and records all budgetary and financial transactions of spending units, thus effectively controlling the execution of the budget and automatically making the accounting postings thereon, producing the federal government's financial statements and financial reports required at the various government management levels; and, concentrates all federal government cash revenues in the treasury's unified account (Conta Unica do Tesouro) held at the Central Bank, and centralizes payments made on behalf of spending units during budget execution. SIAFI offers government managers consultation and reporting facilities, providing access to current and past fiscal year data bases, and permits the importation of data to other management applications. 18. While SIAFI remains a sound operating IT system, it is in urgent need of technological upgrading after 13 years in operation. It was originally developed using programming methodologies and languages that have been largely surpassed and its internal architecture permits user access only by way of terminals, disallowing the use of Windows and other graphic environment facilities. Its data base technology has also been overcome not having the flexibility and agility offered by a new generation of graphic environment data base versions for the expedient customization SIAFI's functionality pursuant changes in financial management legislation, policies and processes. This is particularly important in terms of new functional requirements related to the PPA and the LRF. 19. To address these and other relevant technological and functional issues, the government has designed the SIAFI 21st Century project, aiming at replacing the current SIAFI with a new system using the latest technological advances, improving its current budget, cash management and accounting capabilities, and accommodating its functionality to the new fiscal management framework defined by the PPA, the LRF and emphasis on asset/liability management. The project calls for important enhancements in the system's architecture, establishing a three-layer structure (data/ applications/user interface) which will greatly facilitate the future adaptation of the system to technological and functional changes, and that will offer user-friendly environments and data retrieval and analysis tools so that the systems becomes a real managerial system, rather than remain mainly an operations and financial recording facility. 20. The new system will be structured in four basic subsystems. The budget, financial and patrimonial subsystem would perform most budgetary and cash management functions of the current SIAFI, with enhanced financial planning capabilities and with added functionality serving the information requirements of the PPA and the LRF. A second subsystem will focus on asset/liability administration, with capability to handle the information flows and the management requirements of an assets portfolio amounting to approximately US$185 billion, and a liabilities portfolio, including internal and external debt obligations, amounting to approximately US$335 billion. A new and third subsystem will serve the monitoring requirements established by the LRF for the federal and particularly for the state and municipal governments, including the management of constitutional and voluntary - 6 -

7 transfers made by the federal level to local governments. A fourth subsystem is intended to modernize the internal management of the STN, implementing work flow and other technological systems to improve operational efficiency and controls. Debt Management Institutions 21. Debt management is a fundamental determinant of macroeconomic vulnerability and of fiscal performance. Interest payments on the public debt turned Brazil's primary surplus of 4.3% of GDP into a nominal deficit of 3.49 of GDP, thereby accounting for 7.7% of GDP from January to September of While a primary surplus can offset the burden of interest payments to generate a sustainable debt path, efficient debt management can reduce the primary effort required through a choice of a debt portfolio structure that mitigates the risk component of interest rates faced by the public sector. 22. Growth of Government Debt. Brazil's net public sector debt grew very rapidly from 28.5 percent of GDP in 1995 to 53.4 percent in January 1999, raising doubts about the sustainability of economic policy and on the country's capacity for proper debt management. These concerns were compounded by the short maturity of the domestic public debt, and a rapidly changing operating environment characterized by increased reliance on market sources for financing, greater exposure to financial risks resulting from financial liberalization, and larger international capital flows. The urgency of the situation was indicated by the international attention paid to Brazil's debt structure as a source of vulnerability in late 1998, and by the decision to shift from exchange rate targeting to inflation targeting in the first half of Moreover, the period since March 1999 has been characterized by a rapid evolution in debt policies to take advantage of the new monetary policy environment. 23. Composition of Domestic Debt. As of September 2000, the net public sector debt of R$ 548 billion (or 48.5% of GDP was comprised of federal net debt (29.4% of GDP), sub-national net debt (16.7%, mostly state governments), and the debt of state-owned enterprises (2.49, mostly state enterprises). Net internal debt constituted 39.0% of GDP, while net external debt was 9.5%. Over time, the share of net public sector domestic debt relative to net external debt has increased. Domestic debt comprised 66 percent of total debt in January 1997, but increased to 78 percent in December Despite the devaluation in January 1999, the relative shares, as of June 2000, have remained at this level. Gross federal securities outstanding in the domestic market in June 2000, excluding Treasury securities held by the Central Bank, amounted to R$511.9 billion or 45.3 percent of GDP. The total stock of federal securities has increased substantially since 1993, reflecting increased financing costs due to higher interest rates, recognition of debts, and recapitalization of state-owned banks. 24. The Government is presently undertaking a reform of its debt management institutions. The reform comprises actions to increase governance and capacity for debt management. The changes will allow the Government to better address debt management challenges, including a desirable move towards a more even distribution of maturities and increasing the use of fixed-rate instruments. A good balance in the use of available instruments should allow Brazil to minimize the volatility of the real interest rate paid on the debt, the parameter which, together with the primary deficit, directly affects debt dynamics. 25. The Government has already undertaken actions to improve the governance and capacity of debt management institutions, including the decision to centralize debt management at the treasury (through a formal agreement between the Federal Government and the Central Bank); the creation of an - 7 -

8 analytical middle office, a unified back office and a unit to assess and quantify contingent liabilities; the introduction of a risk management framework (Asset Liability Management), with preliminary debt risk analysis completed and initial balance sheet produced; and several actions to improve primary and secondary markets of government securities. 26. Under its program, the Government will further improve debt management institutions through actions in the targeted areas as follows:? Governance: (i) establish a debt management committee responsible for policy guidelines(minister level); (ii) implement centralization, as per agreement between the Federal Government and the Central Bank; (iii) prepare assessment report on the benefit of centralizing the different back offices of the project-related debt operations in Treasury; (iv) introduce code of conduct for treasury officials; (v) establish written debt management guidelines and operational procedures, with clear responsibilities for back, middle and front offices;.? Capacity: (i) bring middle office capacity closer to best practice through upgrade of human resources(training program and new hires) and purchase and development of analytical tools. (ii) Diagnose IT needs and produce action plan; (iii) recognition of liabilities which has begun through the obligation (under the LFR) to indicate fiscal risks in an Annex to the LDO.? Legal and organizational framework: Selected key issues with regard to the legal framework are (i) clearer definition of debt management objectives; (ii) centralization of authority to issue new debt complemented by mechanisms which prevent the potential over-issuance of debt; (iii) regulations concerning trading of options and derivatives in the domestic market. the key requirement regard to the organizational framework is to ensure that it be clearly specified, that there be coordination and sharing of information, and that the mandates of the respective players be clear.? Benchmark and Annual borrowing plan: issue borrowing plan and submit initial debt portfolio strategic benchmark and medium term funding strategy for internal review by senior authorities. Disclosure of annual borrowing plan is expected to occur following approval of the 2001 budget, which is in the final stages in Congress. This plan will provide some signal regarding an initial benchmark and medium term debt strategy. THE LOAN PROGRAM OBJECTIVE 27. Given the background discussed in the previous chapter, the operation described below would support a program with the following objective: to improve Brazil's aggregate fiscal performance, and the quality of public expenditures (better allocational and technical efficiency and better delivery of public services), including the quality of debt service expenditures. This objective falls within the CAS objectives of development and implementation of structural reforms and fiscal improvement. Pursuit of these objectives continues to be urgent to sustain the gains that Brazil has achieved by reducing inflation and implementing the Government's rigorous fiscal adjustment program during PROGRAM DESCRIPTION 28. The Program consists of policy actions to improve fiscal performance, public sector expenditure management, and debt management chiefly through continued implementation of the Government's primary surplus and debt targets (the Fiscal Stability Program), deepening of Fiscal Discipline (through the new Fiscal Responsibility Law), a better design of the public expenditure - 8 -

9 planning and implementation process (through the new PPA and improved monitoring of expenditures); and more professional debt management (through better debt management institutions). They are classified into three of the four areas discussed in the previous chapter (fiscal, expenditure, and debt management. Tax reform is excluded because it is not expected to materialize within the PFRSAL horizon ( ). If passed, it could be included as part of a future operation under the program. DESCRIPTION OF FINANCIAL ASSISTANCE 29. The Bank's financial assistance in support of the program would be comprised of two or three one tranche loans with a possible total amount of $ billion. The amount of this proposed first loan, $ million (including the amount of the front-end fee), would disburse soon after effectiveness, in support of the policy actions that have been completed. These include chiefly the issuance of the Fiscal Responsibility Law and the Fiscal Crimes Law, the introduction of the new multi-annual budgeting framework (the PPA), the early design of an upgraded financial management system, and initial actions to improved debt management governance and capacity (para. 25). Future policy actions, including compliance with fiscal planning and transparency provisions of the LFR, improved budget evaluation and integration of planning and evaluation to budgeting, implementation of the SIAFI 21st Century Project, regulation of administrative reform, and follow up actions to improve debt management governance and capacity (para. 26) would be supported by one or two additional loans depending on the timing of the actions. A second loan of $ million could disburse between June and December of 2001, if all of the expected future actions materialize and is approved by the Board. 30. The Bank's financial assistance will help Brazil meet its external financing requirements, while the proposed reform program supports mediumterm fiscal adjustment. During the year 2001, Brazil's current account deficit balance is expected to amount to about $24.8 billion, of which $5.0 billion are expected to come from multilateral institutions. Moreover, the loan will also help meet the federal government's financing requirement of about R$15 billion in 2001, and will also help lengthen the term structure of the public sector's debt, which would reduce vulnerability to financial shocks. 31. The financial assistance provided by the proposed PFRSAL will be complemented by a TA project that would include four components: (i) assistance in the implementation of the LFR (e.g., in governments' various obligations under the LFR); (ii) assistance in the implementation of the PPA (e.g., in methods of program evaluation) (iii) assistance in the proposed development of the SIAFI 21st century program; and (iv) assistance in the improvement of debt management institutions. PROGRAM BENEFITS 32. The overall benefits of the program would be to improve Brazil's performance on growth, poverty reduction and public service delivery to its citizens. Direct benefits of the program components include: (i) continued aggregate fiscal balance; (ii) improved fiscal planning, transparency, and performance incentives, including stronger incentives for sub-national creditworthiness; (iii) an improved federal financial management system, (iv) improved incentives for civil service performance; (v) a long term expenditure framework (the PPA), closely linked to the budget, and (vi) quality of debt management raised to international best practice for large open economies. These direct benefits translate into the more fundamental aims of fiscal sustainability, allocative and technical efficiency of public expenditures, and better public services to Brazil's citizens. These are aims -9-

10 that ultimately have a bearing on economic welfare. Fiscal sustainability implies an eventual reduction in debt levels that will help reduce real interest rates, increase economic growth and reduce poverty. Increased allocative and technical efficiency of public services has a direct bearing on economic welfare of the population. Also, given the importance of education and health in public expenditures, these services play a direct role in poverty reduction. 33. Poverty Category: No. Poverty focus does not apply. Contact Point: Task Manager Mauricio Carrizosa InfoShop The World Bank 1818 H Street, NW Washington, D.C Telephone: (202) Fax: (202) Note: This is information on an evolving project. Certain activities and/or components may not be included in the final project. Assessment of fiscal risks is being done in the context of the Law of Fiscal Responsibility, which requires governments to undertake an assessment of fiscal risks and indicate the measures to address them, should they materialize