This Technical Memorandum of Understanding (TMU) sets out the specific performance criteria (PCs), indicative targets (ITs), structural benchmarks (SBs) and assumptions that will be applied under the Stand-By Arrangement (SBA) for Brazil for the second half of 1999.

I.  Phasing of Purchases and Reviews

While the general phasing of purchases remains unchanged from what was set out during the First and Second Reviews, some minor changes concerning the phasing of purchases for the second half of 1999 are proposed in Table 1;¹ these changes are explained below. After completing the third review, which will make available to Brazil the third purchase under the Supplemental Reserve Facility (SRF) together with a purchase under the credit tranches (CT), Brazil will complete at least one more review with the Fund during the remainder of calendar year 1999 (as shown in Table 1).

• The fourth purchase under the SRF, together with a purchase under the CT, will become available no earlier than August 31, 1999. These purchases will become available upon observance of the relevant PCs, and upon completion of the fourth review. Monetary sector PCs for December 1999 will be established at the time of the fourth review. Also, at the time of the fourth review, PCs, ITs, structural benchmarks, and all other relevant program parameters for calendar year 2000 (including, among others, number and timing of reviews) will be established.

• A purchase under the CT will become available no earlier than December 3, 1999. This purchase will become available upon observance of the relevant PCs, and upon completion of the fifth review.

• PCs, ITs, structural benchmarks, and all other relevant program parameters, including, among others, number and timing of reviews during calendar year 2001 will be established during calendar year 2000.

For any given month, the primary balance of the consolidated public sector is measured, in Brazilian reais (R$), as the total net interest (i.e., net interest accrued on the consolidated net domestic debt of the public sector, plus the net interest due (competência contratual) on the net external debt of the public sector) minus the borrowing requirement of the consolidated public sector, where the public sector is defined as above. For foreign-exchange indexed government securities, the interest rate is the accumulated rate of change of the U.S. dollar vis-à-vis the R$, plus the fixed coupon rate. The fixed coupon rate applies to the nominal value of the security revalued by the rate of change of the U.S. dollar vis-à-vis the R$ from the issuance date to the relevant date. For any given month, the borrowing requirement of the consolidated public sector is defined as the change in the nominal outstanding net domestic debt plus the change in the net external debt, converted into R$ at the actual period average R$/US$ exchange rate.² The stock of the U.S. dollar-indexed domestic debt is revalued at the end of a given month to reflect any change in the value of the real vis-à-vis the U.S. dollar that has taken place during the month. The proceeds from privatization during that period are added to these results; amounts representing the recognition of unregistered liabilities during that period are subtracted from these results. The cumulative primary balance from January 1, 1999 to the relevant date is the sum of the monthly primary balances of the consolidated public sector for that period.

The above floor for the cumulative primary balance of the consolidated public sector is predicated on the baseline path for concession revenue shown in Table 2 below. Deviations from this path will be taken into account as appropriate during the relevant reviews.

Total net debt outstanding of the consolidated public sector is measured on an accrual basis (including accrued interest) for the domestic debt component, and on an interest-due basis (competência contratual) for the external debt component. The stock of external debt and of foreign-exchange indexed domestic debt is valued at the actual R$/US$ exchange rate prevailing at the end of each period. Deviations of the net debt of the consolidated public sector from the above ITs will be taken into account during the relevant reviews in setting or revising the PCs for the primary balance of the consolidated public sector for subsequent periods to give sufficient confidence that the target ratio for public sector debt to GDP of 46.5 percent can be reached by the year 2001.

The central government will continue to incorporate into its registered debt various unregistered liabilities that are currently outstanding. The above ceilings for the total net debt outstanding of the consolidated public sector are predicated on the paths for privatization receipts (defined here to exclude concession revenue) and the recognition of unregistered liabilities that are shown in Table 2 below. These ceilings will be adjusted downward (adjusted upward) to the extent that privatization receipts exceed (fall short of) the amounts implied by Table 2 below; they will be adjusted upward (adjusted downward) to the extent that the recognition of unregistered liabilities exceeds (falls short of) the amounts implied by Table 2 below.

2.  External Sector Targets

The above limits will be adjusted upward to accommodate new external borrowing that is made in order to undertake a voluntary early or advance repurchase to the Fund or to the bilateral sources of support for the exceptional financing package. Should the authorities wish to make any advance repayments to other contributors to the exceptional financing package, they would make advance repurchases from the Fund on at least a proportional basis.

The above limits will be adjusted upward to accommodate new external borrowing that is made in order to undertake a voluntary early or advance repurchase from the Fund or to the bilateral sources of support for the exceptional financing package.

d.  Performance criterion on net international reserves (NIR) in the BCB

The floor on NIR in the BCB at the end of each month from July 1999 to December 1999 will be equal to the NIR in the BCB projected for the corresponding month (as shown in Table 2 below) minus US$3 billion. This is a performance criterion under the program for each of these months.

The NIR in the BCB are equal to the balance-of-payments concept of net international reserves in the BCB (reservas internacionais líquidas ajustadas) and include gross official reserves minus gross official liabilities.

Gross official reserves are defined as liquid foreign currency denominated claims in the BCB. Gross official reserves include (i) monetary claims, (ii) free gold, (iii) holdings of SDRs, (iv) the reserve position in the IMF, and (v) holdings of fixed income instruments. Items (i) through (iv) will be valued at the end-period prices shown in Table 3 below. Item (v) will be valued at the purchase price. Gross official reserves will exclude participation in international financial institutions, the holdings of nonconvertible currencies, and the holdings of precious metals other than gold.

Gross official liabilities in foreign currencies include (i) foreign currency liabilities with original maturity of one year or less, (ii) the use of Fund resources extended in the context of the exceptional financing package, (iii) the use of bilateral credit extended in the context of the exceptional financing package, and (iv) any forward foreign exchange (FX) liabilities on a net basis—defined as the long position (posição vendida) minus the short position (posição comprada)—directly undertaken by the BCB or by other financial institutions on behalf of the BCB. Items (i) through (iii), will be valued at the prices shown in Table 3 below.

After May 31, 1999, any increases in foreign currency-denominated claims (both spot and forward) against residents, or against foreign branches or subsidiaries of Brazilian institutions, do not count towards NIR in the BCB.

• Adjuster for a deviations from the baseline path of gross disbursements of loans from the Interamerican Development Bank and the World Bank

e.  Performance criterion on the BCB's exposure in FX futures markets

The BCB will continue to refrain from entering into FX futures contracts, either directly or through any institution it uses as its financial agent. This constitutes a performance criterion under the program.

f.  Performance criterion on the BCB's exposure in FX forward markets

The BCB will continue to refrain from entering into FX forward contracts, either directly or through any institution it uses as its financial agent. This constitutes a performance criterion under the program.

3.  Monetary Targets

The monetary base for any given month is measured as the average of the daily closing positions during the working days of that month (média nos dias úteis do mês). The NIR for any given month, are measured as the average of the NIR (daily closing positions) during the working days of that month (média nos dias úteis do mês). The resulting U.S. dollar number will be converted into R$ using the average accounting exchange rate for that month, as shown in Table 3 below.

In addition, in any period, the following automatic adjusters to the NDA ceilings will apply:³

• Adjuster for a deviations from the baseline path of gross disbursements of loans from the Interamerican Development Bank and the World Bank

The NDA ceilings are predicated on the assumption of net disbursements of loans from the Interamerican Development Bank (IDB) and the World Bank Group as shown in Table 2 below. The NDA ceilings for each month during July-December 1999 will be adjusted downward (upward) for the cumulative excess (shortfall) from July 1999 to the month in question of the actual net disbursements from these sources, relative to the cumulative baseline path in Table 2, up to a maximum adjustment of R$1,750 million.

• Adjuster for changes in the required reserve ratio on demand deposits.

For any change to the required reserve ratio on the stock of demand deposits, the NDA ceilings will be adjusted by NDA = D(r_n-r_o), where r_n and r_o denote the new and the old reserve ratio respectively, and D denotes the stock of demand deposits subject to the relevant reserve ratio at the time of the change. In the formula, D is measured as the average of the daily closing positions in the last month for which the old reserve requirement is still in effect.

For any change to the required reserve ratio on changes in the stock of demand deposits, the NDA ceiling, in any period t subsequent to the change in reserve requirements, will be adjusted by NDA =  (D_t-D_o)(r_n- r_o), where D_t and D_o denote the stock of demand deposits subject to the relevant reserve ratio at time t and at the time of the change, respectively. In the formula, D_o is measured as the average of the daily closing positions in the last month for which the old reserve requirement is still in effect, and D_t is measured as the average of the daily closing positions in month t.

• Adjuster for changes in the reservable base of demand deposits.

For any change to the definition of the reservable base for any category of demand deposits, the NDA ceilings will be adjusted by NDA = r R, where R represents the difference in the reservable base as a result of the change in definition, and r is the relevant reserve ratio that applies to the reservable base; _R is measured using the data for the close of business on the day immediately prior to the day the change enters into effect.

b.  Understanding on consultations

There will be regular consultations between the BCB management and IMF management or staff on the implementation of the inflation targeting framework.

III.  Structural Benchmarks

1. By end-August 1999

• Proposal of an action plan for statistical improvements that will permit Brazil's subscription to the Special Data Dissemination Standard (SDDS).

• Submission to congress of the multi-year plan (PPA) that will guide the selection of expenditure priorities during calendar years 2000-2003 (as described in paragraph 13 of the Memorandum of Economic Policies (MEP) of July 1999).

• Submission to congress of legislation reforming the pension systems for private sector workers, including the special regimes for the self-employed and for rural workers (as described in paragraph 15 of the MEP of July 1999).

2. By end-November 1999

• Acceptance of the obligations under Article VIII, Sections 2, 3 and 4 of the Fund's Articles of Agreement, with a definite time table for removing remaining restrictions (if any).

• Submission to congress of legislation on reform of the pension system for public sector workers (RJU).

• Further progress in the resolution of state-owned banks, including privatization of BANESPA.

• Implementation of regulations for the implementation of a capital charge related to market risks, and a forward-looking loan classification system (as described in paragraphs 21 of the MEP of July 1999).

The authorities will regularly provide to Fund staff the following specific daily, weekly, and bi-weekly data (at the indicated frequencies, and lags):

• Composition of gross international reserves under the cash concept (posição de caixa) and the liquidity concept (posição liquidez internacional) (weekly, the following week);

• The levels of gross international reserves and of net international reserves as defined under the NIR concept (daily, the next business day);

• The BCB's position in FX futures, including (i) notional amounts of open-interest contracts, both bought and sold, in each contract for the next four months; (ii) cumulative fiscal gains or losses on these positions; and (iii) estimates of cumulative fiscal gains or losses if contracts are held to maturity under different scenarios (daily, the next business day);

• Base money (base monetária); currency issued (papel-moeda emitido); bank reserves (reservas bancárias); factors determining the monetary base (fatores condicionantes da base monetária); sources of base money expansion (base monetária—fontes de expansão) with details; monetary impact of federal debt titles (impacto monetário com títulos públicos federais) with details (daily, the next business day);

• Maturity structure (vencimentos) of outstanding federal debt by instrument and day (bi-weekly, with a one week lag);

• Results of domestic debt auctions, listing the instruments, the amounts supplied and demanded, the demand accepted; averages, minimum, and maximum prices and interest rates achieved in the auctions (weekly, with a lag of one week);

• Individual bank data for the 50 largest banks on their summary balance sheets (monthly, with a two-month lag);

• Coded individual bank data on foreign currency exposure for the 50 largest banks, including exposure in off-shore branches and affiliates, dollar-indexed assets and liabilities, and off-balance sheet positions (monthly, with a two-month lag).

• Quantitative results of the monitoring of the external credit lines of financial institutions (two business days after the deadline at which these institutions have to comply), and of external medium- and long-term bank claims on Brazilian nonbank debtors (once a week for the previous week).

All data will be provided preferably in electronic format; the above list will be reassessed during scheduled reviews of the program.

V.  Baselines and Conversion Rates Used for Selected Variables

The following Tables 2 and 3 set out baselines and accounting rates used for selected variables.