Brazilian Economic Scenario October 2006

The Brazilian economy faces a positive period. Inflation is low and aligned with the economic policy goal for 2006. The product grows in real terms. The internal demand is heated. The trade balance is positive and has been registering successive records. The monetary authorities continue promoting an orderly decrease of the basic interest rate, begun one year ago. The net foreign debt was zeroed this year. The risk of internal federal securities debt diminished significantly through the elimination of its net installments indexed to the dollar and with the increase of its prefixed installment. The primary result of the Central Government is a surplus of more than 3% of the GDP. Unemployment is stabilized at the 10% level, but the worker average income is rising.

Inflation

After the inflationary bubble of the second semester of 2002 largely caused due to the speculative increase of the dollar during that year, inflation was quickly contained. In 2003, the IPCA^- the price index of inflation target system reached one digit. Between May 2004 and May 2005 there was an increase bounce back of the inflation, to which the monetary authorities answered by increasing the interest rates. Since then, inflation has followed a dropping trajectory and is likely to end 2006 at 3%, below the 4.5%-target.

Internal Demand

The dropping tendency of the inflation is seen in spite of a heating of the internal and external demand. The volume of the retail trade in comparison with the same month last year, dropped up to the beginning of 2004. From then on, there was a vigorous reheating of the internal demand. Since 2005, the sales volume has grown 5% in average per month, in comparison to the same period last year.

Trade Balance

Thanks to the heating of the developed economies and the boom of investments in China, the Brazilian trade balance has presented a surplus and has registered successive records since 2002, contributing decisively for the equilibrium of our foreign accounts. That trade result is also explained by the high prices of commodities^- and primary products exported by Brazil, such as iron and soybean. In 2006, the Brazilian trade surplus will likely surpass US$ 46 billion, approximately 2.2% of the GDP.

Interest rates

The capital cost in Brazil has been historically high, but the monetary authorities have gathered success in diminishing it in a consistent manner during recent years. In 2003, there was a significant monetary tightening in which the basic rate was elevated to 26% per year, as a reply to the inflation bubble of the previous year. However, the interest rate was rapidly diminished yet during 2003 to 16%. Between 2004 and mid-2005, there was another tightening, as a reply to a quick inflation acceleration and to heating in the trade area. Now, once the inflation has been controlled, the basic rate was reduced to less than 14% per year and will probably reach one digit in 2007.

Public debt

The Brazilian public debt improved in every aspect in the past recent years. The stock of the internal federal securities debt dropped from a level of 57% of the GDP between 2003 to 2004 to 50% of the GDP. The installment indexed to the dollar was canceled through collection and reverse swap operations. Furthermore, the prefixed installment almost increased four-fold since 2003 to approximately 31% of the stock today. With those changes, not only the debt stock dropped as a GDP percentage, but also its risk profile improved substantially, leaving the National Treasury less vulnerable to external disturbances.

Employment and income

The unemployment rate in Brazil dropped from a 12% level to 10% in the past two years. Despite the relatively high rate, the average worker income has constantly been increasing since the end of 2003. That, and the credit expansion derived from the lowering of interests and from regulatory incentives, largely explains the heating of the internal demand, upon which there can be built a long-term economic expansion in Brazil.

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