ANNEX

REDUCTION OF THE "BRAZIL COST"

Several structural reforms were initiated in 1995. These reforms are designed to increase the efficiency of Brazil's economy, eliminating distortions that diminish the country's competitiveness. The elimination of these distortions, identified as the "Brazil Cost," has been one of the government's priority objectives. What has been done and what has yet to be done?

I) Reducing Taxes

The government exempted inputs for exports from two taxes (PIS-COFINS) and reduced corporate income tax rates. With these measures, the estimated tax burden on exports of manufactured products fell from 18.6% to 12.9%, on semi-manufactured goods from 22.4% to 17.1%, and on primary products from 24.6% to 23.1%. Pending constitutional reforms would reduce the sales tax (ICMS) on exports of primary goods, semi-manufactures and manufactures to 6.8%, 6.9%, and 10.1%, respectively. Once the constitutional amendment is promulgated, the ICMS tax reduction on primary goods and semi-manufactures can be quickly implemented.

ESTIMATED TAX BURDEN ON EXPORTS

	Previous Situation	After the Tax Reduction	With the Constitutional Reform
Manufactures	18.6%	12.9%	10.1%
Semi-manufactures	22.4%	17.1%	6.9%
Raw Materials	24.6%	23.1%	6.8%

II) Lowering Labor Costs

Excessive labor related costs and outdated legal requirements discourage the creation of employment and/or stimulate an expansion of the informal economy. In Brazil, the non-salary costs of labor are equal to 81.9% of the wage bill. By contrast, these costs are equal to 60% of the wage bill in Germany, 58.8% in England, and 51% in Holland. The Government plans to relax the requirements generating these labor-related costs, encouraging negotiations between capital and labor.

NON-WAGE LABOR COSTS AS A % OF WAGE COSTS

Brazil	81.9%
Germany	60%
England	58.8%
Holland	51%

In addition, some measures are already bearing fruit, such as the executive decree concerning labor's participation in corporate profits and the intensification of labor training. The National Plan for Professional Development trained approximately 210,000 workers in 1995, compared to only 90,000 in 1994, and plans to enroll some 1,000,000 in 1996.

III) Improving Infrastructure

The steps taken thus far have produced the following progress:

• An easing of the government monopoly in the infrastructure;
• Privatization of Escelsa (The Electricity Company of Espírito Santo), inclusion of Eletrobrás in the National Privatization Plan, setting an April date for the auction of Light, and providing federal support for state privatization programs, notably the plan to sell CERJ — Centrais Elétricas do Rio de Janeiro (The Eletricity Company of Rio de Janeiro);
• Definition of conditions for the sale of three segments of the railroad system with the first auction set for March; approval of the Concessions Law, permitting initiation of bidding for four electrical generating installations in 1996 and eleven more in 1997, a total potential of 5.1 thousand MW;
• Reactivation of construction on 22 other electrical generating plants, including Itá and Serra da Mesa, involving an increase of 9.3 thousand MW of electrical energy;
• The concession of 4 federal highways, including the Rio de Janeiro-São Paulo highway (Dutra), within the Concession Program of Federal Highways;
• Creation of the Executive Group for the Modernization of Ports. This group has rationalized the management of port workers. It also accelerated the grant of private concessions for ports such as Cosipa and Praia Mole and has improved procedures at the customs service. The actions already underway should reduce port costs approximately 20% by the end of the year. Moreover, priority has been given to the port of Sepetiba, with the mineral pier scheduled to become operational this year under private management.

IV) Making the Financial System Responsive

The high level of interest rates and the small amount of funds available for investment and technological development are two sides of the same coin, creating a tremendous dependency on public resources. The government has striven:

• To reduce gradually the interest rates and progressively to end the compulsory deposit requirements. The basic interest rate in the economy went from an average of 4.4% per month in the second half of 1994 to 2.5% in January.
• To eliminate the restrictions on foreign financial capital.
• To revise the Export Financing Program - PROEX which, in addition to helping to match foreign interest rates for exporters, now finances durable goods exports and, this year, will have twice as many resources as in 1995.
• To increase the volume of BNDES investment loans by 105% in the first eleven months of 1995 compared to the same period in 1994.
• To replace the Reference Interest Rate (TR) with the Long Term Investment Rate (TJLP) for underwriting industrial investments. The TR in April reached 50.6% p.a., whereas the TJLP was 21.9% p.a., which implied a savings of 23.5% p.a. for the borrower.
• To set the interest rate for agricultural credits at 16% and to create credit lines for the small and medium businesses within the Program to Generate Employment and Income — PROGER.
• To reduce the Tax on Financial Operations (IOF) and the incidence of the PIS on productive investment operations.
• To institute soon the Fund for Programmed Individual Retirements whose resources can be channeled into investment.

V) Deregulation

The government altered much of the price structure for the distribution of gasoline and alcohol. It also reduced the subsidies that were distorting electrical energy and telecommunications prices and inflating public sector charges to the productive sector. These steps permitted the public sector tariffs affecting the "Brazil Cost" to be raised less than the inflation rate without resorting to artificial measures or increasing the public deficit. Thus, the average price of fuels, electrical energy, and business communications declined in real value by, respectively, 12.8%, 6.8%, and 17.7% since the introduction of the Real.