II - RECENT DEVELOPMENTS

Setbacks on the Fiscal Fronth

• Although key elements of the fiscal adjustment program were approved, some political setbacks occurred:
• The proposed measure to increase social security contribution of civil servants, and to extend it to retired ones, was not approved by the Chamber of Deputies in early December;

• The government's efforts to pass the financial transactions tax (CPMF) ran into delays;
• The 1999 budget approval process was delayed;

• Some important state governors challenged the terms of renegotiation agreements signed with the federal government.

• In the event, the process of confidence restoration that had been triggered by the announcement of the Fiscal Stabilization Program was intensely impaired.

Unabated Pressures

• To revert the situation, the government reaffirmed its commitment to fiscal consolidation with compensating initiatives (budget cuts, increase in CSLL and IOF).
• Market confidence continued to erode, and intensifying pressures on international reserves led the government to float the currency on January 15th.

Progress in the Fiscal Arena

• Meanwhile progress was made on the fiscal front:

• The measures on the pension contributions for active and retired civil servants were approved by the Congress (January 28th);
• The 1999 budget was approved on January 29th;
• The measures proposed by the government to compensate for the delay in the CPMF were approved (January 21st);
• Significant progress was made in passing the CPMF (approved in the Senate and in Chamber of Deputies);
• Enabling legislation associated with the Administrative Reform.

The Floating Exchange Rate Regime

• Opportunities:

• to shift monetary policy towards domestic goals;
• to reduce the equilibrium real interest rate;
• to enhance competitiveness of domestic production.

• Challenges:

• to use monetary and fiscal policy to restrain the impact of the devaluation on domestic prices.

Balance Sheet Exposure of the Private Sector

• In contrast to what happened elsewhere, Brazilian enterprises were largely hedged against an exchange rate devaluation;
• The consolidated private sector was significantly protected:

ASSETS	LIABILITIES
U$ bilion
Hedged Assets 71.0	External Liabilities 95.0
Indexed Securities 60.5
Foreign Exchange
Derivative Position 10.5

As of January 12^th, 1999.

• Notwithstanding, activity will suffer an important temporary setback.

Foreign Exchange Exposure of the Financial System

• Foreign exchange exposure of the financial system is minimized as external and indexed assets outweigh foreign currency liabilities.

USD assets and liabilities of the consolidated financial system	Nov98(R$billion)
Loans                                                       23.6	Non-Interest Bearing Deposits    0.4
Agribusiness Loans                                     2.8	Commercial Paper & Notes       10.4
Demand Deposits in Foreign Currency        10.9	Borrowings in Foreign Currency 45.6
Securities                                                  34.0	Foreign exchange transactions   46.8
Foreign exchange transactions                    38.3
Total USD Assets                                    109.6	Total USD Liabilities                103.2
Foreign exchange exposure of the financial system                                                                     (6,453)

Note: Total governments securities denominated in USD corresponds to approximately 28% of the total securities.

Costs to the Public Sector of the Devaluation

• The burden of the devaluation was borne by the public sector;
• The depreciation of the real has increased the value of the net debt of the public sector by the equivalent of about 11 percentage points of GDP, to around 53 percent of GDP in January 1999.