III. ECONOMIC TRENDS AND OUTLOOK - Major Trends and Outlook GDP growth is expected to total 2 percent in 1994, compared to 5.0 percent last year. The decline is due to a deceleration in industrial activity from 9.6 percent in 1993 to an expected 1.1 percent this year due to expectations that real interest rates will remain high. Brazil's trade surplus is expected to decline by nearly two billion to USD 11.6 billion in 1994 due to declining export growth and rising imports. The prospects for inflation and growth will depend heavily on the execution of the GOB's economic program which included the creation of a new currency, the Real. A crucial assumption in the program is that the combined operation fiscal accounts will be close to balance during 1994 which is a major election year. Failure to meet this objective would seriously undermine hopes that the program will reduce inflation, currently running at an annual rate of 8,500 percent, to near zero during the second half of the year. Constitutional economic reform will not occur this year. The May 1994 deadline for the constitutional review process passed with the Congress unable to accomplish anything due to its failure to obtain a quorum. Despite doubts that the GOB has undertaken sufficient fiscal adjustments, Brazilian businessmen seem optimistic that inflation will decline substantially during the second half of 1994. - Principal Growth Sectors The Brazilian economy grew about five percent in 1993, the best it has done in the previous seven years. However, the agricultural sector following a sharp increase in 1992 turned in a poor showing with a 1.9 percent drop in 1993. Despite high inflation which results in a de-capitalization of the sector's resources, agricultural output is expected to grow during the next several years by an average of one to three percent annually. According to the Brazilian Statistical Institute (IBGE), industrial production rose 9.6 percent in 1993, prompted by increased consumer demand. Growth was significant in the manufacturing sector. Durable consumer goods output surged 41 percent and capital goods rose 14.9 percent, but output in the non-durable and mineral extraction sectors remained low. At the close of 1993, industries were operating at an average of 75 percent capacity, higher than the 71 percent average recorded in 1992. Following are percentage changes in output (compared to 1992) for various sectors: Mineral Extraction 1.5 percent Manufacturing Industry 10.1 percent Capital Goods 14.9 percent Intermediate Goods 6.6 percent Consumer Goods 11.3 percent Durable 41.0 percent Non-Durable 3.9 percent Data from the S o Paulo State Federation of Industries (FIESP) indicate that the cumulative industrial activity index increase for 1993 was 11.7 Percent. Transport equipment and electrical and communications equipment industries registered the highest growth rate, while the chemicals sector posted a negative performance. Industrial employment increased by 4,900 jobs during the same period, a increase of 0.21 Percent. The overall value of retail sales increased 11.3 percent during 1993 compared to 1992. Rising taxes, high interest rates and inflation make performance in 1994 difficult to predict. However there is a consensus among executives from the S o Paulo State Industrial Federation (FIESP) and National Industrial Confederation (CNI) that the industrial economy should continue to grow in 1994, but at a slower pace than in 1993. - Government Role in the Economy Under the development policies of previous Brazilian administrations, the government established a tradition of being the dominant force in shaping economic growth by means of planning and management. Its influence was felt not only directly through the day-to-day activities of government entities, but also through governmental wage, price, and credit policies, and subsidy and fiscal incentive programs. While the central government still retains an important economic role, the policies of the current administration focus on reducing the role of the government in economic activities and concentrating government activities on more traditional roles, such as improving public health, safety, and education. As a result, the government is emphasizing creating greater economic opportunities for the private sector through privatization, deregulation, and removal of impediments to competition. - Balance of Payments Situation Brazil's trade surplus is expected to decline by nearly two billion U.S. dollars to 11.6 billion U.S. dollars in 1994 due to declining export growth and rising imports. Brazil's process of trade liberalization has produced significant changes in the country's trade profile. Imports are increasing in response to lower tariffs and generally freer markets, and are now composed of a wide variety of industrial, agricultural and consumer goods. In 1993 the U.S. trade deficit with Brazil was $1.4 billion or $438 million less than in 1992. U.S. merchandise exports to Brazil were $6 billion, up $294 million or 5 percent compared to 1992. Brazil was the United States' nineteenth largest export market in 1993. U.S. imports from Brazil totaled $7.5 billion in 1993 or 2 percent less than 1992. - Trade and Investment Barriers Brazil has maintained significant barriers to U.S. exports and investment for years. Since 1990, it has made substantial progress in reducing traditional border measure barriers (tariffs, import licensing etc.), even though tariff rates in some areas are still high. Significant non-border measure barriers remain. Import licenses, a few years ago the most significant barrier, are now automatically granted within 5 days. However, on occasion obtaining an import license remains difficult. For example, the Government of Brazil has refused to grant an import license for lithium for over a year, contradicting its policy of automatically granting such licenses. Quantitative restrictions in general are no longer a significant barrier. Tariff Barriers Tariffs, in general, are the primary instrument in Brazil for regulating imports. The trade weighted average tariff stands at 14.2 percent ad valorem as of July 1, 1993. The average tariff in 1990, by contrast, was 32 percent. The maximum tariff level in Brazil is expected to be 35 percent by 1994, down from 105 percent in 1990. The United States continues to encourage tariff reductions on products of interest to U.S. firms. The primary venue for pursuing tariff reductions in Brazil has been the Uruguay Round, but the United States has supplemented this effort with bilateral discussions when necessary. The GOB also signed and ratified the Treaty of Asuncion in 1991. It provides for the establishment of a common market incorporating a customs unions involving Argentina, Brazil, Paraguay and Uruguay, known as the Southern Common Market, by December 31, 1994. The United States signed a trade and investment framework with this emerging common market in 1991. At the request of the United States, the members of the Southern Common Market, or MERCOSUL, also agreed to the formation of a GATT working party to examine the emerging MERCOSUL. The United States will continue to encourage the reduction of barriers to trade and investment and the creation of a customs union that is open and consistent with the GATT, specifically Article XXIV of the GATT. Government Procurement Barriers The federal, state, and municipal governments, as well as related agencies and companies, follow a "buy national" policy. Brazil permits foreign companies to compete in any procurement-related multilateral development bank loans. However, some state- controlled firms still specify contracts as open only to "national" firms and the criteria for the award of a recent public works contract included "percentage of national ownership" of the competing firms. Given the significant influence of the state-controlled sector due to its large size, discriminatory government procurement policies are, in relative terms in Brazil's market, an important barrier to U.S. exports. For example, discriminatory government procurement practices in the computer, computer software and digital electronics sector may have significant adverse market access implications for the United States firms, particularly firms not established in Brazil. To the extent that the privatization program in Brazil continues, and non-discriminatory policies are adopted, United States firms will have greater opportunities in Brazil. Although Brazil now applies "buy national" policies informally, article 171 of the new Brazilian constitution provides for government discrimination in favor of "Brazilian companies with national capital". On June 21, 1993, Brazil adopted procurement legislation, Law Number 8666, requiring open bids based upon the lowest price. However, subsequent to Law Number 8666 the Government of Brazil introduced new regulations regarding procurement related to telecommunications, computers and digital electronics goods and services. The new regulations allow consideration of non-price factors and preferences to telecommunications,computers and digital electronics goods produced in Brazil, and also stipulate local content requirements for eligibility for fiscal benefits. The Government of Brazil is also reviewing proposed regulations to give preference to locally produced computer products based on a complicated and non-transparent price/technology matrix. Brazil is not a signatory to the GATT Government Procurement Code. It is not possible to estimate the economic impact of these restrictions upon U.S. exports. However, free competition could provide significant market opportunities for U.S. firms. The United States seeks adoption of competitive procurement procedures, elimination of any measures favoring domestic producers, and provision of predictable, nondiscriminatory treatment for U.S. suppliers in Brazil's government procurement. To encourage Brazil to liberalize its own government procurement markets, the United States prohibits awards of government contracts to suppliers of Brazilian products for procurement covered by the GATT Government Procurement Code. Intellectual Property Rights Barriers Patents. Brazil does not provide either product or process patent protection for chemical compounds, foodstuffs or chemical/pharmaceutical substances. Product protection is not available for metal alloys and for new uses of products including species of microorganisms. Brazil's National Institute of Industrial Property (INPI) has not issued a patent for a biotechnological invention. Brazil requires a patent owner to work the patented invention in Brazil. A third party may request a compulsory license if a patent owner has failed to work the patent within three years of issuance or if exploitation has been discontinued for more than one year unless working is prevented by force majeure. Furthermore, the patent term of 15 years from the date of application is short. Patents may also be forfeited for lack of working. The Government of Brazil publicly stated its intent on June 26, 1990 to revise its laws pertaining to intellectual property rights. Included in this proposed legislation would be protection for pharmaceutical processes and products. As a result, on July 2, 1990 the U.S. Trade Representative terminated an ongoing section 301 investigation, and eliminated the 100 percent ad valorem tariffs imposed on certain Brazilian goods pursuant to that investigation. Subsequently, on May 1991 the Government of Brazil submitted new legislation to the Congress. This legislation was subsequently replaced in 1992 by a bill prepared in the Chamber of Deputies which improved upon the previous draft law. This bill was again revised in mid-1992. The United States informed the Government of Brazil at that time that the proposed legislation contained major flaws. Late in 1993 and early in 1994 the Government of Brazil arranged for additional amendments in the pending legislation consistent with the requirements of the Uruguay Round's results. The United States designated Brazil as a "Priority Foreign Country" under the 1988 Trade Act in April 1993 and initiated a formal investigation of its practices on May 28, 1993. The United States Trade Representative extended that investigation on November 24, 1993 for up to an additional three months (i.e., until February 28, 1994). On February 25, 1994, United States Trade Representative Kantor announced the termination of the investigation and the revocation of Brazil's identification as a priority foreign country citing Brazil's decision to amend its industrial property law and to strengthen IPR protection. Trademark and Technology Transfer Barriers. All licensing and technical assistance agreements including trademark licenses must be registered with INPI (National Institute of Industrial Property). Failure to register with INPI invalidates the license, which can result in trademark registration cancellation for nonuse. Brazil took action in 1992 to implement the substantive provisions of Stockholm text of the Paris Convention and has moved to provide greater protection to internationally "famous" marks. The fraudulent use of such marks, which had been tolerated by the GOB, has been a significant problem. Progress has been made in this are and the GOB is expected to issue new trademark guidelines. Significant trademark revisions, along with the proposed patent reforms, are included in the proposed industrial property legislation pending in the Brazilian Congress. Copyright Barriers. Brazil's copyright-related laws conform in numerous ways to world standards. However, the term of protection for computer software is too short. The 1987 Software Law extended explicit copyright protection to computer software, but only for a period of 25 years. The Berne Convention standard for the term of protection is the life of the author, plus 50 years. Enforcement of these laws has been lax. According to estimates by the U.S. private sector, piracy of video cassettes, sound recordings and musical compositions, books, and computer software continues at substantial levels. Enforcement of laws against video cassette and software piracy has shown some, but not sufficient, progress. Market access for U.S. computer software remains a source of concern, although it has improved. The Government of Brazil, in an effort to open the software sector, has de facto eliminated the so- called "Law of Similars", which had been used to preclude non- Brazilian software from the market if a "similar" Brazilian domestic software existed. Draft legislation was introduced to the Congress in 1991 that proposed the elimination of the requirement that all software be distributed in Brazil by a Brazilian distributor. It also does away with the requirement that all software be registered with the government. Additionally, the Brazilian Government has reduced from 25 percent to zero the Tax on Financial Operations for software imports. The United States continues to urge the elimination of the remaining market access barriers for computer software. Brazil has indicated a willingness to eliminate some of these barriers. Market access barriers also exist in the motion picture sector. These include screen quotas for theatrical exhibition, quotas for home video distribution, required registration of production contracts with the Government of Brazil, and requirements that foreign productions undertaken in Brazil must be made under contract with a Brazilian production company. It is possible that some of these restrictions will be moderated in future regulations. Service Barriers Restrictive investment laws, administrative nontransparency, legal and administrative restrictions on remittances, and arbitrary application of regulations and laws limit U.S. service exports to Brazil. Service trade possibilities are also affected by limitations on foreign capital participation in many service sectors. Foreign companies, particularly construction engineering firms, are prevented in government procurement contracts from providing technical services unless Brazilian firms are unable to perform them. INPI, which must approve all technical service contracts, has subjected them to substantial delays. Restrictions exist on the use of foreign-produced advertising materials. These include limits on the use of foreign film footage (two-thirds must be produced in Brazil) and sound tracks (all must be produced in Brazil), limits on foreign capital participation, residence requirements and requirements that the majority of the directors of a company must be Brazilian. Furthermore, discriminatory government procurement practices exists. Foreign legal, accounting, tax preparation, management consulting, architectural, engineering, and construction industries are hindered by various barriers. These include forced local partnerships, limits on foreign directorships and non-transparent registration procedures. The Government of Brazil reserves the right to refuse entry of managers or executives associated with providing a service if they do not provide new technology, increase productivity in Brazil, or attract new investment. The Government of Brazil discriminates against foreign firms in the insurance sector through: (l) limitations of foreign capital (50 percent) equity participation, limitations on the voting stock (no more than 30 percent) that foreign firms can control in an existing insurance company, insurance brokerage, or private premium fund; (2) limitations on the entry of new firms int he sector (i.e., due to market "saturation"); and (3) forced incorporation in Brazil. Furthermore, the government of Brazil maintains a monopoly in the area of reinsurance and restricts import insurance through Resolution Number 3/71 to Brazilian firms. This denies U.S. marine cargo insurers an opportunity to compete for business. Resolution number 3/71 also requires that state companies doing business with insurance brokerage firms to use 100 percent Brazilian-owned brokerages. Furthermore, the Government of Brazil has granted no new authorizations to transact insurance since 1966. Brazil's Resolution Number 3/71 of the National Private Insurance Council and other governmental actions effectively restrict Brazilian import insurance to Brazilian firms. Requirements for withholding insurance premiums and outstanding loss reserves also expose U.S. reinsures to serious exchange losses. Brazilian regulatory policy precludes the issuance of new licenses. Brazil is South America's largest potential insurance market. The United States will continue to seek improved market access for trade in insurance and other service industries. Investment barriers Foreign investment is prohibited in several sectors, including petroleum production and refining, public utilities, media, real estate, shipping, and various "strategic industries". Even with these restrictions, many U.S. and foreign firms have major investments in Brazil. In other sectors Brazil limits foreign equity participation, imposes local content requirements, and links incentives to export performance requirements. For example, there are equity limitations, local content requirements and incentive based performance requirements in the computer and digital electronics sector. In the auto sector, local content and incentive based export performance requirements exist. Brazil's constitution bars majority participation in direct mining operations and bans foreign investment in health care. However, these constitutional provisions have not been implemented through legislation. The Constitution imposes prohibitions on foreign capital participation in land, river, coastal, maritime, and internal air transportation as well as foreign ownership of television, radio, and print media. Foreigners are also barred from owning land in certain coastal zones and/or areas on national security grounds. The Government of Brazil proposed in 1991 several constitutional amendments that would remove certain restrictions on foreign investment, particularly in the mining and petroleum sectors. That legislation remains in the Brazilian Congress. The Brazilian tax code was modified in 1991 to eliminate, effective January 1992, the supplementary income tax (surcharge) on foreign profit and dividend remittances that exceed 12 percent of registered capital. In addition, the Central Bank revised its internal regulations in December to allow foreign firms to reinvest earnings at the exchange rate in effect on the date of the new investment, rather than on the date on which the earnings were declared. This addresses the problem of capital erosion, due to inflation, for foreign capital registration purposes during the interval between earnings declarations and reinvestment. Capital may still be under- registered because some intangible capital assets, such as trademarks and know-how, cannot be registered. However, a bill in the Brazilian Congress would, if approved, lift the current prohibition on the transfer of royalties and technical assistance fees from foreign subsidiary firms to parent firms abroad. Under the new 1992 tax code, Brazil has removed prohibitions on remittances for royalty and technical service payments between related parties. Royalty payments between related parties can be deducted from earnings from the purposes of computing Brazilian income tax. Additionally, Brazil has reduced the base tax rate on profits and royalty remittances from 25 percent to 15 percent. Investment restrictions have been discussed in bilateral discussions of Brazil's computer and digital electronic sector policies. The United States is seeking liberalization of Brazilian performance requirements. The United States has also raised the importance of open and non-discriminatory investment regimes in the context of talks under the trade and investment framework agreement concluded with the countries of the emerging Southern Common Market in 1991, which includes Brazil. - Labor Force Available employment statistics indicate that Brazilian economic growth since late 1992 has not improved overall employment levels. According to the S o Paulo State Data Analysis Foundation (SEADE) and the interunion Department for Statistics and Socio- Economic Analysis (DIEESE), open unemployment rates for the S o Paulo metropolitan region during the first three months of 1994 were at or very near the 1993 records for those months. Unemployment increased from a seasonal low of 7.6 percent in December 1993 to 9.8 percent in March 1994, identical to the March 1993 level which set the survey record for this month. April through June will be critical to see whether unemployment peaks and then drops off sharply as in 1993, or levels off to a high plateau as in 1992. Note: These figures are "open" unemployment, directly comparable to the principal U.S. unemployment measure. The Brazilian press most often reports "total" unemployment rates from the SEADE- DIEESE survey, which add two categories of concealed unemployment: discouraged job-seekers and persons in temporary or "precarious" employment. Similar surveys are conducted for two other metropolitan areas. Brasilia metropolitan area unemployment was fairly stable around 9.5 percent through the end of 1993. Porto Alegre saw a slow decline in unemployment to 7.0 in December 1993. Other figures indicate Brasilia saw a sharp rise in joblessness during the first two months of 1994, with a similar but later increase in Porto Alegre. - Major Local & Third Country Competitors in Specific Sectors Major third country competitors are Argentina (10.2 percent of Brazilian imports), Germany (8.8 percent), Japan (5.9 percent) and Italy (3.9 percent). Locally, Brazilian subsidiaries of Italian, French, German, British and Japanese companies present strong competition in major Brazilian industry sectors. Examples of stiff third country competition follows: European (Seimens, Alcatel, and Ericcson) and Japanese (NEC) firms with local manufacturing operations currently dominate segments of the telecommunications equipment market. European suppliers also present strong competition in most sectors of defense equipment procurement. Japanese, European and Korean automobile manufacturers are aggressively pursuing the imported automobile market. Argentina and Chile maintain strong presence in Brazil's agricultural markets. Brazilian suppliers have majority of the market share in the following sectors: Agricultural Chemicals, Apparel, Automotive Parts and Service Equipment, Computer Hardware, Electrical Power Systems, Electronic Components, Food Processing Equipment, Hotel and Restaurant Equipment, Household Consumer Goods, Industrial Chemicals, Machine Tools and Metalworking Equipment, Medical Equipment and Supplies, Oil and Gasfield Equipment and Services, Packaging Machinery, Plastic Materials and Resins, Plastics Production Machinery, Pollution Controls, Security and Safety Equipment, Sporting Goods and Recreational Equipment, and Telecommunications. - Major Infrastructure Projects Underway Name of Project: Tiete-Parana Valley Waterway Project. Estimated Value of Project: USD 930 million. Date Competitive Activity Likely to Begin: Already initiated. Category: Transportation. Name of Project: Bolivia-Brazil Natural Gas Pipeline. Estimated Value of Project: USD 1.7 billion. Date Competitive Activity Likely to Begin: 1994. Category: Energy. Name of Project: Tiete River Cleanup Project, S o Paulo. Estimated Value of Project: USD 2.6 billion. Date Competitive Activity Likely to Begin: Already initiated. Category: Environmental. Name of Project: Clean up of the Guanabara Bay, Rio de Janeiro. Estimated Value of Project: USD 793 million. Date Competitive Activity Likely to Begin: Already initiated. Category: Environmental. Name of Project: Amazon Surveillance Project (SIVAM/SIPAM). Estimated Value of Project: USD 1.2 billion; value of U.S. content: Approx. USD 500 million. Date Competitive Activity Likely to Begin: On July 22, 1994 a consortium led by Raytheon was awarded the contract. Category: Environmental communications/air traffic control. Name of Project: Pro-Amazon Project. Estimated Value of Project: USD 248.65 million; value of U.S. content: Approx. USD 208.91 million. Category: Communications. Date Competitive Activity Likely to Begin: 1994. Name of Project: Central Telephone Switching Systems. Estimated Value of Project: USD 200.00 million; value of U.S. content: USD 80.00 million. Category: Telecommunications. Date Competitive Activity Likely to Begin: Already initiated. Name of Project: Projeto Caulim-Rio Capim Quimica S.A.. Estimated Value of Project: USD 300 million. Date Competitive Activity Likely to Begin: Already initiated. Category: KAOLIN (construction of a KAOLIN-processing plant); port construction (engineering construction). Name of Project: Guaiba River Cleanup. Estimate Value Project: USD 1.5 billion. Date Competitive Activity Likely to Begin: Already initiated. Category: Environmental. Name of Project: Expansion of S o Paulo City Mass Transportation. Estimated Value of Project: USD 1.2 billion. Date Competitive Activity Likely to Begin: Early 1994. Category: Public transportation.