Search

 

Cablegate: Office of the Comptroller of the Currency (Occ) Meets With

VZCZCXRO1562
RR RUEHRG
DE RUEHSO #0432/01 1411233
ZNR UUUUU ZZH
R 211233Z MAY 07
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 6967
INFO RUEHBR/AMEMBASSY BRASILIA 8101
RHEHNSC/NSC WASHDC
RUCPDOC/USDOC WASHDC 2784
RUEHMN/AMEMBASSY MONTEVIDEO 2340
RUEHBU/AMEMBASSY BUENOS AIRES 2734
RUEHSG/AMEMBASSY SANTIAGO 2049
RUEHLP/AMEMBASSY LA PAZ 3348
RUEHAC/AMEMBASSY ASUNCION 3005
RUEHRG/AMCONSUL RECIFE 3581
RUEHRI/AMCONSUL RIO DE JANEIRO 8078
RUEHFR/AMEMBASSY PARIS 0267
RUEATRS/DEPT OF TREASURY WASHDC
RUEHC/DEPT OF LABOR WASHDC

UNCLAS SECTION 01 OF 04 SAO PAULO 000432

SIPDIS

SENSITIVE
SIPDIS

DEPT FOR WHA/BSC, WHA/EPSC, EB/IFD/OMA
STATE PASS FEDERAL RESERVE BOARD FOR P.ROBITAILLE
STATE PASS TO USTR FOR SCRONIN
STATE PASS EXIMBANK
STATE PASS OPIC FOR MORONESE, NRIVERA, CMERVENNE
NSC FOR FEARS
USDOC FOR 4332/ITA/MAC/WH/OLAC
USDOC FOR 3134/USFCS/OIO
DEPT OF TREASURY FOR JHOEK
PARIS FOR ECON - TOM WHITE
USAID FOR LAC/AA

E.O. 12958: N/A
TAGS: EFIN ECON EINV PGOV BR
SUBJECT: OFFICE OF THE COMPTROLLER OF THE CURRENCY (OCC) MEETS WITH
CENTRAL BANK AND OTHER BANKING INSTITUTUIONS


SENSITIVE BUT UNCLASSIFIED; PLEASE PROTECT ACCORDINGLY

-------
Summary
-------

1 (U) The Deputy Comptroller for Global Banking and Financial
Analysis, Ms. Nancy Wentzler, and two other OCC economists in the
International Banking and Finance department visited Sao Paulo April
25-27 for a series of informational meetings with various financial
sector economists and bankers in Sao Paulo. They were joined by the
new regional Treasury Representative in Sao Paulo, William Block,
and Econoff. In addition to Central Bank representatives, they met
with Banco Santander, Banco Itau, Banespa, Citigroup, JP Morgan,
Lehman Brothers, Maua Investments, Nossa Caixa Bank, and Unibanco.


2. (U) The current local mood about Brazil's near and medium-term
prospects is almost uniformly positive. In contrast to more
cautiously optimistic views heard during previous meetings here
(September 2006), current sentiment is much more upbeat. Most
growth forecasts have been revised upward in recent months by 50
basis points (4.0-4.5 percent projected growth in 2007). Domestic
demand is improving, trade performance is solid, and net financial
inflows have accelerated. Continued foreign exchange appreciation
(USD 1.90-1.95 from USD 2.00-2.05 at end-April) is forecast for
2007. Brazil's Emerging Markets Bond Index (EMBI) spread is only
20-30 basis points above Mexico's despite Brazil's being two notches
below investment grade (upgraded since this visit by Fitch and S&P).
Falling interest rates have supported credit growth, capacity
utilization, and increased fiscal policy space. A financial crisis
- domestic or external - in the next 3-5 years is difficult to
imagine. End Summary.

-------------------------------
SOURCES OF BRAZIL'S IMPROVEMENT
-------------------------------

Disinflation

3. (U) In the view of virtually all market participants,
disinflation has been the most important factor contributing to the
improvement in Brazil's performance in recent years. Low and stable
inflation is now perceived to be a largely permanent feature of
Brazil's economy and, as one analyst stated, "has made Brazil a
normal country for the first time in its history." Stable inflation
expectations have reduced Brazil's country risk premium and cost of
capital, allowed investors to project cash flows over much longer
time horizons (5-10 years), reduced dead-weight loss associated with
unstable prices, and helped extend Brazil's term structure out to
more than 10 years in BRL denominated instruments. Brazil's central
bank is the most respected economic institution in the country.

Reserve Accumulation

4. (U) The pace of reserve growth accelerated sharply in the first
quarter of 2007. The current stock of reserves (around USD 120
billion at end-April, and subsequently higher by an additional USD
5-10 billion) has helped eliminate net public external debt and
significantly reduced Brazil's exchange rate vulnerability. Most
analysts believe considerable room remains to build reserves further
in 2007-08. Few if any concerns were expressed about the potential
costs of continued reserve growth - for example, the quasi-fiscal
costs of rising sterilization (offset in part by falling interest
rates) or rising inflation (offset by stable inflation expectations
and rising real money demand). The quality of recent financial

SAO PAULO 00000432 002 OF 004


inflows is seen as high, with net foreign direct investment inflows
(in part resulting from rising IPO activity) comprising a large
share of inflows. High local yields and stable foreign exchange
expectations have encouraged global carry-trade inflows. The
private banking system maintains a net long position in Brazilian
currency.

Rising Private Sector Productivity

5. (U) Although productivity figures are scarce and subject to
significant standard error, the consensus view is that Brazil's
private sector is experiencing rapid productivity and investment
growth despite high bureaucratic costs and weak business climate
indicators. In contrast to most other Latin American countries (for
example, Mexico), Brazil's private sector is seen as highly dynamic
and globally competitive. Growth sectors include energy,
agri-business, construction, and financial services. With key
micro-level reforms, Brazil's private sector is poised for rapid and
sustained growth.

Banking System Strength


6. (U) Bank balance sheets are strong (average 16 percent
capitalization, legal minimum of 11 percent), and banks should
experience rapid growth in coming years (real estate, medium-sized
commercial lending). Credit growth (consumer and commercial
lending) has expanded rapidly (Citibank has doubled its employees in
its consumer lending department in the past 12 months). Many
analysts noted growth opportunities in housing finance (now only 1.5
percent of GDP), though legal reforms (for example, implementation
of a recent bankruptcy law) are needed first to catalyze lending.
Payroll lending to public sector employees (monthly income serves as
underlying collateral) has risen sharply. A small enterprise loan
market exists but is hobbled by high delinquency (average 1.5
percent default rate per month) and the absence of adequate credit
rating information. Local derivative markets are adequate for most
hedging purposes, with swaps available at reasonable cost and
duration. The quality of bank supervision is reported to be high.
Implementation of Basel II will begin in 2008.

Low Political Risk

7. (SBU) Political risk is low and fears of Latin-style populism in
Brazil have largely disappeared. Most Brazilians view Venezuela and
Bolivia as risks, not benefits, for Brazil and want to avoid
alignment with both countries. The parameters of economic policy
debate in Brazil have narrowed considerably in recent years. Even
among bankers, Lula is well regarded - not because of what he has
accomplished but because of what he has avoided, which is inflation.
One banker stated that Lula "is the most pragmatic person in the
world, and doesn't have an ideological bone in his body." Another
stated that Lula will be recorded as one of Brazil's greatest
presidents because he has "discredited populism in Brazil." At the
same time, all analysts agreed that prospects for economic reform
are non-existent under Lula, and are looking to 2010 as the next
reform window.

-------------------------
CHALLENGES AND PRIORITIES
-------------------------

Poor Fiscal Performance

8. (SBU) Despite continued strong headline numbers, Brazil's fiscal
framework and the underlying quality of its fiscal performance are

SAO PAULO 00000432 003 OF 004


seen as weak. Problems most commonly cited were: (a) poor quality
of public sector expenditures and the lack of social returns earned
on public spending; (b) high tax rates (around 35 percent average
rate) and complexity, which increase evasion and add to economy-wide
dead weight loss; and (c) continued growth in expenditure
indexation. Unwinding indexation, especially with pensions, is
essential but will be politically difficult. Because of low public
sector expenditure quality, Brazilian firms and individuals must
absorb many additional health and educational costs, effectively
increasing the tax rate. Modest tax reform is seen as possible
before 2010. Pension reform, however, will require more time.

Financial Sector Reforms

9. (U) Despite a reasonably robust and healthy banking system,
problems most frequently cited included: (a) a large financial
sector bureaucracy that imposes high red-tape costs, (b) the absence
of securitized and syndicated loan markets (for example, an MBS
market barely exists), and c) weak and costly foreclosure procedures
that contribute to high loan-deposit spreads. Until loan recovery
rates improve, unsecuritized lending is unlikely to grow. The
average monthly interest rate for small-sized enterprise lending is
reportedly 5-7 percent.

Costly Labor Markets

10. (SBU) The high cost of firing employees is seen as a
significant barrier. One analyst stated that it is "virtually
impossible to fire anybody in Brazil." High costs discourage future
employment growth, decrease labor market mobility, reduce resources
available for capital spending, and push a large number of employees
into the informal sector (around 35 percent of GDP). There are no
expectations of labor market reform under Lula.

Energy Sector

11. (U) Several analysts noted emerging weaknesses in Brazil's
energy infrastructure and rising vulnerability to an energy shock.
Brazil remains highly dependent on rainfall to generate electricity.
Brazil's government is responding by increasing capacity, though
too slowly. Private investment is discouraged both by formal
barriers and by a rigid retail price regime. Even absent a shock, a
supply-demand imbalance is expected to emerge by 2010 and become a
growing supply-side constraint.

------------------------------
ISSUES FOR FURTHER EXPLORATION
------------------------------

Intensity of Bank Competition

12. (U) Although most analysts believe Brazilian banks do compete
against each other, a consistent view was not provided about why
abnormally high profits in the sector (recent annual
Return-on-Equities of 30 percent) are not increasing existing
competition or attracting new entrants. Brazil's banking system is
fairly concentrated; 5-6 banks hold two-thirds of deposits and many
banks have quasi-monopolistic holds in some lending markets. Some
believe the lack of competition is due to regulatory barriers (for
example, the time and paperwork involved when consumers try to
transfer accounts to different banks, which reduces bank
competition), while others believe that further capital market
deepening is needed to increase the level of competition banks face.


Economic Openness

SAO PAULO 00000432 004 OF 004

13. (U) Views also differed on the extent to which Brazil is
externally open. While formal trade barriers have fallen, informal
barriers remain high. A recently established "IPOD Index" (akin to
the Big Mac index of The Economist news magazine, measuring relative
prices of non-tradables across countries) that attempts to proxy the
international price of tradable goods reportedly showed that Brazil
has the highest IPOD costs of any country in the world, thus
suggesting a lack of openness.

Reducing Real Interest Rates

14. (U) Some analysts believe that further reductions in real rates
(currently around 8.5 percent) are needed for higher growth. Others,
however, believe that lower rates, while beneficial, will have a
smaller impact on growth. One reason cited is that Brazil is
already thought to be growing at or near its full employment level
(i.e., reducing the output effects and increasing the price effects
of further monetary stimulus). Some analysts also noted that lower
rates may further diminish Lula's political incentive to enact
reforms by providing him with further breathing room with fiscal
policy.

Central Bank Foreign Exchange Intervention

15. (U) Most analysts believe recent central bank reserve growth is
motivated by its interest in increasing precautionary reserves.
However, at least one major bank (Unibanco) stated that intervention
is being driven primarily by a need to prevent excessive currency
appreciation and pre-empt export-industry political pressures.

Benefits of Investment Grade Status

16. (U) Views also differed on the expected benefits of investment
grade status. Some analysts believe this will be an important
milestone and will generate important spinoff benefits (for example,
further investment from institutional investors). Others noted that
Brazil's external, dollar-denominated debt is already trading close
to investment grade spreads and do not foresee significant
additional benefits. As a result of Brazil's recent GDP revision and
reduced debt ratios, investment grade status is now expected by the
end of 2009 rather than 2010.

17. (U) This cable was coordinated with Embassy Brasilia.

MCMULLEN

© Scoop Media

 
 
 
World Headlines

 

New IPCC Report: ‘Unprecedented Changes’ Needed To Limit Global Warming

Limiting global warming to 1.5°C will require “far-reaching and unprecedented changes,” such as ditching coal for electricity to slash carbon emissions, says a special report that finds some of the actions needed are already under way, but the world must move faster… More>>

ALSO:

Jamal Khashoggi: UK, France, Germany Join Calls For Credible Investigation

Germany, the United Kingdom and France share the grave concern expressed by others including HRVP Mogherini and UNSG Guterres, and are treating this incident with the utmost seriousness. More>>

ALSO:

MSF Not Wanted: Nauru Government Shows Continued Callousness

The Nauruan Government’s decision to ask Doctors Without Borders to immediately leave shows continued callousness towards asylum seekers desperately seeking a safe place to call home, Green MP Golriz Ghahraman said today. More>>

ALSO:

Sulawesi Quake, Tsunami: Aid Response Begins

Oxfam and its local partners are standing by to deploy emergency staff and resources to the Indonesian island of Sulawesi, as an estimated 1.5 million people are thought to be affected by the massive earthquake and tsunami that hit on Friday. More>>

ALSO:

Decriminalising Same-Sex Relationships: UN Rights Chief Applauds Indian Decision

“This is a great day for India and for all those who believe in the universality of human rights," Bachelet said. "With this landmark decision, the Indian Supreme Court has taken a big step forward for freedom and equality...” More>>

ALSO:

 
 
 
 
 
 
  • Pacific.Scoop
  • Cafe Pacific
  • PMC