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Cablegate: World Financial Market Volatility Rocks Brazil In

VZCZCXRO6077
PP RUEHRG
DE RUEHSO #0709/01 2291935
ZNR UUUUU ZZH
P 171935Z AUG 07 ZFF6
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC PRIORITY 7360
INFO RUEHAC/AMEMBASSY ASUNCION PRIORITY 3072
RUEHBR/AMEMBASSY BRASILIA PRIORITY 8479
RUEHBU/AMEMBASSY BUENOS AIRES PRIORITY 2826
RUEHCV/AMEMBASSY CARACAS PRIORITY 0532
RUEHLP/AMEMBASSY LA PAZ PRIORITY 3440
RUEHME/AMEMBASSY MEXICO PRIORITY 0804
RUEHMN/AMEMBASSY MONTEVIDEO PRIORITY 2401
RUEHSG/AMEMBASSY SANTIAGO PRIORITY 2103
RUEHRG/AMCONSUL RECIFE PRIORITY 3721
RUEHRI/AMCONSUL RIO DE JANEIRO PRIORITY 8262
RHEHNSC/NSC WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RUEHRC/DEPT OF AGRICULTURE WASHDC PRIORITY
RHMFISS/CDR USSOUTHCOM MIAMI FL PRIORITY

UNCLAS SECTION 01 OF 02 SAO PAULO 000709

SIPDIS

SENSITIVE
SIPDIS

STATE FOR WHA/FO, WHA/BSC, WHA/EPSC, INR
STATE PASS USTR FOR KATE DUCKWORTH
NSC FOR TOMASULO
TREASURY FOR JHOEK

E.O. 12958: N/A
TAGS: ECON EFIN BR
SUBJECT: WORLD FINANCIAL MARKET VOLATILITY ROCKS BRAZIL IN
SHORT TERM

SAO PAULO 00000709 001.4 OF 002


1. (SBU) Summary: The global financial turmoil resulting
from losses in global credit markets as well as concerns
about the US sub-prime credit market have hit Brazilian
assets hard over the last several days. BOVESPA, Brazil's
principal stock market, registered declines of more than 15
percent since the beginning of August due to capital flight
from international investors. In addition, stock market
declines have put downward pressure on the country's
appreciating currency. Over the short-term, Consulate
General financial contacts expect the volatility to continue;
however, they are cautiously optimistic that Brazil's
economic fundamentals remain strong enough to weather any
short-term fluctuations. Brazil may in turn benefit over the
medium-term by demonstrating to international investors the
country's resilience to external financial shocks. End
Summary.

Brazil Taking a Big Hit in the Short Term
-----------------------------------------
2. (U) On August 16, BOVESPA suffered its worst performance
since April, falling by more than 8 percent before rallying
to close down nearly 3 percent. The combined market value
losses for Brazilian companies total more than $270 billion
USD and the currency has depreciated by more than 11 percent
in August alone. While liquidity in the Brazilian stock
exchange encourages international investors and has been a
key factor in driving down the country's risk premium,
Brazilian assets suffered extensive impacts from the
worldwide global financial turmoil as international investors
moved out of the market. The country risk premium, which
measures the market's confidence in the country, reached 229
points on August 16 (a significant increase from just a few
months ago), and is now at Brazil's highest level since
December 2006. Mauricio Oreng, the Vice-President for
Economic Research at Banco Itau, one of Brazil's top banks,
told Econoffs that one of the reasons Brazil has seen such an
impact is because Brazil's higher stock market trading volume
facilitates the quick withdrawal by international investors
that are opting to cash out of emerging market assets.

Short-term Volatility Likely to Continue
----------------------------------------
3. (SBU) Brazilian financial market analysts are
unaccustomed to the extreme fluctuations worldwide financial
markets experienced in the first part of August. While the
Brazilian currency and stock market indices have steadily
increased over the past few years, the rapid swings surprised
local market analysts. Local financial analysts told the US
Treasury Financial Attache that they expect volatility to be
high for the foreseeable future and that it is impossible to
predict when markets will calm down.

4. (SBU) Starting on August 14, the Brazilian Central Bank
refrained from buying up dollars to curb the Brazilian
currency's appreciation vis--vis the US dollar. This
decision not to intervene in the currency market was the
first time the Brazilian Central Bank has made this decision
in over a year. Banco Itau told Econoffs the Central Bank
likely opted against intervening as a sign to encourage
market self-regulation and to increase market confidence over
the long-term in the floating exchange rate regime. Itau
believes Brazil's Monetary Policy Committee's (COPOM) recent
trend of reference interest rate cuts is unlikely to continue
over the short-term, and stock traders in Sao Paulo told the
Attache that local reaction suggests no major shift in
expectations at its upcoming meetings in September and
October.

Economic Fundamentals Remain Sound
----------------------------------

SAO PAULO 00000709 002.3 OF 002


5. (SBU) Although Brazil's financial market has suffered
some significant losses over the last several days, Consulate
General financial contacts remain cautiously optimistic. The
origin of the sell-off of Brazilian stocks is entirely
external, and the country's fundamental economic performance
is broadly unchanged. Brazil is one of several emerging
market countries that are experiencing an outflow of foreign
capital as part of a worldwide market reaction, which
indicates investors are not differentiating between the
various emerging markets. Contacts believe the markets will
eventually correct themselves. Brazilian stock traders told
the Attache that valuations now look much more attractive
than before when emerging markets had experienced large price
appreciations, and the decline over the last week may bring
prices closer to more sustainable levels and encourage some
investors to start buying Brazilian stocks.

6. (SBU) Brazilian financial and economic analysts generally
agree that the recent volatility is unlikely to affect the
country's economic performance over the medium term.
Financial analysts told the Attache that they have no reason
to fear an economic crisis given Brazil's economic
fundamentals. Brazil's trade balance remains sharply
positive around $45 billion USD, and international reserves
are at an historic high of nearly $160 billion USD. Together
with the country's improving debt position, the macroeconomic
picture seems strong enough to withstand the volatility.
Brazil's domestic economy drives the country's economic
growth, and because of its diverse export product and market
base, Brazil's external sector is relatively insulated from a
downturn in the US economy. Brazil, however, would likely
feel the secondary impacts of a worldwide slow-down in
economic growth.

Comment
-------
7. (SBU) Brazil is well-positioned to overcome the global
short-term financial market volatility. Two years ago,
Brazil's economic fundamentals may not have been strong
enough to withstand sustained capital flight, however today
the country is likely to benefit over the medium-term. The
recent movements could help buttress Brazil's quest to win
investment grade ratings from the major ratings agencies by
the end of 2008. BOVESPA has, at least over the past few
months, closely tracked with changes in the Dow Jones (DJ).
Should that trend continue, upward movements in the DJ could
also portend an upward trend in the BOVESPA. The country's
ability to successfully weather extremely volatile market
conditions could prove its resilience to external shocks and
strengthen perceptions about its economic fundamentals,
welcome news to international investors. End Comment.

8. (U) This cable has been coordinated with the US Treasury
Attache in Sao Paulo and with Embassy Brasilia.
WHITE

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