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Cablegate: Brazil Awarded Investment Grade Credit Rating

VZCZCXRO5456
RR RUEHRG
DE RUEHSO #0247/01 1361552
ZNR UUUUU ZZH
R 151552Z MAY 08
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 8226
INFO RUEHBR/AMEMBASSY BRASILIA 9354
RUEHRG/AMCONSUL RECIFE 4101
RUEHRI/AMCONSUL RIO DE JANEIRO 8714
RUEHBU/AMEMBASSY BUENOS AIRES 3143
RUEHAC/AMEMBASSY ASUNCION 3391
RUEHMN/AMEMBASSY MONTEVIDEO 2695
RUEHSG/AMEMBASSY SANTIAGO 2391
RUEHLP/AMEMBASSY LA PAZ 3802
RUCPDOC/USDOC WASHDC 3082
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 03 SAO PAULO 000247

SIPDIS
SENSITIVE

STATE PASS USTR FOR KDUCKWORTH
STATE PASS EXIMBANK
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE
DEPT OF TREASURY FOR JHOEK, BONEILL

E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD BR
SUBJECT: BRAZIL AWARDED INVESTMENT GRADE CREDIT RATING

SENSITIVE BUT UNCLASSIFIED--PLEASE TREAT ACCORDINGLY

REF: A. 07 Sao Paulo 0768
B. Sao Paulo 0227

1. (SBU) Summary: In a surprising move, credit ratings agency
Standard and Poor's (S&P) upgraded Brazil's foreign currency
sovereign credit rating to investment grade on April 30. Financial
analysts had widely speculated that Brazil might earn the upgrade
later in 2008, but S&P surprised analysts and investors alike,
largely by upgrading Brazil amidst looming prospects of a global
economic slowdown. As a result of this upgrade, investment in
Brazil is widely expected to increase. However, some interlocutors
told Econoff that the new-found status symbol could discourage the
GOB from making any meaningful reforms especially tax reform.
Brazil's status as an investment grade sovereign is tenuous and
could still be blown off course by a change in external
circumstances such as an economic slowdown in China. To solidify
these gains, the GOB needs to make meaningful reforms. End
Summary.

2. (SBU) Over the past year, both in discussions with ratings
agency heads in Brazil and local economic and financial analysts
(reftels), nearly all agreed that Brazil would get the coveted
upgrade to an investment grade foreign currency sovereign credit
rating before 2009. Brazil was the last of the so-called "BRIC"
(Brazil, Russia, India, and China) countries to receive an
investment grade credit rating. A Credit Suisse economist told
Econoff that he had expected Brazil to obtain investment grade in
2008 because of Brazil's improved solvency indicators such as
foreign reserves of nearly USD 200 billion and economic policies
that reduce uncertainty and improve economic stability. Indeed, S&P
cited Brazil's stability in recent months amidst global financial
market volatility, the anti-inflationary response of the Central
Bank, continued strong revenue collection, and the fact that Brazil
is now a net external creditor as some of the major reasons for the
upgrade.

3. (SBU) All economists that Econoff spoke to about Brazil's
upgrade to investment grade agreed that it would increase investment
flows into Brazil. Brazil closed out 2007 with USD 34.6 billion in
foreign direct investment (FDI) and reached USD 8.8 billion in the
first quarter of this year, up 34 percent over the same period last
year. Luiz Figueiredo of MAUA Investments told Econoff he believes
total FDI for 2008 will reach USD 50 billion. Bear Stearns
economist Emy Shayo said that the upgrade would be a confidence
enhancer for companies willing to make long-term investments in
Brazil and that she expected FDI flows to swell, especially after
the U.S. economy rebounds.

4. (SBU) Giovanna Rocca, an economist at Unibanco, told Econoff
that the upgrade would drive portfolio investment flows and should
take Brazilian asset prices to higher levels. Indeed, markets in
Brazil and New York reacted positively to the news with the Bovespa
hitting an all-time high of 70,000 points on May 5 and many American
Depository Receipts for Brazilian firms listed on the New York Stock
Exchange up by as much as 10 percent. Similarly, Bovespa's Advisor
for Development and International Relations Cristiana Pereira added
that the upgrade would facilitate pension fund investment in
Brazilian assets. Despite her optimism, institutional investors
that are restricted to investment grade assets could take some time
to move their positions into Brazilian assets. Local press
highlighted in an interview with Calpers, the California state
government employees' pension fund worth USD 245 billion, that
Calpers had not previously been restricted from holding Brazilian
assets. Indeed, Calpers currently holds USD five million in
government paper and another USD eight million in Brazilian
companies' stocks. Brazil can expect to wait for the mega-fund to
buy up Brazilian assets because the Calpers representative stated
that it revises its allocations every three years.

5. (SBU) Investment banks outside Brazil also agreed that the move
was positive, but would take time for Brazil to see the effects.
Fiona Gallagher, Global Head of Private Investments at Deutsche Bank
in London, told Econoff that investors are keeping a close eye on
Brazil and waiting for upgrades from Fitch and Moody's. Without two

SAO PAULO 00000247 002 OF 003


sovereign ratings as investment grade, large insurance companies
cannot make significant investments in Brazil. She said many are
starting to read up on Brazil in anticipation of a second upgrade,
but opined that the big wave probably would not happen until at
least one other ratings agency improves its rating. She also noted
that the Japanese ratings agency R&I had already rated Brazil as
investment grade; however, the National Association of Insurance
Commissioners does not yet recognize R&I's ratings. She said R&I
was working to have their status changed, which could expedite
fixed-income investment flows to Brazil. UBS Global Asset
Management Director for Growth Investors Stephen Derkash based in
San Diego, California, told Econoff that the effects would not be
immediate and they are dependent on other factors. He noted that
although more fixed-income investors may now be able to invest in
Brazil, he did not believe they would in the near-term because
Brazilian debt is already expensive. New equity flows should enter
the country, but investors will want to wait until growth picks up
or fixed-income spreads gradually decline, making equity valuations
more attractive, he said.

6. (U) Unlike other investment grade countries, the title itself
probably will not drive down real Brazilian interest rates in the
short-term. (Note: Real interest rates in India and South Africa,
for example, declined from 3.9 to 1.6 percent and 9.4 to four
percent, respectively, from one year before attaining investment
grade to one year after. End Note.) Brazil, instead, probably will
see interest rate hikes over the next year given widespread concerns
about inflation (ref B). Press comments noted that the timing of
the upgrade was also likely due in part to the Central Bank's
aggressive tightening last month, in what many saw as consolidating
its operational independence from the GOB.

7. (SBU) Brazil has already capitalized on its new status. The
National Treasury on May 7 issued USD 500 million in
dollar-denominated debt to U.S. and European investors at the lowest
interest rates for this bond-class to date. The GOB plans to use
the proceeds to retire more expensive debt. A Credit Suisse
economist told Econoff that the upgrade should also reduce the
average borrowing costs for companies and extend loan maturities.

8. (SBU) Brazil's award of an investment grade credit rating,
however, is not the "magic" moment that President Lula proclaimed
upon hearing about S&P's announcement. Solid finances are a
necessary but not by itself sufficient condition for broader
economic development. Ratings are an opinion about a country's
solvency and ratings can change. Uruguay is the most recent example
of a country to win a foreign currency investment grade sovereign
credit rating only to quickly lose it in 2002. Reforms are the only
real way to protect against risk. Without meaningful reforms to
generate sustained economic growth, Brazil is unlikely to maintain
annual growth rates above five percent. David Fleischer, a
long-time Brazil analyst, noted in his most recent analysis that no
major reform has been approved in the last five years. In his view,
the award of investment grade could provide even less incentives for
the GOB to institute reforms.

9. (SBU) Comment: Brazil deserves recognition for its achievements
over the last six years. The Lula Administration has brought net
external debt down from 59.6 percent of GDP in 2002 to 42.8 percent
last year. However, exploding tax revenues are helping to hide the
GOB's expansionary fiscal policy and Brazil will need to tighten the
purse-strings if there is a change in external circumstances, such
as a deeper U.S. economic slowdown, a slowing Chinese economy, or a
sharp fall in commodity prices. Indeed, the other dominant rating
agency Moody's pointed to reduced government spending as a percent
of GDP as one of the necessary precursors for the firm to upgrade
Brazil to investment grade. As some market analysts have
speculated, S&P's hasty upgrade may have been in part an effort to
outdo its competition. Likewise, the potential rush of foreign
capital following the upgrade would put even more upward pressure on
the Brazilian currency, a growing concern that the GOB would need to
face if exporters become more vocal. However, rather than lifting
import restrictions to help absorb the foreign currency, the GOB
will likely continue to concoct quick fixes to provide exporters
with temporary relief. End Comment.


SAO PAULO 00000247 003 OF 003


10. (U) This cable has been coordinated with and cleared by Embassy
Brasilia and coordinated with the US Treasury Financial Attache in
Sao Paulo.

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