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Cablegate: Brazilian Industrial Policy Increases Gob's Hold On

VZCZCXRO7499
RR RUEHRG
DE RUEHSO #0268/01 1511724
ZNR UUUUU ZZH
R 301724Z MAY 08
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 8255
INFO RUEHBR/AMEMBASSY BRASILIA 9383
RUEHRG/AMCONSUL RECIFE 4117
RUEHRI/AMCONSUL RIO DE JANEIRO 8732
RUEHBU/AMEMBASSY BUENOS AIRES 3158
RUEHAC/AMEMBASSY ASUNCION 3406
RUEHMN/AMEMBASSY MONTEVIDEO 2710
RUEHSG/AMEMBASSY SANTIAGO 2406
RUEHLP/AMEMBASSY LA PAZ 3817
RUCPDOC/USDOC WASHDC 3097
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC
RUEHC/DEPT OF LABOR WASHDC

UNCLAS SECTION 01 OF 03 SAO PAULO 000268

SIPDIS
SENSITIVE

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

E.O. 12958: N/A
TAGS: ECON ELAB EIND ETRD KTDD EINV BR
SUBJECT: BRAZILIAN INDUSTRIAL POLICY INCREASES GOB'S HOLD ON
ECONOMY

SENSITIVE BUT UNCLASSIFIED--PLEASE PROTECT ACCORDINGLY

REF: A. Sao Paulo 0207 B. Sao Paulo 0264

1. (SBU) SUMMARY: The Brazilian government announced on May 12 a
new industrial policy intended to stimulate economic growth with a
goal of growing GDP by five percent per year from 2008 to 2010. The
Productive Development Policy incorporates financing and tax breaks
to achieve four main objectives: increase investment as a share of
GDP, stimulate research and development for industrial innovation,
expand Brazil's share of global exports, and provide incentives for
more small and medium size exporters. However, most interlocutors
have said the new plan is unlikely to have any noticeable impact on
economic growth. The policy visibly increases the state's
participation in the economy, a potentially negative development for
Brazil. END SUMMARY.

GOB LAUNCHES NEW INDUSTRIAL POLICY
----------------------------------

2. (U) On May 12, President Lula unveiled the Productive
Development Policy (PDP) aimed at stimulating investment and
domestic production of goods to increase Brazilian exports. The GOB
is striving to maintain five percent GDP growth from 2008 to 2010 by
redoubling its efforts in four target areas: increasing fixed
capital investment from 17.6 to 21 percent of GDP by 2011 for a
total of USD 385 billion in 2010; stimulating private investment in
research and development of industrial innovation from 0.54 percent
of GDP to 0.65 percent in 2010; expanding Brazil's share of global
exports from 1.18 to 1.25 percent of total world exports by the end
of 2010; and increasing small and medium-sized export companies by
10 percent to a total of almost 13,000 companies by 2010.

TAX CUTS AND LOW-COST LOANS TO BOOST EXPORTS
--------------------------------------------

3. (U) The GOB plans to stimulate the four target areas via
financing and tax incentives. On the financing side, the Brazilian
Development Bank (BNDES) is set to distribute USD 131 billion over
three years to finance industrial production and services, with
additional financing benefits for capital goods investment. (Note:
BNDES President Luciano Coutinho said that this total excludes
financing made available for infrastructure projects under the
Program for Growth Acceleration (PAC) unveiled in 2007. End Note.)
Tax breaks, including credits for capital goods purchases, and
reduced financial transactions and industrial taxes would total USD
12.5 billion by 2011 to boost industrial production; however, some
of these tax breaks already exist. According to Bear Stearns, the
GOB's main objective is to provide incentives to the Brazilian
export sector to help contain the appreciation of the Brazilian
currency and ultimately strengthen Brazil's external accounts. The
GOB also has marketed the PDP as a way to improve Brazil's
competitiveness in high-tech industries and promote domestic
industries that serve a majority of the population such as
construction, IT, and agriculture.

TARGETS BY INDUSTRY
-------------------

4. (U) Following are targets by industry through 2010:

--Civil construction: Increase productivity by 50 percent.
--Capital Goods: Investment of USD 11.5 billion, increase in R&D and
increase exports;
--Made-to-Order Capital Goods: Double exports and increase
investment in R&D;
--Wood and Furniture: Increase domestic sales by 15 percent;
increase exports by 7.5 percent and increase domestic market
consumption by 30 percent;
--Hygiene and Toiletries: Increase exports to reach USD 700
million;
--Leather and Footwear: Increase exports of leather products by 10
percent;
--Plastics: Double exports to reach USD 2.2 billion;

SAO PAULO 00000268 002 OF 003


--Automobiles: Target production to reach four million units by 2010
and 5.1 million by 2013;
--Aerospace: Double production and exports and maintain third place
in world ranking;
--Agribusiness: Increase exports by 25 percent;
--Services: Increase service exports to USD 40 billion
--Naval: Increase domestic content to reach 85 percent;
--Information Technology: Promote software and IT services to
increase revenues to USD 3.5 billion;
--Meat: Promote exports to reach USD 14 billion;
--Textiles: Increase revenues to USD 41.6 billion;
--Cellulose, Mining, and Steel: Increase investment and keep Brazil
among the five top worldwide producers;
--Biodiesel: Increase production to 3.3 billion liters;
--Ethanol: Increase production to 23.3 billion liters and increase
to reach 5 billion liters;
--Oil and Natural Gas: Increase oil production to 2.4 million
barrels per day;
--Healthcare: Decrease trade deficit to USD 4.4 billion by 2013;
--Defense: Invest USD 1.4 billion in modernization and R&D and
increase purchase of Brazilian-made goods;
--Biotechnology: Stimulate the creation or development of 100 small
and medium companies.
--Nanotechnology: Increase investment to USD 70 billion in R&D,
innovation, and science and technology.

IT AND CAPITAL GOODS PRIORITY INDUSTRIES
----------------------------------------

5. (U) The Brazilian IT industry is set to reap significant
potential benefits from the new PDP. The policy allows IT firms to
reduce their social security contributions from 20 to 10 percent and
to deduct research and development expenses from a federal tax on
net profits (CSLL) and corporate income taxes. The GOB also
announced USD 598 million in public investment to expand the
software and IT services industries through 2010.

6. (U) The PDP also includes a provision that allows domestic
industrial manufacturers of capital goods, automobiles, and auto
parts to reduce depreciation of investments in domestically produced
capital goods from a period of 10 to two years. According to the
private think tank Institute of Industrial Development Studies
(IEDI), more than half of the USD 3.8 billion in tax breaks on
investments would go to auto manufacturers and auto parts in Brazil.
Indeed, the Ministry of Finance calculated that these two sectors
would save approximately USD 1.9 billion from now until 2010 in tax
breaks thanks to the accelerated depreciation.

MIXED-REACTION
--------------

7. (SBU) Brazilian industry has reacted cautiously to the GOB's
industrial development plan. Former Finance Minister and Economist,
Luis Carlos Mendonca, although satisfied with the plan, highlighted
the need to support domestic producers in sectors that export to
China over sectors competing with China. According to Paulo Skaf,
President of the Sao Paulo Federation of Industries (FIESP), the
measures appear positive, but FIESP needed more details to make a
comprehensive analysis. Jackson Schneider, President of the
Brazilian National Auto Industry Manufacturers Association
(ANFAVEA), is in favor as the PDP provides strong benefits for the
auto industry. However, others including IEDI have criticized the
implicit preferential treatment for the auto industry, noting that
the auto industry did not require financial support and cited as
evidence the sector's phenomenal performance to date. (Comment:
Brazilian auto sales are up 31 percent and production is up 10
percent over the same period last year. For more information on
Brazil's auto sector see Ref A. End Comment.)

8. (SBU) Interlocutors in the Sao Paulo finance community told
Econoff that they view the PDP as a political initiative that would
be ineffective at stimulating Brazil's productive sector. Emy Shayo
of Bear Stearns said that the GOB's immediate goal of combating the
Brazilian currency's appreciation by promoting exports is unlikely

SAO PAULO 00000268 003 OF 003


to be of much benefit as export gains are currently driven by high
commodity prices which have little to do with government incentive
policies. Furthermore, Shayo would have preferred universal and
deeper tax benefits that would address Brazil's high tax burden,
which continues to be the Brazilian industry's biggest concern. In
her view, Brazil's industrial policy should have instead targeted
emerging industries that are unable to compete in the global
marketplace and that have a potential comparative advantage.

COMMENT
-------

9. (SBU) The PDP has a clear undertone of greater state
intervention in the Brazilian economy and is another example of
forces within the Lula Administration's preference for greater state
participation in influencing the marketplace (Ref B). The GOB's
attempt to pick winners and losers is unlikely to stimulate economic
growth and keep the economy growing at five percent per year.
Indeed, the plan appears to target Brazil's most robust industries
rather than helping improve conditions for industries that are
unable to meet market demand such as the chemicals and metallurgy
industries. The PDP fails to address the tax reforms needed to
sustain economic growth. Despite the fanfare, it is unclear whether
the GOB has the resources to implement the new industrial policy.
Instead, the government would do better to reduce spending, simplify
and reduce taxes, and use excess revenues to accelerate its payment
of public debt. END COMMENT.

10. (U) This cable has been coordinated with and cleared by Embassy
Brasilia.

WHITE

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