Cablegate: Brazil: "Sovereign Wealth Fund" Aka "Fiscal Savings Fund"

DE RUEHBR #0792/01 1621723
P 101723Z JUN 08




E.0. 12958: N/A
SUBJECT: Brazil: "Sovereign Wealth Fund" aka "fiscal savings fund"
aka "investment fund"

Refs: a) Sao Paulo 53 b) Sao Paulo 264

(SBU)1. SUMMARY: Despite its name, GOB interlocutors from Finance,
Planning and Central Bank agree that Finance Minister Mantega's
proposal for a "sovereign wealth fund" could more accurately be
described as an "investment fund" or a "fiscal savings fund" of
about 10 to 20 bn usd. Planning and Central Bank interlocutors
appear considerably more relaxed regarding the current formulation
of the planned proposal to establish this fund than they were
regarding previous iterations (reftels). While Finance hopes
President Lula will forward a legislative proposal to congress in
June, exact timing remains unclear. Mantega's June 8 press
statements that the fund could draw on oil revenues in three to five
years to create a 200-300 bn usd fund does not take into account
that these fields are not expected to generate revenue in this
timeframe and would likely if eventually formally proposed encounter
Central Bank and congressional opposition. END SUMMARY

(SBU) 2. Alexandre da Rosa, Secretary for International Affairs at
Planning Ministry, told Treasury DAS Brian O'Neill June 2 that the
current government concept is more accurately described as a "fiscal
fund," a countercyclical instrument. Demand is heating in Brazil and
the government needs to reduce its own spending as a component of
that demand. Da Rosa stated that this leads to the idea that a fund
that can absorb excess dollars would be helpful. Da Rosa indicated
that Singapore had come to Brazil and explained its sovereign wealth
fund, and that Finance had discussed sovereign wealth fund
structures with relevant Gulf states. Da Rosa underlined that
reserves were off the table as a funding source for the fund, and
that Brazil hoped to increase the primary surplus target by 0.5% of
GDP (or about usd 13 billion/year) to fund this mechanism. He
acknowledged that how the resources would be used remains undefined
- one possibility would be to use the funds to buy down BNDES (the
National Development Bank of Brazil) debt.

(SBU) 3. In a separate meeting, Alvaro Vereda Oliveira, Finance
Ministry Assistant Secretary for Financial Organizations and
Regional Integration, noted Brazil is dealing with an issue that
would have been inconceivable twenty years ago - how to deal with an
excess of dollars coming into its economy. Vereda noted that the
structural evolution of Brazil in international trade has financial
consequences and this is the real rationale for the "sovereign
wealth fund" - it is a structural tool to deal with this situation.

(SBU) 4. In a meeting with SFRC Senior Professional Staff Member
Carl Meacham on June 4, Deputy Secretary of the Finance Ministry's
National Treasury, Cleber Ubiratan de Oliveira noted that while the
primary surplus target is 3.8%, as of end-April the surplus was
4.23% (allowing the GOB to estimate that 0.5% of GDP would be
available to stock the fund). Describing the fund as a "key public
policy alternative fund" given the positive fiscal environment,
Ubiratan explained the GOB would like to propose expanding the
primary surplus to 4.5% and use these receipts to expand the fund.
Responding to Meecham's question, Ubiratan noted that, while
Petrobras currently contributes about 35% of the primary surplus,
recent finds (that will take years to exploit) are not expected to
dramatically affect Petrobras' contributions in the short-term and
do not figure particularly into the rationale behind proposing a
sovereign wealth fund. He stated Brazil was unique in that the
rationale for a sovereign wealth fund was not based on commodity
revenues, but on its robust reserves and good fiscal position, and
therefore was not comparable to other countries SWFs. Ubiratan
characterized the fund as a "fiscal savings fund" using primary
surplus funds that can be invested on more favorable terms with more
profitable returns than reserves can generate. He asserted the
National Treasury would manage the fund through a financial
institution, but acknowledged that no regulations or operating
procedures had been drafted or "appropriate structure and apparatus"
decided yet. Ubiratan said the fund's investment policy was not
decided yet but that BNDES would probably "be involved." Visibly
nervous answering questions, Ubiratan claimed that all signs
indicated the Congress would pass the proposal (other interlocutors
were more realistic). Finance confirmed the proposal was expected
to go forward as a legislative proposal rather than as a
"provisional measure."

5. (SBU) Alexandre Tombini, the Central Bank's Deputy Governor for
Financial System Regulation and Organization, told Treasury DAS
O'Neill that the Central Bank buying reserves (around 200 bn usd at
present) helps "soften" the effects of the floating exchange rate,

BRASILIA 00000792 002 OF 003

and no major foreign exchange shocks are foreseen for 2008. He
considered the Finance Ministry announcement proposing to request an
increase in the primary surplus target would have a positive effect
in controlling exchange rates. He believed that the Finance
Minister's proposal "as it is now" is fine from the Central Bank's
perspective. Noting this is a "fiscal fund" or an "investment fund"
rather than a classic "sovereign wealth fund" proposal, Tombini felt
the fund might help Brazil control demand if funds were invested
abroad, although it would be costly as a demand management tool.

(SBU) 6. In a separate discussion with econoff June 4, Alexandre
Pundek, senior Advisor to the Central Bank board, noted Mantega had
wanted the fund as a tool to control the foreign exchange rate - to
help FIESP and to provide additional funding for BNDES beyond the
FAT (the workers' fund that is the primary revenue source for
BNDES). He said Central Bank at this point is not worried about
Mantega's fund and feels more comfortable supporting the proposal
because: 1) the level of the 2009/2010 primary surplus is set in the
2008 budget law and Finance can not change at this point - they set
0.5 percent of GDP as the funding target because they can not raise
more now; 2) Mantega envisions between ten billion and twenty
billion usd going to this fund. From Central Bank's perspective,
the Finance-controlled fund would only be an important player if the
fund were bigger than the Central-Bank managed reserves (200 bn usd)
- otherwise, any foreign exchange intervention Finance attempts
could be immediately countered by Central Bank reserve activity if
necessary; and 3) any attempt to raise the primary surplus above the
current 3.8 percent in order to fund the mechanism is highly
unlikely to survive Congress. In an election year, Congress will
not agree to a proposal that decreases public spending at a time
they want to fund programs popular with the electorate. He added
that Central Bank head Meirelles thinks the fund is a good proposal
in the sense that it would prevent the government from spending at
even higher levels now that in-coming revenues are higher.

(SBU) 7. Officials at Brazil's National Treasury (Otavio Ladeira,
Director of Public Debt Strategic Management, and Lena Oliveira,
Director of Research) strongly defended the establishment of the
Wealth Fund in a meeting with the Treasury Financial Attache on June
3. They stated that the Fund's overriding purpose was to provide the
Finance Ministry with room to intervene in Brazil's foreign exchange
market, helping to manage appreciation of the Brazilian real.
However, they do not believe this objective will conflict with the
Brazilian Central Bank's mandate to target inflation at 4.5%. A
secondary purpose of the Fund is to help finance large Brazilian
export firms via BNDES credit lines and BNDES purchases of debt
issued by these firms. The firms that will receive this support will
be selected by an intra-governmental committee that will include the
Finance Ministry, Planning Ministry, Ministry of Industry and
development, and BNDES. Participation by the Central Bank is
uncertain. The Fund will initially be financed by fiscal resources.
Ladeira, however, stated that it is possible the Fund will borrow in
the future to help increase the size of its asset base. Assets will
consist of foreign currency instruments. Details about the specific
instruments that might be purchased, however, remains under internal
(SBU) 8. COMMENT: While variously presented as a tool to cut
government spending as a factor in heating demand and as a way to
maximize return on government investment, GOB interlocutors clearly
view this fund as a tool to manage foreign exchange rates. Although
the timing for putting any legislative proposal forward remains
unclear (Mantega has said publicly the proposal could go forward by
mid-June), the sovereign wealth fund is likely to meet with
congressional opposition, both for inserting Finance Ministry into
monetary policy and because it would decrease government spending in
an election year. Meanwhile, Senator Renato Casagrande (PSB -
government alliance) announced May 29 that, when the Government
forwards its proposal to the House for its consideration, the Senate
will begin to simultaneously consider the SWF proposal he drafted in
February which proposes that if Brazil's international reserves pass
ten percent of GNP, the amount over that ten percent should be used
to establish a fund that would invest in the international market to
obtain returns higher than US Treasury bonds. The government
proposal is expected to rely on primary surplus funds to buy
dollars, without recourse to reserves. Behind the scenes
negotiations among Ministries and with the Central Bank appear to be
moving GOB toward a proposal that satisfies both Mantega's desire
for a central role and Central Bank's ultimate control over monetary
policy. Mantega's statements to the press June 8 that the fund
will start small but in three to five years be able to draw on new
oil field revenues to provide a fund of 200 to 300 billion usd is

BRASILIA 00000792 003 OF 003

not realistic given these fields are not expected to begin producing
in this timeframe. Any proposal to expand the fund to that size in
the future would likely encounter renewed Central Bank opposition
and experience difficulty in the congress. END COMMENT.

This message was drafted with input from FinAtt Sao Paulo.


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