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Cablegate: Global Financial Volatility-Brazil Reserved Not Scared

VZCZCXRO7107
RR RUEHRG
DE RUEHSO #0486/01 2611718
ZNR UUUUU ZZH
R 171718Z SEP 08
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 8520
INFO RUEHBR/AMEMBASSY BRASILIA 9652
RUEHRG/AMCONSUL RECIFE 4193
RUEHRI/AMCONSUL RIO DE JANEIRO 8849
RUEHBU/AMEMBASSY BUENOS AIRES 3248
RUEHAC/AMEMBASSY ASUNCION 3495
RUEHMN/AMEMBASSY MONTEVIDEO 2773
RUEHSG/AMEMBASSY SANTIAGO 2495
RUEHLP/AMEMBASSY LA PAZ 3908

UNCLAS SECTION 01 OF 03 SAO PAULO 000486

SIPDIS
SENSITIVE

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

C O R R E C T E D C O P Y (CORRECTING FORMATTING ISSUES)

E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD BR
SUBJECT: GLOBAL FINANCIAL VOLATILITY-BRAZIL RESERVED NOT SCARED

REF: SAO PAULO 476

SAO PAULO 00000486 001.2 OF 003


1. (SBU) Summary: The unprecedented bankruptcy of Lehman Brothers,
the fourth largest U.S. investment bank, sent shockwaves across the
financial markets, hitting Brazil's stock exchange, the Bovespa,
particularly hard. On September 15, the Bovespa fell 7.59 percent,
bringing the total losses for the year to 23 percent as of September
16. While these kinds of market movements are quantitatively
significant, they do not seem to reflect any sense of local panic,
but rather a readjustment of asset prices and international
investors cashing in to improve liquidity in the United States and
other markets. Most commentary here, in fact, seems remarkably calm
and detached. Analysts may be slightly surprised by the scale of
the market movements on September 15, but are in no way hysterical.
The biggest near-term risk for Brazil is the possible decline in
foreign direct investment, which has been financing Brazil's current
account deficit. A global decline in demand could also slow
Brazil's exports and negatively impact the trade balance; however,
economic interlocutors downplayed either occurrence, citing Brazil's
domestic economic performance and the Brazilian Central Bank's
prudent monetary policy as anchors for economic stability. End
Summary.

Brazil Did its Homework
-----------------------

2. (SBU) Across the board, economic interlocutors told Econoff that
this week's turbulence was more about global risk aversion than any
indication of a decline in Brazil's economic fundamentals. Mauricio
Oreng from Itau Bank told Econoff that global investors were fleeing
from assets with even the smallest risk, noting that some preferred
holding cash. As a result, he said that emerging market stock
exchanges and commodities prices had naturally suffered the
consequences. In particular, Brazil's stock exchange, the Bovespa,
dropped 7.59 percent on September 15, in part because nearly 60
percent of its value is directly tied to commodities. Giovanna
Rocca from Unibanco told Econoff that because Brazil implemented
prudent fiscal and monetary policies, the economy is doing well.
She cited the Brazilian Central Bank's (BCB) efforts to curb
inflation and the accumulation of foreign reserves of over USD 200
billion as sufficient to face immediate liabilities. Indeed,
Priscila Trigo from Bradesco asserted that the BCB's hawkish
approach to curbing inflation and cooling domestic growth stands
apart as an example for other emerging market countries to emulate.


3. (SBU) The strength of the Brazilian banking sector was also
noted when defending Brazil's position amid the global financial
turbulence. Oreng told Econoff that Brazilian banks continue to be
extremely well-capitalized according to Basel standards. External
funding represents a small fraction of funding, and delinquency
rates are very low, and although the Central Bank raised interest
rates, bank performance is not linked to the interest rate.
Similarly, Rocca told Econoff that Bradesco has counseled investors
to sit tight because they view Brazilian financial institutions as
solid.

Potential Concerns Minimal
--------------------------

4. (SBU) Over the medium-term, Brazil's trade balance could decline
given the deteriorating outlook for commodity prices and the fact
that Brazil is still forecast to grow at a fairly robust pace. In
fact, the most recent GDP forecast, unemployment data, and new
incoming FDI announcements have surprised on the upside. Looking
further down the road, Trigo told Econoff that the biggest risk
facing Brazil is that foreign direct investment inflows would
decline, noting that FDI and portfolio flows are funding Brazil's
current account deficit (Reftel). She posited that if commodity
prices continued to fall, exports would decline and further
undermine Brazil's trade balance; however, imports would also
decline if the Brazilian currency continued to depreciate relative
to the US dollar. (Note: The Real has depreciated 20% from its
high of 1.56/USD on August 1 to 1.86/USD on September 17. End
Note.) She concluded that she did not believe that FDI would dry up
in Brazil, but could slow down due to the lack of liquidity
worldwide. Alexandre Cancherini from Merrill Lynch supported this
view explaining that Brazil's relatively low domestic savings rate
requires Brazil to depend on financing from abroad. Although he
does not expect any banks to collapse, he believes that small banks
would feel the higher borrowing costs because of the global

SAO PAULO 00000486 002.2 OF 003


liquidity crunch and that some could face bankruptcy over the
longer-term.

5. (SBU) The current turmoil in financial markets was also the
primary topic of conversation at a dinner the Consul General hosted
for 10 American company CEOs on September 16. Citibank Brazil
President Gustavo Marin stated the crisis is far from over, and
argued that the effects will percolate through the financial sector
for some time to come. He correctly predicted that the USG would
step in to prevent the precipitous collapse of American insurance
giant AIG. Marin believes that European and Asian banks have yet to
realize the full extent of their losses, and that once the financial
sector upheaval has abated, restricted credit will begin to play
through the performance of major economies, reducing growth rates.
Marin predicted that the major impacts of the crisis on the
Brazilian economy would be through tighter credit conditions for
major development and investment projects (public and private) -
reducing the level of new investment activity - and reduced IPO
activity in Brazil. He also expects to see a significant uptick in
Merger and Acquisition (M&A) activity due to reduced book values for
many companies, both in Brazil and abroad. He noted that recent
Brazil IPOs are currently trading at 40 to 50 percent of earnings,
making them attractive M&A targets. Brazil growth should slow to
three to three and a half percent in 2009, but rebound to five
percent level in 2010.

6. (SBU) Nelson Barbosa, Secretary for Economic Policy at the
Ministry of Finance told Brasilia Econoff that he thought that
Brazil would fare well, even given the drop in commodity prices
because Brazil still imports more petroleum than it exports. He
said he didn't foresee the need for Brazil to take any specific
measures in response to recent problems. He said he thought that
the problems in the U.S. financial markets were contained and that
the situation would right itself soon, probably after the November
elections when the uncertainty over the next administration would be
eliminated.

Uncertainty to Continue
-----------------------

7. (SBU) Economic interlocutors all pointed to widespread
uncertainty about the future economic performance of the U.S. and
the broader global economy. Trigo noted that decisions in the U.S.
including whether the Federal Reserve would need to rescue another
bank, the duration of a U.S. slowdown, and possible contagion
effects have spooked the market. These uncertainties would limit
available financing and could restrict investment, she said, both of
which could damage Brazil. Rocca told Econoff that Unibanco expects
the BCB to take a wait-and-see attitude and is expected to provide
liquidity if needed. She noted that both Finance Minister Guido
Mantega and Central Bank President Henrique Meirelles had confirmed
their support.

8. (SBU) Despite the turbulence, Itau Bank has not altered its base
case scenario. Oreng told Econoff that economic growth is still on
pace to reach five percent this year, and that only in 2009 would
Brazil see possible ramifications of a global slowdown. He said
that under the worst case scenario, Itau forecasts that exports

SAO PAULO 00000486 003.2 OF 003


would decline and growth could fall to approximately three percent.
Oreng stated that because only 15 percent of exports go to the U.S.,
a U.S. slowdown on its own would not disrupt Brazil's trade balance.
He noted, however, that a global slowdown would be more of a risk
for the Brazilian currency if demand for commodities continued to
decline. Finally, he pointed to the domestic economy as Brazil's
engine of growth and told Econoff that he believes the domestic
economy should continue to drive economic growth.

Comment
-------

9. (SBU) While it is clear that markets are spooked and still
looking for the floor of the financial crisis, the outlook in Brazil
remains optimistic if guarded. The major concern is centered on the
continued access to international credit which, if it becomes overly
restricted, will have a negative impact on Brazil's growth rate at
least in 2009. A world economic slowdown that reduces international
demand for Brazilian commodities would have a negative impact on
Brazil's trade balance, but given that Brazilian growth is driven by
the domestic sector, the overall impact should be manageable. The
Brazilian financial community is certainly concerned, but there is
no sense of panic. End Comment.

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

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