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Cablegate: Brazil's Response to Info Gathering Request Summit

VZCZCXRO9927
PP RUEHRG
DE RUEHBR #1427/01 3050953
ZNY CCCCC ZZH
P 310953Z OCT 08 ZFF6
FM AMEMBASSY BRASILIA
TO RUEHC/SECSTATE WASHDC PRIORITY 2772
INFO RUEHAC/AMEMBASSY ASUNCION PRIORITY 7179
RUEHBR/AMEMBASSY BRASILIA PRIORITY
RUEHBU/AMEMBASSY BUENOS AIRES PRIORITY 5912
RUEHCV/AMEMBASSY CARACAS PRIORITY 4284
RUEHLP/AMEMBASSY LA PAZ PRIORITY 6677
RUEHMN/AMEMBASSY MONTEVIDEO PRIORITY 7577
RUEHSG/AMEMBASSY SANTIAGO PRIORITY 0695
RUEHSO/AMCONSUL SAO PAULO PRIORITY 2994
RUEHRG/AMCONSUL RECIFE PRIORITY 8644
RUEHRI/AMCONSUL RIO DE JANEIRO PRIORITY 6811
RUEAWJA/DEPT OF JUSTICE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RHEHNSC/NSC WASHDC PRIORITY
RHMFISS/CDR USSOUTHCOM MIAMI FL PRIORITY
RUEAIIA/CIA WASHDC PRIORITY

C O N F I D E N T I A L SECTION 01 OF 03 BRASILIA 001427

SIPDIS

STATE FOR WHA/BSC, WHA/EPSC, EEB/DAS NELSON, EEB/OMA SAKAUE
STATE ALSO FOR EEB/OMA WHITTINGTON
DEPT OF TREASURY FOR IMB/BMURDEN, WMONROE, CCARNES AND
DEPT of TREASURY ALSO FOR WHA/JHOEK
NSC FOR GTOMASULO

E.O. 12958: DECL: 10/30/2018
TAGS: ECON EFIN BR
SUBJECT: BRAZIL'S RESPONSE TO INFO GATHERING REQUEST SUMMIT
NOV. 15

REF: A. SECSTATE 114420
B. SAO PAULO 0548
C. BRASILIA 1299
D. SAO PAULO 0086
E. BRASILIA 1417
F. SAO PAULO 0522
G. SAO PAULO 0486
H. Erath/WHA-EEB e-mail October 28

Classified By: DCM Lisa Kubiske; Reasons 1.4 (b) and (d).

1. (U) The following is in response to Ref A action
request for information gathering leading up to the Summit
on Financial Markets and the World Economy in Washington,
November 15, 2008. Post also recommends
Refs B, C, E, F and G which all address Brazil's
reaction and response to the U.S. financial crisis.

Key Objectives and Priorities
- - - - - - - - - - - - - - -

2. (C) Brazil's objectives at the Summit on Financial
Markets and the World Economy will likely include making a
strong statement at the outset of the meeting (in its role
as G-20 president) about the urgency of global financial
reform and also encouraging reforms such as stronger
financial disclosure standards, greater prudential
regulation, and increased limits on "shadow banks."
Indeed, President Lula has spoken of the need for a global
regulatory framework. Going forward, the GOB is certain to
want to ensure that the equities of emerging economies and
developing countries are protected. The Lula
Administration was clear in its initial statements laying
the blame at the doorstep of actors within the U.S. Brazil
has not yet made any specific proposals for global
financial reform. However, Brazil has increasingly sought
to take a leading role. Brazil has voiced its interest in leading a
"regional response" and held a meeting with Mercosul-plus country
officials on October 27 (Septel from Brasilia) and will host a G-20
meeting of Finance Ministers November 8-9. The Brazil-hosted December
Latin American summit is also expected to focus on the global
financial crisis. President Lula has been critical of the IMF, and
Brazil is unlikely to support an expanded oversight role for the IMF
without further reforms and an expanded Brazilian role within the
IMF. Brazil's wariness of supranational organizations in which it
does not have a voice includes the Financial Stability Forum as well.
Contacts at the Foreign Ministry note that they would be open to the
G-20 being a decision-making group but also want to ensure global
transparency. In fact the GOB has advocated outreach, but not
decision making, through ECOSOC to permit multiple voices to be heard
in the consensus building process.

Key Concerns: FX Shortage and Lack of Trade Finance
- - - - - - - - - - - - - - - - - - - - - - - - - - -

3. (U) Brazil's immediate concern has been the shortage of
foreign exchange (specifically USD) in the Brazilian market
due to the foreign exchange outflows since September.
These outflows have had ripple effects on the exchange
rate, the stock market, and a shortage of trade financing,
which is likely to be President Lula's foremost concern at
the G20. Likewise, credit growth has slowed sharply, some
Brazilian companies have reported losses from derivatives
contracts, and some small and medium banks have suffered
from the lack of external credit financing.

Impact of Financial Market Crisis on the Financial Sector
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

4. (U) The most visible impacts have been the currency

BRASILIA 00001427 002 OF 003


depreciation and decline of the stock market resulting from
foreign currency outflows. Brazil's main equity index has
declined by 50 percent since May, reflecting the readjustment of
asset prices and international investors
cashing in to improve liquidity in the United States and
other markets. Most analysts agree that the drop in the
index does not reflect a change in the fundamentals of
Brazilian companies.

5. (U) Brazilian Central Bank (BCB) data for October
(October 1 to 21) indicate rising net foreign exchange
outflows. As a whole, the foreign exchange market has had
net outflows of USD 3.4 billion this month. Commercial
foreign exchange transaction (i.e. trade-related) inflows
were USD 1.5 billion, while non-commercial (i.e. financial)
foreign exchange outflows were USD 4.9 billion. As a
result of the shortage of foreign exchange, the BCB has
heavily intervened in the foreign exchange market. Since
September 19, the BCB has provided a total of USD 28
billion in loans, swaps, and spot market sales (USD 5.3
billion, 17.6 billion, and 4.9 billion respectively).

6. (U) On a small scale, some of Brazil's small and medium
banks have experienced some financial stress. Economic
interlocutors agreed that although the Brazilian banking
system has enough liquidity without external credit lines,
it is not balanced across the system. Small and medium
banks are less liquid because they were more reliant on external
credit lines and have a smaller deposit base upon which to draw.
Relative to other emerging markets and to other countries in the
region, however, Brazil's financial system is stable and healthy.
According to a recent World
Economic Forum report, the overall health and stability of
Brazil's banking system ranks 24th out of 134 countries
worldwide. Indeed, Brazil's banking system is well
positioned to weather the external financial crisis. In a
recent conference on Brazil's financial sector, Moody's
highlighted the advantages that Brazilian banks have over
other regional financial institutions, including low
dependency on USD, high profitability, high capital
adequacy, and comparatively fewer "skeletons in the closet."
Brazilian financial institutions are relatively
conservative--every major Brazilian bank has a capital base
that outpaces their respective Basel ratio. (Note: See Ref
B for more on the U.S. financial crisis and the Brazilian
banking system. End Note.)

7. (U) Local credit growth has slowed significantly. A
recent survey of local banks indicates that household
credit growth is expected to be between five to 15 percent
next year. Through September, household credit had
expanded by 34 percent, following 33 percent growth last
year. BCB data for the first 10 days of October showed
that overall credit concessions plunged by approximately 13
percent in comparison to the same period in September.

8. (U) Finally, some Brazilian companies have suffered
from derivates contracts, as well as a more general lack of
transparency with derivatives accounting. So far, three
prominent Brazilian firms, Votorantim (manufacturing,
financing, new business), Aracruz (pulp), and Sadia (meat
packing), have reported losses of approximately USD 2.5
billion. Rumors continue to circulate that a large number
of medium-sized firms, most of which lack USD
export/revenue flows, have sizeable foreign exchange
mismatches and would suffer large losses if the Brazilian
currency depreciates further. The BCB has begun surveying
Brazilian firms and banks to determine how large this
exposure is. Brazil's securities market regulator began
requiring publicly traded companies to disclose their

BRASILIA 00001427 003 OF 003


derivatives exposure on a quarterly basis.

Actions Taken to Address the Crisis
- - - - - - - - - - - - - - - - - - -

9. (U) While Brazilians spent the last year of the
worldwide financial crisis preaching the strength of the
Brazilian economy, economists and government officials
alike have slowly altered their rhetoric and actions. The
GOB has taken several precautionary measures to increase
liquidity and to permit the BCB to rescue failed banks. It
has also encouraged larger financial institutions to make
small loans to help shore up the more vulnerable small bank
sector. In a more controversial measure, the GOB submitted
legislation to allow two state-run banks to purchase stock
in private banks and also suspended a federal tax on
international financial transactions to stimulate
investment as well as to try to stem capital flight (Ref
E). The BCB has also announced that it will have USD 50
billion in derivatives to sell to the market and has held
several USD auctions. Finally, the BCB has postponed
planned increases to reserve requirements on leasing
operations (Refs C and D) and partially lifted the reserve
requirements on longer-term deposits that the BCB estimates
will inject approximately USD 50 billion into the system
(Ref B). The crisis has also encouraged Finance Minister
Mantega and Central Bank President Meirelles to coordinate
their message and appear to be publicly in agreement on the
handling of the crisis, in stark contrast to past public
disagreements over policy.

Current Economic Situation/Near-Term Outlook
- - - - - - - - - - - - - - - - - - - - - - -

10. (SBU) Like most other countries, Brazil has been
strongly affected by recent global market turmoil.
Brazil's 2009 growth forecast (3.5 percent consensus) has
fallen by one to 1.5 percent in recent months.
Unemployment may rise as economic growth slows. The
outlook for inflation, the current account, fiscal
performance, and other key macroeconomic indicators remains
broadly stable. Despite the short-term inflationary
pressures from the deprecation of the currency, the medium
and long term decline in domestic demand resulting from the
worldwide credit crunch is likely to keep inflation down.
The current consensus is approximately five percent for
2009. Analysts noted, however, that Brazil's 2009 primary
surplus could fall below the 3.8 percent of GDP target if
growth next year slows to 2.5 percent or less. In consideration of
these factors, Brazil's monetary policy committee (COPOM) October 29
decided to leave the benchmark rate (SELIC) at 13.75 percent, in
contrast to raising the rate in previous sections in an effort to
control inflation. (Brazil's inflation target is 4.5%, with a band
permitted to go to 6.5%. Brazil is currently near the top of that
band - making yesterday's COPOM conversation reportedly challenging
in building consensus on the SELIC decision).

11. (U) This cable was written and coordinated by Econ Sao Paulo
with input from Treasury Attache and Embassy Brasilia and represents
a coordinated Mission Brazil overview in response to Ref A.
SOBEL

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