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Cablegate: Brazil's Finance Minister: Steady As She Goes

This record is a partial extract of the original cable. The full text of the original cable is not available.

C O N F I D E N T I A L SECTION 01 OF 02 BRASILIA 000786

SIPDIS

NSC FOR DEMPSEY
TREASURY FOR OASIA - SEGAL
USDA FOR FAS (U/S PENN AND TERPSTRA)
SOUTHCOM FOR POLAD

E.O. 12958: DECL: 03/30/2014
TAGS: ECON EFIN PGOV BR
SUBJECT: BRAZIL'S FINANCE MINISTER: STEADY AS SHE GOES

REF: A. BRASILIA 613

B. BRASILIA 657
C. BRASILIA 776

Classified By: Economic Counselor Roman Wasilewski, Reasons 1.4 (b) and
(d).

1. (C) Summary: After weeks of intensifying criticism of the Lula administration's stringent fiscal line from within and without the government (Ref A), Finance Minister Palocci received unexpectedly cordial treatment during a marathon
seven hours of testimony to the Senate Economic Affairs Committee March 30. The hearing featured the unscheduled visit of Senate President Jose Sarney and Chamber of Deputies President Joao Paulo Cunha, who dropped by to publicly affirm their support for Palocci. The show of coalition unity on economic policy helped reassure the markets: the Real appreciated, Sao Paulo's stock exchange was up and spreads on Brazilian eurobonds narrowed. Lula himself continues to publicly defend both Palocci and the GoB,s current economic policy line. While we have no doubt of continued GoB policy steadfastness, failure to deliver near-term growth may make it politically ever more difficult to get legislative approval of the structural economic reforms necessary for medium and long term growth. End Summary.

2. (SBU) GoB economic policy, in particular its strict
adherence to the fiscal goal of a 4.25% of GDP primary
surplus and the Central Bank,s ultra-cautious stance on
inflationary pressures, have come under ever broader
sustained criticism for the last several weeks (Refs A and
B). Even Vice-President Alencar has periodically joined the bandwagon, recently labeling the GoB,s fiscal policy
"irresponsible." Palocci nevertheless reaffirmed the GoB,s
unwavering commitment to the primary-surplus goal in March 30 Senate hearings, saying that this pillar of economic policy would be maintained for years to come and is the best way to create an environment that ultimately allows sustained lower interest rates. Palocci's appearance garnered backing from the opposition PSDB party, but given the infighting within Lula's coalition over economic policy (ref C), there likely was more political import to the public affirmation of support from the PMDB's Sarney (whose party is part of the governing coalition) and from the PT's Cunha.

3. (U) The March 30 show of unity in the governing coalition reassured markets, with the Real appreciating against the dollar, the Sao Paulo stock exchange (BOVESPA) gaining 2.38% and spreads on Brazilian eurobonds above U.S. treasuries falling 3.3%. Despite this market uptick, popular perceptions have actually been worsening: recent polling data shows the percentage of Brazilians who expect no economic growth in 2004 was up over 11 percentage points to 34.2%.

4. (C) The GoB, by contrast, has not shaved its official
growth projections, although its view of what sectors will
lead GDP growth has changed. Planning Ministry chief
economic advisor Miranda told Econoff March 24 that exports
and investment will lead growth this year, which he still
expects to come in about 3.5%. Previous predictions had been that pent-up consumer demand would spark consumption growth as interest rates came down, thus spurring new investment. While not disputing Miranda's take, newly arrived IMF resident representative Alier (please protect) told us March 30 that he believes the biggest danger to GDP growth this year is a "wait and see" attitude among investors and large companies. He agreed that unexpectedly low foreign borrowings by Brazilian companies in February and early March, after record January levels, were consistent with this "wait and see" diagnosis.

5. (SBU) The market turbulence that Brazilian investors are
waiting out began after the Central Bank unexpectedly
interrupted its cycle of interest rate cuts in January,
citing inflationary pressures (Ref B). In this context, the March Central Bank decision to cut the baseline SELIC
interest rate was notable not for its modest
quarter-percentage-point size, but for the statement in the
minutes of Central Bank's meeting, released March 25, that
the Bank sees inflationary pressures easing. The first
quarter inflation report, released March 31, reinforces the
data on the easing of inflationary pressures and predicts
consumer price inflation of 5.2% for the year, below the
Central Bank's 5.5% target. Other hints of an improving
economy may buy the GoB room for maneuver. Unemployment, for example, edged slightly lower in the latest national figures, while credit grew (8.2% on loans to private individuals and 12.5% to companies). Foreign borrowings by companies began to recover at the end of March as well. Many data points on current economic growth, however, have been either inconclusive or negative.

6. (C) Comment. The public closing of coalition ranks behind Palocci at his March 30 committee hearings has provided some welcome reassurance of the prospects for GoB policy steadfastness -- which we do not believe should have been in doubt. The political sniping of recent weeks, however, has forced Lula to identify himself publicly in a very personal way with stringent fiscal and monetary policies that remain highly unpopular.
He also has had to use political capital
to keep coalition partners in line, at a time when his
government's popularity has slipped (ref C). If first- and second-quarter results fail to show positive developments with regard to GDP growth and new jobs, Lula will be forced to spend ever more time defending policies popularly perceived to be failing. The same political dynamic risks further hampering the GoB's legislative momentum for the structural and microeconomic reforms required for longer-term growth.

HRINAK

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