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Cablegate: After 500 Days, the Question Is: Can Lula Govern?

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 04 BRASILIA 001275

SIPDIS

E FOR SMITHAM
NSC FOR SHANNON, DEMPSEY, CRUZ
TREASURY FOR OASIA/SEGAL
EXIMBANK FOR DIRECTOR FOLEY
FED BOARD OF GOVERNORS FOR ROBITAILLE
USDA FOR U/S PENN, FAS/FAA/TERPSTRA
USDOC FOR 3134/USFCS/OIO/EOLSON/DDEVITO
USDOC FOR 4332/ITA/MAC/WH/OLAC/MCDOUGALL, DRISCOLL, BASTIAN
SOUTHCOM FOR POLAD

E.O. 12958: DECL: 05/25/2009
TAGS: ECON PGOV EFIN EINV ENRG PREL SOCI BR
SUBJECT: AFTER 500 DAYS, THE QUESTION IS: CAN LULA GOVERN?


Classified By: Ambassador Donna Hrinak, reasons 1.4 B),D)

1. (C) SUMMARY. Lula's man-of-the-people rhetoric and
heartfelt commitment to social progress quickly captured
imaginations inside Brazil and abroad, but practical results
of his first 500 days in office have been far less soaring.
Without better economic news, stronger executive capacity and
a firmer political base, his GoB may find itself falling into
a crisis of governance by the second half of his term.
Lula's fiscal and monetary policies have been all that the
market wanted, but he has reaped no visible domestic rewards
yet in the form of new growth, jobs, income or investment.
His administration's executive ineptitude, and the ramshackle
nature of its coalition alliances, are further factors that
both contribute to and are themselves worsened by the
economy's non-recovery so far. We expect pressure on Lula to
mount further, with a fair chance he will feel forced to move
to New-Deal-style spending programs in 2005. END SUMMARY.

The Personal Aura
-----------------

2. (SBU) Lula's charismatic initial impacts, and his triumph
in gaining market confidence after Brazil's 2002 crisis, have
entered history as the first chapter of his presidency. What
next? With more than a third of that presidency now past,
his personal popularity is a healthy 60%, defying Brazil's
absence of new growth and jobs, even if down from his
high-80's of a year ago. Financial markets and institutions
continue to lavish him with praise for the GoB's orthodox
monetary/fiscal management. His constant foreign travel and
diplomatic activism garner a high profile and mainly positive
image worldwide, bolstering his and Brazil's claims to
international leadership and thus appealing to nationalists
on left and right. He has banked much good will on which to
draw at home and abroad in terms of what he indisputably
represents for Latin-American democracy and social
aspirations. His comportment shines out as that of an
uncorrupt, democratic, inclusive, charismatic but unassuming,
down-to-earth negotiator. Yet Lula finished his first 500
days in office at his lowest domestic political ebb to date.
What is the problem?

The Real Economy
----------------

3. (SBU) First and foremost, it's the economy. Brazil's
macro-economic stabilization since 2002 has been a continuing
true triumph of Lula's political will. He persistently
endorses Meirelles' and Palocci's strict inflation and
budget-surplus targets through 2005. Plainly, he has been
won by the argument that fiscal/monetary loosening would risk
forfeiting the gains that the Plano Real -- and especially
the last year's sacrifices under the PT -- have brought
Brazil. But palpable real-world results for Brazil's
citizens have remained absent, and for Lula henceforth there
will be no substitute for more growth, jobs, income,
investment. Some recent data are positive, and forecasters
concur that 3-3.5% GDP growth this year is likely. But they
also generally agree that 3-3.5% will have only a marginal
effect on jobs and income, and that that rate is unlikely to
strengthen through 2006.

4. (SBU) Plus there are new economic concerns in the shape of
outside uncertainties: Chinese demand, Fed interest-rate
policy, the oil-price trend. These have helped erode the
exchange rate by 10% since April. Further weakening could
produce a halt - or even a reversal -- of the year-long
decline of Brazil's benchmark SELIC interest rate. That in
turn would hit the growth rate and might prevent the expected
reduction in the debt/GDP ratio this year, which would be a
truly crippling portent for Meirelles/Palocci.

5. (SBU) Brazil's external financial vulnerability is greatly
down since 2002, thanks to superior current-account trends
and GoB debt-management. Still, the market is not Brazil's
friend. If last year's benign global atmosphere were to
shift, Brazil could fall to investor-herd fears despite its
own best efforts. And those efforts, in the present climate
of GoB political shakiness and inept governance, are far
short of what they could be.

Executive Ineptitude
--------------------

6. (C) Shaky leadership is an over-arching problem. Lula
remains the undisputed arbiter of GoB policy differences, but
his limitations are not being mitigated by the so-called
"hard nucleus" of his closest Planalto advisors. On the
contrary, this group of long-time Lula friends and PT
veterans - e.g., Secretary General Luiz Dulci and Secretary
of Government Communication and Strategic Management Luiz
Gushiken - evidence no strategic vision or decisive executive
competence. The one standout, Chief of Staff Jose Dirceu,
was a virtual prime minister during the administration's
first year, managing most key initiatives and coordinating
congressional strategy. But his dramatic diminishment by the
Diniz scandal has rendered Dirceu much less effective,
leaving a vacuum that has sucked coherence and energy out of
Planalto.

7. (C) Lula's executive problem extends through
senior-personnel ranks. His first, tortuously drawn-out
cabinet reshuffle has produced no rejuvenating results. And
the process of installing new faces in ministries is still
underway as part of Lula's coalition-reinforcing efforts, to
the further detriment of efficient policy-making. Not by
accident, those policy areas with the relatively best records
under Lula - trade, macroeconomic, industrial, agricultural -
are run almost entirely by non-PT ministers he appointed at
the outset. Yet he has shown no readiness since then to
reach out for expert talent beyond the PT.

8. (SBU) Meanwhile, ideological currents still run deep
through the PT grass roots and into its senior echelons.
Finance Minister Palocci's enlightened fiscal views are the
exception: many, perhaps most of Lula's old allies still see
the state as the main, natural, legitimate actor for directly
implementing programs for national progress. At worst, this
mindset has spawned fresh barriers to investors in the shape
of GoB regulatory-agency and energy-model legislation. More
generally, we suspect it causes Lula's GoB not to really know
its own mind about its agenda. As former President Cardoso
recently quipped: "I suppose the government must have a
plan, but I cannot figure out what it is."

Ramshackle Political Base
-------------------------

9. (C) In the Congress, Lula has slipped backwards. His
ability to push legislation depends on the unity of an
unwieldy, PT-led coalition which includes parties that are
all over the map in terms of ideology and seriousness. On
paper the coalition is ample enough to carry the day on most
votes, but in reality fragmentation and rebellion are
becoming the norm. The Diniz scandal, together with
unhappiness on the right with lack of growth and on the left
with lack of progress on the touted social agenda, brought
Lula a major legislative defeat in early May. More may come.
The fragile coalition is barely held together by Lula's
charisma and promises of pork and government jobs. Passage
of his pension and tax bills in 2003 hinged on support from
opposition parties, and he may hope to reach out more in
future to the PSDB, which is likeminded on various platform
issues. But this will further dilute coalition discipline
and the efficacy of legislation produced by barter.

10. (SBU) At the local level, GoB/PT prospects in October's
municipal elections have faded. The PT has always been an
urban party (its mayors run 10 of Brazil's largest cities but
only a tiny percentage of smaller municipalities), and early
in the Lula government there was PT hope for a breakthrough
bandwagon effect. After the administration's last four
months of difficulties, however, PT leaders are no longer
willing to predict large gains and are digging in for tough
challenges to party incumbencies, notably Sao Paulo, where a
loss would be iconic for Lula and the PT.

11. (C) Foreign policy is one area which Lula and his
diplomats doubtless view as one of unalloyed triumph. In
reaching for a weightier world role, they have mirrored
previous Brazilian ambitions. The outcome of the Cancun WTO
talks, the dilution of the FTAA process at Miami, the
formation of the G-20 Group, have had no downside, in their
view. But much of what Itamaraty portrays as Lula's personal
impact on the world scene is plain fanciful, e.g., his
grandiloquent plan for a tax on arms transactions to go into
a hunger-relief fund. And his foreign policy and travels may
hold future risk for his image, e.g., if Venezuela goes
critical or if Itamaraty doctrinaires ultimately stymie FTAA
negotiations.

The Next 500 Days
-----------------

12. (C) It is not easy to see Lula making a strong recovery
in his next 500 days. Conversely, it is not hard to envision
further political and economic slippage. Worst-case: if
Lula's domestic political standing worsens, and external
economic developments turn bad, Brazil could be back within
months to a deteriorating economic/financial spiral.
More-likely case: growth picks up modestly and Brazil avoids
external economic buffets, but there still is little sense of
new momentum or relief through year's end. If either of
these scenarios combines with a poor PT election result, what
might be Lula's political and policy follow-on?

13. (C) Lula's orthodox economic policy remains exactly what
most outside observers have counseled, but he and the PT are
unlikely to soldier on with it indefinitely, absent palpable
returns. This would be especially the case if an external
shock sparks a "hot-money" investor flight that could be
perceived as confiscating the gains of Brazilians' past
sacrifices. Should GDP not pick up convincingly by
year's-end, arguments for a policy adjustment from "Herbert
Hoover" policies towards "Roosevelt New Deal"-style
public-works employment, with a priority on useful
infrastructure projects like railroads and water-treatment,
may become hard to resist.

COMMENT
-------

14. (C) Are Lula's struggles just a spring slump, or a
presage that his team is headed for a losing season?
Arguably, no party fresh like the PT to national power could
have made a fast start in a nation like Brazil, less than
twenty years emerged from dictatorship, with its primitive
and corrupt feudalities, undisciplined and unprincipled
political parties, and inadequately-established state
institutions generally.

15. (C) Lula-backers can still hope that Brazil's GDP growth
this year will be sufficient to ease social pressures; that
the PT will do well enough in October's elections to solidify
its coalition; that the President will thereafter recruit new
ministers and key figures, re-launch his legislative program
at the start of 2005, and, learning from past missteps, make
an expeditious success of the further reforms vital for
Brazil's economy to break through and attain its long-term
potential. The glum alternative opinion is that he and the
PT already are showing they lack the personnel, platform,
party, political power, and general conditions to carry out
their transformational "project" for Brazil, period.

HRINAK

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