Cablegate: Few Economic Risks As Strong Growth Continues;

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





E.O. 12958: N/A



1. (SBU) Summary: Brazil's economic growth continues at
scorching rates. According to third quarter statistics,
growth in the 12 months through September 2004 was 5.3%,
putting 5% growth for 2004 as a whole well within reach.
Central Bank President Henrique Meirelles confirmed the
rosy economic outlook in a December 8 meeting with the
Ambassador. With external vulnerability reduced, Meirelles
saw the balance of risks ahead shifting from the economic
to the political. Pushing the microeconomic reform agenda
through the Congress, he affirmed, was a sine qua non for
sustaining relatively healthy growth rates. With the
politically-charged election season behind it, the Congress
may be able to focus on the reforms, such as the new
bankruptcy law, which on December 14 finished an 11-year
voyage to final approval, he added. Meirelles professed
not to be panicked about the dollar's extraordinary slide
on world currency markets, but thought that there would
have to be an adjustment in the U.S. current account in the
medium term. The Central Bank bought dollars in the Sao
Paulo currency market December 6, ostensibly to bolster
reserves prior to the March expiry of the IMF program (ref
B). The intervention has effectively put a floor on the
dollar's drop against the Real. End Summary.

2. (U) Recent official GoB statistics for the third quarter
of 2004 show economic growth continuing at what is, for
Brazil, a scorching rate. Growth in the twelve months
through September 2004 clocked in at 5.3%. Financial
sector expectations of 5% growth for 2004 look likely to be
borne out. The data (see table below) show, however, a
clear slowing trend in the quarter-on-quarter growth
figures. This suggests that the economy already has begun
to cool off after clocking annualized growth rates of well
over six percent for the three quarters beginning in
September 2003. This may be good news on the inflation
front, since 1% growth quarter-on-quarter (4% annualized)
is much closer to what the Central Bank currently believes
is the economy's potential growth (i.e. 3% to 4%). Export
growth, while still healthy, appears to be on a cooling
trend as well. As an aside, overall 2003 GDP Growth of
negative 0.2%, was revised upwards to positive 0.5%.

Brazilian GDP
Percent Growth - Seasonally Adjusted

Annual/1 Quarterly Growth/2
2002 2003 4Q03 1Q04 2Q04 3Q04

Total GDP 1.9 0.5 1.9 1.8 1.4 1.0

Supply Side
- Agriculture 5.5 5.0 6.2 2.1 1.2 -3.6
- Industry 2.6 -1.0 1.6 1.1 1.5 2.8
- Services 1.6 -0.1 1.3 1.1 1.4 0.7

Demand Side
- Consumption
(Private) -0.4 -3.3 2.0 0.8 1.4 1.4
- Govt. 1.4 0.6 0.2 0.2 0.2 -0.2
- Investment -4.2 -6.6 4.9 2.8 4.8 6.7
- Exports 7.9 14.2 8.0 4.6 2.9 1.5
- Imports -12.3 -1.9 9.2 3.7 1.3 3.7

/1 Percent Change on Previous Year
/2 Percent Change on Previous Quarter, Preliminary
Source: Statistics and Geographic Institute (IBGE)

Living in the (Macroeconomic) Moment

3. (SBU) In their December 8 meeting, Meirelles told the
Ambassador that Brazil is living its best economic moment
in recent memory. The combination of strong growth
(expected to be about 5% for the year), inflation under
control, declining debt-to-GDP ratios and a strong external
balance makes this growth cycle much more sustainable than
previous spurts. As Brazil's external vulnerability had
fallen, Brazil risk, measured by the spread above
treasuries on Brazilian Eurobonds, had fallen to about 400
basis points. With external vulnerabilities reduced, the
risks Brazil faces now, Meirelles argued, were political.

4. (SBU) Meirelles expects growth to slow next year to what
he said he "hoped" was its current potential growth rate,
3.0% to 3.5%. While acknowledging that this is slow for a
country with huge social problems, Meirelles pointed out
that Brazil's average growth over the last decade had been
1.8%. People underestimate the damage that the lack of
macroeconomic stability did to growth potential, Meirelles
affirmed. With stability restored, businesses had a
planning horizon and could begin to invest again. This
investment initially grabbed the "low-hanging fruit,"
boosting productivity by de-bottlenecking or adding shifts
at factories. This initial round of productivity
increases, he stated, likely could sustain growth at about
3.5%. It was crucial, to push the microeconomic reform
agenda, which would begin the hard work of increasing
productivity -- and thereby potential growth.

Inflation and Investment

5. (U) Two pieces of data in the recently released
statistics, the growth in investment and the growth in
industry, speak to the twin issues of inflation and
investment that Meirelles and the Central Bank face right
now (ref A). Industrial growth in the third quarter was
2.8% over the previous quarter, continuing a surprisingly
strong upward trend. This reflects record capacity
utilization in many industries, according to recent
surveys. The high level of capacity utilization appears to
be driving some of the inflationary pressure that the
Central Bank currently is trying to wring out of the
system, including with its December 15 interest rate hike
(to 17.75%), the third in as many months. The second
surprising result was the 6.7% growth in investment for the
third quarter. Investment growth has exceeded GDP growth
in each of the last four quarters, which bodes well for
increasing capacity and productivity and improving
sustainable growth rates. This data, however, does not
reflect the impact on investment, if any, of the Central
Bank's interest rate hikes since September.

Bankruptcy Law Passed

6. (U) After an eleven-year journey through the Brazilian
Congress, a law reforming Brazil's bankruptcy code was
passed December 14. The bill now goes to the President for
signature. The new law aims to create the opportunity, as
Chapter 11 of the U.S. bankruptcy code does, for firms in
financial straits to negotiate a restructuring with their
creditors outside the courtroom. Only if the company and
its creditors were unable to reach agreement on a
restructuring, would there be a need for a judge to become
involved. In the event that a company ultimately is
declared bankrupt and liquidated, the new law gives
commercial creditors higher priority to collect their debts
than under the old system, addressing a longstanding
bankers' complaint. Banks will now be second in line to
collect debts from the bankrupt company, after employees.
Under the previous law, debts to the government had
seniority over commercial creditors and there were no
limits on how much a judge could award to workers.

Dollar's Slide

7. (U) Meirelles told the Ambassador there was "no reason
to panic" about the dollar's slide in world currency
markets in the short term, but that U.S. current account
must adjust in the longer term. Brazilian businesses,
however, have been expressing deep concern that the
dollar's fall will price them out of export markets.
Against that backdrop, the Central Bank intervened in the
foreign exchange markets December 6 to purchase an unknown,
but likely relatively modest, amount of dollars. The day
after, the dollar appreciated 0.37%. The Bank has said
that this was merely the first of several planned small
purchases in its effort to begin rebuilding its foreign
exchange reserves ahead of the March 2005 expiration of the
IMF program. The markets have interpreted the move as a
clear signal that the Central Bank will not accept an
exchange rate below R$2.7.


8. (SBU) The GoB's primary task now is working to increase
the level of sustainable growth, a process which entails
implementation of the microeconomic reform agenda. With
the municipal elections behind it, the GoB is in a better
position to focus on moving the reform agenda through
Congress. The post-election passage of the bankruptcy
reform as well as passage of a portion of the judicial
reform are welcome signs that the Congress may be returning
to the job. But, the departure of the PMDB and PPS from
the governing coalition to better position themselves for
the 2006 presidential elections, while by no means
crippling the GoB's ability to get its legislative agenda
through Congress, may mean a more chaotic road ahead (ref


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