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Cablegate: Brazil: Worries That Political Scandal Will

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

UNCLAS BRASILIA 002012

SIPDIS

NSC FOR CRONIN
TREASURY FOR OASIA - DAS LEE AND FPARODI
STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/DDEVITO/DANDERSON/EOL SON
AID/W FOR LAC/SA

SENSITIVE

E.O. 12958: N/A
TAGS: ECON EFIN
SUBJECT: BRAZIL: WORRIES THAT POLITICAL SCANDAL WILL
DERAIL ECONOMIC GAINS

REF: A) Brasilia 1968, B) Brasilia 1973

1. (SBU) While to date the Brazilian economy has largely
been immune to the growing three-month old vote-
buying/influence peddling scandal which is currently
plaguing the Lulu administration, there are growing signs
that contamination could soon occur. Between July 21 and
July 25, the real dropped by 5.5 percent and the Sao Paulo
Stock Exchange (BOVESPA) dropped by 5.1 percent. Although
both indicators appreciated in subsequent sessions, the
mantra among analysts here is that foreign investors --
heretofore attracted by the country's sky high real interest
rates (near 14 percent) on Brazilian bonds -- are now
viewing the country with caution.

2. (U) To ward off possible contamination, on July 27
opposition party representatives floated a trial balloon to
the effect that the GOB should work with its colleagues
across the aisle to fashion a consensus package of basic
measures to shield the economy from the scandal in the
coming weeks. That same day, Jaques Wagner, the Lula
administration's Secretary for Economic and Social
Development/Institutional Relations responded positively to
this suggestion, noting that it would benefit all concerned.

3. (SBU) Brazil's National Confederation of Industries (CNI)
is already working on a plan, which would include previously-
discussed items such as tax reform, political reform,
changes to the rules governing infrastructure, and
reductions in government expenditures. Prior to the
emergence of the scandal, the GOB had great difficulty in
moving these items through the legislature as each had drawn
opposition from constituencies who might have been adversely
affected. Now that the Lula administration is weak and
Congress is paralyzed, making progress on these measures
will be even more difficult.

4. (SBU) Analysts fear that efforts to concoct such a
package -- while well-intentioned -- could harm markets more
than they help. Specifically, various camps will likely
want to put their own stamp on any package, in many cases
altering it for the worse. For instance, industries
adversely affected by high nominal interest rates would
likely want a commitment from the GOB to lower the benchmark
SELIC rate -- thereby calling into question central bank
independence. As for the left-wing of the PT, it would
likely want a moratorium on external debt payments and/or an
end to the GOB's 4.25 primary surplus target -- thereby
calling into question the GOB's economic program in general.
Even if these constituencies prove unsuccessful in grafting
their desired policies onto the package, the mere fact that
such proposals were circulating could in and of itself
unsettle the markets.

5. (SBU) Right now, the most likely outcome, in our view, is
that no package will pass. Finance Minister Palocci, who
after the departure of Chief of Staff Jose Dirceu ranks as
Lula's most influential advisor, can be counted on to deep
six any effort to dilute/weaken the GOB's orthodox economic
program. In the coming days, as before, what will likely
determine how far (and how fast) any scandal-related
contagion spreads to the economy is: a) the degree to which
the various congressional inquiries continue to uncover
additional wrong-doing and, b) whether any evidence of
misconduct by Lula or Palocci surfaces.

LINEHAN

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