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Cablegate: Secretary Snow's Meetings with Finance Minister

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 03 BRASILIA 002145

SIPDIS

PARIS PASS USOECD
STATE FOR E, WHA, EB, AND EUR
STATE PASS USTR FOR LEZNY/YANG
NSC FOR CRONIN
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
TREASURY FOR DAS LEE AND F.PARODI

E.O. 12958: DECL: 08/11/2015
TAGS: EFIN ECON
SUBJECT: SECRETARY SNOW'S MEETINGS WITH FINANCE MINISTER
PALOCCI AND CENTRAL BANK PRESIDENT MEIRELLES

Classified By: Charge d'Affaires Patrick Linehan, reason 1.4 (b)
and (d
).

1. (C) Summary: Secretary Snow met separately with Central
Bank President Meirelles and Finance Minister Palocci August
1 in Brasilia for broad discussions of Brazil's current
economic performance. Meirelles and Palocci both argued that
Brazil's stellar economic performance, with a current account
surplus of 1.9% of GDP anchored by booming exports and a
strong fiscal stance (5.1% of GDP primary surplus), had
insulated the economy from current political turbulence.
Palocci implicitly acknowledged that the microeconomic reform
agenda was stalled, but hoped that stronger growth in the
second half of 2005 would allow the GoB to press forward with
reforms, including a simplification of the tax system as
applied to small and medium enterprises. Palocci placed
significant emphasis on reenergizing trade negotiations as a
tool to improve productivity in the economy (septel).
Palocci said Brazil would like to join the OECD and sought
support for Brazil's position on IMF quota reallocations.
End Summary.

2. (U) Background: Treasury Secretary Snow visited Brazil
July 31 to August 3, 2005, to participate in the fourth
session of the bilateral Group for Growth, an outgrowth of
the 2003 Summit between Presidents Bush and Lula. Secretary
Snow held bilateral meetings August 1 in Brasilia with
Central Bank President Henrique Meirelles (along with the
majority of the Bank,s Governing Board), Finance Minister
Palocci and President Lula, in addition to meeting with
Brazilian venture capitalists. In Rio de Janeiro on August
2, the Secretary participated in Group for Growth meetings
(including a business breakfast), gave a speech sponsored by
the Brazilian Council on Foreign Relations (CEBRI), and held
a round-table discussion with representatives of the
financial services sector. On August 3, in Vitoria, the
capital of the Brazilian state of Espirito Santo, the
Secretary emphasized the themes of private sector

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infrastructure investment and the importance of good
governance in visits to the port of Tubarao and in a working
lunch with Governor Hartung and local business. The
Secretary concluded his stay in Vitoria with a visit to a

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favela (poor neighborhood) that benefited from an
Inter-American Development Bank (IDB)-financed basic services
project, aimed at providing running water, sewage hook-ups
and paved streets. This cable reports on the Secretary's
meetings with the Central Bank President Meirelles and
Finance Minister Palocci. Septel reports on the trade
aspects of Secretary Snow's discussions.

Economy, Interest Rates and Directed Credit
-------------------------------------------

3. (SBU) Meirelles outlined Brazil's excellent economic
performance over recent months and described its current
policy stance. He argued that Brazil's pursuit of its three
main macroeconomic policy pillars (fiscal adjustment,
inflation targeting monetary policy and a flexible exchange
rate) were producing outstanding results. While growth
registered a small adjustment in the first quarter, he
expected it would pick up in the remaining quarters, with the
economy posting annual growth of about 3.4%. He added that
the fiscal performance (5.1% of GDP primary surplus in the 12
months through June) had been solid and the external accounts
outstanding (1.9% of GDP current account surplus in the 12
months through June).

4. (SBU) Meirelles declared that the Central Bank has been
able to establish credibility with the market, despite its
lack of formal legal autonomy. Still, he emphasized, the
Bank,s lack of formal independence meant that investors were
demanding a small inflation premium -- which would only
disappear once formal autonomy was granted. Economic Policy
director Bevilaqua added that inflation expectations for the
year, after spiking in the first and second quarters, were
nevertheless declining faster than expected in response to
the current monetary policy adjustment.

5. (SBU) Meirelles noted that one of the reasons for Brazil's
infamously high lending spreads is the country,s system of
directed credit. Although bank lending has been growing, he
noted, only 34.5% of overall credit was freely allocated by
banks -- the rest is directed primarily to low-cost
agricultural credits or by the national development bank
(BNDES). Meirelles argued that, while this system created
credit market distortions, it reflected a set of widely-held
societal priorities. However, he agreed with the
Secretary,s observation that this societal consensus might

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change over time. Meirelles further pointed out that these
subsidized credits meant that the average lending rate was
lower than the headline interest rates.

Vulnerability has Declined
---------------------------

6. (C) Citing similar factors, Palocci and Meirelles both
argued (separately) that Brazil's vulnerability to shocks had
decreased markedly. The GoB's debt burden was down (52% of
GDP) and its external profile had improved. Dollar-linked
domestic debt had fallen from 40% to less than 4% of total
domestic debt while the GoB had increased substantially the
amount of fixed interest rate debt. The current account
surplus and the country's strong fiscal performance, they
stated, were insulating the economy from the current
political turbulence. Palocci affirmed that the return of
GDP growth expected in the second half of the year may allow
the GoB to retake the microeconomic reform agenda adding that
he would like to see the economy open up faster. He stated
that the GoB hopes to pass in the second half of 2005
legislation to simplify the tax system applicable to small
and medium enterprises, and is now implementing the
recently-enacted bankruptcy law. The goal is to maintain the
strong fiscal stance and press forward with microeconomic
reforms so as to create space for a monetary easing. The
Secretary welcomed the focus on the microeconomic agenda,

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noting that the markets' benign reaction to date to the
current political scandal was a tribute to the policies the
GoB had pursued.

Palocci - OECD, IMF and Venture K
---------------------------------

7. (C) Palocci stated that given its ongoing extensive
cooperation with the Organization for Economic Cooperation
and Development (OECD), Brazil would like to pursue
membership in that organization. The GOB,s goal is to forge
with OECD interlocutors a common vision governing Brazil's
accession process. The Secretary undertook to raise Brazil's
request in Washington.

8. (C) Palocci thanked the Secretary for USG support of
Brazil's position in the current review of IMF quotas. He
asked for continued support as the process advanced.

9. (C) The Secretary briefed Palocci on his meeting with a
group of local venture capitalists. Bringing together ideas
and financing was a critical function of the financial
system, the Secretary said, and it was encouraging to see
this nascent sector in Brazil helping new companies get
started. Palocci agreed, stating that he believes the
sector, while new, has significant potential. He singled out
the important contribution that venture capitalists make to
the governance of small firms.

10. (U) This cable was cleared by Treasury.

LINEHAN

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