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Cablegate: Brazil Responds to U.S. Financial Crisis

VZCZCXRO5935
RR RUEHRG
DE RUEHBR #1299/01 2751100
ZNR UUUUU ZZH
R 011100Z OCT 08
FM AMEMBASSY BRASILIA
TO RUEHC/SECSTATE WASHDC 2553
INFO RUEHRI/AMCONSUL RIO DE JANEIRO 6680
RUEHSO/AMCONSUL SAO PAULO 2830
RUEHRG/AMCONSUL RECIFE 8519

UNCLAS SECTION 01 OF 02 BRASILIA 001299

SIPDIS
SENSITIVE

STATE FOR WHA/BSC, WHA/EPSC, EEB/CIP, EEB/IFD
STATE ALSO FOR E:HASTINGS, WHA:KELLY, WHA:MCMULLEN
STATE PASS USTR FOR KDUCKWORTH
STATE PASS EXIMBANK
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE
DEPT OF TREASURY FOR JHOEK, BONEILL

E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD BR
SUBJECT: Brazil Responds to U.S. Financial Crisis

REF: SAO PAULO 486

1. (SBU) Summary: In response to the U.S. financial crisis,
Brazil's Central Bank (CB) has partially reversed its hawkish
anti-inflationary policies by adding 13.2 billion reais to the
financial system in hopes of freeing up credit and has indicated
that future interest rate hikes are unlikely given the diminishing
threat of inflation due to a global slowdown and falling commodity
prices. Brazil's Foreign Minster continues to assert that Brazil is
well positioned to weather the crisis, while he and a key Central
Bank contact also confirm moves to try to mitigate the effect of the
crisis. President Lula continues to criticize the United States for
a lack of financial regulation, claiming that a global regulatory
body is needed to address the situation. Lula has admitted, for the
first time, that the Brazilian economy may be adversely impacted by
the crisis, drawing widespread criticism for not having a real grasp
on the potential of the crisis. Brazilian market reactions are
being reported by ConGen Sao Paulo SEPTEL. END SUMMARY

CENTRAL BANK ACTIONS AND INTROSPECTIONS
---------------------------------------

2. (SBU) The CB announced, on September 24th, a suspension in the
implementation of new, higher reserve rate levels required for
commercial banks. The new levels were to have been implemented in
November, but the CB decided to delay this implementation by two
more months. The CB also raised the threshold on commercial banks'
exemptions for cash, time and savings deposits, which was previously
at 100 million reais (approximately 200 million USD) to 300 million
reais (approximately 600 million USD). The measure will return 13.2
billion reais( USD7.16 billion) to the financial system in what is a
reversal to the original policy of removing 40 billion reais from
the credit markets in an effort by the CB to slow lending growth
that was fueling inflationary pressures. Responding to the U.S.
financial crisis, the CB announced that this was a preventative
measure meant to ensure sufficient availability of liquidity in the
Brazilian financial markets. In their recently released quarterly
inflation report, the CB diminished the role of inflationary
pressures, claiming that the global economic slowdown and falling
commodity prices will offset a devaluation of the Brazilian real and
keep inflation in check. In fact, many economists have steadily
lowered the year end inflation rate from 6.45 to 6.17 and many view
the CB's most recent inflationary report as an indication that the
CB will temporarily abandon their hawkish inflation stance and
deviate from their recent rounds of rate hikes that saw an increase
from 13 to 13.75 at their most recent meeting on September 9th.
3. (SBU) Central Bank of Brazil Senior Advisor Alexandre Pundek
told Econ FSN, the main possible fallout from the Congressional
rejection of the bailout package would be a reduction of credit
lines to finance Brazilian foreign trade. Pundek also worries that
if the crisis leads risk-averse Americans to shy away from investing
abroad, countries such as Brazil could experience a reduction in
foreign direct investment. On the Brazilian monetary/credit policy
side, Pundek reports that in addition to the measures reported
above, the Central Bank has decided to postpone plans to subject
lease lending (long term purchase installment plans)to phased-in
application of new reserve requirements. The Central Bank will now
apply the new requirements at a rate of 15 percent in March 2009 and
25 percent in June 2009. On the exchange rate policy side, Pundek
says that the Central Bank recently sold two lots of 80 day forward
purchase agreements at USD 500 million each in order to contain
volatility. Finally, Pundek noted that inflation will likely fall
depending both on international commodity prices, as well as the
continued relative strength of the Real. Pundek observed that there
is still a great deal of uncertainty and as a result, economic
policymakers will refrain from forecasting.
4. (SBU) Alvaro Vereda, Deputy Secretary of International Affairs
of the Finance Ministry confirmed for Econ FSN public statements by
Finance Minister Mantega that the Ministry believes that the USD 700
billion White House package will be approved on a second round in
the House of Representatives, and that as soon as it is approved,
the credit situation will stabilize. After meeting with President
Lula, Development Minister Jorge, Agriculture Minister Stephanes and
Central Banker Meirelles, Finance Minister Mantega assessed that the
Brazilian economy is functioning normally, although the CB (see
previous paragraph) has recently conducted USD auctions to increase
dollar liquidity. He also said that the Brazilian agricultural
sector has sufficient resources, and that the GOB can tackle any
problems ahead. Mantega asserted that Brazil has been suffering
from the crisis, through the reduction of credit by private banks,
but reinforced that the GOB is ready to act whenever necessary.
According to the Minister, "the market is fine, the companies are
solid, the banks are solid and the government is ready to respond to
any problems put to them." Mantega noted that there should be a

BRASILIA 00001299 002 OF 002


distinction between advanced economies, the core of the crisis with
financial institutions in trouble, and emerging and developing
countries, whose economies are solid, domestic markets are robust,
financial accounts are balanced and are growing more. The Minister
mentioned that the Brazilian fiscal surplus in line with and above
previous years' and that inflation is under control, within the
ceiling limit of the target band (note: the limit is 6.5), which in
turn enables the country to deal with the global situation on stable
footing.

WHAT THE PRESIDENT SAYS
------------------------
5. (SBU) President Lula meanwhile continued his public criticism of
the U.S. financial crisis, commenting in interviews with Folha de
Sao Paulo and Estado de Sao Paulo today (September 30)that the
situation is the result of "casino-type" deregulatory practices and
that the ultimate victims will be the poor. President Lula, at the
UN General Assembly, called for a global solution to the financial
crisis while proposing that the global financial crisis can only be
resolved through multi lateral forums. Lula added that the crisis
has proven market fundamentalists wrong and demonstrated the need
for state interventions. Lula asserted at the U.N. that only
decisive action by governments, especially those at the heart of the
crisis, can correct the disorder that has spread throughout the
global financial markets. In commenting yesterday on the proposal's
failure to gain house passage, Lula implored the U.S. Congress to
stop politicizing the bailout package and put national interest
first. Lula has recently adjusted his position on what impact the
crisis will have on the Brazilian economy, declaring initially that
Brazil would be immune to the problems while admitting today that
the crisis could do harm due to the enormity of the U.S. economy and
the inevitable ripple effects. In today's editorial in Folha de Sao
Paulo, Lula was criticized for not correctly predicting the crisis'
impact on the economy; deriding him for his change in position and
accusing him of not have the capacity to understand the gravity of
the crisis. The editorial also depicted the CB president Henrique
Meirelles as a curious, confused and powerless spectator.
6. Comment: Brazilians are very cognoscente of the country's past
economic turmoil caused by global downturns (most recently the Asian
crisis in 1997) and are quick to point out the advances in economic
growth that the country has achieved, potentially partially
insulating Brazil from the current crisis. Despite the efforts of
both President Lula and well respected commentators in easing the
anxiety surrounding the U.S. crisis' potential impact, no one seems
to know exactly how this will affect Brazil. The CB's attempt to
maintain capital flows by partially reversing their monetary policy
indicates that there is some recognition of the potential of the
crisis' impact despite the rosy scenarios given officially (reftel).
Whether that will be enough to mitigate a crisis of yet
undetermined magnitude remains to be seen. The issue will likely be
a topic of great interest during the planned visit of Under
Secretary for Economic, Energy and Agricultural Affairs, Reuben
Jeffery, to Brasilia on October 3rd when several interlocutors will
likely look to the Undersecretary for insights into the unfolding
developments surrounding the crisis. End Comment.

KUBISKE

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