Cablegate: Private Sector Optimistic for Brazilian Economy in 2010

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DE RUEHSO #0018/01 0111711
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R 111710Z JAN 10
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 0284
INFO RHEHNSC/WHITE HOUSE NATIONAL SECURITY COUNCIL WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHAC/AMEMBASSY ASUNCION
RUEHBO/AMEMBASSY BOGOTA
RUEHBR/AMEMBASSY BRASILIA
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RUEHRG/AMCONSUL RECIFE
RUEHRI/AMCONSUL RIO DE JANEIRO
RUEHSG/AMEMBASSY SANTIAGO
RUEHSO/AMCONSUL SAO PAULO

UNCLAS SAO PAULO 000018

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD EINV PGOV PREL BR
SUBJECT: Private Sector Optimistic for Brazilian Economy in 2010

REF: 09 SAO PAULO 624; 09 SAO PAULO 630; 09 BRASILIA 950
09 BRASILIA 1354

1. (SBU) Summary: Brazilian private sector analysts see a bright
economic outlook for 2010 with GDP growth nearing six percent,
inflation remaining within target, and strong job creation. Boosted
by the enduring impact of GOB stimulus measures implemented to
weather the global economic crisis and strong domestic consumer
demand, Brazil has emerged from the financial crisis earlier and
more robustly than most countries. While inflation pressures and a
strong currency pose moderate short-term risks, business contacts
contend that sustained high rates of growth beyond 2010 are
dependent on curbing the growth in GOB spending, progress on
long-pending tax and labor reforms, and boosting infrastructure
investment. End Summary.

2009 Ending Positive

--------------------

2. (SBU) While final data is not complete, most private sector
analysts agree Brazil's economy closed 2009 on a positive note.
Despite the global economic crisis' immediate effects on the
Brazilian economy, the GOB was able to implement timely
countercyclical measures (e.g. interest rate cuts, tax cuts,
increased fiscal transfers to households, and softening lending
restrictions, etc.) that prevented the external shock from reaching
deeper into employment and income (ref C). Brazil's economy came
out of a recession in the second quarter of this year, growing by
1.9 percent of GDP, and the Central Bank estimates that total
annual growth may finish positive at around 0.2 percent. According
to a study by leading Brazilian bank Itau-Unibanco, without the GOB
economic stimulus measures the economy would have shrank 3.2
percent.

Economic Growth Likely to Reach Pre-Crisis Levels

--------------------------------------------- ----

3. (SBU) Building off 2009 momentum, the Brazilian economy is
likely to attain GDP growth levels of around 5.5 percent in 2010.
Some of our contacts, such as Brazil's Central Bank (BCB) Senior
Analyst Alexandre Pundek and Itau Bank Economic Analyst Mauricio
Oreng, are even predicting about six percent GDP growth fueled by
high domestic demand. They also cite as drivers the enduring
economic stimulus measures the BCB and the Lula administration
adopted in 2009 to weather the global economic crisis. Santander
Bank Chief Economist Alexandre Schwartsman says these measures are
likely to stimulate consumption, output, capacity utilization and
investment well into 2010. Echoing the point, an Itau-Unibanco
study indicates that without the GOB stimulus measures and their
multiplier effects, the 2010 GDP growth outlook would only reach
3.7 percent.

4. (SBU) With respect to trade, business leaders expect both total
exports and imports to increase in 2010 as the global economy
rebounds. According to the Federation of the Industries of the
State of Sao Paulo (FIESP), exports are likely to increase by 16
percent from the current $152 billion whereas imports are likely to
increase by 30 percent from the current $128 billion, due to the
strength of the Brazilian currency and slower global economic
growth than Brazil. Nonetheless, FIESP expected Brazil to register
a trade surplus of $10.5 billion, down from $24 billion in 2009.

Output Growth Likely to Boost Job Creation

------------------------------------------

5. (SBU) Brazil is also ending the year with a positive job
creation record, despite the recession in early 2009. According to
the Brazilian Labor Ministry 1.3 million jobs were created this
year, pushing the unemployment rate down from 7.9 to 7.4 percent.
Alexandre Schwartsman attributes the Brazilian labor market's
resiliency to two key factors. First, companies were reluctant to
let go of workers despite a decline in industrial production due to
perceptions that the slowdown would be short-lived. Second,
companies wanted to avoid incurring the high cost of firing and
hiring workers, choosing instead to keep workers even if
underutilized. Meanwhile Schwartsman estimates around 2 million
jobs will be created in 2010 as industrial output rebounds further.

Central Bank Tightening to Contain Inflation

--------------------------------------------

6. (SBU) Amid the positive outlook, the private sector is
increasingly expecting the Central Bank to start raising interest
rates from their historic lows to contain inflation risks.
According to Schwartsman from Santander, if economic growth for the
first quarter approaches six percent, then the Central Bank will
almost certainly raise its benchmark rate early in the second
quarter. Yet, if the economy grows closer to five percent, then he
expects the tightening process will start mid-year. Most other
contacts agree that inflation risks are likely to surface in 2010,
as higher economic growth reduces the output gap, with some like
Itau's analyst Oreng predicting that the Central Bank will raise
its benchmark as high as 10.75 percent, or about 200 bases points
higher than this year's rate, to protect the inflation target of
4.5 percent.

Currency to Experience Minor Election-Year Volatility

--------------------------------------------- ---------

7. (SBU) While export industries continue to fret about the
strength of the Brazilian Real (ref A), up 34 percent against the
U.S. dollar in 2009, most of our financial sector contacts predict
the Real will remain strong and not depart significantly from its
2009 closing of 1.73 R$/USD for most of 2010. Nevertheless, the
Real may experience some minor volatility in the run up to national
elections in October, and as the GOB continues to search for ways
to quell the Real's appreciation. A Ministry of Finance official
said January 4 that the GOB has allowed Brazil's sovereign wealth
fund to invest in U.S. Dollars, representing another move by the
GOB to try and stop Real appreciation, but perhaps more
significantly gives the Ministry of Finance a tool to control the
national currency, an activity that traditionally resides within
the Central Bank. Schwartsman from Santander predicts the Real
will likely depreciate to 1.8 Reais per dollar, due to election
volatility.

Economic Risks Could Hamper Long-Term Growth

--------------------------------------------- -

8. (SBU) Despite the positive outlook, some in the business
community worry that the heady recovery expected in 2010 is
unsustainable in the long-run unless Brazil tackles deeper
structural issues including fiscal account deterioration caused by
increased government spending, and competitiveness and efficiency
shortcomings caused by burdensome labor and tax regulations and
failing infrastructure (ref D). In a recent luncheon hosted by the
Consul General, prominent businessman Roberto Teixeira da Costa
lamented the lack of progress on an economic reform agenda, a
tendency by the GOB toward greater policy interventionism, and
concern that prospects for much-needed amendments to simplify the
labor code and tax system were slim in the upcoming electoral cycle
(NOTE: Congressional opposition, unwilling to award additional
political victories during the Lula administration's final months,
will make passage of any significant reform measures unlikely this
year. END NOTE). Alexandre Pundek told econoff in Brasilia that
the Central Bank is concerned about permanent spending increases
that are taking place within the GOB in government payroll and
personnel. The Central Bank and the Ministry of Finance are
counting on a strong recovery in tax collections to keep additional
fiscal erosion at bay. (NOTE: the latest data for tax collections
in October and November were both recent record highs. END NOTE).

9. (SBU) Meanwhile, Brazil's rate of investment, particularly in
infrastructure, is failing to keep pace with demand. Despite its
impressive recovery from the recession, Brazil continues to lag
investment in fixed capital as well as in infrastructure. While
FIESP estimates 2010 investment will account for 19 percent of
Brazil's economy, an increase from 2009, much of the boost will
likely be driven by planning for the upcoming World Cup and Rio
Olympic Games, as well as offshore pre-salt oil projects. FIESP
and other contacts acknowledge that long-term investment remains
too low, considering IMF calculations that developing economies in
Asia invest about 42 percent of their respective GDP and the
world's investment average is 24 percent. According to Luis
Fernando Lopes, chief economist at Patria Investimentos, Brazil
will need to invest about 23 percent of GDP annually to sustain
economic growth at five percent over the longer term.

Comment

--------

10. (SBU) Spurred by government stimulus measures, the increased
purchasing power of a strong Real, and a burgeoning middle class
(ref B), Brazil's domestic market, more and more the country's key
economic growth engine, is poised for a strong year. Given the
broad political consensus on sound macroeconomic policies among the
country's leading candidates, any presidential election jitters are
unlikely to have a major impact on the economy, aside from some
minor currency volatility. Meanwhile, preparations for major
offshore oil development in the pre-salt region, the 2014 World
Cup, and the 2016 Olympic Games represent an opportunity to spur
much-needed public investment. However, private sector analysts
make a cogent argument that broad structural tax and labor reforms,
along with infrastructure improvements and fiscal constraint are
necessary for Brazil to achieve sustained high rates of growth over
the longer term. End comment.
This message was coordinated/cleared with Embassy Brasilia.
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