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

UNCLAS SECTION 01 OF 03 BRASILIA 003115 
 
SIPDIS 
 
SENSITIVE 
 
NSC FOR RENIGAR, SHANNON 
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/EOS LON 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV EINV BR
SUBJECT: FEW ECONOMIC RISKS AS STRONG GROWTH CONTINUES; 
POLITICAL RISKS REMAIN 
 
REFS: A) BRASILIA 2447 
 
      B) BRASILIA 2711 
      C) BRASILIA 3031 
 
¶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. 
 
Comment 
------- 
 
¶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 
C). 
 
DANILOVICH