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 000490 
 
SIPDIS 
 
SENSITIVE 
 
NSC FOR BREIER, RENIGAR 
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: ECON EFIN PGOV EINV BR
SUBJECT: BRAZIL - HOW MUCH SPENDING SEQUESTRATION IS ENOUGH? 
 
REF: A) Brasilia 43 
     B) 04 Brasilia 291 
     C) 04 Brasilia 1098 
     D) Brasilia 387 
 
¶1.   (SBU) Summary.  The GoB is preparing to issue on 
February 25 a decree sequestering Reals 5 to 10 billion 
(approximately USD 2 to 4 billion) of spending called for in 
the 2005 budget law passed by the Brazilian Congress 
December 29.  This is part of an annual exercise in which 
the executive branch walks back some of the spending and 
revenue assumptions made by the Congress in the budget law 
to reflect its own evaluation of the likely fiscal scenario 
for the year.  This is a precautionary exercise, and the 
money may ultimately be spent.  In 2004, the Congress's 
projections proved to be much closer to the mark than those 
the GoB used to justify its February sequestration of about 
Reals 7 billion in expenditures, all of which was later 
spent.  The biggest wildcard this year is the social 
security deficit.  Recent projections of healthier social 
security contributions, due to increasing employment, may 
significantly reduce the amount the GoB sequesters on 
February 25.  End Summary. 
 
¶2.   (U) The Brazilian Congress passed on December 29 a 
Reals 482.5 billion federal budget (ref A).  As is 
traditional, the Congress topped up both revenue and 
spending levels from the budget proposal that the Executive 
submitted (see chart 1 below).  The Congress is free to 
indulge in this political maneuvering because execution of 
the budget as passed by Congress is not mandatory, but 
rather serves merely as an authorization -- something that 
newly elected speaker of the Chamber of Deputies Severino 
Calvacanti says he wants to change (ref D).  The executive, 
however, currently retains responsibility, under the Fiscal 
Responsibility Law, to sequester spending (within thirty 
days of the signing of the budget) to match its own revenue 
projections.  While this has been invaluable tool for the 
GoB to enforce fiscal discipline and meet its primary fiscal 
surplus targets, the process places squarely on its 
shoulders, and not those of Congress, public opprobrium over 
spending cuts.  The system also creates significant gaps, 
both positive and negative, between what the executive 
branch proposes, what the Congress passes and what is 
ultimately executed. 
 
 
                  Chart I - Brazil's Budget 
                      Billions of Reals 
 
 
                    2004      2004      2005      2005 
                    1st       As        Budget    Budget 
                    Rev       Executed  Proposal  Law 
 
Total Revenue       406.1     424.5     457.4     482.5 
 (% of GDP, approx)            23%       23.5%     24.3% 
 - Transfers 
   to States & 
   municipalities    62        65.1      69.9      78.3 
 
Net Revenue         344.1     359.4     387.5     404.1 
 
Expenditures        344.1     361.2     389.5     404.1 
 
 - Payroll           84.3      88.6      90.3      91.3 
 - Other non- 
   discretionary     32.2      30.9      32.1      36.3 
 - Judicial and 
   Legislature 
   Expenditures       3.7       3.3       4.6       4.6 
 - Social Security 
   Benefits         121.5     125.8     140.0     140.0 
 - Discretionary     60.8      62.6      77.2      84.6 
 - Primary 
   Surplus 
   Target            41.6      50        45.3      47.3 
 
Source: Ministry of Planning and Budget 
 
¶3.   (SBU) Ana Teresa Holanda, the director of the Office of 
Fiscal Affairs in the Ministry of Planning and Budget, told 
Emboff February 3 that the GoB is preparing to sequester 
about Reals 10 billion in spending to adjust the budget law 
for more recent projections of revenues.  This compares to 
about Reals 7 billion sequestered last year (ref B). 
Further adjustments can be made throughout the year to 
reflect actual revenues.  For example, the GoB later spent 
the Reals 7 billion it sequestered early in the 2004 when 
strong economic growth and changes in the PIS/COFINS taxes 
boosted revenues significantly.  Holanda was uncertain what 
categories of spending would bear the brunt of the 
sequestration.  The 2004 sequestration primarily reduced 
expected investment spending. 
 
                          Table II 
                   Social Security Deficit 
                        Reals Billion 
 
          2003 Executed                 24.5 (1.99% of GDP) 
          2004 First Review             28.3 
          2004 Executed                 32.0 (1.9% of GDP) 
          2005 Budget Proposal          32.3 
          2005 Budget Law               32.3 (1.55% of GDP) 
          January 2005 projection       40.9 
          February 2005 projection      35.5 
 
          Source: Ministry of Planning and Budget 
 
¶4.   (SBU) The social security deficit currently is the 
biggest wild card for budget planning, according to Holanda. 
The 2004 deficit had come in Reals 3.7 billion above 
projections, and the GoB had estimated in January that the 
deficit could jump to Reals 40.9 billion.  This Reals 8.6 
billion increase represents the lion's share of the Reals 10 
billion sequestration, she said.  The primary culprit for 
the increased deficit had been an unexpected flood of small 
claims court decisions requiring readjustment of benefits to 
beneficiaries whose pensions were not indexed correctly in 
the switch to the new currency at the beginning of the Plano 
Real in 1994. 
 
¶5.   (U) The GoB has since come out with another social 
security deficit projection, this one of Reals 35.5 billion. 
This rosier estimate is based on higher projections of 
revenues, reportedly justified by strong job growth and 
falling unemployment, which should increase social security 
revenues.  If adopted, the lower social security deficit 
projection could justify reducing the amount to be 
sequestered, by as much as Reals 5 billion.  The GoB would 
need to weigh, however, the possibility that another major 
pending court decision on the calculation of social security 
benefits will be decided against it.  The GoB has lost this 
case at the appellate court level.  If the Supreme Court 
upholds that earlier decision, this would force payment of a 
reported Reals 6.8 billion in back benefits and increase 
monthly outlays by Reals 105 million. 
 
¶6.   (SBU) Comment:  The positive news on economic growth 
and expectation of continued strong revenue performance have 
helped make the sequestration process this year remarkably 
low key.  This stands in sharp contrast to last year, when 
the GoB was subject to routine attacks over its 
sequestration of investment spending.  It is clear, however, 
that the social security deficit remains a significant 
fiscal vulnerability.  While the deficit may fall as a 
percent of GDP this year (as it did from 2003 to 2004), even 
the healthy social security revenues projected for 2005 
would cover barely a quarter of social security outlays. 
Clearly, the system requires further reform to reduce its 
vulnerability. 
 
DANILOVICH