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 000949 
 
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/EOL SON 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV EINV BR
SUBJECT: BRAZIL: CHIPPING AWAY AT THE FISCAL RESPONSIBILITY 
LAW 
 
REF:  Brasilia 321 
 
This cable is Sensitive but Unclassified, please protect 
accordingly. 
 
¶1. (SBU) Summary.  Faced with the awkward prospect of 
enforcing the Fiscal Responsibility Law (LRF) against 
former Sao Paulo mayor, friend of Lula and prominent 
Workers' Party (PT) figure Marta Suplicy (reftel), the GoB 
has been less than coherent.  Finance Minister Palocci sent 
to Congress a letter acknowledging that Suplicy had 
violated the law in taking out a loan to finance a public 
lighting program without the Finance Ministry's prior 
approval.  Then, in an apparent about face, the GoB issued 
an executive decree that retroactively created an exception 
to the LRF for public investments of just that sort. 
Despite Lula Administration efforts to shield her, the 
matter may soon be out of the GoB's hands since Suplicy's 
replacement as Sao Paulo mayor, Jose Serra of the 
opposition PSDB, has forwarded to the municipal Accounts 
Tribunal (a fiscal oversight body) the final financial 
report for 2004, Suplicy's last year in office, indicating 
that her administration left uncovered obligations of over 
a billion Reals.  In addition, State Deputy Alberto 
Goldman, the President of the Sao Paulo PSDB party filed a 
complaint with the Federal Public Prosecutor's office 
listing her alleged LRF violations.  Prosecutors, we are 
told, are itching to get their hands on such a high profile 
case.  For her part, Suplicy is reportedly considering a 
run in 2006 under the PT banner for the Sao Paulo state 
governorship.  While the GoB's actions in this case have 
chipped away at the integrity of the LRF system, they have 
not yet struck its foundations.  End Summary. 
 
Marta's Law 
----------- 
 
¶2. (SBU) Apparent violations of the fiscal responsibility 
law (LRF) by Lula associate and prominent PT member Marta 
Suplicy during her 2001-2004 tenure as mayor of Sao Paulo 
(reftel) have put the GoB on the defensive.  Finance 
Minister Palocci admitted in a January letter to Congress 
that one Suplicy administration action, the contracting of 
debt to fund a public lighting program without prior 
Finance Ministry approval, had violated LRF provisions 
restricting such actions by cities whose debt stock is 
above 120% of revenues.  Shortly thereafter the GoB 
inserted in Provisional Measure (MP) 237, a decree dealing 
primarily with other issues, a few paragraphs that created 
a retroactive exemption to the LRF specifically for the 
type of investment in question.  While four other cities 
also benefited from this rule change, no one doubts that 
the measure was meant to create an exemption for Suplicy's 
Sao Paulo administration.  (Note: Meant to deal with urgent 
problems, provisional measures are a peculiarity of the 
Brazilian system.  They are executive decrees with the 
force of law that take effect immediately upon publication. 
To become permanent legislation, however, they must be 
ratified by Congress, which in turn is required to vote on 
them within a defined time period.  End note.)  The MP has 
not yet been voted out of Congress, where some have 
questioned its constitutionality. 
 
¶3. (U) The Finance Ministry separately issued a resolution 
changing the interpretation of "mid-course" debt ceilings, 
set by Congress at the same time the LRF was passed, so 
that they would not be binding for another decade.  The 
debt ceilings at issue were set by Congress to limit 
states' and municipalities' ability to take out new debt. 
The GoB's action appears aimed at bypassing a somewhat 
arcane technical miscalculation in the inflation indexing 
that was used to correct state and city nominal debt stocks 
for inflation (reftel).  The LRF uses an exchange rate- 
sensitive inflation index, the IGP-DI, to adjust for 
inflation the debt that states and cities owe the Federal 
Government.  State and municipal revenues, however, tend to 
closely track consumer inflation levels, which are much 
less exchange rate sensitive.  This mismatch makes it 
possible for a state or municipality's debt to the GoB to 
grow much more quickly than its revenues, even without new 
debt.  And, while Sao Paulo did take out some new debt, the 
bulk of growth in its debt stock was due to this indexation 
problem, setting the stage for a somewhat artificial 
violation of the Congressionally-set debt ceilings. 
 
¶4. (SBU) Raul Velloso, a financial consultant and economist 
linked to new Sao Paulo mayor Jose Serra acknowledged to 
Econoff April 1 that the indexation mismatch needed to be 
addressed.  He argued, however, that the GoB's approach, 
which boiled down to saying the debt ceilings will not be 
enforced in the near term, failed both to address the 
underlying technical problem and created the distinct 
impression that it was doing so to protect Suplicy.  (Note: 
Most media that covered the issue sounded a note of alarm 
on precisely that point.)  Velloso, however, was not 
worried that the vitiation of the debt ceilings would open 
the way for uncontrolled spending by the states and 
municipalities.  He pointed out that the LRF's real 
procedural teeth were the requirements for prior Finance 
Ministry approval for contracting debt and the Federal 
Government's ability to withhold transfer payments to the 
states and municipalities should they miss debt payments. 
 
¶5. (SBU) Reflecting on the Suplicy case, UN Economic 
Commission economist Carlos Mussi told Econoff that the 
GoB's actions raised clear concerns about its ability to 
maintain fiscal discipline among states and municipalities. 
Now that one exception had been made, he predicted that 
governors and mayors would be lining up at the Finance 
Ministry's door asking that they be given the similar 
treatment.  While concerned, Mussi did not believe the GoB 
had undermined the foundations of the LRF. 
 
Out of the GoB's Hands? 
------------------------ 
 
¶6. (U) The Serra administration in Sao Paulo, meanwhile, 
has sent to the municipal-level Accounts Tribunal (a 
judicial branch fiscal oversight body) the final report on 
the city's accounts for 2004, the last year of the Suplicy 
administration.  According to the Serra administration's 
calculations, Suplicy left over a billion Reals of bills to 
be paid, but only 379 thousand Reals cash on hand in city 
coffers at the end of 2004.  It is a violation of the LRF 
for elected officials to leave unpaid obligations without 
the resources to cover them at the end of their 
administration.  The Accounts Tribunal has 90 days to 
evaluate the financial accounts before deciding whether to 
accept or reject the annual report.  If irregularities are 
found in the accounts, the Tribunal is expected to refer 
them to the Public Prosecutor's office (Ministerio Publico) 
for action. 
 
¶7. (SBU) Independently, the state president of the PSDB in 
Sao Paulo last week filed a complaint with the Federal 
Prosecutor's office, with a case file on alleged breaches 
of the LRF under the Suplicy administration.  According to 
Velloso, the primary accusation is that Suplicy did not 
leave funds to cover unpaid bills, a violation of the LRF. 
Velloso felt this alleged breach of the LRF, which includes 
the supplier debt that Suplicy reneged on as she left 
office (reftel), was much more serious than the separate 
violations of the debt ceiling and the procedural failure 
to get Finance Ministry approval for the public lighting 
program loan.  MP 232 and the separate Finance Ministry 
resolution addressing the latter two points do not shield 
Suplicy from prosecution under the former.  Velloso 
believed that the Municipal Accounts Tribunal would forward 
the case to the Public Ministry for prosecution within a 
few months.  Velloso said the prosecutors were salivating 
at the thought of getting their hands on such a high 
profile case, implying that they would move the case to 
trial. 
 
Comment 
------- 
 
¶8. (SBU) Other than looking the other way, the GoB appears 
not to have a strategy to deal with the Suplicy problem. 
This likely reflects the many directions it is being pulled 
by political forces and, within some parts of the GoB, a 
desire not to undermine the LRF.  Those actions they have 
taken so far to protect Suplicy, however, have been 
unalloyed bad news.  We nevertheless agree with Mussi that 
the foundations of the LRF system have not yet been shaken. 
The LRF system was designed to have a life of its own and 
gave other actors, such as the courts, the ability to press 
enforcement action.  So, Suplicy may yet have her day in 
court.  That alone would help shore up the LRF's 
credibility.  On the parallel political track, the case 
promises to be a practice match for the 2006 elections, 
with the PSDB working to undermine the PT party's, and 
thereby the Lula Administration's carefully cultivated 
image of fiscal responsibility. 
 
¶9. (U) This cable was coordinated with Consulates Sao Paulo 
and Rio de Janeiro. 
 
CHICOLA