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

C O N F I D E N T I A L SECTION 01 OF 02 BRASILIA 002237 
 
SIPDIS 
 
STATE PASS USTR FOR LEZNY 
NSC FOR CRONIN 
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 
TREASURY FOR DAS LEE AND F.PARODI 
 
E.O. 12958: DECL: 08/18/2015 
TAGS: EFIN PGOV ECON EINV
SUBJECT: BRAZIL SCANDAL: NEW ALLEGATIONS TOUCH FINANCE 
MINISTER PALOCCI AND THE MARKETS 
 
REF: A. BRASILIA 2219 
     ¶B. BRASILIA 2150 
     ¶C. BRASILIA 2149 
 
Classified By: Economic Counselor Bruce Williamson, Reasons 1.4 
(b) and 
 (d). 
 
 ¶1. (C) Summary: Rogerio Buratti, a former advisor to Finance 
Minister Antonio Palocci during the latter's tenure as Mayor 
of the city of Ribeirao Preto (Sao Paulo State), told police 
during a deposition August 19 that Palocci was involved in a 
kickback scheme that sent Reals 50,000 per month to PT party 
coffers during the 2001-2002 presidential campaign.  By 
mid-afternoon, Palocci's office had issued a categorical 
denial of the allegations.  Palocci's statement helped 
reassure the markets, which made up lost ground after initial 
sharp reactions to the news (the Real fell almost 4% and the 
Sao Paulo stock exchange lost over 2% of its value when the 
news initially was released).  Market participants told 
Econoff that Palocci still has significant credibility and 
that his statement denying the allegations would be taken 
seriously.  One analyst argued to Econoff that, barring the 
emergence of convincing evidence corroborating the 
allegations, Brazil's current solid economic fundamentals 
would reassert themselves as the driving forces in the 
financial markets.  It is clear from this episode that 
Palocci's tenure remains a red-line with the markets.  End 
Summary. 
 
The Allegations 
--------------- 
 
¶2. (U) On August 18, former Palocci advisor Rogerio Buratti 
was arrested August 18 on charges that he was destroying 
evidence of corruption, money laundering and tax evasion. 
Buratti, reportedly as part of a deal to try to obtain 
leniency by prosecutors, agreed to testify about the schemes 
he was involved in.  It was during this deposition that 
Buratti alleged that in elections from 1994 to 2002 then 
mayor Palocci had been involved in a kickback scheme that 
sent Reals $50,000 monthly (about US$21,000) to PT party 
coffers.  In an August 19 press release, federal prosecutors 
stated that Buratti named PT Treasurer Delubio Soares as the 
ultimate recipient of the funds.  The kickbacks allegedly 
were paid by a trash collection company and continued to be 
paid as late as 2004, through Palocci's replacement as mayor, 
Vice-mayor Gilberto Maggione, to Delubio Soares.  It is as 
yet unknown whether Buratti offered any compelling evidence 
to back up his claims.  From 1993-1994, Buratti served as 
Palocci's Municipal Finance Secretary.  Palocci issued a 
statement the afternoon of August 19 categorically denying 
the charges. 
 
Market Reaction 
--------------- 
 
¶3. (SBU) The Real fell sharply (from 2.38/dollar to 
2.48/dollar, a 4% drop) immediately upon release of the 
prosecutor's statement to the press but then recovered some 
lost ground, ultimately trading between Reals 2.44 and 2.48 
to the dollar as of mid-afternoon August 19.  Stock 
valuations exhibited a similar pattern, dropping over 2% when 
the news was released and then appreciating, with the Bovespa 
down 1.4% at the time of Palocci's statement.  Interest rate 
futures on the Sao Paulo futures exchange reflected 
expectations of higher long term interest rates.  Nilson 
Teixeira, chief economist at CSFB, told Econoff that 
Palocci's statement had helped reassure the markets. 
 
¶4. (C)  BankBoston investment manager Odair Abate, speaking 
prior to Palocci's denial of the allegations, said the 
accusations had caught the markets off guard since there had 
not been any hint during the several months of 
scandal-watching that Palocci might be implicated.  Arguing 
that Buratti was "not the most reputable" character, JP 
Morgan President Charles Wortman told EconOff that Palocci 
still had credibility in the markets and that he would have 
the chance to defend himself.  The markets were still working 
through their initial reaction to the news, and financial 
markets, Wortman pointed out, tend to over-correct.  Wortman 
also noted that those players that reacted quickly and 
negatively to the news had been primarily local investors; 
foreign investors had not moved.  Speaking to Econoff after 
Palocci's statement (and after the sharp market adjustment 
had halted), CSFB's Nilson Teixeira commented that there had 
been a market over-reaction.  Like Wortman, Teixeira 
downplayed Buratti's credibility. 
 
What Now? 
--------- 
 
¶6. (C) All three noted that the market uncertainty could well 
spill over into next week should additional allegations or 
evidence emerge in the weekend news magazines.  Abate worried 
that Palocci's departure, should it occur, would stretch 
beyond the breaking point the already thin credibility of 
Lula's denial of knowledge of irregular campaign financing. 
Assessing the probabilities of different scenarios, Abate 
said he now believed that it was just as likely that Lula 
would be forced out as it was that he would serve out the 
remainder of his term.  Charles Wortman of JP Morgan and 
Nilson Teixeira of CSFB were less pessimistic, although 
Wortman agreed that markets "would take Palocci's departure 
hard."  Wortman nevertheless believed Vice-Minister Murilo 
Portugal would be a credible replacement for Palocci. 
Teixeira predicted that, absent new and plausible evidence 
contradicting Palocci's denial of involvement, he would 
expect Brazil's solid fundamentals to reassert themselves 
with the markets in the days to come. 
 
Comment 
------- 
 
¶7. (C) Many prosecutors and members of Congress have been 
using the political scandal to grandstand, but the 
prosecutors in the Buratti case appear to have gone overboard 
-- taking aim at a big target with (as yet) very little 
ammunition.  Buratti, moreover, has some incentive to stretch 
the truth, if not lie outright, to strengthen his hand as he 
negotiates for leniency with prosecutors on 
evidence-tampering charges.  While Buratti's credibility has 
yet to be established, the market's willingness to take 
Palocci's statement at face value speaks volumes about their 
faith in the Finance Minister.  It also is clear from the 
markets' initial reaction to the allegations that the scandal 
has at last bumped up against one of their red lines: 
Palocci's tenure.  His (theoretical) departure, in addition 
to immediate effects on the financial markets, may force the 
Central Bank to reconsider beginning a widely-expected cycle 
of interest rate cuts in the benchmark overnight interest 
rate (SELIC) from the current 19.75%, to try to persuade 
short-term foreign capital to remain in Brazil.  All of which 
would augur ill for economic growth in the near term. 
 
DANILOVICH