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 04 BRASILIA 002774 
 
SIPDIS 
 
NSC FOR CRONIN 
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 
AID/W FOR LAC/SA 
 
E.O. 12958: DECL: 10/18/2015 
TAGS: ECON EFIN PGOV
SUBJECT: VISITING TEAM FROM THE OFFICE OF THE COMPTROLLER 
OF THE CURRENCY DISCUSSES MACRO AND BANKING ISSUES IN BRAZIL 
 
Classified By: ECON COUNSELOR BRUCE WILLIAMSON, REASONS 1.4 (b) 
and (d) 
 
 ¶1. (SBU) Summary. The week of September 28 Robert J. 
Scavotto, Senior International Economic Advisor in the 
Comptroller of the Currency's International Banking and 
Finance unit and Oliver Taft, Financial Economist in the same 
office, visited Brazil to meet with a variety of government 
officials and market analysts.  Overall, both the OCC team's 
public and private sector interlocutors provided an upbeat 
assessment of the current state of Brazil's macro-economic 
prospects.  While all those the OCC team consulted agreed 
upon the need for Brazil to move forward with its economic 
reform agenda, given the current political scandal paralyzing 
the Brazilian Congress no one saw any quick congressional 
action on this front prior to the 2006 elections.  End 
Summary. 
 
 
Discussions with the Finance Ministry and Central Bank 
--------------------------------------------- --------- 
 
¶2. (C) In a September 28 meeting with the OCC team, Central 
Bank Deputy Governor for Monetary Policy Rodrigo Azevedo and 
Bank Deputy Governor for International Affairs Alexandre 
Schwartsman spoke at length on the Brazilian macro-economy. 
Overall, they were optimistic regarding the state of the 
macro economy given stronger underlying fundamentals and a 
benign external environment.  They said that Central Bank 
monetary policy, which many market analysts have found to be 
conservative, is having a positive effect in retaining 
central bank credibility for controlling inflation.  Although 
exports have been expanding for the past two years, Azevedo 
and Schwartsman noted that most GDP growth stemmed from 
domestic demand.  They noted that imports of capital goods 
are up 29% for this year and 24% in the past 12 months - and 
have outpaced almost everything but oil.  After a yearlong 
tightening cycle, the two forecast a downward trajectory for 
the Selic benchmark interest rate stating that a a nominal 
interest rate of 13% by the end of 2006 may be achievable. 
In addressing one of the structural rigidities that has 
played a part in keeping real interest rates high, the two 
noted that bank reserve requirements were being analyzed and 
that some of the requirements may be phased out in the next 
2-3 years. 
 
¶3. (C) With respect to credit expansion, the two Central 
Bankers, noted the growth, albeit from a very small base, of 
payroll-linked loans.  As loan payments are automatically 
deducted from workers' paychecks, banks are able to offer 
lower interest rates relative to those associated with more 
traditional lines of credit (on average 2% per month, instead 
of the customary 7-8%).  They noted that the state-owned bank 
Caixa Economica Federal was leading the market in terms of 
offering this product, although Banco do Brasil, and now the 
privately-owned banks, were getting into this market as well. 
 Strong sales of durable goods were helping to boost demand 
for payroll-linked loans. 
 
¶4. (C) The team also met with the Ministry of Finance's 
Secretary for Economic Policy Bernard Appy.  According to 
 
SIPDIS 
Appy, Brazilian society strongly supports the Lula 
administration's macro-economic policies and will not accept 
any major changes in economic direction as the country has 
paid a high price to get to where it is today.  Appy declared 
that the objective of his team was to grow the economy so as 
to ensure that if a financial crisis occurred Brazil would 
not be in as vulnerable a position as it had been in the 
past.  Appy further stated that the GOB was working to reduce 
its current expenditures as a percentage of GDP. Additional 
reform of the tax regime in order to reduce tax arbitrage 
amongst the states was also mentioned as part of the reform 
agenda.  However, it was observed that the reform agenda 
would likely be postponed until after the 2006 elections. 
 
¶5. (C) Carlos Mussi, an economist at the local office of the 
Economic Commission for Latin America and the Caribbean, 
emphasized the overall positive market fundamentals that now 
characterize the Brazilian economy. He said that he has 
identified a large volume of FDI coming from European Union 
and wondered whether such investment would continue given the 
uncertainties in the GOB's energy regulatory framework. 
Mussi also briefed the team on discussions regarding the 
proposed CCA - i.e., a reciprocal compensation agreement 
involving the Latin American central banks whereby payments 
of goods imported would be made directly by the central banks 
to the foreign vendor.  Brazil was against this, Mussi 
observed, as such a situation would transfer the risk of 
non-payment from the importers to the Brazilian Central Bank. 
 
¶6. (C) Anderson Silva, Coordinator General for the Ministry 
of Finance's National Treasury Secretariat, spoke of the 
advances that the GOB has made regarding its outstanding debt 
and in particular the efforts to increase the maturity of 
future obligations and reduce the percentage of fixed rate 
debt.  Silva had just gotten back from Washington where he 
gone to help promote the country's debut auction of 
real-based bonds overseas.  According to Silva, the US$ 1.5 
billion issuance was oversubscribed, with strong demand for 
the bonds, in part spurred by tax incentives, from foreign 
investors.  Still, Silva did not want to predict the results 
of any future such issuances in either the short or the 
long-term.  He did state, however, that during the 2006 
election year economic/political risk should be considerably 
lower compared to 2002.  Companies are less leveraged now and 
they are able to find domestic finance given that corporate 
losses are the lowest they have been in the last 10 years. He 
predicted that the 
 National Treasury would continue with its current path 
regarding bond issuance and does not expect to roll-over all 
of its international obligations over the next 2 years 
(anticipated roll-over rate of 76%). 
 
Meetings with Sao Paulo Market Analysts 
--------------------------------------- 
 
¶7. (C)  In their September 26-27 meetings in Sao Paulo, the 
OCC team met, inter alia, with Daniel Araujo, Director, 
Financial Services, Standard & Poor's; Thomas Malaga, Chief 
Economist, Banco Itau; Nilton Teixeira, Chief Economist , 
CSFB; and Mauricio Oreng, Economist, UNIBANCO.  Generally 
speaking, the four economists agreed that Brazil's economic 
growth is robust, notwithstanding the current domestic 
political crisis.  They provided the following outlook on the 
country's economic and political perspective. 
 
¶8. (C) Araujo (strictly protect) gave a brief description of 
the banking system and said that the Central Bank's November 
2004 intervention in Banco Santos had had little impact on 
large banks like Bradesco, Itau, Unibanco, HSBC, Citibank and 
BankBoston.  He said the large banking institutions, in fact, 
benefited somewhat from the intervention because it helped 
them to lend money to the small and mid-size banks that had 
felt the impact of the Banco Santos collapse.  Changing the 
subject a bit, Araujo pointed out that the two banks, BMG and 
Banco Rural, linked to the ongoing political corruption 
scandal, had no S&P credit rating.  Fortunately, these two 
banks had not caused any serious damage to the banking 
sector, with the exception of the Banco do Brasil and Caixa 
Economica, both state-owned banks, which already had had 
investments with Banco Santos. 
 
¶9. (C) Finally, Araujo thought there was little chance of 
more state-owned banks being privatized in the near-term and 
did not see any possibility of sale, merger or incorporation 
of big banks among themselves, as most of them were 
family-owned and highly profitable.  Nevertheless, Araujo 
predicted that smaller banks would face difficulties over the 
long-term if the GOB's reform agenda remained stalled in the 
Brazilian Congress.  He noted that large and mid-size banks 
were already on the lookout for the acquisition of banks 
doing retail business.  With respect to foreign banks, 
despite their size and years operating in Brazil, Araujo did 
not foresee them getting deeply involved in the consumer 
loans business. 
 
¶10. (C) On the issue of paycheck secured loans, Araujo noted 
that this market was primarily being pursued by small banks, 
because the larger banks were not particularly interested in 
this type of business.  While the small banks were attracted 
by low risks of such loans, the amount of credit extended 
could not exceed 30 percent of the employee's salary. 
 
¶11. (C) Itau Chief Economist Malaga (strictly protect) opined 
that Brazil was doing a great job in several areas, but that 
economic growth was still insufficient.  He said that the 
Central Bank's stringent monetary policies had stabilized the 
economy, inflation was well under control and the substantial 
trade surplus was keeping the exchange rate low, thus helping 
to restrain inflationary pressures.   Progress on inflation 
would allow the Central Bank to consistently lower the 
benchmark SELIC interest rate, with it stabilizing somewhere 
around 16.4 percent at the end of 2006.  He thought that the 
political crisis put a question mark on Brazil's ability to 
continue doing business in an ethical, serious and confident 
manner, but nonetheless was happy that the international 
environment had been favorable up to now.  Malaga declared 
that the economic reforms concluded in past years were 
yielding positive results and that implementation of the 
Fiscal Responsibility Law had compelled administrators to 
control expenditures, which in past years left huge deficits 
at the end of an elected official's mandate. 
 
¶12. (C) Partially answering his own question as to whether 
Brazil could repeat its extraordinary economic performances 
of the past two years, Malaga stated that "he did not foresee 
any serious economic crisis in Brazil, given the favorable 
international environment."  This positive outlook was based 
on the lack of any foreseeable internal or external economic 
crisis that could affect the country's trade performance, 
which was propelled mainly through exports of commodities and 
manufactured goods.  Brazil soon would become the world's 
largest exporter of commodities, he added. 
 
¶13. (C) CSFB Chief Economist Teixeira (strictly protect) 
noted that it was important to remember that today's Brazil 
cannot be compared to the Brazil of 1997.  In the past, 
monetary guidelines were not observed and other macro targets 
were never met because of economic shocks which distorted 
economic and fiscal fundamentals.  Now, he said, there is 
greater discipline and a tighter monetary policy helps keep 
inflation under control.  He saw automatic inflation indexing 
of wage contracts gradually decreasing and (hopefully) 
phasing out by 2008.  Teixeira foresaw energy risks ahead in 
2008/2009, given the lack of investment in the energy sector. 
 If Brazil wants economic growth averaging 5 percent a year, 
he noted, then huge investments in energy production will be 
needed, which will take about five years to mature. 
 
¶14. (C) With respect to the GOB's reform agenda, Teixeira 
said that passage of these measures needed the urgent 
attention of Congress.  The country's labor legislation was 
obsolete and needed to be completely overhauled and brought 
into line with global standards.  Nevertheless, he said that 
approval of such reforms would be a lengthy process and 
wasn't sure the Brazilian Congress would be willing to deal 
with it as the election year grew closer.  Given the delays, 
he did not expect Brazilian sovereign debt to reach 
investment grade status until 2009. 
 
¶15. (C) UNIBANCO's Mauricio Oreng (strictly protect) noted 
that the reversal of global economic growth trends, fast 
weakening of the USD, continued hikes in oil prices, and 
international terrorism were all potential external risks 
that had to be looked at carefully.  On the domestic front, 
the probable risks Brazil faced were the 2006 elections and 
related political corruption scandals; an inappropriate 
political reaction to a less favorable economic environment; 
and difficulty in maintaining the quality of its fiscal 
adjustment. 
 
¶16. (U) This cable was cleared with the OCC team prior to 
being transmitted. 
DANILOVICH