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C O N F I D E N T I A L SECTION 01 OF 02 BRASILIA 000546 
 
SIPDIS 
 
SIPDIS 
 
NSC FOR CRONIN 
TREASURY FOR OASIA - PARODI AND LEE 
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/DDEVITO/DANDERSON/EOL SON 
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D 
STATE PASS USAID FOR LAC 
STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE 
 
E.O. 12958: DECL:03/16/2016 
TAGS: EFIN ECON PGOV PREL BR
SUBJECT: ICE THINNING UNDER BRAZILIAN FINANCE MINISTER PALOCCI 
 
REF: A) BRASILIA 0502 
 B) BRASILIA 0416 
 C) BRASILIA 0353 
 D) 05 BRASILIA 3349 and previous 
 
Classified by Deputy Economic Counselor J. Andrew Plowman, 
resons 1.4 (b) and (d). 
 
¶1. (C) Summary:  The Congressional Investigative Commission 
(CPI) on Bingo Houses, which is conducting hearings into 
allegations of corruption in the Lula government, heard 
testimony on March 16 from a gardener/handyman who said Palocci 
had frequently visited a Brasilia house where several of his 
advisors are alleged to have conducted corrupt dealings.  The 
CPI hearings were cut short by the arrival of a Supreme Court 
injunction, obtained by the ruling Workers Party (PT), which 
claimed the hearing violated Palocci's privacy rights.  In 
contrast with previous CPI hearings on Palocci's activities, the 
opposition social democratic party (PSDB), which this week 
announced that Sao Paulo Governor Geraldo Alckmin would be its 
presidential candidate, did not try to shield Palocci and 
instead called for his departure.  Palocci's international 
affairs advisor, who two weeks ago categorically denied that 
Palocci would depart the Ministry before the end of Lula's 
mandate, was far less certain in a discussion with Econoff on 
March 17. 
 
¶2. (C) The markets are taking the news in their stride, as CSFB 
Chief Economist Nilson Teixeira told us that there is little 
expectation Lula would shift economic policies prior to the 
elections, even if Palocci were to leave.  While Lula's 
commitment to macroeconomic orthodoxy is unlikely to falter, we 
have less faith in his March 16 statement that Palocci will stay 
on the job.  The PT's ham-handed injunction caper has created 
the distinct impression that Palocci has something to hide and 
weakened him politically.  While Lula may soon begin wondering 
whether Palocci's presence has not now become a bigger liability 
than asset, we do not expect an immediate change. End Summary. 
 
New Witness Contradicts Palocci Denials 
--------------------------------------- 
 
¶3. (SBU) Among the many allegations of corruption and/or 
involvement in influence peddling that have been leveled against 
Minister Palocci (Ref D and previous), one set revolves around 
the activities of a group of advisors who supposedly engaged in 
influence peddling and corrupt contracts.  The group is alleged 
to have conducted these corrupt dealings at a Brasilia house 
rented by one of these advisors.  Palocci testified to the CPI 
that he never went to the house.  Costa and a driver for one of 
Palocci's aides both have contradicted that testimony. 
 
¶4. (SBU) Costa's March 16 testimony to the CPI was cut short by 
the arrival of an injunction from the Supreme Court, obtained at 
the behest of the PT party, which claimed the hearings would 
violate Palocci's privacy rights.  The PT justified the 
injunction on the grounds that Costa's testimony might touch on 
intimate details of Palocci's alleged activities at the house, 
since other witnesses have claimed that Palocci's advisors 
frequently brought prostitutes to the premises for parties. 
Even though it alleges the claims to be false, the PT argued 
that the testimony stood to violate Palocci's privacy rights. 
 
Opposition no longer Shielding Palocci 
-------------------------------------- 
 
¶5. (C) In contrast with previous CPI sessions on the allegations 
surrounding Palocci, members of the opposition PSDB and PFL 
(Liberal Front Party) no longer sought to shield Palocci.  In 
 
BRASILIA 00000546  002 OF 002 
 
 
meetings prior to yesterday's CPI session, PSDB Party leaders 
had told PolCons that in retrospect, their decision to spare 
Palocci --  motivated by a desire to act as good citizens and 
preserve Palocci's fiscal policies -- had been a strategic 
error.  The PSDB and PFL changed course at the March 16 hearing 
and in its aftermath, called for Palocci's departure and sharply 
criticized the PT decision to seek the Supreme Court injunction. 
 PSDB party president Tasso Jereissati termed Palocci's tenure 
"unsustainable."  Even some members of the PMDB party, nominally 
allies of the PT, jumped on the bandwagon, calling on Palocci to 
leave office. 
 
¶6. (C) Throughout the roller-coaster ride of the Palocci 
corruption allegations, the ministry's international affairs 
advisor, Sergio Bath (please protect), repeatedly has assured us 
that Palocci has no intention of leaving the ministry.  On March 
3, he categorically denied reports published by the press that 
Palocci would leave to be Lula's campaign coordinator and stated 
that Palocci expected to stay in office for the remainder of 
Lula's term.  In a March 17 conversation about the most recent 
developments, he was far less categorical, saying that he 
anticipated no change over the course of the next few days. 
 
Markets Calm, Expect no Change 
------------------------------ 
 
¶7. (SBU) CSFB Chief Economist Nilson Teixeira told Econoff March 
17 that financial market participants appear not to be concerned 
about the latest twists in the Palocci saga.  The most likely 
scenario, he stated, is that Palocci would remain on the job for 
the rest of Lula's term.  Even were Lula to opt to replace 
Palocci, there was little chance he would change economic 
policies this late in the game.  The economy was Lula's biggest 
success story going into the election, Teixeira pointed out. 
Even were Palocci to be replaced with someone like Senator 
Aloizio Mercadante, a senior PT member who has at times 
questioned the degree of the finance ministry's zeal in pursuing 
elevated primary surpluses, Teixeira believed there would be 
policy continuity for the remainder of Lula's term. 
 
¶8. (C) Comment: The political equation surrounding Palocci has 
changed fundamentally given Lula's (entirely unexpected) 
resurrection in the opinion polls and the PSDB's decision to 
nominate Sao Paulo Governor Alckmin as its presidential 
candidate; the opposition no longer has any incentive to spare 
Palocci.  Moreover, the ham-handed way in which the PT sought to 
stop yesterday's testimony with a supreme court injunction has 
created the distinct impression that Palocci has something to 
hide.  Palocci has reasons to want to stay on the job, as his 
ministerial rank means that only the Supreme Court can prosecute 
him.  Moreover, Lula has no obvious candidate to replace 
Palocci, for few people would be acceptable both to the markets 
and Lula's left wing.  Lula must nevertheless be wondering 
whether keeping Palocci will not become an increasing liability, 
presenting the opposition with an easy target as the election 
season begins.  We do not expect an immediate change, however, 
as the GoB evaluates the political fallout of yesterday's fiasco 
and, just maybe, begins to plot Palocci's exit strategy. 
 
CHICOLA