VZCZCXRO8008
RR RUEHRG
DE RUEHBR #1008/01 1451654
ZNR UUUUU ZZH
R 251654Z MAY 06
FM AMEMBASSY BRASILIA
TO RUEHC/SECSTATE WASHDC 5459
INFO RUEHRG/AMCONSUL RECIFE 4817
RUEHRI/AMCONSUL RIO DE JANEIRO 2120
RUEHSO/AMCONSUL SAO PAULO 7012
RUEHAC/AMEMBASSY ASUNCION 5437
RUEHBU/AMEMBASSY BUENOS AIRES 4022
RUEHMN/AMEMBASSY MONTEVIDEO 6252
RUEHSG/AMEMBASSY SANTIAGO 5513
RUEHME/AMEMBASSY MEXICO 1971
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDO/USDOC WASHDC
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 02 BRASILIA 001008 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
NSC FOR CRONIN 
TREASURY FOR OASIA - DAS LEE, D.DOUGLASS 
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/SHUPKA 
STATE PASS USAID FOR LAC 
 
E.O 12958: N/A 
TAGS: EFIN ECON EINV PGOV BR
SUBJECT: BRAZIL - FOREIGN EXCHANGE LIBERALIZATION AND MARKET 
VOLATILITY 
 
REF:  BRASILIA 0366 
 
¶1. (SBU) Summary:  Growing pressure from exporters for some sort of 
GoB action in the face of the Real's appreciated levels has forced 
Finance Minister Guido Mantega and Central Bank President Henrique 
Meirelles to state they will put forward a proposal to liberalize 
the country's foreign exchange regime.  Recognizing that Brazil's 
solid fundamentals (continuing strong trade and current account 
surpluses, along with net positive investment flows) will continue 
to underpin the strong Real, exporters will continue pressing for 
liberalization despite the almost 4% depreciation of May 22, which 
was due primarily to external market jitters.  While the GoB has 
said it will build on industry's February liberalization proposal to 
Congress, which would revoke current requirements that exporters 
repatriate earnings and allow domestic dollar-denominated bank 
accounts (reftel), Mantega implied during a May 22 meeting with A/S 
Tom Shannon (see septel reporting cable) that the GoB would not any 
pursue substantial relaxation of the rules governing foreign 
exchange transactions.  Separately, Finance Ministry International 
Secretary Luiz Pereira told Shannon he expects the markets to remain 
 
SIPDIS 
volatile until the Federal Reserve makes its interest rate 
intentions clearer, but that Brazil was well-placed to weather the 
storm.  End Summary. 
 
Competing Ideas Regarding Reform 
-------------------------------- 
 
¶2. (U) Continuous pressure from industrial and agricultural 
exporters, who allege increasing loss of competitiveness due to the 
appreciated Real, has forced the GoB to state it will consider 
liberalizing the foreign exchange transaction regime.  Exporters 
have criticized current regulations, which require repatriation of 
earnings within 210 days of the export sale and ban domestic 
dollar-denominated bank accounts, as increasing demand for Reals, 
thus, they argue, strengthening the exchange rate.  Mantega met 
Meirelles on May 18 to discuss foreign exchange regime 
liberalization, according to the press.  Meanwhile, on May 19, Sao 
Paulo Federation of the Industries (FIESP) President Paulo Skaf 
presented Mantega with a "Foreign Exchange Manifest" stating the 
case for a looser foreign exchange regime.  Mantega told FIESP 
representatives that the GoB would build on FIESP's February 
liberalization proposals in elaborating a liberalization measure. 
 
¶3. (SBU) Many analysts question whether full foreign exchange 
liberalization would in fact affect the exchange rate.  Former 
Central Bank director for International Affairs Alexandre 
Schwartsman has argued that while FIESP's liberalization bill would 
reduce exporters' transaction costs, it would have little or no 
effect on the current exchange rate since the regulations do not 
prevent exporters, once they have repatriated their dollars, from 
immediately remitting them abroad again.  Doing so, however, 
increases the number of foreign exchange transactions a company 
undertakes:  FIESP estimates that changes in the regulations would 
save companies 3% to 4% of total export costs.  The Central Bank is 
nevertheless hesitant to support any such measure because it 
believes liberalization would make it harder to combat money 
laundering or to deal with a foreign exchange crisis.  In a May 22 
meeting with A/S Shannon, Mantega, while acknowledging that many in 
industry felt the exchange rate to be over-valued, did not list 
exchange rate liberalization among the reforms the GoB plans to make 
a priority.  Separately, UN Economist Carlos Mussi commented to 
Econoff that the Central Bank views the vestigial exchange controls 
as an institutional hedge, which could be activated in a crisis. 
 
 
Brazil Positioned to Weather Market Volatility 
--------------------------------------------- - 
 
¶4. (SBU) Mantega's International Affairs Secretary, Luiz Pereira, 
separately noted to Shannon that the uncertainty in international 
financial markets over the course of the Federal Reserve's future 
interest rate decisions drove the nearly 4% depreciation of the Real 
on May 22.  (Note: this was followed by an almost 5% depreciation on 
 
BRASILIA 00001008  002 OF 002 
 
 
May 24.)   Pereira stated that Brazil was well-prepared for a period 
of market volatility, with continuing strong trade and current 
account surpluses driving a marked improvement in the country's 
external position.  Both the GoB and private sector have reduced 
external debt.  The GoB, moreover, has built up a large stock of 
international reserves (US$63.5 billion as of May 12), which was now 
almost equal to its net external debt and well in excess of short 
term debt.  Pereira expected that the markets would find a new 
equilibrium once the Fed's intentions became clear. 
 
¶5. (SBU) Comment:  Although the Real's depreciation of the last few 
days may give the GoB some respite, we do not expect exporters to 
reduce their pressure for some action that would give them relief 
from the appreciated Real's effect on their bottom line.  The GoB's 
commitment to a floating exchange rate as a fundamental pillar of 
its macroeconomic policy -- a commitment President Lula reiterated 
on May 23 -- limits its options as it attempts to be seen as 
politically responsive to its exporters.  Indeed, the Central Bank 
sees full exchange transaction liberalization as a clear danger 
should a crisis come -- an argument that current market volatility 
may strengthen.  Instead, look for window-dressing liberalization, 
with the GoB extending the period which exporters have before they 
must repatriate earnings, among other minor measures. 
 
CHICOLA