VZCZCXRO9914
RR RUEHRG
DE RUEHBR #0971/01 1381825
ZNR UUUUU ZZH
R 181825Z MAY 06
FM AMEMBASSY BRASILIA
TO RUEHC/SECSTATE WASHDC 5411
RUCPDO/USDOC WASHDC
INFO RUEHRG/AMCONSUL RECIFE 4791
RUEHRI/AMCONSUL RIO DE JANEIRO 2095
RUEHSO/AMCONSUL SAO PAULO 6977

UNCLAS SECTION 01 OF 05 BRASILIA 000971 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
FROM CHARGE CHICOLA FOR SECRETARY GUTIERREZ 
 
E.O. 12958: N/A 
TAGS: PGOV ECON BR
SUBJECT: SCENESETTER FOR THE VISIT OF COMMERCE SECRETARY GUTIERREZ 
 
 
¶1. (SBU) The United States Mission in Brazil warmly welcomes your 
planned June 4-8 visit to Rio de Janeiro, Brasilia, and Sao Paulo. 
I will greet you in Sao Paulo airport on June 4 prior to your active 
schedule of events at the AACLA meeting in Rio and with Minister of 
Development, Industry, and Commerce Luiz Furlan.  During your 
stopover in Brasilia, we are seeking sessions for you with President 
Lula and his Chief of Staff Dilma Rousseff, Minister of Foreign 
Affairs Celso Amorim, and Minister of Justice Marcos Thomaz Bastos. 
In addition, in Sao Paulo you will meet with regional governors, 
young entrepreneurs, and private sector officials concerned with key 
issues such as Intellectual Property Rights (IPR). 
 
¶2. (SBU) Your trip, scheduled right before the soccer World Cup, 
comes at a transition point on the political scene.  During the 
second semester of 2005, congressional deputies from Lula's 
governing coalition were accused of accepting bribes, while 
officials from the President's party (the PT) were alleged to have 
engaged in influence peddling and illegal campaign fund-raising. 
These revelations forced the resignation of several members of 
Lula's inner circle, including his former Chief of Staff (who was 
also expelled from Congress). 
 
¶3. (SBU) However, "scandal fatigue" has set in, and President Lula 
has successfully used the slack time to recover lost political 
ground.  Recent polls show Lula regaining the lead in the 
presidential race, and he is currently engaged in a busy schedule of 
visits around the country -- campaigning in all but name -- while 
the leading opposition candidate from the PSDB party has stalled in 
the polls.  The election campaign will commence in earnest after the 
World Cup ends in early July, with presidential and congressional 
elections set for early October. 
 
THE BILATERAL RELATIONSHIP 
-------------------------- 
 
¶4. (SBU) While relations between the U.S. and Brazil are friendly, 
often the USG encounters major difficulties in gaining the 
cooperation of senior policymakers on issues of significant interest 
to the United States.  Eager to assert its own influence, the 
Brazilian government shies away from cooperation with the USG -- 
unless it can clearly be characterized as a reciprocal exchange 
among equals.  Indeed, hyper-sensitivity on issues viewed as 
infringing on Brazil's sovereignty can get out of hand and may be 
seen as signs of political immaturity.  Many Brazilians believe the 
U.S. has designs on the Amazon.  Our fingerprinting of visitors to 
the U.S. drew reciprocal treatment for Americans here; visa and 
immigration issues remain sensitive points. 
 
¶5. (SBU) During recent months, our ongoing dialogue with the 
Brazilians has focused on a variety of potentially useful projects 
for both sides.  We sought to interest the GOB in a Defense 
Cooperation Accord, but the Foreign Ministry rejected the proposal 
even though the Defense Ministry was supportive.  Gaining agreement 
on privileges and immunities to be granted U.S. servicemen engaging 
in military exercises has been just as tough, as the Foreign 
Ministry saw it as "a foot in the door" and linked it with Brazil's 
strong opposition to Article 98 agreements.  We are receptive to 
renegotiation of a stalled bilateral agreement governing space 
launches at the country's equatorial base at Alcantara, but the GOB 
has moved glacially to re-engage, even though the agreement clearly 
serves Brazilian interests.  On trade issues, when unscripted, 
President Lula has characterized the FTAA as "off his agenda."  IPR 
is another sore point, as it has become clear that the USG and the 
Brazilian government have different views on the degree of 
protection to be afforded to intellectual property.  Only after much 
lobbying have we gotten the GOB to: a) turn the corner on copyright 
piracy, and b) persuaded policymakers to pursue negotiated solutions 
rather than compulsory licensing of AIDS anti-retrovirals. 
 
¶6. (SBU) However, not all our conversations are difficult.  At the 
personal level, President Lula has met President Bush several times 
and the two have a good rapport.  On issues involving matters 
perceived as technical in nature -- i.e., law enforcement and 
science (but not counter-terrorism) -- the GOB is eager to engage. 
For example, from 2003 to 2004, the GOB worked quietly with us on 
the timing and details of its shoot-down program to accommodate our 
statutory requirements.  Brazil's Ministry of Health has expressed 
its desire to expand the collaboration they have with the U.S. 
Centers for Disease Control and the National Institutes of Health as 
these agencies work within the Brazilian medical community to bring 
newer treatments and technologies.  The Brazilians have also eagerly 
participated in the dialogue leading up to the first meeting of a 
bilateral commission on science and technology, scheduled for June, 
2006, in Washington. 
 
¶7. (SBU) On development assistance issues, our dialogue is positive 
-- but constrained.  Notwithstanding lackluster results to date, the 
 
BRASILIA 00000971  002 OF 005 
 
 
Brazilian government's multi-billion dollar poverty alleviation 
program -- Zero Hunger -- receives substantial funding from the 
World Bank and the Inter-American Development Bank (IDB).  Given USG 
budget constraints and the fact that Zero Hunger is, in essence, a 
cash transfer program (albeit with conditions), USAID support has 
been limited.  Instead of focusing on cash transfers to the poor, 
USAID has sought to target its efforts towards promoting sustainable 
livelihoods - inter alia, through working with small and 
medium-sized enterprises.  The Embassy's Public Affairs programs 
aimed at promoting young leaders take a similar targeted approach. 
This difference in focus, broad cash transfers versus targeted 
assistance, ends up putting the USG at the margins of Brazil's 
overall anti-poverty efforts. 
 
FOREIGN POLICY 
------------- 
 
¶8. (SBU) Reflecting Brazil's ambivalence toards the United States, 
President Lula has run an activist foreign policy with a focus on 
South Amrica and the Third World, seeking to forge alliancs with 
other mid-sized powers (South Africa, India, etc.).  He has traveled 
extensively in pursuit of a higher international profile for Brazil. 
 Despite prodding from the USG and others, Lula has refused to 
condemn Cuba for human rights violations and, in fact, has pushed 
for Cuban membership in the Rio Group.  Brazil has also advocated a 
Cuba-Mercosul trade pact.  The GOB has worked to increase both its 
economic and political ties with Venezuela.  It has agreed to 
upgrade Venezuela from associate membership to full membership 
status in Mercosul and enhanced integration of the two countries' 
energy sectors is high on its agenda.  Lula has been especially 
solicitous of Chavez in the recent past.  Lula has praised the 
Venezuelan President's democratic credentials ("if anything, 
Venezuela has an excess of democracy") and declared that the Chavez 
government had been demonized by its foes.  However, Venezuela's 
apparent involvement in Bolivia's recent decision to nationalize 
that country's oil and gas industry has dulled the luster on this 
relationship. 
 
¶9. (SBU) Given its size and natural resources, Brazil has long seen 
itself as the natural leader of the region (even though that 
perception is not shared by its neighbors).  Brazil's reaction to 
Bolivia's recent nationalization of foreign petroleum installations 
in that country is a case in point.  Shocked that the Bolivians 
viewed the Brazilian oil parastatal Petrobras as a "boss, not a 
partner,"  government policymakers have vacillated in response to 
President Morales' actions and continuing threats. 
 
¶10. (SBU) Emblematic of Brail's efforts to gain greater standing on 
the world stage is its tenacious pursuit of a permanent UN Security 
Council (UNSC) seat.  In fact, many observers point out that Brazil 
has "subordinated" other economic and political interests with such 
countries as China and Russia in exchange for support (which has not 
been forthcoming) for its UNSC aspirations.  Brazil and other G4 
states (Inda, Germany, Japan) are, despite recent setbacks,continuing to press 
their campaign for a vote on aresolution on 
UNSC reform.  This stance s at odds with the position of many Latin 
American countries, including those which Brazil believes should 
follow its "natural leadership." 
 
¶11. (SBU) Brazil has long seen international fora as a way to 
enhance its international stature.  Reflecting this, in 2005 it 
launched failed national candidates for the top jobs at both the WTO 
and the IDB.  The failure of both, together with the unlikely 
prospects for a permanent seat in the UNSC, has widely been seen in 
Brazil as a "political disaster." 
 
PRESIDENT LULA 
-------------- 
 
¶12. (SBU) President Luiz Inacio Lula da Silva was inaugurated in 
January 2003 after a career as a Sao Paulo metalworker and labor 
leader.  He founded the left-of-center Workers' Party (PT) in 1980 
and lost three presidential campaigns before winning in the October 
2002 elections.  Lula is eligible to run for reelection in October 
¶2006.  Elected in large part on promises of promoting an ambitious 
social agenda, including the "Zero Hunger" program, Lula's 
government has failed to deliver much in this area, as managerial 
shortcomings and the public's top concern -- crime and public 
security -- have not improved under this administration. 
 
¶13. (SBU) As noted above, the Lula Administration has been beset by 
a grave political crisis as interlocking influence 
peddling/vote-buying scandals plagued elements of Lula's PT party. 
During the second half of 2005, the crisis placed Lula on the 
defensive and politics were dominated by investigations, accusations 
and revelations.  The President's Chief of Staff resigned his post 
and was later expelled from Congress.  Meanwhile, several other 
 
BRASILIA 00000971  003 OF 005 
 
 
congressmen were the subjects of investigations and expulsion 
proceedings owing to bribery allegations.  In April 2006, the 
President's influential Finance Minister was forced to resign (and 
remains under criminal investigation) because of unrelated abuse of 
power allegations.  Thus far, Brazilian society -- including the 
opposition -- seems disinclined to hold Lula personally responsible 
for the scandals, and he has recovered lost ground in public 
opinion. 
 
TRADE POLICY 
------------ 
 
¶14. (SBU) To increase its international profile(both economically 
and politically), the Foreign Ministry (Itamaraty) is seeking 
expanded trade ties with developing countries, as well as 
strengthening the Mercosul customs union with Uruguay, Paraguay and 
Argentina.  Arguably the GOB has fallen short on this latter 
objective.  The Brazil-Argentine relationship is rife with trade 
disputes, recently leading to adoption of a safeguard mechanism for 
bilateral trade.  Meanwhile, Uruguay and Paraguay regularly complain 
that Brazil and Argentina reap a disproportionate share of benefits 
from the bloc, and threaten the group's solidarity in various ways 
-- for instance, Uruguay's recent discussions with the United States 
regarding a possible FTA (which would contravene Mercosul rules). 
 
¶15. (SBU) Nonetheless, the bloc remains engaged in certain external 
trade negotiations.  In 2004, Mercosul concluded free trade 
agreements with Colombia, Ecuador, Venezuela and Peru, adding to its 
existing agreements with Chile and Bolivia to establish a commercial 
base for the newly-launched South American Community of Nations.  As 
noted earlier, Mercosul is upgrading Venezuela's status from 
associate to full membership.  In addition to Cuba, the bloc is 
currently exploring free trade talks with Israel, the Dominican 
Republic, Panama and states of the Gulf Cooperation Council, as well 
as trying to build on partial trade liberalization agreements 
concluded with India and South Africa in 2004. 
 
¶16. (SBU) China, which was offered market economy status by Brazil 
as a part of Lula's effort to secure PRC support for Brazil's bid 
for a USNC seat, has increased its importance as an export market 
for Brazilian soy, iron ore and steel, becoming Brazil's fourth 
largest trading partner and a potential source of investment. 
However, low-priced Chinese imports, particularly in the textile, 
footwear, and toy sectors, are now threatening to displace domestic 
Brazilian production.  As many Brazilian observers have indicated, 
all this effort is aimed at countries which together represent less 
than a third of Brazil's foreign trade. Free trade negotiations with 
the EU continue to languish. 
 
DOHA AGENDA - WTO 
----------------- 
 
¶17. (SBU) While Brazil emphasizes South-South trade through 
Mercosul's bilateral negotiations, it uses that Doha Development 
Agenda (DDA) negotiations as the main forum for engaging with 
developed country partners.  The DDA is Brazil's top trade priority, 
viewed as the last chance for perhaps 15-20 years to secure 
fundamental changes in international trade rules, in particular, for 
international agricultural trade.  Brazil leads the G-20 group of 
developing countries that is pressing for agricultural trade reform 
in the DDA.  Brazil's assertive leadership of the G-20 was blamed in 
some quarters for causing the failure of the WTO Cancun Ministerial 
in September 2003.  Since then, Brazil has been more constructively 
engaged in the Doha Round, initially as a member of the "Five 
Interested Parties" and more recently G-6 informal group, although 
many of its positions are still at odds with U.S. interests.  At the 
December 2005 Hong Kong Ministerial meeting, Brazil was key to 
brokering the deal -- albeit one of limited ambition -- coming out 
of that session.  Brazil can be expected to maintain its assertive 
stance in the Doha Round on agricultural trade reform while 
remaining reluctant to engage on discussions covering industrial 
products and services. 
 
FREE TRADE OF THE AMERICAS - FTAA 
--------------------------------- 
 
¶18. (SBU) As indicated above, the Lula Administration shows no 
serious interest in pursuing the FTAA.  Despite serving as co-chair 
and having secured in the November 2003 Miami meeting a new 
framework for negotiation, Brazil has shown no inclination to move 
the process along and has so far declined to convoke the next FTAA 
Ministerial -- which is now overdue. 
 
U.S. EXPORTS 
------------ 
 
¶19. (U) For 2005, Brazil was ranked the 15th largest market for both 
 
BRASILIA 00000971  004 OF 005 
 
 
U.S. imports and exports.  In 2005, U.S. goods exported to Brazil 
totaled US$15.3 billion, representing a 10.4% increase from 2004. 
Our top export categories to Brazil include machinery, electronic 
machinery, organic chemicals, aircraft and aircraft parts, and 
optical and medical instruments.  However, the U.S. trade deficit 
with Brazil continues to grow as well in spite of the strong 
appreciation of the Brazilian real against the U.S. dollar.  For the 
past four years, the U.S. trade deficit with Brazil on goods has 
grown steadily, and reached US$9.1 billion in 2005.  However, our 
trade in services has held steady over the same period, with the 
U.S. exporting about US$5 billion in services to Brazil and 
importing about US$2 billion in return. 
 
¶20. (U) There are a variety of trade matters of concern to U.S. 
companies seeking to do business in Brazil.  Market access and 
investment are major issues for U.S. companies, specifically high 
taxes and nominal tariffs, the latter averaging 10.7 percent - much 
higher than those in the U.S.  In addition, complicated customs, 
import licensing and tax regimes combine to make life difficult for 
U.S. (and third-country) exporters.  Piracy and counterfeiting 
continue to be a concern, although the Brazilian government is 
slowly making progress in addressing deficient enforcement of 
copyright protections.  Both U.S. and Brazilian companies complain 
about "Custo Brazil," (i.e., factors that increase the cost of doing 
business in Brazil such as logistical costs, infrastructure 
bottlenecks, and the cumbersome regulatory framework). 
 
ETHANOL 
------- 
 
¶21. (U) The success of Brazil's ethanol program has made it a model 
for the world in terms of alternative energy.  Brazil's comparative 
advantage is its ability to inexpensively produce ethanol from 
sugarcane, which has the highest starch content of any plant stock. 
In addition to obtaining five harvests from one planting, cane hulls 
(bagasse) are used to produce the thermal energy necessary to power 
the conversion process.  Cane also requires less processing than 
ethanol produced from corn -- which is the method used in the U.S. 
to manufacture ethanol.  According to the World Bank, at current 
prices, Brazil can make ethanol for about US$1 a gallon, compared 
with the international price of about US$1.50 a gallon for gasoline. 
  At the pump ethanol receives favorable tax treatment from the 
Brazilian government.  It is exempted from the largest federal tax 
on gasoline (CIDE) and is subject to lower rates on two other 
federal levies (PIS and COFINS).  Nevertheless, ethanol prices can 
vary substantially from state to state.  In contrast, gasoline 
prices tend to vary less and are controlled by the government. 
 
¶22. (U) Since the 1980s, Brazil has attempted, without great 
success, to promote ethanol fuel exports to the United States.  U.S. 
tariffs and charges make Brazilian imports uncompetitive.  In 
addition to import tariffs of 1.9 to 2.5 percent, the U.S. imposes a 
54 cents/gallon charge on ethanol imported for use as fuel.  These 
charges must be paid by countries not covered by FTAs or other trade 
preference arrangements.  Given the requirements of its fast-growing 
domestic market, whether Brazil will indeed be able to produce 
enough ethanol to supply international markets is an open question. 
Some estimate that over the next one to two years, the maximum 
percentage of Brazil's cane crop which can be devoted to ethanol 
production is 54%.  If so, this would mean that Brazilian ethanol 
production is already running at 95 percent of capacity; and the 
country's ability to expand its sugarcane acreage is limited to 
perhaps 20 percent over the next 3-4 years. 
 
MACRO-ECONOMIC DEVELOPMENTS 
--------------------------- 
 
¶23. (SBU) President Lula and his economic team have implemented 
prudent fiscal and monetary policies and pursued necessary reforms. 
Brazil's external accounts, aided by a benign international 
environment, have improved substantially over the last three years. 
Although GDP growth dropped to 2.3% in 2005, down from a strong 
performance (4.9%) in 2004, Brazil has experienced booming exports, 
healthy external accounts, inflation under control, decreasing 
unemployment and reductions in the debt-to-GDP ratio.  Economic 
activity should pick up in 2006; the markets expect GDP growth of 
about 3.5%.  Buoyed by exports and investment inflows, the Real has 
remained at appreciated levels, allowing the government and 
businesses to pay down external debt.  The government pre-paid its 
IMF obligations, its last remaining rescheduled Paris Club 
obligations, and in April 2006 announced it had retired the last of 
its Brady bonds.  This removes from the books all restructured debt 
associated with Brazil's late-1980's default.  Based upon the 
improving external debt dynamics, Fitch IBCA upgraded its credit 
rating on Brazil's sovereign debt in February 2006, to BB (two 
notches below investment grade).  The economy also has shown 
resilience, remaining for the most part unaffected by a major 
 
BRASILIA 00000971  005 OF 005 
 
 
political scandal and the replacement of the finance minister. 
 
¶24. (SBU) Despite this considerable progress, key challenges remain. 
 The public sector-debt-to-GDP ratio is on a downward trend but 
remains high, at about 51.6%.  Real interest rates are among the 
highest in the world; reducing them will require both reductions in 
the government's borrowing requirement and reform of the financial 
sector and the judiciary.  Income and land distribution remain 
skewed.  Investment and domestic savings are low, although growing. 
 The informal sector constitutes between 35 to 40 percent of the 
economy, in part because the tax burden (nearly 38 percent of GDP) 
is high. 
 
¶25. (SBU) Sustaining high growth rates in the longer term depends on 
the impact of President Lula's structural reform program and efforts 
to build a more welcoming climate for investment, both domestic and 
foreign.  In its first year, the Lula administration passed key tax 
and pension reforms to improve the government fiscal accounts. 
Judicial reform and an overhaul of the bankruptcy law, which should 
improve the functioning of credit markets, were passed in late 2004, 
along with tax measures to create incentives for long-term savings 
and investments. 
 
¶26. (SBU) Public-Private Partnerships, a key effort to attract 
private investment to infrastructure, also passed in 2004, although 
implementation of this initiative still awaits promulgation of the 
necessary regulations.  Labor reform, additional tax reform and 
autonomy for the Central Bank were on the agenda for 2005, but now 
look unlikely to be addressed at least until after the October 2006 
elections.  Much remains to be done.  The government needs to 
improve the regulatory climate for investment, particularly in the 
energy sector; to simplify torturous tax systems at the state and 
federal levels; and to further reform the pension system. 
 
CHICOLA