VZCZCXRO1249
RR RUEHRG
DE RUEHSO #0454/01 1221820
ZNR UUUUU ZZH
R 021820Z MAY 06
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 4943
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHRG/AMCONSUL RECIFE 2881
RUEHRI/AMCONSUL RIO DE JANEIRO 7039
RUEHBR/AMEMBASSY BRASILIA 6083
RUEHMN/AMEMBASSY MONTEVIDEO 1938
RUEHBU/AMEMBASSY BUENOS AIRES 2189
RUEHSG/AMEMBASSY SANTIAGO 1680
RUEHAC/AMEMBASSY ASUNCION 2531
RUCPDOC/USDOC WASHDC 2395
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 04 SAO PAULO 000454 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
NSC FOR CRONIN 
TREASURY FOR OASIA - DAS LEE, 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/SHUPKA 
STATE PASS USAID FOR LAC 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV PREL BR
SUBJECT: TREASURY A/S LOWERY MEETS WITH SAO PAULO CONTACTS 
 
REF: BRASILIA 665 
 
¶1. (SBU) Summary: Treasury A/S Clay Lowery's interlocutors during an 
April 4 Sao Paulo visit pointed to problems obtaining financing and 
skilled labor, along with the high and complicated taxes, as 
hindering the development of Small and Medium Enterprises (SMEs).  A 
round-table with recipients of conditional cash transfer programs 
highlighted the value of such programs in helping parents to keep 
their children in school.  The chief economists of several banks 
expressed confidence in Brazil's macroeconomic scenario and the 
direction of macroeconomic policy, although all see the 
microeconomic agenda lagging.   U.S. businesses enumerated 
education, job creation and labor reform, tax reform, Intellectual 
Property Rights (IPR) protection and the need for trade agreements 
as their priorities for policy engagement with the GoB. 
Participants in a roundtable on infrastructure investment 
highlighted regulatory uncertainty, particularly environmental 
licensing as a principal obstacle to infrastructure investments in 
Brazil.  End Summary. 
 
¶2. (U) Background: Treasury A/S Clay Lowery met in Sao Paulo on 
April 4 with representatives of U.S. businesses, infrastructure 
investors, the Brazilian Banking Association (FEBRABAN) and had a 
round table discussion on financing for Small and Medium Enterprises 
(SMEs).  Lowery visited Cidade Tiradentes, a low-income neighborhood 
in Sao Paulo, where he met with regional Vice-Mayor Arthur Xavier 
and discussed social and economic development problems with several 
beneficiaries of GoB conditional income transfer programs.  Lowery 
also delivered a speech on poverty at the Sao Paulo branch of the 
Fundacao Getulio Vargas (FGV), a leading research institution. 
Lowery's delegation included Treasury DAS Nancy Lee, Western 
Hemisphere Office Director Ramin Toloui and deputy director Chris 
Kushlis.  Consul General McMullen and DPO David Wolfe rounded out 
the USG delegation.  Lowery noted to all his interlocutors that he 
had come to Brazil for the annual Inter-American Development Bank 
(IDB) meetings and was making use of the opportunity to get a deeper 
understanding the challenges of dealing with poverty in Brazil, the 
state of the Brazilian economy, infrastructure issues and U.S. 
business concerns.  End Background. 
 
SME Challenges: Finance, Skilled Labor, Informality 
--------------------------------------------- ------ 
 
¶3. (U) Lowery's interlocutors made two principal points on the 
challenges facing Brazilian SMEs:  the difficulty of gaining access 
to finance and problems finding skilled labor.   Cidade Tiradentes 
roundtable participant Cicero Ferreira da Silva, owner of a video 
rental store that has grown to seven area outlets, complained of the 
lack of skilled labor available for hire in the area.  This meant 
that his business assumed substantial training costs; Silva is 
investing in further developing his work force by paying for several 
workers to take college-level courses.  Cibele Angela Miranda, who 
runs a small business that makes stamps, toys and educational 
materials, reinforced this point, noting that her business routinely 
faces problems finding skilled labor in the area.  One source of 
labor was the Tiradentes municipality's vocational training program 
which provided laborers with some basic skills; this made it easier 
for these new hires to pick up job-specific skills. 
 
¶4. (SBU) Tiradentes roundtable participants uniformly singled out 
the difficulty in accessing finance as a significant recurring 
problem for their SMEs.  Silva noted his ongoing negotiations with 
his bank for the financing to open his seventh video rental outlet 
already had taken several months.  Asked about financing from the 
National Economic and Social Development Bank (BNDES), the 
roundtable participants said that only large firms were able to 
obtain low-cost BNDES loans.  Separately, FEBRABAN Chief Economist 
Luis Troster downplayed BNDES's role in SME finance, noting that 90% 
of its lending is to large corporations.  He derided BNDES as an 
example of a regressive income-distribution program, since it draws 
its funding from a payroll tax (i.e. primarily from the working 
class) and does almost all its lending to larger, successful 
companies.  ABN Amro representative Cesar Goncalves stated that 
government borrowing crowded out lending to SMEs by private banks. 
Goncalves noted that while there had been large credit growth over 
 
SAO PAULO 00000454  002 OF 004 
 
 
the last two years, including of the smallest size loans, most of 
this growth was in consumer lending, not SME financing. 
 
¶5. (SBU) Luiz Pedutti, the Chief Executive of WAPPA, a Brazilian 
software startup that is currently drawing its financing from the 
limited venture capital market in Brazil, blamed the high level of 
informality among small businesses on the complex tax structure. 
Beyond the issue of high tax rates, even a reasonably well-financed 
and well-run business like his own, he said, had difficulty 
fulfilling the complicated tax filing requirements.  Marcelo Toledo, 
an economist at leading Brazilian bank Bradesco, echoed this 
assessment at the FEBRABAN lunch.  Toledo argued to Lowery that the 
GoB must sequence its reform efforts, first tackling government 
current expenditures, a sine qua non for tax reform, which would in 
turn begin to address the problem of informality. 
 
Dealing with Poverty - Income Transfer Programs 
--------------------------------------------- -- 
 
¶6. (U) Tiradentes Vice Mayor Xavier held a round-table with 
municipally employed social workers and beneficiaries of conditional 
income transfer programs.  One of these credited the 40 Reais (about 
US$19) per month that she received from a program for the prevention 
of child labor (PETI - Programa de Erradicacao do Trabalho Infantil) 
for allowing her to keep her daughter in school.  Her daughter also 
was able to access municipally-sponsored after-school programs. 
Another mother said that PET and the complementary municipal 
after-school programs were helping keep her son of the streets. 
This was important, since the 2.5 hour commute to work in Sao Paulo 
meant she was unable to provide after-school care.  Janete Santos, a 
municipal social worker, stated that they municipality targets the 
2,000 most vulnerable families in this low income district, ensuring 
they get access to those programs that are available.  A/S Lowery 
assured the round-table participants that poverty reduction, 
including through institutions such as the IDB was a USG priority 
and thanked them for the opportunity to learn from their 
experiences. 
 
Bankers: Macroeconomic Scenario Good 
------------------------------------- 
 
¶7. (SBU) Over lunch hosted by FEBRABAN, chief economists of several 
banks told A/S Lowery that the macroeconomic situation was good 
(reftel).  There was unanimity of opinion that President Lula would 
continue the same broad macroeconomic policy stance, despite having 
been forced to replace Finance Minister Antonio Palocci with BNDES 
President Guido Mantega.  Alexandre Bassoli of HSBC stated that the 
external balance had been an anchor for the economy, with strong 
exports (export prices up 40% over 2002).  Andre Loes of Banco 
Santander added that structural changes also had contributed to 
export performance, including targeted tax measures, a new awareness 
by business of the importance of exports, and Brazil's shift to 
being a net oil exporter as of this year.  Bassoli added that the 
Lula administration deserved credit for improving debt dynamics, 
which were no longer hostage to the exchange rate. 
 
¶8. (SBU) Bassoli argued that inflation was still volatile, having 
gone from 12.5% in 2002 to about 5% now (based on a rolling 12 month 
estimate), thus creating an interest rate premium.  He further noted 
that disinflation since 2003 had been largely based on the exchange 
rate appreciation, which had restrained the prices of tradable 
goods.  Although there might be a few changes in the personnel at 
the Central Bank, Bassoli did not expect any variations in monetary 
policy.  (Note: On April 6 the Central Bank announced that two of 
its directors, Alexandre Scwhartsman and Sergio Darcy, would be 
leaving, to be replaced by Mario Mesquita, chief economist of ABN 
Amro and Paulo Viera da Cunha from HSBC Securities New York office. 
Most analysts believe the new directors will not change the bank's 
orthodox stance.) 
 
¶9. (SBU) The biggest challenges facing Brazil right now, regardless 
of who wins the October election, affirmed Andre Loes, are the 
quality of the fiscal adjustment and the need for microeconomic 
reform.  Brazil had achieved high primary surpluses, he explained, 
despite substantial growth in current expenditures, because revenue 
 
SAO PAULO 00000454  003 OF 004 
 
 
growth has been even stronger.  This increasing tax burden, coupled 
with the complexity of the tax system, was a growing constraint for 
the economy and reduced potential growth.  While new Finance 
Minister Mantega is expected to meet, although not exceed, the 
formal 4.25% of GDP primary surplus target, there is more concern 
about his ability to reign in primary expenditures, said Jose Pena 
Garcia of BankBoston.  Pena Garcia also expressed concern about 
Lula's ability to push for microeconomic reforms, necessary to boost 
growth rates, during a potential second Lula administration. 
Leading opposition presidential candidate Geraldo Alckmin likely 
would pursue the microeconomic reform agenda more vigorously, Pena 
Garcia argued. 
 
Amcham Concerns 
--------------- 
 
¶10. (SBU) In a morning session with leaders the American Chamber of 
Commerce (Amcham), Mickey Peters of Duke Energy outlined to A/S 
Lowery U.S. business concerns and priorities.  Peters enumerated 
education, job creation and labor reform, tax reform, Intellectual 
Property Rights (IPR) protection and the need for trade agreements 
as the main Amcham concerns.  Elucidating on educational issues, Jim 
Whitaker of Intel highlighted problems with exclusion of certain 
societal sectors as well as lack of standards and transparency.  The 
Amcham, he said, has a program to collect and disseminate best 
practices.  Intel Capital, according to Whitaker, was investing $50 
million in technology startups in Brazil.  Maria Fernanda Teixeira, 
(Formerly of EDS), noted that development of SMEs, tax reform, 
reduction of the infrastructure gap and improvements to the 
investment climate all played into the question of job creation. 
FGV researcher Paulo Figueiredo advocated addressing exclusion 
issues by asking firms to give preferences in contracting to SMEs 
owned by members of Brazil's excluded classes. 
 
¶11. (SBU) The Amcham has lobbied both the GoB and USG hard to try to 
advance the WTO Doha Round (DDA) and Free Trade Area of the Americas 
(FTAA) process, according to Simone Aguiar, Amcham trade committee 
head and Latin American Director for JP Morgan Chase Vastera. 
Brazil and Mercosul were, de facto, being excluded from the web of 
bilateral FTA that the USG was advancing.  He urged that the USG 
make a few conciliatory gestures to Brazil, which would help 
maintain close coordination in the DDA and potentially open the way 
for renewed FTAA discussions.  A/S Lowery noted that the USG has put 
a very aggressive agriculture offer on the table at DDA, which the 
EU has resisted.  Brazil and the G-20, however, were reluctant to 
move as far as the USG and EU sought on services and 
non-agricultural market access (NAMA), complicating negotiations. 
But there was a desire from the agricultural committees in the U.S. 
Congress to complete an ambitious agricultural round, Lowery said, 
which created an opportunity that should not be wasted. 
 
Infrastructure: Regulatory Uncertainty 
-------------------------------------- 
 
¶12. (SBU) Participants in a roundtable on infrastructure investment 
highlighted regulatory uncertainty as a principal obstacle to 
infrastructure investments in Brazil.  GE's Alexandre Silva and Duke 
Energy's Mickey Peters pointed out that the regulatory agencies were 
under-funded and lacked qualified personnel.  Alvaro Novas of major 
Brazilian construction firm Odebrecht suggested that the IDB make 
the establishment of professional regulatory institutions a 
condition for its infrastructure lending.  Novas applauded the new 
IDB infrastructure fund, although he noted working with 
sometimes-inflexible multilateral institutions could be difficult. 
Novas and Sao Paulo State Secretary of Transportation Director of 
Planning Milton Xavier noted the concession law for infrastructure 
projects (most notably roads) functioned well.  The project finance 
framework was problematic, however, because of a problem with the 
rules for accounting for project debt on individual company balance 
sheets. 
 
¶13. (SBU) The environmental licensing problem came in for uniform 
criticism.  Novas and Peters of Duke Energy noted that environmental 
licensing for a project could take as long as 4 years.  The Public 
Ministry (akin to the attorney general's office) complicated the 
 
SAO PAULO 00000454  004 OF 004 
 
 
process tremendously, Novas said, by seeking injunctions halting the 
environmental licensing process without solid justification, Novas 
said.  He warned that Brazil might face an energy shortage in 2008 
or 2009 should several hydropower plants still awaiting 
environmental licensing not begin construction quickly. 
 
¶14. (SBU) Eduardo Nishi, a lawyer who has focused on legislation 
creating the framework for Public-Private Partnerships (PPPs) in 
infrastructure investments, noted that the federal government has 
yet to put out for bids its first PPP project, despite the GoB's 
early hyping of PPPs.  The law contained some innovations, for 
example allowing disputes to be settled by arbitration, but 
implementation has been slow.  Although some states have moved to 
regulate state-level PPPs with more alacrity, they face financial 
limitations which limit their ability to finance their portions of 
PPPs, said Nishi. 
 
¶15. (U) During his day in Sao Paulo Assistant Secretary Lowery 
delivered a speech a on the importance the Bush Administration 
attaches to poverty reduction in the hemisphere and what lessons can 
be drawn from global experience.  Lowery emphasized that countries 
that have successfully reduced poverty have all grown rapidly, 
maintained low inflation and sustainable public finances and pursued 
microeconomic reforms that spread opportunity, including opening 
markets, reducing barriers to starting a business, investing in 
health and education, and linking the poor to markets through 
infrastructure, strengthened property rights and increasing access 
to capital.  In Latin America, the record on poverty reduction has 
been weak, with the exception of some countries such as Chile, 
Mexico, Costa Rica and Brazil.  Finally, Assistant Secretary Lowery 
outlined the US priorities for the region, including debt relief for 
the poorest countries, expanding IDB lending to the private sector, 
tripling credit to small and medium sized enterprises, halving the 
cost of remittances, catalyzing private infrastructure investment, 
supporting the millenium challenge account programs and advancing 
our free trade agenda. 
¶16. (U) This cable was cleared by Treasury and Embassy Brasilia. 
MCMULLEN