VZCZCXRO5674
RR RUEHRG
DE RUEHBR #0060/01 0111453
ZNR UUUUU ZZH
R 111453Z JAN 07
FM AMEMBASSY BRASILIA
TO RUEHC/SECSTATE WASHDC 7815
INFO RUEHRG/AMCONSUL RECIFE 6085
RUEHRI/AMCONSUL RIO DE JANEIRO 3675
RUEHSO/AMCONSUL SAO PAULO 8981
RUEHBU/AMEMBASSY BUENOS AIRES 4501
RUEHAC/AMEMBASSY ASUNCION 5867
RUEHSG/AMEMBASSY SANTIAGO 6008
RUEHMN/AMEMBASSY MONTEVIDEO 6675
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 02 BRASILIA 000060 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR FOR CRONIN 
STATE PASS USAID FOR LAC 
TREASURY FOR OASIA - J.HOEK 
NSC FOR FEARS 
USDOC FOR 4332/ITA/MAC/WH/OLAC/jandersen/adriscoll/mwar d 
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/SHUPKA 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV BR
SUBJECT: BRAZIL: FISCAL PACKAGE CLAIMS FIRST BUREAUCRATIC VICTIM 
 
REF: A) 06 BRASILIA 2490 
 B) 06 BRASILIA 2562 
 
¶1. (SBU) Summary: The fiscal battle over President Lula's planned 
package of economic measures -- which the GoB is now referring to 
prosaically as a "package to accelerate growth" (PTAG) -- has 
claimed its first bureaucratic victim.  Finance Ministry Treasury 
Secretary Carlos Kawall (under-secretary equivalent) resigned just 
 
SIPDIS 
prior to the New Year, after Lula overruled the finance ministry on 
the size of its proposed minimum wage increase and then postponed 
the package's planned December 21 announcement, asking his economic 
team to make it more "daring."  Kawall, a fiscal hawk, claimed 
personal reasons for resigning.  His resignation surprised market 
actors, but as the overall course of GoB fiscal policy for the near 
term is already set by the 2007 budget and the medium term budget 
directives framework law, the resignation did not appear to concern 
markets.  This is because fiscal hawks such as Vice Minister Appy 
remain in place and Brazil's fiscal accounts can accommodate 
moderate loosening.  But the incident reinforces the judgment that 
the GoB will not be pursuing an ambitious fiscal reform agenda in 
¶2007. End Summary. 
 
¶2. (SBU) The Finance Ministry had proposed a minimum-wage increase 
from the current Reais 350 (about USD 167) to Reais 367 (USD 174), 
but Lula reportedly insisted on Reais 380 (USD 180), a figure which 
was subsequently inserted in the 2007 budget by Congress.  As the 
minimum social security pension level is constitutionally linked to 
the minimum wage, the increase also will affect the rapidly growing 
social security system deficit.  The postponement of the 
announcement of the plan reportedly was driven by a divergence of 
views on how to offset the fiscal costs, under the terms of Brazil's 
fiscal responsibility law, of the minimum wage increase.  To do so, 
Kawall and the Finance Ministry proposed to reduce the scope of 
targeted tax breaks originally included in the package (ref B), but 
Lula reportedly rejected that idea and asked for more "daring" 
approach from his economic team. 
 
¶3. (SBU) Finance Minister Mantega has named Assistant Secretary 
Tarcisio Godoy to replace Kawall on an interim basis.  Godoy, a 
respected technocrat, seems unlikely to remain in the job long, but 
will face the challenge of balancing the presidency's demands with 
the fiscal responsibility law.  The presidency plans to announce the 
contents of the PAG on January 22.  Meanwhile, both Lula and Mantega 
went on vacation, leaving their staffs to sort out the details. 
 
¶4. (SBU) A former Finance Ministry Under-Secretary told Emboff 
January 9 that while he foresaw fiscal policy becoming less 
"stringent," it would by no means become populist.  He pointed out 
that there were few downside risks for the GoB in this approach, 
given the current strength of external accounts, falling inflation 
and strong international liquidity.  He stated that he fully 
expected the GoB to begin to put on the table in the first half of 
2007 for public debate some of the potential components of a 
structural reform package.  Even if these were not eventually 
adopted, he argued, it would be healthy for the process for these 
technical options to be discussed.  The official acknowledged, 
however, that there was no indication that President Lula's key 
advisors were convinced that Brazil should seize the opportunity to 
cut through its rigid and distortionary fiscal system despite the 
political costs. 
 
¶5. (U) Despite the GoB's apparent reluctance to hew to as tight a 
fiscal line as it did during Lula's first term, some factors augur 
well for the continuation of relative health.  Former Central Bank 
Director Alexandre Scwhartsman, who now chief economist for Latin 
America at ABN Amro, recently publicized his own study on the 
evolution of the fiscal scenario.  Schwartsman's study pointed up 
that the faster-than-anticipated fall in the real interest rates the 
GoB is paying on its debt has opened up additional fiscal space. 
Given the reduced financing costs, Schwartsman has calculated that 
the GoB is in a much better position to continue reducing its 
net-debt-to-GDP ratio, even if it runs lower primary surpluses.  By 
his calculations, the GoB could maintain the current 50% debt-to-GDP 
ratio in 2007 by running a primary surplus of a mere 2.5%, well 
below the 4.25% target.  The GoB is mooting the idea, as part of the 
 
BRASILIA 00000060  002 OF 002 
 
 
PTAG, of using an adjustment mechanism that would deduct certain 
infrastructure investments from the primary surplus target.  If 
fully implemented this would, de facto, reduce it's primary surplus 
target to 3.75% of GDP.  The GoB, however, has included the 
adjustment mechanism in each of its last two budget but has not used 
it to run primary surpluses below the 4.25% of GDP target. 
 
¶6. (SBU) Comment: Brazil's fiscal policy position is an orthodox 
one, with ongoing elevated primary surpluses being used to reduce 
debt levels.  Its past positive performance has put it in a 
relatively comfortable position and the GoB can afford to loosen 
fiscal policy moderately without compromising its fundamental fiscal 
health.  At issue in the current fiscal battle, however, is whether 
Brazil will seize the opportunity presented by a benign economic 
situation to take larger, more significant steps to put its fiscal 
house in order.  That outcome appears ever more doubtful. 
 
SOBEL