VZCZCXRO6077
PP RUEHRG
DE RUEHSO #0709/01 2291935
ZNR UUUUU ZZH
P 171935Z AUG 07 ZFF6
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC PRIORITY 7360
INFO RUEHAC/AMEMBASSY ASUNCION PRIORITY 3072
RUEHBR/AMEMBASSY BRASILIA PRIORITY 8479
RUEHBU/AMEMBASSY BUENOS AIRES PRIORITY 2826
RUEHCV/AMEMBASSY CARACAS PRIORITY 0532
RUEHLP/AMEMBASSY LA PAZ PRIORITY 3440
RUEHME/AMEMBASSY MEXICO PRIORITY 0804
RUEHMN/AMEMBASSY MONTEVIDEO PRIORITY 2401
RUEHSG/AMEMBASSY SANTIAGO PRIORITY 2103
RUEHRG/AMCONSUL RECIFE PRIORITY 3721
RUEHRI/AMCONSUL RIO DE JANEIRO PRIORITY 8262
RHEHNSC/NSC WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RUEHRC/DEPT OF AGRICULTURE WASHDC PRIORITY
RHMFISS/CDR USSOUTHCOM MIAMI FL PRIORITY

UNCLAS SECTION 01 OF 02 SAO PAULO 000709 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR WHA/FO, WHA/BSC, WHA/EPSC, INR 
STATE PASS USTR FOR KATE DUCKWORTH 
NSC FOR TOMASULO 
TREASURY FOR JHOEK 
 
E.O. 12958: N/A 
TAGS: ECON EFIN BR
SUBJECT: WORLD FINANCIAL MARKET VOLATILITY ROCKS BRAZIL IN 
SHORT TERM 
 
SAO PAULO 00000709  001.4 OF 002 
 
 
¶1.  (SBU) Summary:  The global financial turmoil resulting 
from losses in global credit markets as well as concerns 
about the US sub-prime credit market have hit Brazilian 
assets hard over the last several days.  BOVESPA, Brazil's 
principal stock market, registered declines of more than 15 
percent since the beginning of August due to capital flight 
from international investors.  In addition, stock market 
declines have put downward pressure on the country's 
appreciating currency.  Over the short-term, Consulate 
General financial contacts expect the volatility to continue; 
however, they are cautiously optimistic that Brazil's 
economic fundamentals remain strong enough to weather any 
short-term fluctuations.  Brazil may in turn benefit over the 
medium-term by demonstrating to international investors the 
country's resilience to external financial shocks.  End 
Summary. 
 
Brazil Taking a Big Hit in the Short Term 
----------------------------------------- 
¶2.  (U) On August 16, BOVESPA suffered its worst performance 
since April, falling by more than 8 percent before rallying 
to close down nearly 3 percent.  The combined market value 
losses for Brazilian companies total more than $270 billion 
USD and the currency has depreciated by more than 11 percent 
in August alone.  While liquidity in the Brazilian stock 
exchange encourages international investors and has been a 
key factor in driving down the country's risk premium, 
Brazilian assets suffered extensive impacts from the 
worldwide global financial turmoil as international investors 
moved out of the market.  The country risk premium, which 
measures the market's confidence in the country, reached 229 
points on August 16 (a significant increase from just a few 
months ago), and is now at Brazil's highest level since 
December 2006.  Mauricio Oreng, the Vice-President for 
Economic Research at Banco Itau, one of Brazil's top banks, 
told Econoffs that one of the reasons Brazil has seen such an 
impact is because Brazil's higher stock market trading volume 
facilitates the quick withdrawal by international investors 
that are opting to cash out of emerging market assets. 
 
Short-term Volatility Likely to Continue 
---------------------------------------- 
¶3.  (SBU) Brazilian financial market analysts are 
unaccustomed to the extreme fluctuations worldwide financial 
markets experienced in the first part of August.  While the 
Brazilian currency and stock market indices have steadily 
increased over the past few years, the rapid swings surprised 
local market analysts.  Local financial analysts told the US 
Treasury Financial Attache that they expect volatility to be 
high for the foreseeable future and that it is impossible to 
predict when markets will calm down. 
 
¶4.  (SBU) Starting on August 14, the Brazilian Central Bank 
refrained from buying up dollars to curb the Brazilian 
currency's appreciation vis--vis the US dollar.  This 
decision not to intervene in the currency market was the 
first time the Brazilian Central Bank has made this decision 
in over a year.  Banco Itau told Econoffs the Central Bank 
likely opted against intervening as a sign to encourage 
market self-regulation and to increase market confidence over 
the long-term in the floating exchange rate regime.  Itau 
believes Brazil's Monetary Policy Committee's (COPOM) recent 
trend of reference interest rate cuts is unlikely to continue 
over the short-term, and stock traders in Sao Paulo told the 
Attache that local reaction suggests no major shift in 
expectations at its upcoming meetings in September and 
October. 
 
Economic Fundamentals Remain Sound 
---------------------------------- 
 
SAO PAULO 00000709  002.3 OF 002 
 
 
¶5.  (SBU) Although Brazil's financial market has suffered 
some significant losses over the last several days, Consulate 
General financial contacts remain cautiously optimistic.  The 
origin of the sell-off of Brazilian stocks is entirely 
external, and the country's fundamental economic performance 
is broadly unchanged.  Brazil is one of several emerging 
market countries that are experiencing an outflow of foreign 
capital as part of a worldwide market reaction, which 
indicates investors are not differentiating between the 
various emerging markets.  Contacts believe the markets will 
eventually correct themselves.  Brazilian stock traders told 
the Attache that valuations now look much more attractive 
than before when emerging markets had experienced large price 
appreciations, and the decline over the last week may bring 
prices closer to more sustainable levels and encourage some 
investors to start buying Brazilian stocks. 
 
¶6.  (SBU) Brazilian financial and economic analysts generally 
agree that the recent volatility is unlikely to affect the 
country's economic performance over the medium term. 
Financial analysts told the Attache that they have no reason 
to fear an economic crisis given Brazil's economic 
fundamentals.  Brazil's trade balance remains sharply 
positive around $45 billion USD, and international reserves 
are at an historic high of nearly $160 billion USD.  Together 
with the country's improving debt position, the macroeconomic 
picture seems strong enough to withstand the volatility. 
Brazil's domestic economy drives the country's economic 
growth, and because of its diverse export product and market 
base, Brazil's external sector is relatively insulated from a 
downturn in the US economy.  Brazil, however, would likely 
feel the secondary impacts of a worldwide slow-down in 
economic growth. 
 
Comment 
------- 
¶7.  (SBU) Brazil is well-positioned to overcome the global 
short-term financial market volatility.  Two years ago, 
Brazil's economic fundamentals may not have been strong 
enough to withstand sustained capital flight, however today 
the country is likely to benefit over the medium-term.  The 
recent movements could help buttress Brazil's quest to win 
investment grade ratings from the major ratings agencies by 
the end of 2008.  BOVESPA has, at least over the past few 
months, closely tracked with changes in the Dow Jones (DJ). 
Should that trend continue, upward movements in the DJ could 
also portend an upward trend in the BOVESPA.  The country's 
ability to successfully weather extremely volatile market 
conditions could prove its resilience to external shocks and 
strengthen perceptions about its economic fundamentals, 
welcome news to international investors.  End Comment. 
 
¶8.  (U) This cable has been coordinated with the US Treasury 
Attache in Sao Paulo and with Embassy Brasilia. 
WHITE