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DE RUEHSO #0053/01 0380904
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FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 7872
INFO RUEHBR/AMEMBASSY BRASILIA 9024
RUEHRG/AMCONSUL RECIFE 3986
RUEHRI/AMCONSUL RIO DE JANEIRO 8567
RUEHBU/AMEMBASSY BUENOS AIRES 3050
RUEHAC/AMEMBASSY ASUNCION 3298
RUEHMN/AMEMBASSY MONTEVIDEO 2604
RUEHSG/AMEMBASSY SANTIAGO 2301
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RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC
RUEHC/DEPT OF LABOR WASHDC

UNCLAS SECTION 01 OF 03 SAO PAULO 000053 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR FOR KDUCKWORTH 
STATE PASS EXIMBANK 
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE 
DEPT OF TREASURY FOR JHOEK 
USDOC FOR 4332/ITA/MAC/WH/OLAC 
USDOC ALSO FOR 3134/USFCS/OIO 
DOL FOR ILAB PEREZ-PKOPEZ AND WHOLEY 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV BR
SUBJECT: WILL BRAZIL JOIN THE SOVEREIGN WEALTH FUND CLUB? 
 
REF A: BRASILIA 0036 
    B: SAO PAULO 1005 
    C: SAO PAULO 0012 
    D: SAO PAULO 0768 
 
SENSITIVE BUT UNCLASSIFIED - PLEASE PROTECT ACCCORDINGLY 
 
¶1.  (SBU) SUMMARY:  In the closing months of 2007, Brazil's Finance 
Minister Guido Mantega proposed establishing a Sovereign Wealth Fund 
(SWF) as a vehicle to intervene in foreign exchange markets to curb 
the appreciation of Brazil's currency.  Brazil's controversial plan 
differs substantially from other nations' funds and sparked a public 
battle between the Ministry of Finance and the Brazilian Central 
Bank over the government's commitment to maintain Brazil's floating 
exchange rate regime.  Brazil's Central Bank is unlikely to hand 
over access to Brazil's sizeable foreign reserves and relinquish 
control over monetary policy.  Furthermore, Brazil is a poor 
candidate for a SWF because the GOB is not flush with excess 
revenues from the commodity price boom and does not have a 
burgeoning fiscal surplus to fund a SWF.  Sao Paulo-based financial 
analysts believe Minister Mantega's plan would amplify any economic 
crisis following an external shock instead of minimizing the risk. 
Most are skeptical that the GOB would create a SWF given the timing 
and global economic turmoil.  END SUMMARY. 
 
Lack of Coordination and Planning 
--------------------------------- 
 
¶2.  (U) Brazil's Finance Minister Guido Mantega first proposed last 
October the idea of establishing a Sovereign Wealth Fund (SWF) that 
would draw on Brazil's foreign reserves of USD 180 billion to fund 
infrastructure projects in Brazil.  That idea sparked a public 
dispute between Minister Mantega and the Brazilian Central Bank 
President Henrique Meirelles, who argued that the fund would not be 
created until foreign reserves could cover Brazil's gross external 
debt of USD 200 billion.  In December, Mantega announced an 
unorthodox scheme for a SWF in 2008 that would be a tool for the GOB 
to directly intervene in foreign exchange markets to counter the 
appreciation of the Brazilian currency.  Since 1988, Brazil's 
Central Bank has exclusively controlled monetary policy (the Central 
Bank falls under the Ministry of Finance and is therefore not 
technically independent), and this development would be a 
significant departure from the GOB's recent economic policies. 
Although the details are limited, according to Mantega's publicly 
announced scheme, the SWF would, in theory, be used to invest in 
offshore assets of Brazilian companies including securities issued 
by the National Development Bank (BNDES) to boost public 
infrastructure investment.  [Note: Brazil is currently 
under-executing its public infrastructure budget due to a lack of 
clear investment guidelines and mechanisms to pursue such activities 
as public private partnerships,as well as, the GOB's inability to 
identify good projects and make them viable.  End Note.] 
 
¶3.  (SBU) In part, these uncertainties reflect a lack of discussion 
within and among Brazil's ministries and highlight the fact that a 
unified view among Brazil's key ministries does not exist. A senior 
adviser to the COPOM (Political Monetary Committee of the Central 
Bank of Brazil equivalent to the U.S. Board of Governors of the 
Federal Reserve Bank) told the Treasury Attache that a SWF "is an 
idea" but that the Ministry of Finance had not prepared a single 
internal policy paper on this issue (ref A).  A senior member of the 
Central Bank's Department of Economics told Treasury officials that 
it knows nothing about Mantega's proposal other than what has been 
reported in the press. Likewise, the Ministry of Foreign Affairs 
told Treasury officials in December that it has no specific 
knowledge about a SWF and believes creating such a fund is 
ill-advised.  In a recent meeting with Mission officials, former 
Finance Minister and GOB insider Antonio Palocci agreed that a SWF 
is ill-advised, and said that the plan is on hold in light of recent 
domestic and international economic turbulence. 
 
There's No Money 
 
SAO PAULO 00000053  002 OF 003 
 
 
---------------- 
 
¶4.  (SBU) One immediate problem in establishing a SWF is that the 
GOB has not identified the source of funding. Although Brazil's 
foreign reserve assets are excessive by most measures of reserve 
adequacy, Central Bank President Meirelles has stated previously to 
the Treasury Attache that Brazil's large foreign reserve assets have 
been the single most important factor in preserving Brazil's 
stability amidst recent global financial market volatility.  Given 
that view, it seems highly unlikely that Brazil's central bank would 
be willing to use reserves for this purpose. 
 
¶5.  (SBU) Brazil's fiscal framework also leaves no room in which to 
finance a SWF. Ten billion dollars, the initial injection in the 
Mantega scheme, represent approximately five percent of Brazil's 
non-interest expenditures. To finance this expenditure from the 
budget, the Ministry of Finance would be forced to raise revenues, 
reduce expenditures, or lower its primary surplus target. Given the 
USD 22 billion hole created by the failure to pass the CPMF 
(financial transactions tax) in December, Brazil's 2008 fiscal 
framework is already facing new pressures (ref B and C).  Minister 
Mantega has publicly ruled out any adjustment in Brazil's 2008 
primary surplus target which if changed could potentially undermine 
Brazil's march towards receiving an investment grade sovereign 
credit rating (ref D).  Furthermore, expenditure reductions would be 
politically difficult in 2008 as municipal elections will be taking 
place throughout the country, setting the tone for national 
elections in 2010. 
 
Private Sector Opposition 
------------------------- 
 
¶6.  (SBU) Brazil's private sector also has been largely opposed to 
Mantega's idea to create a SWF because Brazil does not fit the 
typical model country.  Mauricio Oreng, from Itau Bank, explained to 
Econ Specialist that Brazil is not in the same position as nations 
which, due to their large foreign exchange reserves and fiscal and 
current account surpluses, have been able to establish SWFs to 
invest money that would otherwise remain unproductive in short-term 
instruments.  Brazil's foreign debt exceeds its foreign exchange 
reserves and its current account surplus is approximately 0.7 
percent of GDP, not nearly enough to sustain Brazil's economy in the 
event of a future crisis, he said.  Furthermore, Oreng said Brazil 
is expected to post a current account deficit this year.  Oreng 
opined that Mantega had likely not discussed the proposal with the 
Central Bank prior to his announcement, but said that the idea had 
thankfully fallen off the radar screen for now. 
 
¶7.  (SBU) ABN Amro noted Mantega's plan for a SWF might incite 
further appreciation of the Brazilian real by encouraging local 
companies to issue more securities via the new investment vehicle, 
in turn increasing the flow of dollars.  As a result, in their view, 
the GOB would therefore undermine its chief goal of limiting the 
Brazilian currency's appreciation.  Tomas Malaga, a senior economist 
at Itau Bank also noted that Mantega's plan to use the SWF to 
finance BNDES investments would intensify the impact of external 
shocks on the Brazilian economy by increasing exposure to Brazilian 
assets instead of diversifying away from them.  He also highlighted 
a potential financing mismatch because the GOB would conceivably 
finance BNDES lending abroad through Brazilian banks at higher 
interest rates than the likely return on investments.  Virgilio 
Castro Cunha, an economist at Merrill Lynch, concurred with Malaga's 
analysis and opined to Econoff that BNDES had encouraged Mantega's 
proposal as a way to increase BNDES budget allocations in a less 
transparent manner. 
 
¶8.  (U) Unlike countries that employ SWFs to control excessive 
government revenues from state-run enterprises, the GOB would need 
to issue debt to fund the SWF as Brazil's private sector is the 
primary driver of Brazilian exports.  According to an ABN Amro 
analysis of SWFs, typically countries that established SWFs export a 
single commodity (oil, gas, minerals, etc.) that brings in 
 
SAO PAULO 00000053  003 OF 003 
 
 
government revenue in the form of royalties, dividends, or taxes. 
For these countries, higher prices translate directly into improved 
fiscal performance.  ABN Amro's case study showed that SWFs help 
mitigate the cyclical nature of these revenues as a savings tool for 
prudent fiscal management.  Brazil doesn't have a single commodity 
that dominates exports nor excessive government revenues directly 
associated to export performance because Brazil has a diversified 
export base. 
 
Central Bank Opposition Likely 
------------------------------ 
 
¶9.  (SBU) The Brazilian Central Bank's decision-making body, the 
National Monetary Council (CMN), is likely to question the idea of a 
SWF and using reserves to create a wealth fund will require formal 
approval by the CMN.  [Note: The Council includes the Central Bank, 
Finance Ministry, and Planning Ministry.  End Note.]  Furthermore, a 
senior Ministry of Finance official told the Treasury Attache on 
December 13 that the Finance Ministry was aware that the Central 
Bank was not enthusiastic about an SWF and might resist if the 
Ministry of Finance tried to push.  Although Minister Mantega could 
likely persuade Planning Minister Paulo Bernardo to support his 
plan, Central Bank President Meirelles seems certain to oppose any 
efforts to spend its reserves. Any perception of political pressure 
on Meirelles and his board members in this effort would undermine 
the perceived independence and hard-earned credibility of Brazil's 
Central Bank. Finance Minister Mantega is thus likely to face strong 
internal opposition and negative market reaction if he moves too 
aggressively to create a SWF. 
 
Comment 
------- 
 
¶10.  (SBU) Support for the GOB's proposal for a Sovereign Wealth 
Fund is limited.  Financial analysts from Sao Paulo's private sector 
clearly oppose the GOB's unorthodox idea and cite valid concerns 
about its possible implementation.  The GOB also faces an uphill 
battle to get funding and approval from the Central Bank, suggesting 
that the GOB may be unable to develop and launch an official 
proposal over the near-term.  For now at least, the GOB is focused 
on defending the Brazilian economy against the recent global 
economic turmoil and appears to have shelved the proposal.  END 
COMMENT. 
 
WHITE