VZCZCXRO1785
RR RUEHRG
DE RUEHSO #0236/01 1331057
ZNR UUUUU ZZH
R 121057Z MAY 08
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 8209
INFO RUEHBR/AMEMBASSY BRASILIA 9338
RUEHRG/AMCONSUL RECIFE 4091
RUEHRI/AMCONSUL RIO DE JANEIRO 8703
RUEHBU/AMEMBASSY BUENOS AIRES 3133
RUEHAC/AMEMBASSY ASUNCION 3381
RUEHMN/AMEMBASSY MONTEVIDEO 2685
RUEHSG/AMEMBASSY SANTIAGO 2381
RUEHLP/AMEMBASSY LA PAZ 3792
RUCPDOC/USDOC WASHDC 3075
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 03 SAO PAULO 000236 
 
SIPDIS 
SENSITIVE 
 
STATE PASS USTR FOR KDUCKWORTH 
STATE PASS EXIMBANK 
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE 
DEPT OF TREASURY FOR JHOEK, BONEILL 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV ETRD BR
SUBJECT: BRAZIL MOSTLY INSULATED FROM U.S. SLOWDOWN 
 
 
SENSITIVE BUT UNCLASSIFIED--PLEAE TREAT ACCORDINGLY 
 
REF: A. 07 Sao Paulo 086 
¶B. Sao Paulo 227 
 ¶C. Sao Paulo 130 
 
¶1.  (SBU) ummary: Brazil is more insulated from any U.S. drien 
worldwide economic slowdown than other emergin market countries. 
Its domestic economy fuels ecnomic growth, Brazilian banks have 
plenty of captal to lend, and Brazil is increasingly integrated 
into world markets.  Similarly, the Brazilian stck exchange 
outperformed its emerging market peers, nearly doubling the gains of 
the next best emeging market performer.  At a time when 
international markets are more risk averse, Brazil received the 
coveted investment grade foreign currency sovereign credit rating 
from Standard and Poor's.  However, Brazil is not immune.  There are 
some signs that access to international credit lines is more limited 
than before, and the impact of a U.S. slowdown on other countries, 
particularly on China, may have a measurable impact on Brazil.  End 
Summary. 
 
Lots of Padding 
--------------- 
 
¶2.  (SBU) Brazil's financial system is strong and has demonstrated a 
resiliency to the U.S. economic downturn that would not have been 
possible ten years ago.  The Brazilian banking system is extremely 
well-capitalized.  Indeed, Itau Securities CEO Roberto Nishikawa 
told Econoff that Brazilian banks have enough capital to avoid a 
similar credit crisis even with domestic credit expansion to a 
record level on the order of 40 percent of GDP this year.  (Note: 
Henrique Meirelles, President of the Central Bank stated to Econoff 
on April 11 that he expected the credit growth to decrease from over 
20 percent per year to approximately 10 to 15 percent growth in 
¶2008.  End Note.)  Brazil's public sector has nearly retired its 
dollar-denominated debt, which was a source of trouble in earlier 
financial crises.  Brazil in February became a net creditor, 
indicating that Brazil now holds more in reserves than it owes. 
 
¶3.  (SBU) Brazil's two stock exchanges, the Bovespa and the 
Commodities and Futures Exchange, merged to form the world's third 
largest stock exchange (ref A).  The Bovespa outperformed its 15 
emerging market peers between August 2007, when the U.S. sub-prime 
crisis first unraveled, and April of this year.  (Note: The 
Brazilian index Ibovespa gained 19 percent, beating out Russia which 
had 11 percent, and India and Mexico with six percent.  The primary 
Chinese index has dropped 26 percent since August.  End Note.) 
 
¶4.  (U) Brazil is now increasingly integrated into world markets, 
exporting a diverse range of products to hundreds of countries 
worldwide.  For example, the GOB's export destinations by region in 
2007 showed a balanced distribution between the four principal 
regions: the European Union (25 percent), Latin America and the 
Caribbean (22 percent), the U.S. (15 percent), and Asia (15 
percent).  Similarly, Brazilian exports span consumer goods, 
manufactured products, and agricultural products, and no one 
commodity dominates exports.  Among Brazil's exports are several 
commodities including sugar, soy products, coffee, meats, and metals 
that have seen record prices in recent years.  According to Sergio 
Werlang, Director of Credit at Banco Itau, commodity 
producer-countries are less vulnerable to an economic downturn as 
long as demand for commodities stays strong.  Brazil will be less 
affected by the U.S. downturn because it should continue to prosper 
from high commodity prices. 
 
¶5.  (SBU) Even with soaring commodity prices, domestic demand drives 
the Brazilian economy, growing by 6.85 percentage points in 2007. 
By contrast, the external sector negatively contributed to GDP 
growth and drove overall GDP growth down to 5.4 percent last year. 
Director of Economic Research at Bradesco Bank, Octavio de Barros, 
told Econoffs that Bradesco expected about five percent GDP growth 
this year regardless of international conditions due to Brazil's 
strong domestic demand.  He identified credit expansion (27 percent 
last year), real wage growth (two percent from March 2007 to March 
2008), and the predictability of a stable economy when making 
investment decisions as keys driving this growth. 
 
SAO PAULO 00000236  002 OF 003 
 
 
 
On the Margins? 
--------------- 
 
¶6.  (SBU) For the most part, the Brazilian financial system does not 
depend on external financing.  Barros told Econoff that for 
approximately 70 percent of private investments last year, companies 
used their own resources, while 11 percent used domestic commercial 
banks and only two percent relied on external financing for their 
investments.   Despite Brazil's independence, however, there are a 
few areas on the margins where less international credit 
availability, primarily from U.S. banks, may affect investments in 
Brazil.  Carlos Bentancourt, CEO of Bracor Investments, told Econoff 
that the Bear Stearns collapse immediately hit the Brazilian credit 
market as banks cut international lines of credit.  Betancourt 
noted, however, that he had not seen any change in Brazil's 
fundamentals that would merit a credit crunch.  He pointed instead 
to contagion caused by the banks, likely to result in decreasing 
leverage and a move towards less risky debt.  Press reports have 
also listed tightened international credit lines among the factors 
for the failures of a few large projects. 
 
Inflation Bigger Concern 
------------------------ 
 
¶7.  (U) Brazilian officials are more concerned about food price 
inflation than a global economic slowdown (ref B).  Despite single 
digit inflation numbers over the last five years, the Central Bank 
took a forceful stand in April by raising interest rates by 0.5 
percentage points amid fears that inflation would surpass the target 
of 4.5 percent.  According to Luiz Fernando Figueiredo of Maua 
Investments, the investment community expects two more interest rate 
hikes of 0.5 percentage points each between now and July.  There is 
little expectation that the current tightening cycle will result in 
rates rising more than 1.5 to two percentage points. 
 
Investment on Track 
------------------- 
 
¶8.  (U) Despite the adjustment in monetary policy and a real 
interest rate of 7.1 percent (among the highest in the world), 
Barros told Econoff that Bradesco thinks interest rate hikes 
probably will not significantly alter the private sector's 
investment decisions.  Barros highlighted Bradesco's proprietary 
survey that queries 1,600 Brazilian companies whether interest rate 
hikes would affect their investment decisions.  Approximately 60 
percent of companies said that a one percent increase over the 
course of the year would not affect their investment decisions, and 
only 17 percent said it would moderately or heavily affect their 
decisions.  With a two percent hike, 50 percent said it would not 
affect their decision and 27 percent said that it would.  By 
comparison, the survey showed that 67 percent of respondents said 
that the global market turbulence and an eventual U.S. recession 
would not affect their investments over the next six months, and 
only five percent said it would have a marked impact on their 
middle-term horizon. 
 
¶9.  (U) On April 30, Standard and Poor's upgraded Brazil's sovereign 
credit rating to investment grade (septel).  The upgrade opens the 
doors for further investment in Brazil, especially to funds limited 
to investment grade assets, and is likely to mitigate any investment 
slowdown because of interest rate hikes.  Foreign direct investment 
(FDI) in Brazil last year was USD 34.6 billion and is at record 
levels already this year.  According to the UN, Brazil ranks fifth 
among the most attractive countries for FDI, behind only China, 
India, the U.S., and Russia. 
 
The China Factor 
---------------- 
 
¶10.  (U) While trade with the U.S. is declining, Brazilian trade 
flows with emerging markets are up from 35 percent of exports 20 
years ago to 55 percent today, according to Octavio de Barros. 
Brazil's second largest trading partner, China, is a primary driver 
of this trend toward emerging markets.  Brazilian exports to China 
last year were up 28 percent from 2006 and imports from China were 
 
SAO PAULO 00000236  003 OF 003 
 
 
up were up 57 percent (ref C).  Barros stated that Brazil's main 
risk of a global economic slowdown would be a secondary slowdown in 
China.  Barros underscored, however, that Bradesco does not expect 
any deceleration because they believe domestic demand will continue 
to drive the Chinese economy.  Barros pointed to several large 
infrastructure projects the Chinese government has planned, 
including building mass transit in all cities over one million 
people, which should drive demand especially for Brazilian 
commodities such as iron ore.  Sergio Werlang told Econoff that Itau 
believes China is the key to determining whether there will be any 
measurable impact in Brazil from the U.S. downturn.  He stated that 
the Chinese economy is larger every day and that Chinese growth is 
responsible for maintaining commodity prices.  For these reasons, 
financial analysts in Sao Paulo have not ratcheted down their GDP 
growth forecasts for 2008.  Merrill Lynch's forecast, for example, 
showed growth only slightly down from 4.6 percent to 4.5 percent 
after the April interest rate hike. 
 
Comment 
------- 
 
¶11.  (SBU) Brazil's performance amid worldwide fears of a U.S. 
slowdown has been robust.  Indeed, Standard and Poor's awarded 
Brazil with an investment grade sovereign credit rating for its good 
behavior.  However, despite its resilience against a slowdown, 
Brazil is not invulnerable.  Brazil's bigger challenge will be 
achieving higher potential GDP growth above five percent and keeping 
inflation at bay.  End Comment. 
 
¶12.  (U) This cable has been cleared by Embassy Brasilia and 
coordinated with the US Treasury Financial Attache in Sao Paulo. 
 
WHITE