VZCZCXRO6195
RR RUEHRG
DE RUEHSO #0264/01 1501512
ZNR UUUUU ZZH
R 291512Z MAY 08
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 8250
INFO RUEHBR/AMEMBASSY BRASILIA 9377
RUEHRG/AMCONSUL RECIFE 4113
RUEHRI/AMCONSUL RIO DE JANEIRO 8728
RUEHBU/AMEMBASSY BUENOS AIRES 3154
RUEHAC/AMEMBASSY ASUNCION 3402
RUEHMN/AMEMBASSY MONTEVIDEO 2706
RUEHSG/AMEMBASSY SANTIAGO 2402
RUEHLP/AMEMBASSY LA PAZ 3813
RUCPDOC/USDOC WASHDC 3093
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 03 SAO PAULO 000264 
 
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: BRAZILIAN SOVEREIGN WEALTH FUND BACK IN PLAY 
 
 
SENSITIVE BUT UNCLASSIFIED--PLEASE TREAT ACCORDINGLY 
 
REF: A. Sao Paulo 0053; B. Sao Paulo 0247; C. 07 Sao Paulo 0953; D. 
Rio de Janeiro 091 
 
¶1.  (SBU) Summary:  The May 13th announcement by Brazil's Finance 
Minister seeking to establish a sovereign wealth fund (SWF) for 
Brazil has been met with criticism from the financial community and 
concerns by the Central Bank.  On the heels of this outpouring of 
negative press, President Lula asked Finance Minister Mantega to 
clarify the proposal before he decides whether to approve and submit 
the bill to Congress.  Brazil's nebulous proposal for its SWF would 
not fit the traditional pattern of protecting against commodity 
price swings, but instead serve as a mechanism to sop up excess 
foreign currency in the domestic economy.  In addition to 
potentially reducing the operational autonomy of the Central Bank in 
managing monetary policy, the Brazilian economy does not currently 
possess the optimal economic fundamentals that make a fund of this 
type appropriate.  The drive to create this fund as well as the 
announced new industrial policy (septel) show a government 
increasingly interested in taking an active role in the Brazilian 
economy.  A strong and largely autonomous Central Bank was key to 
Brazil recently obtaining the coveted investment grade rating, and 
anything that undermines that institution and increases uncertainty 
could have negative repercussions for the entire economy.  End 
Summary. 
 
¶2.  (SBU) Despite enormous criticism and some incompatibility of 
Brazil's current economic conditions with a Sovereign Wealth Fund 
(SWF), Brazil's Finance Minister Guido Mantega formally announced a 
Brazilian SWF on May 13 after months of behind the scenes 
maneuvering.  Following the announcement, President Lula delayed 
submission to Congress, asking Mantega to clarify his proposal's 
objectives.  He also indicated that now may not be the right time to 
move forward on this proposal.  As with the initial plan from 
February (Ref A), Brazil's controversial SWF proposal differs 
substantially from other nations' funds.  Central Bank President 
Henrique Meirelles is known to have expressed concerns about a SWF 
and has publicly and frequently criticized the idea.  One Central 
Bank concern was Brazil's foreign reserves, which has now been 
addressed as those reserves have now surpassed Brazil's gross 
external debt.  Although the GOB has not announced the initial size 
of the SWF, Mantega suggested it would be between USD 15 and 20 
billion.  Mantega noted two financing sources, the excess tax 
receipts above the 3.8 percent primary surplus target and by issuing 
new debt.  (Note: In the first quarter, Brazil's primary surplus was 
4.5 percent.  End Note.)  Mantega confirmed that Brazil's foreign 
reserves of USD 195 billion would not be touched. 
 
¶3.  (SBU) The GOB would need a majority in both houses of Congress 
if this proposal is introduced as a bill.  It is more likely to be 
introduced as a provisional measure (similar to a presidential 
decree), which requires a vote within 120 days or the bill dies. 
Special Advisor at the Central Bank Alexandre Pundek informed 
Econoff that under Mantega's proposal for the Treasury to manage the 
SWF, the GOB would have to change Law 4595 which established 
monetary policy under the Central Bank's control.  He opined that 
any effort to modify that law would likely face international 
backlash and as well as congressional opposition.  Itau Bank Vice 
President Mauricio Oreng told Econoff that he does not think that 
Congress would approve the bill and believes opposition congressmen 
would question the contradictory role a SWF would play with that of 
the Central Bank. 
 
Criticism Widespread 
-------------------- 
 
¶4.  (SBU) Brazil remains a poor candidate for a SWF despite improved 
conditions since the GOB first suggested a SWF last October.  In 
particular, two conditions often considered important for an SWF do 
not exist in Brazil: (1) a high level of national saving (Brazil's 
national saving rate is only 16 to 17 percent of GDP), and (2) a 
current account surplus (Brazil's current account is currently in 
deficit and is projected to decline).  On the other hand, tax 
revenues have reached record levels, Brazil became a net creditor in 
February (meaning its foreign reserves are greater than its external 
 
SAO PAULO 00000264  002 OF 003 
 
 
obligations), and Brazilian debt became investment grade (Ref B) in 
April.  Pundek told Econoff that Brazil does not have an inflow of 
revenues from a state-owned company that exports a major commodity. 
He noted that Brazil does not have a current account surplus and 
although Petrobras has made two significant oil discoveries (Refs C 
and D), the GOB would not see significant revenue flows until the 
two fields come online potentially as late as 2015.  Pundek noted as 
well that Brazil still runs an overall fiscal deficit close to two 
percent of GDP and would have to increase its already burdensome 
debt profile to fund the SWF at a rate of approximately 12 percent. 
 
 
¶5.  (SBU) Critics have opposed both of the SWF's official 
objectives, which include building up domestic savings to stimulate 
economic growth in downturns and funding Brazilian companies abroad. 
 The National Treasury would manage the SWF's investments in 
Brazilian exporters via overseas investments in private debt and 
equity.  Critics argue that providing financing for the export 
sector does not help address Brazil's major export barriers:  high 
and complex taxes, poor infrastructure, and onerous labor laws. 
Likewise, economist Daniel Weeks at Bradesco Bank noted to Econoff 
that the Brazilian Development Bank (BNDES) would likely finance 
large multinationals that do not need the money.  Indeed, CEO Forum 
member Jorge Gerdau commented to Commercial Offs that his company 
had invested USD eight billion in the U.S. and did not need GOB 
funding for exports.  Oreng agreed that rather than funding a 
vibrant private sector, the GOB should instead be investing in 
domestic infrastructure projects that would make Brazil more 
competitive.  Weeks said the GOB's lack of concrete targets for its 
so-called countercyclical policy would leave the SWF available as 
another vehicle to hide government spending rather than using excess 
revenues to accelerate Brazil's payment of public sector debt. 
 
¶6.  (SBU) Critics condemned the two sources of funding for the SWF 
as well.  Marcelo Solomon, Chief of Economic Research at Unibanco 
told Econoff that the lack of commitment to a higher primary surplus 
means the total contribution to the SWF remains uncertain. 
Furthermore, without a clear target or a credible signal from the 
GOB, he said it would be difficult to estimate the National Treasury 
intervention in the spot market.  Solomon pointed out that the 
absence of a target also implies greater uncertainty in the role 
tighter fiscal policy could play on future monetary policy.  Weeks 
told Econoff that the second funding source was also problematic 
because the National Treasury would take some monetary policy 
control away from the Central Bank.  He said the resulting confusion 
between the National Treasury and Central Bank, combined with the 
new role for BNDES to finance exporters, are very bad signs. 
Finally, a Credit Suisse economist told Econoff that investing 
abroad would carry a cost similar to holding foreign reserves; the 
SWF assets would potentially earn a lower return than the borrowing 
costs. 
 
Politics Perhaps? 
----------------- 
 
¶7.  (SBU) Brazilian domestic politics helps explain why the GOB 
ultimately decided to create a SWF.  The GOB can use the SWF to 
expand its direct role within the financial system, specifically via 
BNDES' purchase of private debt and equity.  Mantega can also take 
credit for this high profile policy initiative to help overshadow 
his reputation as an ineffective and weak Finance Minster within the 
international finance community.  Finally, Mantega noted that the 
SWF is a source of international prestige and helps put Brazil on 
par with other countries with SWFs such as China, Russia, and Saudi 
Arabia.  Indeed, Solomon told Econoff that SWFs have become a status 
symbol for emerging market economies to manage their own wealth, but 
that a fund of USD 20 billion would be insignificant compared to 
others. 
 
Comment 
------- 
 
¶8.  (SBU) The GOB's driving impulse behind the SWF appears to be a 
desire among some elements in the GOB to extend and expand the role 
of the government in the economy.  The GOB would essentially assume 
the role of a private bank, determining the conditions for giving 
 
SAO PAULO 00000264  003 OF 003 
 
 
loans and making financial decisions perhaps best left up to the 
market.  Many in the financial community see this as harking back to 
the 1980s, considered by many the "lost" decade for the Brazilian 
economy.  What they see as the SWF's worst feature is BNDES' new 
role in picking winners and losers in its financing to Brazilian 
exporters.  Together with the GOB's new industrial policy announced 
May 12 that increases the public sector's role in the 
economy(septel), the GOB appears to be continuing its internal 
struggle between those who support a more open approach and those 
whose instincts run toward the statist model.  These moves, together 
with the recent increased role for state enterprises, suggest that 
some key Brazilian policy makers may at heart be strong 
interventionists.  Ultimately, the SWF would take time to get 
through Congress given the backlog in provisional measures, the July 
holidays, and the upcoming municipal elections.  Given President 
Lula's public contradiction of Mantega's statements (a not-uncommon 
occurrence), it remains unclear whether or when this proposal would 
move forward as the battle between the Central Bank and the Finance 
Ministry continues behind the scenes.  Strangely, with the unspoken 
goal of curbing the appreciation of the currency, the SWF could 
instead have the contradictory effect of increasing foreign currency 
export earnings and putting more upward pressure on the Brazilian 
currency.  If this fund does at some point make it through Congress 
and is ultimately used as a tool in setting monetary policy, there 
could be a significant negative impact to Brazil's economy as 
investors may become concerned about an increasing role of 
government in the private sector and the lack of autonomy of the 
Central Bank.  End Comment. 
 
¶9.  (U) This cable has input from, was coordinated with, and cleared 
by Embassy Brasilia and coordinated with the US Treasury Financial 
Attache in Sao Paulo. 
 
WHITE