VZCZCXRO7880
RR RUEHRG
DE RUEHSO #0476/01 2521557
ZNR UUUUU ZZH
R 081557Z SEP 08
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 8506
INFO RUEHBR/AMEMBASSY BRASILIA 9641
RUEHRG/AMCONSUL RECIFE 4184
RUEHRI/AMCONSUL RIO DE JANEIRO 8838
RUEHBU/AMEMBASSY BUENOS AIRES 3240
RUEHAC/AMEMBASSY ASUNCION 3487
RUEHMN/AMEMBASSY MONTEVIDEO 2765
RUEHSG/AMEMBASSY SANTIAGO 2487
RUEHLP/AMEMBASSY LA PAZ 3900
RUCPDOC/USDOC WASHDC 3164
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 03 SAO PAULO 000476 
 
STATE PASS USTR FOR KDUCKWORTH 
STATE PASS EXIMBANK 
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE 
DEPT OF TREASURY FOR JHOEK, BONEILL 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV ETRD BR
SUBJECT:  BRAZIL'S CURRENT ACCOUNT DEFICIT NOT WORRISOME 
 
SENSITIVE BUT UNCLASSIFIED--PLEASE PROTECT ACCORDINGLY 
 
REF: Sao Paulo 0268 
 
¶1.  (SBU) Summary:  Brazil is set to run its first current account 
deficit since 2002; however, unlike previous years, the more stable 
composition of the balance of payments should protect the Brazilian 
economy from crises.  The floating exchange rate, smaller share of 
foreign currency denominated debt, status as an investment grade 
sovereign, and record-shattering foreign direct investment inflows 
all put Brazil in a better position to manage its current account 
deficit.  The primary drivers behind the deficit are twofold. 
Brazil's external financing profile has moved from debt to equity, 
and profit and dividend remittances have replaced interest payment 
outflows.  The declining trade surplus due to the growth in 
capital-intensive imports is also contributing to the current 
account deficit, as companies boost investment spending.  Although 
the Brazilian currency has appreciated by 25 percent against the 
U.S. Dollar over the last three years, many interlocutors disagree 
on its impact on Brazil's trade balance.  Despite the GOB's efforts 
to boost exports, the decline in the trade surplus is likely to 
continue.  Different from the historical crises associated with 
current account deficits, Brazil's current account deficit is now 
more of a signal that foreign investors recognize Brazil's 
potential.  End Summary. 
 
Historically Bad, But Not This Time 
----------------------------------- 
 
¶2.  (SBU) Brazil will close out 2008 with a current account deficit 
of approximately 1.9 percent of GDP; the first deficit in five 
years.  Current account deficits in Brazil were common and have 
historically been an ingredient for disaster.  Since 1947 when the 
Brazilian Central Bank first began measuring the current account, 
Brazil has registered a surplus only 12 times, with five of those 
occurrences in the last five years. 
 
¶3.  (SBU) According to Itau Bank, the composition of the current 
account is very different than in the 1990s when Brazil ran current 
account deficits of more than four percent of GDP.  Brazil no longer 
has a pegged exchange rate; the floating rate will help to 
automatically correct any current account imbalance before it 
becomes unsustainable.  Brazil also has a large stockpile of foreign 
reserves and is a net external creditor, which means that Brazil's 
external accounts now actually benefit when the Brazilian currency 
depreciates. 
 
¶4.  (SBU) Brazil's capital/financial account inflows are very 
different today than in the past.  Foreign direct investment (USD 34 
billion in 2007) and portfolio inflows have substituted debt as an 
important financing source, resulting in increased outflows of 
profit and dividend remittances, negatively impacting the current 
account.  According to Unibanco economist Darwin Dibb, soaring 
outflows of profits and dividends have already inflicted more damage 
to the current account than the shrinking trade balance.  Through 
2003, profit and dividend remittances were approximately USD five 
billion.  Since then, the two have grown exponentially to close to 
USD 30 billion.  Both signal the more stable move in Brazil's 
external financing from debt to equity.  Both are sustainable in the 
event of an economic downturn because dividends and profits retract 
while interest payments are fixed. 
 
¶5.  (SBU) The new financing profile also represents a change in 
perception about Brazil.  Increased foreign direct investment and 
portfolio inflows suggest that the world seems willing to finance 
Brazil's transition towards a credible economy with solid 
macroeconomic stability.  The fact that Brazil is now investment 
grade reduces the likelihood of sudden outflows.  According to 
Merrill Lynch, a current account deficit of up to three percent of 
GDP is consistent with a country that receives foreign savings to 
fund investment, given the higher domestic return on capital. 
 
¶6.  (SBU) Brazil had habitually financed its domestic spending via 
foreign denominated debt, which implied outflows of interest 
payments to foreign creditors; however, in the last few years Brazil 
has reduced its net external debt as share of GDP.  Itau Bank 
 
SAO PAULO 00000476  002 OF 003 
 
 
reported that interest payment outflows as of May were one fourth 
the size of those paid only three years ago. 
 
¶7.  (SBU) The consistent decline of Brazil's trade balance since May 
2007 is another reason for the resurgence of Brazil's current 
account deficit.  Through August, Brazil's trade surplus was down 38 
percent from last year to USD 16.9 billion.  (Note:  The trade 
surplus peaked at USD 47.8 billion in May 2007.  End Note.)  The 
sharp rise in imports is the chief culprit for the declining trade 
surplus.  While the value of exports was up 29 percent through 
August, imports were up a whopping 54 percent.  The Center of 
External Trade Studies Foundation (Funcex) reported that export 
volumes grew by only 1.2 percent over the last year, reflecting the 
deceleration of external demand.  Booming domestic demand in Brazil, 
however, pushed import volumes up 23 percent during the same period. 
 Brazil's recent imports have been highly capital-intensive, 
primarily due to the sharp rise in investment spending now occurring 
in Brazil.  Despite the 25 percent appreciation of the Brazilian 
currency in the last three years (it peaked at nearly 35 percent in 
July), interlocutors have disagreed about how much of an impact the 
exchange rate has had on the trade balance. 
 
Reversing the Spread 
-------------------- 
 
¶8.  (SBU) Faced with the declining trade balance, the GOB has become 
increasingly aware of encouraging export growth and has taken 
several measures to boost exports.  Indeed, the Brazilian Sugarcane 
Industry Association's (UNICA) chief U.S. representative Joel 
Velasco told Econoff that the GOB is starting to catch up to global 
changes.  Velasco said that Brazil's pro-agreement behavior during 
the latest round of Doha talks demonstrated the shift from the 
inwardly focused approach of exporting only domestic surplus to the 
recognition that exports play an important role.  In May, the 
Ministry of Development, Industry, and Foreign Trade announced a new 
industrial policy designed to spur small and medium sized companies 
to export (reftel).  The GOB also increased the export target for 
this year to USD 190 billion in July, compared to USD 160 billion in 
exports in 2007. 
 
Expect More of the Same 
----------------------- 
 
¶9.  (SBU) Economic interlocutors are expecting the trade balance and 
profit and dividend remittances to continue to put downward pressure 
on the current account.  Unibanco forecasted the trade surplus for 
2008 to be approximately USD 23 billion, down 43 percent from 2007. 
Economist Mauricio Oreng from Itau Bank believes that Brazil would 
continue to run a current account deficit and that it would approach 
three percent of GDP by 2012. 
 
¶10.  (SBU) Despite the downward pressure on the Brazilian currency 
because of the recent decline in commodities, the trade surplus is 
unlikely to reverse the trend over the short-term.  Merrill Lynch 
told Econoff that Brazil has benefited relatively little from the 
commodity price boom (a modest 1.2 percent of GDP by their 
calculations) because the Brazilian economy remains relatively 
closed and with a diverse trade in goods and services.  Trade 
represents approximately 25 percent of Brazil's GDP and Brazilian 
commodity exports make up only five percent of GDP, according to 
Merrill Lynch. 
 
Comment 
------- 
 
¶11.  (SBU) The narrowing trade surplus, and by extension, the 
widening current account deficit, are a reflection that the 
Brazilian economy is outperforming other emerging economies.  A 
combination of strong imports, flattening terms of trade, and a 
softening global demand should prompt a continued decline in 
Brazil's trade balance over the coming years.  Likewise, the recent 
upgrade to investment grade should power further foreign direct 
investment and portfolio inflows to finance the current account. 
The current account deficit is now more flexible and would 
automatically adjust during an economic downturn as businesses 
become less profitable, causing dividend payments and purchases of 
 
SAO PAULO 00000476  003 OF 003 
 
 
capital goods imports to diminish.  Going forward, Brazil needs to 
pursue measures to further stabilize the economy and raise 
productivity, capitalizing on the inflows of foreign savings to 
foster greater competitiveness.  End Comment. 
 
¶12.  (U) This cable was cleared by the US Treasury Financial Attache 
in Sao Paulo and by Embassy Brasilia. 
 
WHITE