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RR RUEHRG
DE RUEHSO #0486/01 2611718
ZNR UUUUU ZZH
R 171718Z SEP 08
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TO RUEHC/SECSTATE WASHDC 8520
INFO RUEHBR/AMEMBASSY BRASILIA 9652
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RUEHRI/AMCONSUL RIO DE JANEIRO 8849
RUEHBU/AMEMBASSY BUENOS AIRES 3248
RUEHAC/AMEMBASSY ASUNCION 3495
RUEHMN/AMEMBASSY MONTEVIDEO 2773
RUEHSG/AMEMBASSY SANTIAGO 2495
RUEHLP/AMEMBASSY LA PAZ 3908

UNCLAS SECTION 01 OF 03 SAO PAULO 000486 
 
SIPDIS 
SENSITIVE 
 
STATE PASS USTR FOR KDUCKWORTH 
STATE PASS EXIMBANK 
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE 
DEPT OF TREASURY FOR JHOEK, BONEILL 
 
C O R R E C T E D  C O P Y (CORRECTING FORMATTING ISSUES) 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV ETRD BR
SUBJECT: GLOBAL FINANCIAL VOLATILITY-BRAZIL RESERVED NOT SCARED 
 
REF: SAO PAULO 476 
 
SAO PAULO 00000486  001.2 OF 003 
 
 
¶1.  (SBU) Summary: The unprecedented bankruptcy of Lehman Brothers, 
the fourth largest U.S. investment bank, sent shockwaves across the 
financial markets, hitting Brazil's stock exchange, the Bovespa, 
particularly hard.  On September 15, the Bovespa fell 7.59 percent, 
bringing the total losses for the year to 23 percent as of September 
¶16.  While these kinds of market movements are quantitatively 
significant, they do not seem to reflect any sense of local panic, 
but rather a readjustment of asset prices and international 
investors cashing in to improve liquidity in the United States and 
other markets.  Most commentary here, in fact, seems remarkably calm 
and detached.  Analysts may be slightly surprised by the scale of 
the market movements on September 15, but are in no way hysterical. 
The biggest near-term risk for Brazil is the possible decline in 
foreign direct investment, which has been financing Brazil's current 
account deficit.  A global decline in demand could also slow 
Brazil's exports and negatively impact the trade balance; however, 
economic interlocutors downplayed either occurrence, citing Brazil's 
domestic economic performance and the Brazilian Central Bank's 
prudent monetary policy as anchors for economic stability.  End 
Summary. 
 
Brazil Did its Homework 
----------------------- 
 
¶2.  (SBU) Across the board, economic interlocutors told Econoff that 
this week's turbulence was more about global risk aversion than any 
indication of a decline in Brazil's economic fundamentals.  Mauricio 
Oreng from Itau Bank told Econoff that global investors were fleeing 
from assets with even the smallest risk, noting that some preferred 
holding cash.  As a result, he said that emerging market stock 
exchanges and commodities prices had naturally suffered the 
consequences.  In particular, Brazil's stock exchange, the Bovespa, 
dropped 7.59 percent on September 15, in part because nearly 60 
percent of its value is directly tied to commodities.  Giovanna 
Rocca from Unibanco told Econoff that because Brazil implemented 
prudent fiscal and monetary policies, the economy is doing well. 
She cited the Brazilian Central Bank's (BCB) efforts to curb 
inflation and the accumulation of foreign reserves of over USD 200 
billion as sufficient to face immediate liabilities.  Indeed, 
Priscila Trigo from Bradesco asserted that the BCB's hawkish 
approach to curbing inflation and cooling domestic growth stands 
apart as an example for other emerging market countries to emulate. 
 
 
¶3.  (SBU) The strength of the Brazilian banking sector was also 
noted when defending Brazil's position amid the global financial 
turbulence.  Oreng told Econoff that Brazilian banks continue to be 
extremely well-capitalized according to Basel standards.  External 
funding represents a small fraction of funding, and delinquency 
rates are very low, and although the Central Bank raised interest 
rates, bank performance is not linked to the interest rate. 
Similarly, Rocca told Econoff that Bradesco has counseled investors 
to sit tight because they view Brazilian financial institutions as 
solid. 
 
Potential Concerns Minimal 
-------------------------- 
 
¶4.  (SBU) Over the medium-term, Brazil's trade balance could decline 
given the deteriorating outlook for commodity prices and the fact 
that Brazil is still forecast to grow at a fairly robust pace.  In 
fact, the most recent GDP forecast, unemployment data, and new 
incoming FDI announcements have surprised on the upside.  Looking 
further down the road, Trigo told Econoff that the biggest risk 
facing Brazil is that foreign direct investment inflows would 
decline, noting that FDI and portfolio flows are funding Brazil's 
current account deficit (Reftel).  She posited that if commodity 
prices continued to fall, exports would decline and further 
undermine Brazil's trade balance; however, imports would also 
decline if the Brazilian currency continued to depreciate relative 
to the US dollar.  (Note:  The Real has depreciated 20% from its 
high of 1.56/USD on August 1 to 1.86/USD on September 17.  End 
Note.)  She concluded that she did not believe that FDI would dry up 
in Brazil, but could slow down due to the lack of liquidity 
worldwide.  Alexandre Cancherini from Merrill Lynch supported this 
view explaining that Brazil's relatively low domestic savings rate 
requires Brazil to depend on financing from abroad.  Although he 
does not expect any banks to collapse, he believes that small banks 
would feel the higher borrowing costs because of the global 
 
SAO PAULO 00000486  002.2 OF 003 
 
 
liquidity crunch and that some could face bankruptcy over the 
longer-term. 
 
¶5.  (SBU) The current turmoil in financial markets was also the 
primary topic of conversation at a dinner the Consul General hosted 
for 10 American company CEOs on September 16.  Citibank Brazil 
President Gustavo Marin stated the crisis is far from over, and 
argued that the effects will percolate through the financial sector 
for some time to come.  He correctly predicted that the USG would 
step in to prevent the precipitous collapse of American insurance 
giant AIG.  Marin believes that European and Asian banks have yet to 
realize the full extent of their losses, and that once the financial 
sector upheaval has abated, restricted credit will begin to play 
through the performance of major economies, reducing growth rates. 
Marin predicted that the major impacts of the crisis on the 
Brazilian economy would be through tighter credit conditions for 
major development and investment projects (public and private) - 
reducing the level of new investment activity - and reduced IPO 
activity in Brazil.  He also expects to see a significant uptick in 
Merger and Acquisition (M&A) activity due to reduced book values for 
many companies, both in Brazil and abroad.  He noted that recent 
Brazil IPOs are currently trading at 40 to 50 percent of earnings, 
making them attractive M&A targets.  Brazil growth should slow to 
three to three and a half percent in 2009, but rebound to five 
percent level in 2010. 
 
¶6.  (SBU) Nelson Barbosa, Secretary for Economic Policy at the 
Ministry of Finance told Brasilia Econoff that he thought that 
Brazil would fare well, even given the drop in commodity prices 
because Brazil still imports more petroleum than it exports.  He 
said he didn't foresee the need for Brazil to take any specific 
measures in response to recent problems.  He said he thought that 
the problems in the U.S. financial markets were contained and that 
the situation would right itself soon, probably after the November 
elections when the uncertainty over the next administration would be 
eliminated. 
 
Uncertainty to Continue 
----------------------- 
 
¶7.  (SBU) Economic interlocutors all pointed to widespread 
uncertainty about the future economic performance of the U.S. and 
the broader global economy.  Trigo noted that decisions in the U.S. 
including whether the Federal Reserve would need to rescue another 
bank, the duration of a U.S. slowdown, and possible contagion 
effects have spooked the market.  These uncertainties would limit 
available financing and could restrict investment, she said, both of 
which could damage Brazil.  Rocca told Econoff that Unibanco expects 
the BCB to take a wait-and-see attitude and is expected to provide 
liquidity if needed.  She noted that both Finance Minister Guido 
Mantega and Central Bank President Henrique Meirelles had confirmed 
their support. 
 
¶8.  (SBU) Despite the turbulence, Itau Bank has not altered its base 
case scenario.  Oreng told Econoff that economic growth is still on 
pace to reach five percent this year, and that only in 2009 would 
Brazil see possible ramifications of a global slowdown.  He said 
that under the worst case scenario, Itau forecasts that exports 
 
SAO PAULO 00000486  003.2 OF 003 
 
 
would decline and growth could fall to approximately three percent. 
Oreng stated that because only 15 percent of exports go to the U.S., 
a U.S. slowdown on its own would not disrupt Brazil's trade balance. 
He noted, however, that a global slowdown would be more of a risk 
for the Brazilian currency if demand for commodities continued to 
decline.  Finally, he pointed to the domestic economy as Brazil's 
engine of growth and told Econoff that he believes the domestic 
economy should continue to drive economic growth. 
 
Comment 
------- 
 
¶9.  (SBU) While it is clear that markets are spooked and still 
looking for the floor of the financial crisis, the outlook in Brazil 
remains optimistic if guarded.  The major concern is centered on the 
continued access to international credit which, if it becomes overly 
restricted, will have a negative impact on Brazil's growth rate at 
least in 2009.  A world economic slowdown that reduces international 
demand for Brazilian commodities would have a negative impact on 
Brazil's trade balance, but given that Brazilian growth is driven by 
the domestic sector, the overall impact should be manageable.  The 
Brazilian financial community is certainly concerned, but there is 
no sense of panic.  End Comment. 
 
¶10.  (U) This cable was coordinated/cleared by Embassy Brasilia and 
by the US Treasury Financial Attache in Sao Paulo. 
 
WHITE