VZCZCXRO3797
RR RUEHRG
DE RUEHSO #0216/01 0991335
ZNR UUUUU ZZH
R 091335Z APR 09
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 9101
INFO RUEHBR/AMEMBASSY BRASILIA 0248
RUEHRG/AMCONSUL RECIFE 4344
RUEHRI/AMCONSUL RIO DE JANEIRO 9106
RUEHBU/AMEMBASSY BUENOS AIRES 3470
RUEHAC/AMEMBASSY ASUNCION 3717
RUEHMN/AMEMBASSY MONTEVIDEO 2891
RUEHSG/AMEMBASSY SANTIAGO 2717
RUEHLP/AMEMBASSY LA PAZ 4094
RUCPDOC/USDOC WASHDC 3261
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 03 SAO PAULO 000216 
 
SIPDIS 
SENSITIVE 
 
STATE PASS USTR FOR KDUCKWORTH 
STATE PASS EXIMBANK 
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE 
STATE PASS NSC FOR ROSSELLO 
DEPT OF TREASURY FOR LINDQUIST 
 
E.O. 12958: N/A 
TAGS: ECON EFIN BR
SUBJECT: BRAZIL'S ECONOMY: SLIDING BELOW ZERO PERCENT GROWTH 
 
REF: A. Brasilia 257; B. Brasilia 141 
 
SENSITIVE BUT UNCLASSIFIED--PLEASE PROTECT ACCORDINGLY 
 
¶1.  (SBU) Summary:  Brazil's growth has collapsed more sharply than 
might be expected given the country's limited dependence on exports 
and limited leverage in the banking, corporate, and household 
sectors.  The more important transmission channel of weak global 
conditions is probably its negative effect on consumer and business 
confidence and domestic demand.  In this environment, domestic 
macroeconomic stimulus may have only limited impact.  Fiscal 
expansion will require time to take effect and is unlikely to have 
much impact in 2009.  Monetary policy is also facing headwinds - 
most immediately, a decline in the money multiplier effect and 
reduced willingness to spend by the private sector.  Senior 
officials at the Brazilian Central Bank (BCB) told the Treasury 
Attache that they feel monetary policy is now "pushing on a string" 
and that further rate cuts are unlikely to have a meaningful effect 
on Brazil's growth this year.  Brazil is thus unlikely to regain 
growth until global conditions improve.  However, the global 
recession is also unlikely to do lasting harm to Brazil's fiscal and 
external accounts.  With a global pickup in 2010, Brazil could grow 
by 3.5 percent next year.  End Summary. 
 
Growth Bad and Getting Worse 
---------------------------- 
 
¶2.  (SBU) After growing by 5.7 percent in 2007 and 5.1 percent in 
2008, the current consensus among financial institutions in Brazil 
is that the country's economy should contract by at least 0.2 
percent this year.  (Note and Comment:  While official GDP growth 
forecasts by the Ministry of Treasury have been sliding, the 
Ministry has maintained a more positive outlook of 2% GDP growth. 
Post has yet to encounter any financial institution, economist, or 
academic who supports this assessment.  End Note and Comment.)  Itau 
economist Mauricio Oreng was less hopeful and told Econoff that Itau 
expects total GDP growth to fall by 1.5 percent this year.  Morgan 
Stanley was even more pessimistic and is forecasting a contraction 
of 4.5 percent.  Over the past quarter, several key indicators have 
collapsed and dropped to levels not seen in nearly two decades. 
Sectors most strongly affected by the current downturn include 
agriculture, construction, and, until recently, autos.  Zero percent 
growth implies that Brazil will produce roughly USD 60 billion less 
than at full production capacity. 
 
¶3.  (SBU) The GOB has responded aggressively to the downturn (Ref 
A).  The BCB cut its base rate by 250 points and is likely to cut 
another 300 points in coming months.  The BCB made a similar move 
reducing bank reserve requirements by R$ 100 billion (3.5 percent of 
bank assets).  New lending facilities have helped to inject 
liquidity, boost trade finance, and facilitate private sector 
external debt servicing.  Public banks have increased lending to 
farmers, builders, and in support of capital projects.  The BCB has 
also allowed the real, trade-weighted value of the exchange rate to 
fall by 23 percent since last September. 
 
¶4.  (SBU) The GOB resisted fiscal stimulus until recently.  Although 
its public debt ratios are now far lower than they were several 
years ago (net debt is approximately 37 percent of GDP), Brazil has 
been cautious about large-scale fiscal expansion given its history 
of large deficits and concerns that new spending might harm its risk 
premium.  In March, however, Brazil announced a USD 15 billion 
spending program (approximately 1.1 percent of GDP) to build one 
million low income housing units over the next three years.  While 
these new expenditures will provide stimulus more directly than rate 
cuts, expected lags in implementing the program will limit stimulus 
effects in 2009 (to approximately 0.4 percent of GDP).  Brazil's 
total fiscal stimulus to date is 1.3 percent of GDP (including a 
temporary car tax reduction that took effect in January, Ref B). 
 
¶5.  (SBU) Despite fiscal and monetary stimulus measures, however, 
private sector spending has continued to decline.  As a result, 
aggregate demand has continued to fall and Brazil's GDP forecasts 
have been repeatedly revised down in recent months. 
 
 
SAO PAULO 00000216  002 OF 003 
 
 
Well-Protected but Still Affected 
--------------------------------- 
 
¶6.  (SBU) Given the severe downturn in global economic conditions, 
it is not surprising that Brazil is suffering spillover effects; 
however, the speed and extent of the impact has been surprising. 
Economic interlocutors had touted Brazil's sound fundamentals and 
the relatively closed economy to protect Brazil from the global 
recession.  The relatively large size of Brazil's government (public 
spending represents 41 percent of GDP) should have provided strong 
automatic stabilizers.  Likewise, declining inflation pressures 
created ample room for the BCB to continue aggressively reducing 
interest rates.  Brazil's balance of payments is in good shape, 
including contined strong FDI inflows and USD 200 billion in 
forign reserves.  The private sector is only leveraged by 41 
percent of GDP, and private banks have strong solvency ratios and 
liquidity positions (16 percent average capital adequacy).  Finally, 
Brazil is well positioned due to its relatively closed economy, 
(exports total only about 13 percent of GDP), and limited dependence 
among Brazilian institutional borrowers on external market finance 
(seven percent of total financing comes from external sources). 
 
Exports and Credit 
------------------ 
 
¶7.  (SBU) Despite all the insulation against the crisis, the finance 
sector's consensus estimate for Brazil's growth this year is for a 
contraction of 0.19 percent.  Estimated GDP growth figures for 2009 
have continued to be revised downward over the last three months. 
While both falling exports and tightened credit conditions are often 
blamed, neither factor explains the decline in economic growth. 
Exports have taken a hit given the lack of global consumption, down 
by 14.9 percent in March compared to last year; however, imports are 
also declining, and the net effect that trade flows will have on GDP 
this year should be roughly neutral.  More importantly, however, 
Brazil's economy is not export-intensive.  While exports are 
critical for specific sectors (e.g., autos, metals, agriculture), 
exports have fairly limited direct impact on total output.  Brazil's 
export-to-GDP ratio (13 percent) is well below countries such as 
Korea (45 percent), China (40 percent), and India (22 percent). 
 
¶8.  (SBU) While Brazil's credit channels have tightened, Brazil has 
suffered only relatively modest deleveraging effects compared to 
many other countries.  Over the past quarter, credit growth has 
slowed but has not stopped.  Credit to the private sector is 
expected to grow by roughly 12 percent in 2009 - far slower than the 
30 percent annual growth rate observed in 2007-2008, but not slow 
enough to justify negative GDP growth.  Except for a brief period in 
the final quarter of 2008, high-quality borrowers report that credit 
flows continue (though at shorter tenors and with more collateral). 
Brazil's rates spiked last November, but rates have fallen on 
average by nearly 10 percent since then.  According to the BCB, the 
overall delinquency rate rose 0.4 percentage points over the last 12 
months, but remains at only 4.8 percent of total lending.  (See 
forthcoming Septel for more on credit conditions in Brazil.) 
 
Confidence to Blame 
------------------- 
 
¶9.  (SBU) The most likely explanation for Brazil's current recession 
is the recent steep decline in confidence and its negative impact on 
consumption and investment spending.  Since last April, consumer 
confidence has fallen by nearly 15 percent.  Because household 
consumption represents the largest share of output (62 percent), GDP 
is sensitive to even small shifts in consumption patterns. 
Consumption has also been Brazil's most important engine of growth 
over the past five years.  While investment represents a far smaller 
share of output (18 percent), it will decline by about 11 percent 
this year.  Consumption and investment are both expected to 
contribute negatively to GDP growth in 2009.  The most important 
transmission effect the global recession has had on Brazil's economy 
has therefore probably been its negative effect on domestic 
confidence and spending. 
 
¶10.  (SBU) Low consumer confidence is also closely related to a 
 
SAO PAULO 00000216  003 OF 003 
 
 
weakening labor market.  Over the past four months, Brazil's 
unemployment rate (8.5 percent) has risen by a percentage point and 
may reach 10 percent by the end of 2009.  Average monthly earnings 
in January were 15 percent below their level one year ago.  Consumer 
defaults (8.4 percent) have risen by 17 percent over the past 12 
months.  While most Brazilians deposit their savings in banks rather 
than invest in equities, the decline in Brazil's stock exchange (32 
percent in the past year) has also probably hurt confidence. 
 
¶11.  (SBU) Weak confidence is both bad news and good news.  In the 
near-term, weak confidence is a problem because it cannot be 
reversed with a macroeconomic policy response.  President Lula and 
Central Bank President Meirelles have both unsuccessfully sought to 
encourage greater private sector spending by stressing Brazil's 
strong fundamentals and the benefits that interest rate cuts should 
bring.  Absent greater willingness to spend by Brazil's private 
sector, however, this stimulus is likely to have only a limited 
impact.  Brazil's central bankers have told the Treasury Attache 
that they feel they are now "pushing on a string" and that further 
rate cuts are unlikely to strengthen growth this year. 
 
It's Only Temporary 
------------------- 
 
¶12.  (SBU) The good news is that the confidence crisis Brazil is 
suffering is likely to represent a temporary rather than a permanent 
shock.  Unlike many other countries, Brazil does not need to 
comprehensively restructure its balance sheets, borrow extensively 
from international financial institutions to avoid default, or worry 
about large increases in its public sector debt as a result of the 
global recession.  Brazil's challenge is a cyclical slump rather 
than a need for major structural reforms or a deterioration in its 
core economic fundamentals. 
 
Comment 
------- 
 
¶13.  (SBU) Like other emerging markets, Brazil is highly unlikely to 
regain growth until global conditions improve.  As Brazil's largest 
trading partner and foreign investor (16 percent of exports), the 
U.S. outlook is most important.  China is also critical due to the 
commodity-intensive nature of its imports and the fact that it is 
Brazil's fastest growing trade partner.  Strong fundamentals should 
help Brazil re-establish growth more quickly than many other 
countries.  The global recession is also unlikely to do lasting harm 
to Brazil's fiscal and external accounts.  The current financial 
community consensus is that Brazil will quickly exist the world 
recession and grow by 3.5 percent in 2010, a rate considered to be 
close to Brazil's potential rate of growth.  End Comment. 
 
¶14.  (U) This cable was coordinated/cleared by Embassy Brasilia and 
written in conjunction with the Treasury Financial Attache in Sao 
Paulo. 
 
WHITE