VZCZCXRO7457
RR RUEHRG
DE RUEHSO #0320/01 1521433
ZNR UUUUU ZZH
R 011433Z JUN 09
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 9247
INFO RUEHBR/AMEMBASSY BRASILIA 0394
RUEHRG/AMCONSUL RECIFE 4375
RUEHRI/AMCONSUL RIO DE JANEIRO 9161
RUEHBU/AMEMBASSY BUENOS AIRES 3518
RUEHAC/AMEMBASSY ASUNCION 3765
RUEHMN/AMEMBASSY MONTEVIDEO 2919
RUEHSG/AMEMBASSY SANTIAGO 2765
RUEHLP/AMEMBASSY LA PAZ 4116
RUCPDOC/USDOC WASHDC 3276
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 03 SAO PAULO 000320 
 
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 EINV BR
SUBJECT: BRAZILIAN ECONOMY SHOWING FIRST SIGNS OF RECOVERY 
 
REF: A. Brasilia 0141; B. Sao Paulo 070 
 
SENSITIVE BUT UNCLASSIFIED--PLEASE PROTECT ACCORDINGLY 
 
¶1.  (SBU) Summary: Brazil increasingly appears to be in a state of 
early economic expansion.  Recent market and sentiment indicators 
have shown improvement.  More importantly, contacts have started 
speaking with much greater optimism about Brazil's outlook and their 
willingness to take risk than even one month ago.  Key factors 
underlying Brazil's cyclical improvement include recent gains in 
commodity prices, a rapid reduction in inventories, and stronger 
consumer confidence.  While lending activity is improving, banks 
remain conservative.  Credit conditions, however, are more of a 
lagging indicator of Brazil's cycle than they are a leading 
indicator of where Brazil's economy is headed.  As Brazil starts to 
recover, key questions include the speed of its recovery, potential 
risks to its recovery, and the extent to which Brazil's recovery 
moves in sync with the global economy.  Although the base-case 
scenario remains that that Brazil's recovery will be gradual, a 
growing minority of Brazilians believe that a more rapid recovery is 
plausible.  Most Brazilians believe that current downside risks are 
low and that Brazil, in contrast to past recessions, is now leading 
the global economic cycle rather than following it.  End Summary. 
 
Brazil's Nascent Recovery 
------------------------- 
 
¶2.  (SBU) Like several other economies around the world, Brazil's 
economy has shown signs of improvement in recent weeks. 
Quantitative variables that point to an upswing include a 10 percent 
recent decline in bank spreads, substantial exchange rate 
appreciation (nine percent over the past month), stronger sales and 
spending data, and a jump in the volume of capital market activity. 
Over the past quarter, the number of consumers who report optimism 
about Brazil's economic prospects over the next six months has risen 
by nearly 10 percent.  Business confidence has also risen sharply 
over the past month.  While exuberance would be misplaced, Brazil 
now clearly appears to be in an early stage of cyclical expansion. 
 
¶3.  (SBU) Qualitative indicators also suggest that Brazil is now in 
an early recovery.  In contrast to the gloom almost universally 
prevalent in recent months, bankers and businessmen speak with 
increasing optimism about Brazil's growth and investment outlook. 
Riskier assets are regaining their popularity.  Asset managers 
report that alternative investment markets are unfreezing.  Market 
expectations of large central bank rate cuts in upcoming COPOM 
meetings are being gradually (though not entirely) scaled back.  The 
possibility that Brazil may be growing close to its potential growth 
rate (3.5 percent) by the fourth quarter seems plausible.  Downside 
scenarios are increasingly hard to imagine. 
 
¶4.  (SBU) Recent improvements, however, are not reflected in 
Brazil's 2009 growth forecasts.  Rather than being upgraded, 2009 
growth forecasts have actually been revised down in recent weeks (to 
a 0.53 percent contraction).  This anomaly is explained in large 
part by GDP arithmetic.  Because the contraction in the first 
quarter was sharper and deeper than originally forecast, Brazil's 
recovery is starting from a lower baseline.  Even as quarterly 
growth accelerates, strong second half growth is therefore unlikely 
to lift Brazil's annual GDP growth figure this year into positive 
territory. 
 
Explaining the Recovery 
----------------------- 
 
¶5.  (SUB) Three factors underlie Brazil's recent inflection: (1) 
stronger commodity prices, (2) a rapid inventory correction, and (3) 
a rise in domestic confidence.  Improvements in these variables have 
in turn helped to ease local credit conditions.  The pace of credit 
growth rose last month following five consecutive months of decline. 
 Complaints that banks are rationing credit have fallen 
significantly since the first quarter.  Despite this improvement, 
banks do not yet appear to be playing a central role in Brazil's 
recovery.  Credit conditions are improving, though rates remain 
above pre-crisis levels.  Consumer defaults declined last month 
 
SAO PAULO 00000320  002 OF 003 
 
 
after peaking in March (8.4 percent).  Among businesses, however, 
defaults continue to rise (2.6 percent in March, 2.9 percent in 
April).  Credit portfolios remain conservative.  Lending behavior is 
more of a lagging than a leading indicator of Brazil's cycle. 
 
¶6.  (SBU) Stronger commodities are one factor supporting Brazil's 
recovery; however, the direct impact on Brazil's macroeconomic 
accounts is not decisive.  Over the past quarter, futures prices for 
metals, soy, sugar, and coffee are 20 to 30 percent higher.  Much of 
this increase stems from upward revisions in China's outlook, which 
recently became Brazil's largest export market and where purchases 
of Brazilian iron and agriculture products are rising rapidly. 
Indeed, Brazilian economists track China's economic outlook almost 
as closely as the U.S. outlook.  Although commodities represent 
roughly one-third of Brazil's exports, they also account for a 
similar share of imports.  The net effect commodity prices have on 
Brazil's trade accounts is thus fairly neutral.  Brazil's financial 
account is more closely linked to commodities, with roughly 
one-third of recent FDI inflows directed to the commodity sector. 
Brazil's fiscal accounts are affected positively, though indirectly, 
by higher commodity prices since most commodity firms are privately 
owned. 
 
¶7.  (SBU) Commodities prices are nonetheless a closely watched 
indicator, particularly because the commodities sector is 
investment-intensive.  Higher prices can thus be a useful leading 
indicator of future investment demand.  Another reason is that 
Brazil's Bovespa has a large weighting of commodity firms - 
Petrobras, Vale, and Gerdau are Brazilian flagships and key 
barometers of local conditions.  Commodity gains have helped boost 
share prices, which is strengthening balance sheets as well as 
confidence and spending propensity more broadly.  The Bovespa is 16 
percent higher over the past month. 
 
¶8.  (SBU) A second factor supporting Brazil's recovery has been a 
reduction in inventories.  Rapid inventory reductions have been due 
in part to specific actions taken by Brazil's government - most 
notably, the production tax (IPI) reduction in January that 
stimulated car sales and helped dealers to eliminate excess 
inventories in less than three months (Ref A).  More important, 
however, has been the ability of Brazilian firms to quickly adjust 
their production and cost structures once stockpiles began to build. 
 In the last quarter of 2008 and the first quarter this year, local 
production virtually froze.  The result was a swift, steep drop in 
output that hurt GDP in the near-term (contractions of 3.0 percent 
and 3.1 percent, respectively) but was a necessary supply response 
in the absence of signs of a recovery in demand.  The speed with 
which Brazil's firms responded to reflects their flexibility - an 
interesting contrast given that Brazil often scores poorly in 
cross-country rankings of business conditions (e.g., the World 
Bank's Doing Business indicators). 
 
¶9.  (SBU) Because total demand in Brazil is strongly weighted toward 
private consumption (60 percent), even minor changes in household 
expenditures can have large ripple effects.  Brazilian consumers are 
not heavily indebted, they invest most of their savings in bank 
deposits (hurting returns and wealth in expansions but also 
stabilizing household balance sheets in downturns), and Brazil's 
labor market has weakened but generally held up better than 
initially expected.  Rather than fighting cost reductions, many 
labor unions have proactively agreed to unpaid vacations and 
part-time work to help limit job losses (Ref B).  In contrast to 
past recessions (1983, 1999), Brazil's poverty rate has declined in 
this recession, helping to prevent a complete collapse in spending 
among poorer groups. 
 
Confidence Most Important Factor 
-------------------------------- 
 
¶10.  (SBU) While perhaps the hardest variable to predict, changes in 
confidence are probably the most important factor driving Brazil's 
economic cycle at this stage.  Brazil now has greater space for 
fiscal and monetary expansion.  Compared to previous recessions, 
when rates were tightened and spending reduced, Brazil now has room 
for counter-cyclical policies for the first time in its recent 
 
SAO PAULO 00000320  003 OF 003 
 
 
history.  Some Brazilian economists call this difference the "game 
changer" that has fundamentally separated Brazil's response in this 
crisis from past downturns.  Therefore, Brazil's current recession 
is more about psychology than its own vulnerabilities or economic 
imbalances.  From the outset of the crisis, Brazil had ample 
liquidity, strong banks, solid macroeconomic accounts, and little 
reason to worry about its own financial collapse.  Instead, the main 
source of problems has been negative psychology more than it was a 
cash flow crunch or need for balance sheet restructuring.  Whereas 
psychology was working against Brazil in recent months, however, it 
now seems increasingly likely to work in its favor over the next 
several quarters. 
 
Comment: Remaining Recovery Issues 
---------------------------------- 
 
¶11.  (SBU) While uncertainties remain, a limited data series now 
exists suggesting that Brazil may be at a very early stage of 
economic expansion.  More importantly, a tone of cautious optimism 
is now palpable in Brazil that was completely absent even one month 
ago.  As Brazil starts to grow again, three issues are worth 
watching.  The first issue concerns factors that might derail 
Brazil's recovery.  While a reversal is always possible, the greater 
likelihood is that Brazil's recovery will endure because its 
fundamentals remain sound and local sentiment is improving. 
Likewise, the speed with which Brazil's recovery will occur also 
merits attention.  Although a slow recovery remains the base-case 
scenario, a growing minority of contacts believe a more rapid 
recovery is plausible given that Brazil's current production is 
significantly below the total of its production capacity.  The third 
issue is the link between Brazil's recovery and the global recovery. 
 In contrast to past recessions, Brazil's economy now appears to be 
leading the global cycle rather than trailing it.  For the first 
time in its recent history, Brazil may become an engine for economic 
recovery.  End Comment. 
 
¶12.  (U) This cable was drafted with the Treasury Financial Attache 
and coordinated/cleared by Embassy Brasilia. 
 
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