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Viewing cable 06BRASILIA608, BRAZIL - AN EARLY LOOK AT ECONOMIC ISSUES IN THE 2006
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| Reference ID | Created | Released | Classification | Origin |
|---|---|---|---|---|
| 06BRASILIA608 | 2006-03-28 13:25 | 2011-07-11 00:00 | CONFIDENTIAL | Embassy Brasilia |
VZCZCXRO4220
PP RUEHRG
DE RUEHBR #0608/01 0871325
ZNY CCCCC ZZH
P 281325Z MAR 06
FM AMEMBASSY BRASILIA
TO RUEHC/SECSTATE WASHDC PRIORITY 4938
INFO RUEHRG/AMCONSUL RECIFE 4519
RUEHSO/AMCONSUL SAO PAULO 6633
RUEHRI/AMCONSUL RIO DE JANEIRO 1765
RUEHMN/AMEMBASSY MONTEVIDEO 6137
RUEHAC/AMEMBASSY ASUNCION 5311
RUEHBU/AMEMBASSY BUENOS AIRES 3891
RUEHCV/AMEMBASSY CARACAS 3166
RUEHPE/AMEMBASSY LIMA 2902
RUEHLP/AMEMBASSY LA PAZ 4450
RUEHSG/AMEMBASSY SANTIAGO 5403
RUEHQT/AMEMBASSY QUITO 1757
RUEHBO/AMEMBASSY BOGOTA 3652
RUEHC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHNSC/NSC WASHDC
C O N F I D E N T I A L SECTION 01 OF 05 BRASILIA 000608
SIPDIS
SIPDIS
NSC FOR CRONIN
TREASURY FOR OASIA - DAS LEE, FPARODI
STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/DDEVITO/SHUPKA
STATE PASS USTR FOR SULLIVAN/LEZNY
STATE PASS USAID FOR LAC
E.O. 12958: DECL:03/28/16
TAGS: ECON PINR PGOV ETRD PREL EFIN BR
SUBJECT: BRAZIL - AN EARLY LOOK AT ECONOMIC ISSUES IN THE 2006
PRESIDENTIAL CAMPAIGN (C-AL6-00372)
REF: A) STATE 39813
B) BRASILIA 0546
C) 05 BRASILIA 0521
Classified by Economic Counselor Bruce Williamson, reasons 1.4
(b) and (d).
¶1. (C) Summary: In sharp contrast to Brazil's 2002 presidential
election, in which Lula da Silva and the leftist Workers' Party
(PT) emerged victorious, the 2006 presidential elections carry
much less uncertainty about future economic policies. Lula has
established a surprisingly strong record of orthodox
macroeconomic management and pursued, albeit with less success,
necessary microeconomic reforms. His principal opponent in the
elections, Sao Paulo Governor Geraldo Alckmin, of the opposition
Social Democratic Party (PSDB), also has a record of sound
fiscal management at the state level. While not an economist,
Alckmin has called for a "capitalism shock" to boost economic
growth and has begun to gather around him a team of advisors
that includes players from the Fernando Henrique Cardoso
administration. Although neither Alckmin nor Lula (who has not
yet formally declared his candidacy) has elaborated an electoral
platform, from the point of view of macroeconomic policy both
look like candidates of continuity. But there are differences
in their likely agendas for microeconomic reform, some of which
will affect U.S. interests, such as trade liberalization. How
much of their agenda either candidate will implement will depend
in large part on their mandate and the coalition politics of the
next Congress, both of which remain big unknowns. End Summary.
¶2. (C) This cable is a partial response to ref A request
(C-AL6-00372). Septel will address political issues.
PSDB's Alckmin not an Economist, but a Capitalist
--------------------------------------------- ----
¶3. (C) Raul Velloso, a prominent fiscal expert linked to the
opposition Social Democratic (PSDB) party, shared with Econoff
his reflections on the economic policies that Sao Paulo Governor
Geraldo Alckmin would likely pursue if elected, as well as his
views of what a potential second Lula term would look like.
Velloso confirmed press accounts that Alckmin has consulted him
on economic issues and that he has become one of the Governor's
regular tutors, helping Alckmin, who is a medical doctor by
training, puzzle through complex economic issues. Velloso
stated that Alckmin has made a point of consulting widely with
the leading economists in the PSDB, including many members of
the administration of former President Cardoso. Other analysts
have noted Alckmin's closeness to the Sao Paulo business
community, and in particular the Sao Paulo State Industry
Federation (FIESP).
¶4. (C) Velloso labeled Alckmin a "traditional" politician,
albeit a "serious, well-intentioned" one. He loves to wade into
crowds and knows how to connect with people, Velloso affirmed.
As Governor, Alckmin established a strong record of fiscal
discipline, effectively containing costs. Alckmin, however,
does not have an instinctive feel for the bigger-picture
macroeconomic issues he would face on the presidential campaign
trail. By contrast, he easily perceives the political
consequences of policies, quickly understanding what interest
groups stand to gain or lose from a given economic policy
stance, according to Velloso. Alckmin, for example, easily
identifies the political costs of maintaining high primary
surpluses, Velloso noted, but like many politicians, he has
difficulty understanding the linkages between fiscal and
monetary policy and their implications for the contentious issue
of high real interest rates in Brazil. Alckmin nevertheless is
BRASILIA 00000608 002 OF 005
tenacious in seeking to understand important economic issues,
Velloso said.
Alckmin - Managerial Decision-Making Style
------------------------------------------
¶5. (C) Velloso judged that Alckmin's personal traits and
preferences make his approach to economic decision-making
reminiscent of former President Fernando Henrique Cardoso, who
relied on the majority opinion among his advisors. Other
observers, including the IMF resident representative, have
echoed this assessment, noting that one of Alckmin's strengths
is his ability to select good advisors. Indeed, economic
counsel is one commodity that the PSDB does not lack; the party
counts among its members many of the prominent orthodox
economists in the country. According to the press, Alckmin in
recent weeks has held discussions with notable PSDB economists
Edmar Bacha, Arminio Fraga and Luiz Carlos Mendonca de Barros.
Bacha, a well-known professor of economics at the Catholic
University of Rio de Janeiro (PUC-RIO, a common point of
reference for many PSDB economists), became part of the team
that launched Cardoso's "Real plan" and later served as
President of Brazil's Social and Economic Development Bank
(BNDES). Fraga is best known for his role as president of the
Central Bank from 1999 to 2002.
¶6. (U) According to press reports, Alckmin also frequently
consults Yoshiaki Nakano on fiscal issues. Nakano, a professor
at the Sao Paulo branch of the Fundacao Getulio Vargas (FGV), is
credited with cleaning up Sao Paulo state finances as an aide to
Alckmin's political mentor, the late governor Mario Covas.
Mendonca de Barros, another former BNDES president known to be
close to the Sao Paulo business community, is singled out by
another press report as having become one of Alckmin's economic
advisors.
Macroeconomic Continuity
------------------------
¶7. (SBU) The direction of the economy under an Alckmin
government may not differ that much compared to Lula. In
Brazil, the embrace of sound macroeconomic policies is no longer
particular to one specific candidate or party, but instead has
become institutionalized, JP Morgan President Charles Wortman
declared to Econoff on March 20. This, along with Brazil's
solid macroeconomic fundamentals and continued strong
international liquidity, was the reason financial markets barely
blinked on March 16 when yet another witness accused Finance
Minister Palocci of involvement in illicit activities.
Financial market participants expect continuity of policy even
were Palocci to depart, Wortman affirmed, because the healthy
economy has been Lula's biggest accomplishment. (Note: On
March 27, Finance Minister Palocci did indeed resign. See
septel for further analysis of the implications of Palocci's
exit for the Lula government.) IMF Resident Representative Max
Alier likewise assessed that Lula would maintain the same
overall policy stance for the remainder of his term and, if he
were re-elected, during his second term.
¶8. (SBU) While Alckmin has a clear track record of strong fiscal
management, there is less basis upon which to evaluate his views
on monetary policy. The IMF's Alier expressed confidence to
Emboff that while he lacked formal economic training, Alckmin
would heed sound advice. Among the economists that Alckmin has
been consulting frequently, none is publicly advocating
significant changes to the monetary policy framework. All would
maintain the Central Bank's inflation targeting regime, although
Mendonca de Barros, arguing that Brazil is currently is in a
BRASILIA 00000608 003 OF 005
virtuous cycle of low-inflation growth, believes the Central
Bank could be much more "flexible" in bringing interest rates
down. He has called for real interest rates to fall to 5
percent by 2009.
¶9. (SBU) CSFB Chief Economist Nilson Teixeira voiced some
concerns to Econoff in a March 17 conversation that the Finance
Ministry's steely fiscal discipline might fray around the edges
during the remainder of Lula's administration (or in a second
Lula administration) were Lula to name a political figure as
finance minister. (Currently, its unclear whether Palocci's
replacement, Guido Mantega - previously Lula's Minister of
Planning and President of the National Development Bank - fits
that bill or not.) Teixeira worried that in this scenario, and
with senior technocrats such as Treasury Secretary Joaquim Levy
set to leave the ministry, there would no longer be a voice of
fiscal restraint within the Finance Ministry.
Lula II - Less of a Mandate for Reform
--------------------------------------
¶10. (SBU) Lula has accomplished more on microeconomic reform
than anyone would have expected in 2002 but far less than his
administration set out to do (ref C). Lula made an early
positive mark in 2003 by obtaining passage of social security
reforms that stabilized the deficit in the public employees'
pension system. The GoB also undertook tax reform in 2003,
making the PIS and COFINS taxes more VAT-like. In 2004, the GoB
achieved Congressional passage of a new bankruptcy code, a
legislative framework for public-private partnerships in
infrastructure investment, and a controversial overhaul of the
regulatory framework for the energy sector. An important set of
judicial reforms also was enacted, which included measures that,
over time, should improve the predictability of the judicial
system.
¶11. (SBU) In early 2005, the PT bumbled its way to losing
elections for the speaker of the Chamber of Deputies. Since
then, very few administration priorities have made it through
Congress. The ongoing political scandal over vote buying,
influence peddling and irregular campaign financing erupted soon
after that, further reducing Lula's ability to move legislation
through Congress. Since May 2005, the only microeconomic
legislation to pass has been a set of targeted tax benefits for
exporters which garnered enough industry support to skate
through Congress.
¶12. (SBU) Reflecting wryly on Lula's surprising rebound in the
opinion polls, Velloso said that the PSDB had allowed itself to
believe that its choice of presidential candidate would
determine the next president. Lula, however, had successfully
cleansed his image by shifting blame to the PT for the
interlaced corruption, vote buying and influence-peddling
scandals that engulfed his administration in the second half of
¶2005. That approach -- combined with Lula's personal charisma
and carefully managed public appearances -- had allowed Lula to
convince his core constituency that he was above the scandal.
Velloso argued, however, that Lula's strategy, while opening up
the possibility of reelection, nevertheless carried significant
risks. Principal among these, Velloso believed, was the
weakening of the PT and a strong possibility that Lula would
have less of a mandate in the second term. In addition, Lula
would have to rely even more on coalition partners, as some
analysts here predict that the scandal-tainted PT could elect as
few as 50 federal deputies (out of 513 total) in the upcoming
October elections. Velloso therefore predicted Lula would have
at best limited success in pursuing the microeconomic reform
agenda necessary to improve productivity and growth rates.
BRASILIA 00000608 004 OF 005
Alckmin vs. Lula on Micro Reforms
---------------------------------
¶13. (C) Below are some of the principal microeconomic issues the
candidates will have to deal with:
Trade Liberalization -- While the GoB has engaged constructively
in the WTO Doha round, the GoB has allowed negotiation of the
Free Trade Area of the Americas (FTAA) to languish. When
unscripted, Lula has gone so far as to say that FTAA is not on
his agenda. Velloso assessed that an Alckmin administration
would be much more likely to seek to reenergize the FTAA
process. In public comments, Alckmin has stated that he
believes Brazil needs trade liberalization to boost
competitiveness and specifically mentioned renewing FTAA
negotiations as a priority. On process issues, FIESP contacts
have told us that Alckmin would reorganize the GOB's
decision-making apparatus to take responsibility for trade
negotiations out the hands of entrenched diplomats at the
Foreign Ministry and lodge it with a newly-created interagency
body (very much equivalent to USTR).
Tax Reform -- the Lula administration changed the PIS/COFINS
taxes in 2003 to make them more VAT-like. While it had planned
a badly needed overhaul of the state-level VAT system (ICMS),
political considerations forced the GoB to abandon this effort.
Unable to pursue broader based reforms, the Lula administration
instead enacted several targeted tax measures, aimed variously
at promoting exports, fostering innovation, developing real
estate markets, creating new financial market products and
facilitating capital equipment upgrades. Velloso stated that
Alckmin likely would pursue broad-based tax reform, which
necessarily would include a reduction in mandatory transfers to
state governments to allow the federal government to reduce
taxes.
Social Security -- The social security system deficit is growing
despite previous efforts at reform. A big part of the problem
this time, according to Carlos Mussi of the UN Economic
Commission for Latin America (ECLAC), is that the Lula
administration granted substantial real increases in the minimum
wage in 2004 and 2005. As pensions are by law indexed to the
minimum wage, social security accounts have suffered. Given the
potential political down-side of tinkering with social security
during an election year, we anticipate that both candidates will
largely remain silent on this issue during the campaign and only
reveal their true agenda after the election.
Interest Rates -- Brazil's high real interest rates are likely
to be the most controversial economic issue of the campaign.
Alckmin's stance, however -- that the government's borrowing
requirement must be reduced through expenditure cuts in order to
allow interest rates to fall -- differs little from what Lula
would have to do if he is reelected. (Very likely, a
constitutional amendment would be required to do away with
constitutional earmarks and allow the GoB to reduce
non-discretionary spending.) Neither candidate has, to date,
mentioned the need to reform the directed credit system (for
example, to agriculture at low interest rates), which
effectively increases interest rates for all other borrowers.
¶14. (C) Comment: The fact that an unabashedly pro-business
candidate like Alckmin may have difficulty differentiating his
economic agenda from that of the nominally leftist President is
illustrative of how little uncertainty exists on the overall
economic policies to be followed in Brazil after this election.
This reflects in part the societal consensus in favor of sound
BRASILIA 00000608 005 OF 005
macroeconomic management that the still-present memory of
hyperinflation past has helped to create. It also shows the
degree to which many reforms have become institutionalized,
particularly those introduced by the fiscal responsibility law.
How much of his microeconomic reform agenda either candidate
will in fact be able to accomplish is an open question, which
will depend to a significant degree on post-election coalition
politics. To date, the principal economic policy difference
between the two that stands substantially to impact USG
interests is Alckmin's stated emphasis on re-energizing FTAA
negotiations.
LINEHAN