US embassy cable - 04BRASILIA1275

C O N F I D E N T I A L SECTION 01 OF 04 BRASILIA 001275 
 
SIPDIS 
 
E FOR SMITHAM 
NSC FOR SHANNON, DEMPSEY, CRUZ 
TREASURY FOR OASIA/SEGAL 
EXIMBANK FOR DIRECTOR FOLEY 
FED BOARD OF GOVERNORS FOR ROBITAILLE 
USDA FOR U/S PENN, FAS/FAA/TERPSTRA 
USDOC FOR 3134/USFCS/OIO/EOLSON/DDEVITO 
USDOC FOR 4332/ITA/MAC/WH/OLAC/MCDOUGALL, DRISCOLL, BASTIAN 
SOUTHCOM FOR POLAD 
 
E.O. 12958: DECL: 05/25/2009 
TAGS: ECON, PGOV, EFIN, EINV, ENRG, PREL, SOCI, BR, Economic Policy & General Analysis 
SUBJECT: AFTER 500 DAYS, THE QUESTION IS:  CAN LULA GOVERN? 
 
 
Classified By: Ambassador Donna Hrinak, reasons 1.4 B),D) 
 
1. (C) SUMMARY.  Lula's man-of-the-people rhetoric and 
heartfelt commitment to social progress quickly captured 
imaginations inside Brazil and abroad, but practical results 
of his first 500 days in office have been far less  soaring. 
Without better economic news, stronger executive capacity and 
a firmer political base, his GoB may find itself falling into 
a crisis of governance by the second half of his term. 
Lula's fiscal and monetary policies have been all that the 
market wanted, but he has reaped no visible domestic rewards 
yet in the form of new growth, jobs, income or investment. 
His administration's executive ineptitude, and the ramshackle 
nature of its coalition alliances, are further factors that 
both contribute to and are themselves worsened by the 
economy's non-recovery so far.  We expect pressure on Lula to 
mount further, with a fair chance he will feel forced to move 
to New-Deal-style spending programs in 2005.   END SUMMARY. 
 
The Personal Aura 
----------------- 
 
2. (SBU) Lula's charismatic initial impacts, and his triumph 
in gaining market confidence after Brazil's 2002 crisis, have 
entered history as the first chapter of his presidency. What 
next?  With more than a third of that presidency now past, 
his personal popularity is a healthy 60%, defying Brazil's 
absence of new growth and jobs, even if down from his 
high-80's of a year ago.  Financial markets and institutions 
continue to lavish him with praise for the GoB's orthodox 
monetary/fiscal management.  His constant foreign travel and 
diplomatic activism garner a high profile and mainly positive 
image worldwide, bolstering his and Brazil's claims to 
international leadership and thus appealing to nationalists 
on left and right.  He has banked much good will on which to 
draw at home and abroad in terms of what he indisputably 
represents for Latin-American democracy and social 
aspirations.  His comportment shines out as that of an 
uncorrupt, democratic, inclusive, charismatic but unassuming, 
down-to-earth negotiator.  Yet Lula finished his first 500 
days in office at his lowest domestic political ebb to date. 
What is the problem? 
 
The Real Economy 
---------------- 
 
3. (SBU) First and foremost, it's the economy.  Brazil's 
macro-economic stabilization since 2002 has been a continuing 
true triumph of Lula's political will.  He persistently 
endorses Meirelles' and Palocci's strict inflation and 
budget-surplus targets through 2005.  Plainly, he has been 
won by the argument that fiscal/monetary loosening would risk 
forfeiting the gains that the Plano Real -- and especially 
the last year's sacrifices under the PT -- have brought 
Brazil.  But palpable real-world results for Brazil's 
citizens have remained absent, and for Lula henceforth there 
will be no substitute for more growth, jobs, income, 
investment.  Some recent data are positive, and forecasters 
concur that 3-3.5% GDP growth this year is likely.  But they 
also generally agree that 3-3.5% will have only a marginal 
effect on jobs and income, and that that rate is unlikely to 
strengthen through 2006. 
 
4. (SBU) Plus there are new economic concerns in the shape of 
outside uncertainties: Chinese demand, Fed interest-rate 
policy, the oil-price trend.  These have helped erode the 
exchange rate by 10% since April.  Further weakening could 
produce a halt - or even a reversal -- of the year-long 
decline of Brazil's benchmark SELIC interest rate.  That in 
turn would hit the growth rate and might prevent the expected 
reduction in the debt/GDP ratio this year, which would be a 
truly crippling portent for Meirelles/Palocci. 
 
5. (SBU) Brazil's external financial vulnerability is greatly 
down since 2002, thanks to superior current-account trends 
and GoB debt-management.  Still, the market is not Brazil's 
friend.  If last year's benign global atmosphere were to 
shift, Brazil could fall to investor-herd fears despite its 
own best efforts.  And those efforts, in the present climate 
of GoB political shakiness and inept governance, are far 
short of what they could be. 
 
Executive Ineptitude 
-------------------- 
 
6. (C) Shaky leadership is an over-arching problem.  Lula 
remains the undisputed arbiter of GoB policy differences, but 
his limitations are not being mitigated by the so-called 
"hard nucleus" of his closest Planalto advisors.  On the 
contrary, this group of long-time Lula friends and PT 
veterans - e.g., Secretary General Luiz Dulci and Secretary 
of Government Communication and Strategic Management Luiz 
Gushiken - evidence no strategic vision or decisive executive 
competence.  The one standout, Chief of Staff Jose Dirceu, 
was a virtual prime minister during the administration's 
first year, managing most key initiatives and coordinating 
congressional strategy.  But his dramatic diminishment by the 
Diniz scandal has rendered Dirceu much less effective, 
leaving a vacuum that has sucked coherence and energy out of 
Planalto. 
 
7. (C) Lula's executive problem extends through 
senior-personnel ranks.  His first, tortuously drawn-out 
cabinet reshuffle has produced no rejuvenating results.  And 
the process of installing new faces in ministries is still 
underway as part of Lula's coalition-reinforcing efforts, to 
the further detriment of efficient policy-making.  Not by 
accident, those policy areas with the relatively best records 
under Lula - trade, macroeconomic, industrial, agricultural - 
are run almost entirely by non-PT ministers he appointed at 
the outset.  Yet he has shown no readiness since then to 
reach out for expert talent beyond the PT. 
 
8. (SBU) Meanwhile, ideological currents still run deep 
through the PT grass roots and into its senior echelons. 
Finance Minister Palocci's enlightened fiscal views are the 
exception:  many, perhaps most of Lula's old allies still see 
the state as the main, natural, legitimate actor for directly 
implementing programs for national progress.  At worst, this 
mindset has spawned fresh barriers to investors in the shape 
of GoB regulatory-agency and energy-model legislation.  More 
generally, we suspect it causes Lula's GoB not to really know 
its own mind about its agenda.  As former President Cardoso 
recently quipped:  "I suppose the government must have a 
plan, but I cannot figure out what it is." 
 
 Ramshackle Political Base 
------------------------- 
 
9. (C) In the Congress, Lula has slipped backwards.  His 
ability to push legislation depends on the unity of an 
unwieldy, PT-led coalition which includes parties that are 
all over the map in terms of ideology and seriousness.  On 
paper the coalition is ample enough to carry the day on most 
votes, but in reality fragmentation and rebellion are 
becoming the norm.  The Diniz scandal, together with 
unhappiness on the right with lack of growth and on the left 
with lack of progress on the touted social agenda, brought 
Lula a major legislative defeat in early May.  More may come. 
 The fragile coalition is barely held together by Lula's 
charisma and promises of pork and government jobs.  Passage 
of his pension and tax bills in 2003 hinged on support from 
opposition parties, and he may hope to reach out more in 
future to the PSDB, which is likeminded on  various platform 
issues.  But this will further dilute coalition discipline 
and the efficacy of legislation produced by barter. 
 
10. (SBU) At the local level, GoB/PT prospects in October's 
municipal elections have faded.  The PT has always been an 
urban party (its mayors run 10 of Brazil's largest cities but 
only a tiny percentage of smaller municipalities), and early 
in the Lula government there was PT hope for a breakthrough 
bandwagon effect.  After the administration's last four 
months of difficulties, however, PT leaders are no longer 
willing to predict large gains and are digging in for tough 
challenges to party incumbencies, notably Sao Paulo, where a 
loss would be iconic for Lula and the PT. 
 
11. (C) Foreign policy is one area which Lula and his 
diplomats doubtless view as one of unalloyed triumph.  In 
reaching for a weightier world role, they have mirrored 
previous Brazilian ambitions.  The outcome of the Cancun WTO 
talks, the dilution of the FTAA process at Miami, the 
formation of the G-20 Group, have had no downside, in their 
view.  But much of what Itamaraty portrays as Lula's personal 
impact on the world scene is plain fanciful, e.g., his 
grandiloquent plan for a tax on arms transactions to go into 
a hunger-relief fund.  And his foreign policy and travels may 
hold future risk for his image, e.g., if Venezuela goes 
critical or if Itamaraty doctrinaires ultimately stymie FTAA 
negotiations. 
 
The Next 500 Days 
----------------- 
 
12. (C) It is not easy to see Lula making a strong recovery 
in his next 500 days.  Conversely, it is not hard to envision 
further political and economic slippage.  Worst-case:  if 
Lula's domestic political standing worsens, and external 
economic developments turn bad, Brazil could be back within 
months to a deteriorating economic/financial spiral. 
More-likely case: growth picks up modestly and Brazil avoids 
external economic buffets, but there still is little sense of 
new momentum or relief through year's end.  If either of 
these scenarios combines with a poor PT election result, what 
might be Lula's political and policy follow-on? 
 
13. (C) Lula's orthodox economic policy remains exactly what 
most outside observers have counseled, but he and the PT are 
unlikely to soldier on with it indefinitely, absent palpable 
returns.  This would be especially the case if an external 
shock sparks a "hot-money" investor flight that could be 
perceived as confiscating the gains of Brazilians' past 
sacrifices.  Should GDP not pick up convincingly by 
year's-end, arguments for a policy adjustment from "Herbert 
Hoover" policies towards "Roosevelt New Deal"-style 
public-works employment, with a priority on useful 
infrastructure projects like railroads and water-treatment, 
may become hard to resist. 
 
COMMENT 
------- 
 
14. (C) Are Lula's struggles just a spring slump, or a 
presage that his team is headed for a losing season? 
Arguably, no party fresh like the PT to national power could 
have made a fast start in a nation like Brazil, less than 
twenty years emerged from dictatorship, with its primitive 
and corrupt feudalities, undisciplined and unprincipled 
political parties, and inadequately-established state 
institutions generally. 
 
 15. (C) Lula-backers can still hope that Brazil's GDP growth 
this year will be sufficient to ease social pressures; that 
the PT will do well enough in October's elections to solidify 
its coalition; that the President will thereafter recruit new 
ministers and key figures, re-launch his legislative program 
at the start of 2005, and, learning from past missteps, make 
an expeditious success of the further reforms vital for 
Brazil's economy to break through and attain its long-term 
potential.  The glum alternative opinion is that he and the 
PT already are showing they lack the personnel, platform, 
party, political power, and general conditions to carry out 
their transformational "project" for Brazil, period. 
 
HRINAK