US embassy cable - 05BRASILIA1662

UNCLAS SECTION 01 OF 02 BRASILIA 001662 
 
SIPDIS 
 
SENSITIVE 
 
NSC FOR BREIER, RENIGAR 
TREASURY FOR OASIA - DAS LEE AND 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/DANDERSON/EOL SON 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, Macroeconomics & Financial 
SUBJECT: BRAZIL - ECONOMIC GROWTH AND INFLATION SLOW 
 
REF: A) BRASILIA 1456 
     B) BRASILIA  521 
     C) BRASILIA 1631 
     D) BRASILIA  682 
 
1. (SBU) Summary:  Brazil's economy slowed more sharply than 
expected in the first quarter, clocking growth of 0.3%. 
Growth expectations for the year, therefore, are being 
downgraded, to the 2.5% to 3% range.  The good news is that 
previously intractable inflation and inflationary 
expectations also have begun to fall, responding to the 
cycle of Central Bank interest rate increases begun in 
September 2004.  This allowed the Central Bank's Monetary 
Policy Committee (COPOM) to leave interest rates unchanged 
at its June 14-15 meeting, after an eight-month adjustment 
cycle that increased the bank's overnight rate (the SELIC) 
from 16% to 19.75%.  With growth settling back towards what 
many believe to be the maximum sustainable level in the 
medium term (about 3%), the economic policy focus shifts to 
reforms to increase the economy's productivity, and thereby 
its growth potential.  The current scandal over vote-buying 
in Congress (ref C), however, will make even more difficult 
Congressional approval of President Lula's reform agenda. 
End Summary. 
 
2. (SBU) Economic growth slowed more quickly than 
anticipated in the first quarter of 2005, according to GoB 
data.  The quarterly growth data (see table below) show, on 
the demand side, declines in investment and private 
consumption.  These are reflected on the supply side in a 1% 
drop in industrial output for the quarter.  Taken together, 
the data suggest that the Central Bank's monetary tightening 
has been slowing growth, reducing investment, personal 
consumption and industrial output.  Despite the current 
drought in southern Brazil, the data also show surprisingly 
strong growth in agricultural output.  According to Carlos 
Mussi, an economist with the UN Economic Commission for 
Latin America (ECLAC), the drought's impact will only begin 
to show up in data for the second quarter.  Exports turned 
in another gravity-defying performance despite the 
appreciation of the Real (ref A). 
 
 
                        Brazilian GDP 
            Percent Growth - Seasonally Adjusted 
 
 
                 Annual/1       Quarterly Growth/2 
               2003   2004    2Q04   3Q04    4Q04   1Q05 
 
Total GDP      0.5     4.9     1.1    1.3     0.4    0.3 
 
Supply Side 
 - Agriculture 5.0     5.3     0.5   -1.6     1.8    2.6 
 - Industry   -1.0     6.2     1.0    2.6     0.4   -1.0 
 - Services   -0.1     3.3     1.0    0.9     0.4   -0.2 
 
Demand Side 
 - Consumption 
   (Private)  -3.3     4.1     1.6    1.3     0.8   -0.6 
 - Govt.       0.6     0.1    -1.0    1.3     0.5   -0.1 
 - Investment -6.6    10.9     3.5    6.2    -3.9   -3.0 
 - Exports    14.2    18.0     4.1    2.1     3.3    3.5 
 - Imports    -1.9    14.3     1.4    4.2     3.2    2.3 
 
     /1 Percent Change on Previous Year 
     /2 Percent Change on Previous Quarter, Preliminary 
     Source: Statistics and Geographic Institute (IBGE) 
 
3. (SBU) Analysts, who previously were predicting growth of 
3.5% to 4% for 2005, have been busily revising their growth 
projections downward.  The GoB's Institute for Applied 
Economic Research (IPEA) now is projecting growth of 2.9% in 
2005.  The latest Central Bank survey of market 
expectations, which averages the predictions of financial 
institutions with economic models, shows the market is 
predicting growth of 3.1% for the year.  The IMF Resident 
Representative told Econoff he expects growth of 2.75% to 
3%. 
4. (SBU) The Brazilian Geographic and Statistical Institute 
(IBGE), which produces the official growth and inflation 
numbers, also revised downward its initial estimate of 
growth last year from 5.2% to 4.9%.  Mussi explained to 
Econoff that after receiving additional data from the GoB's 
telecommunications regulatory agency, the IBGE re-estimated 
the growth in telecommunication services, and made other 
lesser adjustments.  While Mussi expressed some doubt about 
the precision of the IBGE estimates -- in particular their 
methodology for seasonal adjustments -- it was clear, he 
said, that the economy would expand less robustly than 
before. 
 
5. (SBU) The good news is that, along with slowing the 
economy, Central Bank interest rate increases finally look 
to be bringing stubborn inflation and inflationary 
expectations under control.  Inflation as measured by the 
consumer price index (IPCA) dropped from 0.87% in April to 
0.49% in May.  Inflationary expectations likewise have 
moderated.  Since the beginning of May, Central Bank surveys 
have shown market expectations for inflation consistently 
falling.  The market now predicts 2005 annual inflation of 
6.16% (down from 12.5% in 2002, 9.3% in 2003 and 7.6% in 
2004).  While this is well above the 5.1% target, it remains 
well within the 2.5 percentage point band on either side of 
the target.  Based on this shifting inflation scenario, the 
Central Bank halted its eight-month cycle of interest rate 
increases, voting at its June 14-15 meeting to keep the 
benchmark SELIC rate at 19.75%.  Mussi noted that although 
inflation was clearly headed in the right direction, 
structural rigidities and credit expansion (ref D) were 
increasing the cost of marginal reductions in inflation. 
 
6. (SBU) Comment:  As GDP growth settles towards 3% -- 
within the ballpark of what most analysts believe is, in the 
medium term, the economy's maximum sustainable expansion 
rate -- this cycle of monetary tightening has made clear the 
need to move forward with badly needed reforms (ref B). 
While it is still early to draw firm conclusions, the 
current political scandal over alleged Lula administration 
vote-buying in the Congress (ref C) looks to have made the 
GoB's already modest reform ambitions for the year (ref B) 
even harder to achieve. 
 
DANILOVICH