US embassy cable - 05BRASILIA2012

UNCLAS BRASILIA 002012 
 
SIPDIS 
 
NSC FOR CRONIN 
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 
AID/W FOR LAC/SA 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, Macroeconomics & Financial 
SUBJECT:  BRAZIL:  WORRIES THAT POLITICAL SCANDAL WILL 
DERAIL ECONOMIC GAINS 
 
REF:  A) Brasilia 1968, B) Brasilia 1973 
 
1. (SBU) While to date the Brazilian economy has largely 
been immune to the growing three-month old vote- 
buying/influence peddling scandal which is currently 
plaguing the Lulu administration, there are growing signs 
that contamination could soon occur.  Between July 21 and 
July 25, the real dropped by 5.5 percent and the Sao Paulo 
Stock Exchange (BOVESPA) dropped by 5.1 percent.  Although 
both indicators appreciated in subsequent sessions, the 
mantra among analysts here is that foreign investors -- 
heretofore attracted by the country's sky high real interest 
rates (near 14 percent) on Brazilian bonds -- are now 
viewing the country with caution. 
 
2. (U) To ward off possible contamination, on July 27 
opposition party representatives floated a trial balloon to 
the effect that the GOB should work with its colleagues 
across the aisle to fashion a consensus package of basic 
measures to shield the economy from the scandal in the 
coming weeks.  That same day, Jaques Wagner, the Lula 
administration's Secretary for Economic and Social 
Development/Institutional Relations responded positively to 
this suggestion, noting that it would benefit all concerned. 
 
3. (SBU) Brazil's National Confederation of Industries (CNI) 
is already working on a plan, which would include previously- 
discussed items such as tax reform, political reform, 
changes to the rules governing infrastructure, and 
reductions in government expenditures.  Prior to the 
emergence of the scandal, the GOB had great difficulty in 
moving these items through the legislature as each had drawn 
opposition from constituencies who might have been adversely 
affected.  Now that the Lula administration is weak and 
Congress is paralyzed, making progress on these measures 
will be even more difficult. 
 
4. (SBU) Analysts fear that efforts to concoct such a 
package -- while well-intentioned -- could harm markets more 
than they help.  Specifically, various camps will likely 
want to put their own stamp on any package, in many cases 
altering it for the worse.  For instance, industries 
adversely affected by high nominal interest rates would 
likely want a commitment from the GOB to lower the benchmark 
SELIC rate -- thereby calling into question central bank 
independence.  As for the left-wing of the PT, it would 
likely want a moratorium on external debt payments and/or an 
end to the GOB's 4.25 primary surplus target -- thereby 
calling into question the GOB's economic program in general. 
Even if these constituencies prove unsuccessful in grafting 
their desired policies onto the package, the mere fact that 
such proposals were circulating could in and of itself 
unsettle the markets. 
 
5. (SBU) Right now, the most likely outcome, in our view, is 
that no package will pass.  Finance Minister Palocci, who 
after the departure of Chief of Staff Jose Dirceu ranks as 
Lula's most influential advisor, can be counted on to deep 
six any effort to dilute/weaken the GOB's orthodox economic 
program.  In the coming days, as before, what will likely 
determine how far (and how fast) any scandal-related 
contagion spreads to the economy is: a) the degree to which 
the various congressional inquiries continue to uncover 
additional wrong-doing and, b) whether any evidence of 
misconduct by Lula or Palocci surfaces. 
 
LINEHAN