US embassy cable - 05BRASILIA2145

C O N F I D E N T I A L SECTION 01 OF 03 BRASILIA 002145 
 
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TREASURY FOR DAS LEE AND F.PARODI 
 
E.O. 12958: DECL: 08/11/2015 
TAGS: EFIN, ECON, Macroeconomics & Financial 
SUBJECT: SECRETARY SNOW'S MEETINGS WITH FINANCE MINISTER 
PALOCCI AND CENTRAL BANK PRESIDENT MEIRELLES 
 
Classified By: Charge d'Affaires Patrick Linehan, reason 1.4 (b) 
and (d 
). 
 
 1. (C) Summary: Secretary Snow met separately with Central 
Bank President Meirelles and Finance Minister Palocci August 
1 in Brasilia for broad discussions of Brazil's current 
economic performance.  Meirelles and Palocci both argued that 
Brazil's stellar economic performance, with a current account 
surplus of 1.9% of GDP anchored by booming exports and a 
strong fiscal stance (5.1% of GDP primary surplus), had 
insulated the economy from current political turbulence. 
Palocci implicitly acknowledged that the microeconomic reform 
agenda was stalled, but hoped that stronger growth in the 
second half of 2005 would allow the GoB to press forward with 
reforms, including a simplification of the tax system as 
applied to small and medium enterprises.  Palocci placed 
significant emphasis on reenergizing trade negotiations as a 
tool to improve productivity in the economy (septel). 
Palocci said Brazil would like to join the OECD and sought 
support for Brazil's position on IMF quota reallocations. 
End Summary. 
 
2. (U) Background:  Treasury Secretary Snow visited Brazil 
July 31 to August 3, 2005, to participate in the fourth 
session of the bilateral Group for Growth, an outgrowth of 
the 2003 Summit between Presidents Bush and Lula.  Secretary 
Snow held bilateral meetings August 1 in Brasilia with 
Central Bank President Henrique Meirelles (along with the 
majority of the Bank,s Governing Board), Finance Minister 
Palocci and President Lula, in addition to meeting with 
Brazilian venture capitalists.  In Rio de Janeiro on August 
2, the Secretary participated in Group for Growth meetings 
(including a business breakfast), gave a speech sponsored by 
the Brazilian Council on Foreign Relations (CEBRI), and held 
a round-table discussion with representatives of the 
financial services sector.  On August 3, in Vitoria, the 
capital of the Brazilian state of Espirito Santo, the 
Secretary emphasized the themes of private sector 
 
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infrastructure investment and the importance of good 
governance in visits to the port of Tubarao and in a working 
lunch with Governor Hartung and local business.  The 
Secretary concluded his stay in Vitoria with a visit to a 
 
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favela (poor neighborhood) that benefited from an 
Inter-American Development Bank (IDB)-financed basic services 
project, aimed at providing running water, sewage hook-ups 
and paved streets.  This cable reports on the Secretary's 
meetings with the Central Bank President Meirelles and 
Finance Minister Palocci.  Septel reports on the trade 
aspects of Secretary Snow's discussions. 
 
Economy, Interest Rates and Directed Credit 
------------------------------------------- 
 
3. (SBU) Meirelles outlined Brazil's excellent economic 
performance over recent months and described its current 
policy stance.  He argued that Brazil's pursuit of its three 
main macroeconomic policy pillars (fiscal adjustment, 
inflation targeting monetary policy and a flexible exchange 
rate) were producing outstanding results.  While growth 
registered a small adjustment in the first quarter, he 
expected it would pick up in the remaining quarters, with the 
economy posting annual growth of about 3.4%.  He added that 
the fiscal performance (5.1% of GDP primary surplus in the 12 
months through June) had been solid and the external accounts 
outstanding (1.9% of GDP current account surplus in the 12 
months through June). 
 
4. (SBU) Meirelles declared that the Central Bank has been 
able to establish credibility with the market, despite its 
lack of formal legal autonomy.  Still, he emphasized, the 
Bank,s lack of formal independence meant that investors were 
demanding a small inflation premium -- which would only 
disappear once formal autonomy was granted.  Economic Policy 
director Bevilaqua added that inflation expectations for the 
year, after spiking in the first and second quarters, were 
nevertheless declining faster than expected in response to 
the current monetary policy adjustment. 
 
5. (SBU) Meirelles noted that one of the reasons for Brazil's 
infamously high lending spreads is the country,s system of 
directed credit.  Although bank lending has been growing, he 
noted, only 34.5% of overall credit was freely allocated by 
banks -- the rest is directed primarily to low-cost 
agricultural credits or by the national development bank 
(BNDES).  Meirelles argued that, while this system created 
credit market distortions, it reflected a set of widely-held 
societal priorities.  However, he agreed with the 
Secretary,s observation that this societal consensus might 
 
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change over time.  Meirelles further pointed out that these 
subsidized credits meant that the average lending rate was 
lower than the headline interest rates. 
 
Vulnerability has Declined 
--------------------------- 
 
6. (C) Citing similar factors, Palocci and Meirelles both 
argued (separately) that Brazil's vulnerability to shocks had 
decreased markedly.  The GoB's debt burden was down (52% of 
GDP) and its external profile had improved.  Dollar-linked 
domestic debt had fallen from 40% to less than 4% of total 
domestic debt while the GoB had increased substantially the 
amount of fixed interest rate debt.  The current account 
surplus and the country's strong fiscal performance, they 
stated, were insulating the economy from the current 
political turbulence.  Palocci affirmed that the return of 
GDP growth expected in the second half of the year may allow 
the GoB to retake the microeconomic reform agenda adding that 
he would like to see the economy open up faster.  He stated 
that the GoB hopes to pass in the second half of 2005 
legislation to simplify the tax system applicable to small 
and medium enterprises, and is now implementing the 
recently-enacted bankruptcy law.  The goal is to maintain the 
strong fiscal stance and press forward with microeconomic 
reforms so as to create space for a monetary easing.  The 
Secretary welcomed the focus on the microeconomic agenda, 
 
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noting that the markets' benign reaction to date to the 
current political scandal was a tribute to the policies the 
GoB had pursued. 
 
Palocci - OECD, IMF and Venture K 
--------------------------------- 
 
7. (C) Palocci stated that given its ongoing extensive 
cooperation with the Organization for Economic Cooperation 
and Development (OECD), Brazil would like to pursue 
membership in that organization.  The GOB,s goal is to forge 
with OECD interlocutors a common vision governing Brazil's 
accession process. The Secretary undertook to raise Brazil's 
request in Washington. 
 
8. (C) Palocci thanked the Secretary for USG support of 
Brazil's position in the current review of IMF quotas.  He 
asked for continued support as the process advanced. 
 
9. (C) The Secretary briefed Palocci on his meeting with a 
group of local venture capitalists.  Bringing together ideas 
and financing was a critical function of the financial 
system, the Secretary said, and it was encouraging to see 
this nascent sector in Brazil helping new companies get 
started.  Palocci agreed, stating that he believes the 
sector, while new, has significant potential.  He singled out 
the important contribution that venture capitalists make to 
the governance of small firms. 
 
10. (U) This cable was cleared by Treasury. 
 
LINEHAN