PENSION REFORM: GOB VEERS, TACKS, TAKES ON WATER

UNCLAS SECTION 01 OF 04 BRASILIA 002407

SIPDIS

SENSITIVE

NSC FOR WALLACE
TREASURY FOR SSEGAL
PLS PASS FED BOARD OF GOVERNORS FOR ROBATAILLE

E.O. 12958: N/A
TAGS: EFIN ECON EINV BR
SUBJECT: PENSION REFORM: GOB VEERS, TACKS, TAKES ON WATER

Refs: A) Brasilia 1466, B) Brasilia 80

SUMMARY
--------------

1. (U) Lula's crucial pension-reform bill was approved by the
Chamber of Deputies special committee on July 23 -- but only
after undergoing political buffets and a perhaps fateful
overhaul. In a fundamental about-face, the GoB has accepted
that all current public-sector employees will remain eligible
for pensions equal to their top salary (albeit with big
improvements in minimum-age and time-worked eligibility
criteria.) Chief factor behind this concession was shameless
lobbying by Brazil's judiciary, which enjoys unique pension
benefits and will ultimately decide any reform's
constitutionality. There was also pressure from the GoB's
base in Congress with its long ties to public-sector unions.


2. (U) Fiscally, the GoB claims the overall impact of its
shift is negligible. Federal savings over the next twenty
years will still total 50.7 billion, vs. 52.4 billion under
the GoB's original proposals, supposedly. `The market' seems
to take these numbers at face value, and has been placid.
Politically, however, these early pension-bill concessions
have seemed to pose doubts over the goals and resolve of
Lula's team. They may have opened the door to a snowball of
public clamor, brinkmanship, and further changes that will
gut the reform. Lula's tax-reform bill, due for a committee
vote soon, could get trapped in a similar cycle. He and his
team undoubtedly sense the danger and now are drumming the
message that they have gone to the limit of their pension-
reform horse-trading. END SUMMARY.

A Fortnight's Commotion in Review
--------------

3. (SBU) The GoB's about-face began on July 9, following
drawn-out dialogue with new Supreme Court Chief Justice
Correa. The latter evidently sees his job as embracing the
duty to lobby for retention of the judiciary's uniquely
generous pension privileges, of which "integral" (100% of
final salary) pensions are the capstone. The GoB in turn has
to bear in mind that the Supreme Court can torpedo any
pension reform by ruling it unconstitutional, as happened
with Cardoso's 1998 proposal to tax pensions. Correa, Social-
Security Minister Berzoini, and lower-House Speaker Cunha,
with Planalto's Dirceu in the wings, conferred secretively
for two weeks. Outcome: while Lula was in Europe, on July
10 local press headlined the administration's alleged
surrender on the principle of "integral" pensions, not just
for the judiciary but for the whole current public sector.
Whether future public-sector workers, too, would get integral
pensions was not made explicit.


4. (U) The news triggered consternation from media, Brazil's
governors, and Finance Minister Palocci. Former Social-
Security Minister Brant, who now heads the Chamber of
Deputies' special committee on the subject, was widely quoted
as saying "the new reform is no reform." Various PT
politicians in and out of Congress lamented having stuck
their necks out defending the GoB's original reform plan.
Palocci by all accounts had not been kept current on the
Cunha/Berzoini/Correa/Dirceu talks and wanted to cancel his
European trip to join Lula, in favor of staying home to fight
for the GoB's original reform guidelines.


5. (U) But the weightiest adverse reaction was from Brazil's
governors. Fiscal pressure on their own state budgets from
the pension system is as acute as on the Union's; many can
afford to pay "integral" pensions even less. Lula made a
point of forming and presenting his pension and tax reform
plans to Congress with the governors' consensus in April.
That the GoB now appeared to have negotiated so great a
change in the pension-reform plan, leaving governors to learn
about it in the papers, sat very badly. Key Minas Gerais and
Sao Paulo governors Neves and Alckmin voiced opposition in
careful but ominous tones. Temporizing, Dirceu convened a
meeting July 16 with five representative governors, plus
Cunha and Berzoini. At that meeting, Berzoini gave figures
purporting that the changes overall would be revenue-neutral
for states as well as the Federal Treasury. Governors seem
to have warily gone along, but with the insistence that
future public workers be ineligible for "integral" pensions.

Lula Decides
--------------

6. (U) Meanwhile, from Portugal, Lula asserted his authority
to arbitrate. At the tense inter-ministerial meeting which
followed his return on Thursday July 17, according to an
account in last week's "Epoca" financial weekly, Lula
censured Berzoini and Cunha (but absolved Dirceu) for undue
"precipitousness" in their political negotiations. Yet at
meeting's end, despite Palocci's and Communications advisor
Gushiken's arguments against, Lula gave his imprimatur to
Berzoini's advocacy of integral pensions. Lula also endorsed
the continuation of "parity," i.e., that retirees' pensions
increase by the same factor as current workers' salaries.
However, he ruled out letting future public-sector workers be
eligible for integral pensions, and he reasserted the GoB's
tough original guidelines in some other key respects.


7. (U) The next day, the bill's sponsor, Deputy Carlos
Pimental (PT-Ceara) presented its adjusted version. Salient
features include the following.

-- minimum conditions for integral pensions: (women) 55 years
old with 30 years of INSS contributions and 20 years in the
public sector, including 10 in present occupation ("cargo");
(men) 60/35/20/10 years, respectively.

-- for future public-sector employees, a monthly pension cap
of BRL 2,400, with the option of a complementary pension fund
contributed to by government (same as the initial GoB
proposal).

-- pensions to be taxed at 11%, starting at the present
personal-income tax floor of 1,058 Reals/month. The earlier
agreement had been for a floor of 2,400/month.

-- salary and hence pension sub-ceilings for state and
municipal judiciary employees of 75% the salaries of Supreme
Court judges. The Berzoini/Cunha agreement had been 90.25%.

-- survivor's benefit (currently 100% of the pension without
limit) to remain 100% only up to 1,058 Reals/month, with a
30% discount on anything above that level.

-- "parity" (cf. above) to be preserved for existing pensions
of current and currently-eligible pensioners, and for other
current public sector, but with definition of parity for the
latter category left to a future complementary law.

GoB Spin, Market's Placidity
--------------

8. (U) The acceptance of "integral" pensions represents an
abandonment of the GoB's original goal of early transition
towards a unified social-security system with an eventual
common ceiling for public- and private-sector pensions so as
to curtail the grossly inequitable privileges enjoyed by
Brazil's high-paid civil servants (Ref B). Defenders see it
as a vital, if ugly, GoB compromise to gain legislative and
Supreme Court approval of a pension reform that will bring
Brazil at least the minimum fiscal benefits needed to keep
the markets sunny. Grandfathering all current workers'
benefits could save the final reform from judicial challenges
based on loose interpretation of the Constitutional principle
of "acquired rights" that cannot be withdrawn. Politically,
the primary gain of the last fortnight's bargaining is that
the governors seem warily back on board. In Congress, there
is grumbling that the GoB walked back too much at the
governors' behest, but no sign of major mutiny.


9. (U) Fiscally, the GoB claims its shift preserves the
reform's "spinal cord" by improving the pension system's mid-
to-long term financial viability. The GoB's prime assertion
is that, thanks to the major increases in mimimum-age and
length-of-work requirements, federal savings will not be
meaningfully reduced by the extension of integral pensions.
Under the original design, those savings were supposed to
total 52.4 billion Reals through 2023. With the changes,
they will be 50.7 billion. (Note: no methodology details
available; these figures refer to federal civil servants
only, excluding state and local public sectors, the military,
firemen, and others. End Note.)


10. (U) For now, financial markets evidently take the GoB
case at face value. Global-bank analyses we read all treat
the revised pension-reform bill as being acceptable, as does
the IMF, to judge from its indirect commentary. The recent
uncertainties have had next to no effect on the exchange
rate, while Brazil's country risk resumed its decline in July
and is now at its lowest level since March 2002.

Fiscally Okay, but Politically Damaging?
--------------

11. (SBU) Fair enough, perhaps, in a green-eyeshade way. Yet
the risk of collateral political damage to Lula seems high.
There isn't even much assurance that the pension bill will
pass Congress in its new form. By ceding so much when the
bill was at merely the second of seven legislative voting
stages, the government may appear to have encouraged every
interest group to stonewall for extra concessions. The GoB's
intent to start taxing retirees' pensions is the most obvious
likely target. Raising the survivor's-benefit ceiling is
another. State and municipal judiciary employees demand that
their salary sub-ceiling go back up to 90.25% of Supreme
Court Justices', not the 75% demanded by the governors, and
have declared they will strike August 5-12.


12. (SBU) More generally, the back-and-forth over pensions
has let doubt be posed as to how clear, set and stable in its
reform course the GoB really is. We believe such doubts are
misplaced. But it is a fact that Lula's team has accepted a
succession of major alterations to the design that it
initially was adamant be taken as a whole. And their
statements on pension issues - including Lula's own -- have
often contradicted or reversed themselves. Hitherto, as a
veteran interlocutor recently put it to us, most of Brazil's
body politic seemed ready to board Lula's reform train, as
long as he was driving it and taking the heat. Now, they can
feel there is a political premium, and no penalty, in
opposing his measures.


13. (U) Most immediately, this could affect Lula's tax-reform
bill. Since the pension-bill's re-working, governors have
been holding out for three compensatory alterations in the
GoB's tax-reform bill: for states to share both the CPMF and
CIDE taxes (each of which currently accrues 100% to the
Union); for extra funds to compensate states for revenue
losses stemming from the federal Kandir Law (which exempts
exports from major taxes); and for lesser earmarking
requirements on transfers from the federal treasury. If
pension and tax reform bog down in a cycle of demands and
concessions, Brazil's fiscal future and Lula's political
stature will both be hard-hit.

Stiffened GoB Stance
--------------

14. (U) The GoB is well aware of these considerations. Lula,
Berzoini and Dirceu as well as Palocci all are loudly warning
that the government has reached the limit of its concessions
vis-a-vis pension reform. In a personal meeting, Lula told
the CUT (largest labor federation) leader that the GoB would
introduce no further changes to its proposals. The
administration responded to the state judges' strike threat
with a refusal to entertain any negotiations, and Lula in a
July 24 speech blasted their demands. And in its strongest
show of renewed force, the administration on July 23 rammed
the reform bill through the Chamber's special committee
without further change by a 30-8 vote.


15. (U) The bill must now pass two Chamber floor votes, of
which the first is expected in early August and the second
probably not before September, with 60% majorities (Ref A).
It would then go to the Senate's Justice Committee for a
ruling on constitutionality and thence to the Senate floor
for a further two votes, also requiring 60% majorities, the
second of which is not generally expected before January. By
all media accounts, Lula and Planalto are determined to take
over direct management of the bills' legislative advance.


16. (SBU) Such signs of fresh resolve offer hope that Lula
and team have absorbed lessons from the latest rough-and-
tumble of the pension-reform process. Should they hold their
re-configured line, the result will probably deserve to be
deemed a success. But the prospect now looks more unsure.
HRINAK