ECONOMIC GROWTH RETURNS; PROBLEMS REMAIN

UNCLAS SECTION 01 OF 03 BRASILIA 001512 SIPDIS STATE FOR EB/IFD/OMA - O'REILLY NSC FOR DEMPSEY, CRUZ TREASURY FOR OASIA - DAS LEE AND SSEGAL STATE PLS PASS TO FED BOARD OF GOVERNORS FOR ROBATAILLE USDA FOR U/S PENN, FAS/FAA/TERPSTRA USDOC FOR 3134/USFCS/OIO/EOLSON/DDEVITO USDOC FOR 4332/ITA/MAC/WH/OLAC/DMCDOUGALL/ADRISCOLL USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSON/WBASTIAN SOUTHCOM FOR POLAD SENSITIVE E.O. 12958: N/A TAGS: ECON EFIN PGOV PREL EINV BR SUBJECT: ECONOMIC GROWTH RETURNS; PROBLEMS REMAIN REFS: A) Brasilia 463 B) Brasilia 1275 This cable is Sensitive But Unclassified, please protect accordingly. ¶1. (SBU) Summary: Latest official figures show the Brazilian economy grew a solid 1.6% in the first quarter of 2004, the second consecutive quarter of growth at an annual rate of over 6%. This still-preliminary growth data has been recently reinforced by, among other positive data points, news that industrial production in the first four months of 2004 climbed 6.1% above the first four months of ¶2003. Pundits have responded with alacrity to these hints of the real economy's recovery from Brazil's 2002/2003 financial storm, with a cover story in newsweekly `Veja' proclaiming Finance Minister Palocci now Lula's most popular minister and the man who "wins them all." Ideally, this favorable turn of fortunes should give the GoB much-needed political room to pursue its broader economic-reform agenda. The June 17 Senate defeat of Lula's minimum-wage bill, however, illustrates how coalition and perhaps government infighting are keeping the GoB on the policy defensive against the background of the looming October municipal elections. The prospect of long-term sustained economic growth seems little closer. End summary. ¶2. (U) GoB end-May figures show the Brazilian economy grew 1.6% in the first quarter of 2004, as compared to the fourth quarter of 2003. The numbers are consistent with a trend of strong growth (over 6% annualized) beginning in the fourth quarter of 2003. Agriculture continued as the leading growth sector on the supply side, registering a 3.3% increase, while industry grew 1.7% and services rose by a much more measured 0.4%. On the demand side, the continued export boom and the third consecutive quarterly increase in investment combined to lead growth. Private consumption, while up 0.3%, increased far less than the 1.5% of the previous quarter. Overall growth is the strongest since 2000, but, unlike then, Brazil in 2004 is racking up record exports and a current-account surplus. Brazilian GDP Percent Growth - Seasonally Adjusted Annual/1 Quarterly Growth/2 2002 2003 2Q03 3Q03 4Q03 1Q04 Total GDP 1.9 -0.2 -0.9 0.5 1.5 1.6 Supply Side - Agriculture 5.5 5.0 1.0 -4.6 5.6 3.3 - Industry 2.6 -1.0 -3.7 3.0 1.8 1.7 - Services 1.6 -0.1 -0.1 0.2 0.8 0.4 Demand Side - Consumption (Private) -0.4 -3.3 -1.2 0.5 1.5 0.3 - Govt. 1.4 0.6 0.3 0.0 0.2 0.8 - Investment -4.2 -6.6 -7.1 3.2 4.0 2.3 - Exports 7.9 14.2 6.2 0.8 5.7 5.6 - Imports -12.3 -1.9 -1.9 0.7 8.2 4.0 /1 Percent Change on Previous Year /2 Percent Change on Previous Quarter Source: Statistics and Geographic Institute (IBGE) ¶3. (U) A host of other recent data points seem to underline the trend of economic recovery. April retail sales were up 9.9% over April 2003. Industrial production was up 6.1% in the first four months of 2004 compared to the same period of 2003. Complete industrial production data for May is not yet available, but production of paper packaging materials, a barometer for broader industrial activity, was up 15.7% in May 2004 over May 2003. Vehicle production rose 7.6% in the same period. A Getulio Vargas Foundation (FGV) survey of manufacturing enterprises found capacity utilization in several sectors (textiles, detergents, paper, rubber, metals) at 90% or greater; an increasing number of business reported investment plans to increase capacity. Consistent with that survey, the value of financing requests with BNDES, the national development bank, almost tripled in Jan-May 2004 compared to Jan-May ¶2003. ¶4. (U) The dark linings behind this silver cloud are the weak growth of private consumption in the first quarter, plus the slow rate of growth of investment. Exacerbating these factors, the Central Bank's monetary policy committee voted June 16 to keep interest rates unchanged at 16%, in the wake of recent inflation data and increasing inflationary expectations in the market. There is growing belief that interest rates are unlikely to be cut further in the near future. Also, some doubts have been raised about the accuracy of the quarterly growth statistics, as they are based on a new industrial production index that some commentators allege was not fully calibrated before being pressed into use. ¶5. (U) The latest growth data nevertheless has given the GOB some welcome relief from the almost constant criticism of the recent past. In particular, Palocci's apparent trip from the public-opinion doghouse to the cover of leading national weekly news magazine Veja, under the headline "Palocci Wins Them All," has been striking. Suddenly, PT leader Genoino is declaring that Palocci will be used as a prime asset on the campaign trail to stump for PT party candidates in October's municipal elections. Demands for a major overhaul of economic policy, which were becoming ever more widespread within Lula's own coalition base, have for now faded. ¶6. (SBU) Ideally, these apparent buds of economic recovery should create a positive atmosphere for the Lula administration to work with the Congress on its broader structural and microeconomic reform agenda -- a necessity for sustained and strengthened growth. But in real life, the GoB remains as much as ever on the policy defensive, hobbled by persistent lack of party discipline, both within and without the PT, and by the ramshackle nature of Lula's political coalition and the GoB's scandal-diminished political stature (ref B). Most recently, on June 17 Lula's bill to increase the minimum wage to no more than Reals 260 was voted down in the Senate, despite the administration's having pulled out all the stops to gain passage (septel). And elsewhere on the fiscal front: the Supreme Court may soon rule against the constitutionality of taxing pensioners, a crucial piece of last year's public-sector pension reform. COMMENT -------------- ¶7. (SBU) With the exception of export growth, there is no clear sign yet that the recovery of the last two quarters is much more than a still modest, natural bounce-back after the extreme recessionary fallout from the 2002 financial crisis. Without its continued export and agricultural success, Brazil's overall economy would still be struggling by any standard. Spreading and sustaining growth in the longer term depends on microeconomic and structural reform measures to increase efficiency and bring investment. The realities of coalition politics in this municipal election year, however, look set to delay most of this agenda. Many independent analysts look for growth to attenuate as the cyclical recovery plays out. HRINAK