ECONOMIC GROWTH RETURNS; PROBLEMS REMAIN

UNCLAS SECTION 01 OF 03 BRASILIA 001512

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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