BRAZIL'S ECONOMY GROWS SOLIDLY FOR THIRD

UNCLAS SECTION 01 OF 02 BRASILIA 002221 SIPDIS SENSITIVE TREASURY FOR OASIA - DAS LEE AND FPARODI NSC FOR DEMPSEY STATE FOR EB/IFD/OMA - MOSS STATE PASS FED BOARD OF GOVERNORS FOR ROBITAILLE 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 E.O. 12958: N/A TAGS: ECON EFIN PGOV PREL EINV BR SUBJECT: BRAZIL'S ECONOMY GROWS SOLIDLY FOR THIRD CONSECUTIVE QUARTER REF: A) Brasilia 1275 B) Brasilia 1512 C) Brasilia 463 D) 03 Brasilia 3682 This cable is Sensitive But Unclassified, please protect accordingly. ¶1. (SBU) Summary: The Brazilian economy grew another 1.5% in the second quarter of 2004, marking the third consecutive quarter of growth at an annual rate of over 6%, according to official figures released August 31. While still preliminary, the growth data confirm what all other recent economic data points have been indicating: the Brazilian economy is growing healthily. The continued economic recovery removes a key GoB (and PT party) concern: Lula, Palocci and Meirelles can confidently assert vindication for their austere macroeconomic policies. The grass-roots question ahead of October's municipal elections remains: to what degree is Brazil's job and personal-income growth is shifting Brazilian voters' perceptions of their own economic well-being to Lula's political benefit? Two threats to the sustainability of the recovery are inflationary pressures and the continued lack of Congressional action on the GoB structural reforms. End Summary. ¶2. (U) GoB end-August figures show that the Brazilian economy grew 1.5% in the second quarter of 2004, as compared to the first quarter. Parsing the numbers, on the supply side Services led growth with a surprising 2.5% increase over the previous quarter. Agriculture output fell slightly (-0.3%),while industry grew 0.2%. On the demand side, Consumption and Investment each grew 1.5%, exports grew a further 2.2%. Import growth of 1.6% and government consumption growth of 0.2% round out the picture. Brazilian GDP Percent Growth - Seasonally Adjusted Annual/1 Quarterly Growth/2 2002 2003 3Q03 4Q03 1Q04 2Q04 Total GDP 1.9 -0.2 0.4 1.7 1.7 1.5 Supply Side - Agriculture 5.5 5.0 -3.0 5.0 3.3 -0.3 - Industry 2.6 -1.0 3.0 1.7 1.5 0.2 - Services 1.6 -0.1 0.1 1.1 0.5 2.5 Demand Side - Consumption (Private) -0.4 -3.3 0.7 2.0 0.8 1.5 - Govt. 1.4 0.6 0.0 0.2 0.8 0.2 - Investment -4.2 -6.6 3.1 4.5 2.2 1.5 - Exports 7.9 14.2 0.9 7.5 5.2 2.2 - Imports -12.3 -1.9 0.6 8.5 2.9 1.6 /1 Percent Change on Previous Year /2 Percent Change on Previous Quarter, Preliminary Source: Statistics and Geographic Institute (IBGE) ¶3. (U) Investment spending, which grew 1.5% quarter-on- quarter, continues to be a significant factor leading this economic recovery, as it has from the start. The solid growth in private consumption (1.5%),however, suggests that recent growth in real incomes is feeding through to consumption decisions. If sustained, that growth in consumption bodes well for the sustainability of the recovery. It also was likely a factor in the surprisingly strong showing of services (up 2.5%) in the quarter. And while the quarter-on-quarter growth rate of exports was down, this merely reflects a modest lessening from the record levels of the previous quarter. Accumulated growth in exports in the first half of 2004 was 17.8%. ¶4. (U) With the strength of current GDP recovery now beyond dispute, pessimists are proceeding to worry that its sustainability will be put at risk from emerging inflationary threats and the continued failure of the Congress to act on the microeconomic and structural reform agenda. On the former point, the recently released notes from the August Monetary Policy Committee (COPOM) meeting suggest that the Central Bank is now focused on inflationary threats, exacerbated by high capacity utilization in industry and high energy prices. While some commentators point to slow wage growth and still high unemployment as mitigating inflationary pressures, financial markets, already resigned to having the Central Bank keep the base interest rate (SELIC) at 16% for the rest of the year, are starting to talk if not bet on a SELIC interest-rate increase before 2005. ¶5. (U) Meanwhile, the GoB's microeconomic reform agenda remains stalled in the Congress, which looks unlikely to push through any major legislation ahead of the October municipal elections. Planning Minister Mantega last week publicly branded the Congress's failure to pass the Public- Private Partnership (PPP) law -- the key GoB measure to increase investment in infrastructure and measures to de- bottleneck the economy. For the first time by any top GoB official, Mantega talked of enacting the legislation through executive decree. The GoB did recently enact via decree a series of adjustments to tax rates designed to foster long- term savings. Comment -------------- ¶6. (SBU) While enactment of the PPP legislation via decree would be of dubious constitutionality and is a probable non- starter, Mantega's utterance may accurately reflect the GoB concern at loss of legislative momentum on its microeconomic reform agenda. The GoB sees the much-delayed PPP law in particular as key to increasing infrastructure investment and eliminating bottlenecks. One of the key questions going forward is whether investment levels under present conditions will lead to sufficient capacity expansion quickly enough to stave off new inflation. Such longer-term preoccupations aside, the economic news these days is good enough that the economy should at least be less of a negative for the PT and GoB in the October elections. How much so depends on how quickly and perceptibly the recovery feeds through to consumers' pocketbooks. DANILOVICH