DEPUTY NATIONAL SECURITY ADVSIOR SHIRZAD'S NOV,

C O N F I D E N T I A L SECTION 01 OF 07 BRASILIA 003100

SIPDIS

NSC FOR FARYAR SHIRZAD/TOM SHANNON
STATE PASS USTR
DEPT OF TREASURY FOR FPARODI

E.O. 12958: DECL: 12/16/2014
TAGS: ECON EFIN ETRD ECIN EINV BR BL AR
SUBJECT: DEPUTY NATIONAL SECURITY ADVSIOR SHIRZAD'S NOV,
22-23 MEETINGS WITH BRAZILIAN ECONOMIC POLICYMAKERS AND
PRIVATE SECTOR CONTACTS

REF: BRASILIA 2447

Classified By: ECONOMIC COUNSELOR BRUCE WILLIAMSON, REASON 1.4(B).


1. (C) SUMMARY AND INTRODUCTION. At a November 22 dinner
for visiting Deputy National Security Advisor Faryar Shirzad
and NSC Director Del Renigar, senior executives of key
Brazilian and multinational companies questioned Brazil's
continued membership in Mercosur (in its current
configuration as a customs union),noting that Argentina, in
particular, is preventing Mercosur from entering into
meaningful trade agreements. The next day Shirzad and
Renigar traveled to Brazilia for a series of meetings with
senior GOB economic policymakers. Among the delegation's
interlocutors were Finance Minister Antonio Palocci, Central
Bank Governor Henrique Meirelles, Presidential Foreign Policy
Advisor Marco Aurelio Garcia, and Foreign Ministry Under
Secretaries Clodoaldo Hugueney (WTO and Bilateral Trade) and

SIPDIS
Luiz Filipe de Macedo Soares (South America and FTAA). The
wide-ranging discussions with the GOB touched upon a variety
of issues, including prospects for the Doha Round, views of
Brazilian business towards trade talks, regional economic
integration, the future of Mercosur, the state of play on
FTAA, and macro-economic, monetary, and tax policy. The
highlights: U/S Hugueney had specific thoughts about how to
best proceed on the Doha Round; Presidential Advisor Garcia
disclosed that the GOB did not plan to renew its IMF Standby
program upon when it expired in March 2005; Finance Minister
Palocci expressed concern about the need for an adjustment in
the USG's current account; and Central Bank Governor
Meirelles made it very clear that he and FinMin Palocci were
the ones dictating GOB orthodox macro-economic policies (and
that these policies would continue). END SUMMARY AND
INTRODUCTION.


WTO Doha Agenda
--------------


2. (C) Ambassador Clodoaldo Hugueney, Under Secretary for
Economics and Technological Affairs, provided a comprehensive
review of GoB interests and expectations for progress in the
WTO Doha Development Agenda trade talks. Hugueney was
explicit that the Doha Round is the GoB,s top trade
priority. He said the GoB prefers multilateral negotiations
because they will provide greater commercial gains than
bilateral or regional accords due to Brazil,s diversified
trade structure (in terms of products and export markets).
Hugueney noted that a recent World Bank study had reached a
similar conclusion, and registered concern that the growing
number of bilateral and regional negotiations could divert
attention from the Doha Round. Hugueney pointed out that
certain issues, such as agricultural subsidies, which are
central to agricultural liberalization -- a key GoB interest,
can only be solved at the WTO level. As a further benefit of
the multilateral talks, he noted the more abundant
opportunities for various trade-offs, which can help to
facilitate negotiations from the domestic side. (Note.
Hugueney added that he believed fewer trade-off possibilities
was largely to blame for the failure to conclude FTAA and
Mercosur-EU negotiations.)

Doha Timing
--------------


3. (C) According to GoB thinking, the Doha Round needs to
be completed by the end of 2006 -- before the mid-2007
expiration of an extended Trade Promotion Authority (TPA).
Should the negotiations drag into 2007, Hugueney contemplated
two scenarios, both undesirable from a GoB perspective. In
one scenario, negotiators facing a mid-2007 cut-off would
adopt a quick-fix, reducing the scope of the agreement.
Alternatively, he foresaw the possibility of protracted
negotiations, extending way beyond 2007 due to a hiatus
awaiting passage of new TPA legislation. Hugueney downplayed
any possible affect from Brazilian presidential elections in
2006 on a Doha timeframe, claiming a broad domestic consensus
exists in favor of the negotiations and Itamaraty,s handling
of them.

4. (C) Hugueney argued that the following elements need to
be in place by the December 2005 Hong Kong Ministerial to
make possible a 2006 end-date: agreement must be reached on
modalities for agriculture negotiations; there must be a
refinement of the scope for industrial products; revised
offers for services must be made; as well as progress on
development issues, including cotton, implementation, and
special and differential treatment. While noting that
"accidents," such as TPA initial expiration, changeover of EU
Commissioners, and CAP reform, could complicate the
discussions, he believed these objectives are feasible by the
Hong Kong meeting. While not mentioning Brazil,s own
candidate for the WTO DG job, Hugueney said he hoped the
selection process would be less contentious than last time
lest it slow down the negotiations. Certain institutional
issues, such as inadequate secretariat funding and
ineffective organization for support of the negotiations,
also need to be addressed, but he believed could be handled
in discussions parallel to the substantive negotiations.

Progress by Hong Kong
--------------


5. (C) The agriculture modality talks will hinge on market
access, according to Hugueney, who described market access
barriers as the last line of defense for many developing
countries, which do not have the resources to utilize export
and domestic support. He argued against a legalistic
approach toward defining criteria for graduation of
developing countries, which he claimed would mire the
negotiations. Instead Hugueney pressed for a more common
sense approach saying its obvious that the same rules cannot
apply to vastly different types of countries, such as
Switzerland and India. When asked by D/NSA Shirzad to
elaborate, Hugueney cited the extent of a country,s rural
poverty and subsistence farming as examples of factors that
should be considered. However, he claimed Brazil would be
willing to take on different market access commitments from
other developing countries because of its overall
competitiveness in agriculture, despite the fact that it also
still has severe problems with rural poverty.


6. (C) Hugueney said Brazil will continue to play a key
role in keeping the G-20 constructively engaged in the
process, but cautioned that a refusal by others to make
accommodations in market access rules for members which are
more defensive on agriculture would likely push them more in
line with the protectionist G-10, making an agreement much
more difficult to reach. Although diverse tariff structures
and differences in offensive and defensive interests present
challenges for the G-20, Hugueney said the group will
continue to formulate proposals. He added that the G-20 is
committed to achieving agriculture modalities by Hong Kong.
(The next G-20 Ministerial is slated for February in New
Delhi.)

How to Move Forward
--------------


7. (C) Hugueney opined that the Five Interested Parties
(FIP) group worked well when convened at minister level, but
was frustrating at the high-official level. He said the GoB
recognizes that some type of small group process is essential
for making deals, but did not think it useful to reconvene
the FIPs until perhaps March or April next year. In the
intervening months, Hugueney suggested ramped-up
consultations, perhaps even a mini-ministerial, to assuage
the concern of some countries over exclusion from the FIP
process and to better identify issues. An FIP meeting in
March/April could then kick off a more intensive phase of
negotiations to produce results before the last sessions of
the Agriculture Committee and General Council in July. At
that point, it should be possible to articulate what would be
the preferred/possible outcome in Hong Kong -- if not full
modalities for agriculture, perhaps a partial package. In
the run up to Hong Kong, attention would have to be paid to
both specific issues and to the emerging package as a whole.


Receptiveness of Brazilian Industry to Trade Talks
-------------- --------------


8. (C) D/NSA Shirzad queried Hugueney regarding the
attitudes of Brazilian industry towards multilateral trade
talks and whether the GOB periodically consulted with the
country's private sector. Hugueney replied he regularly
conducted such consultations, and that one could detect three
general clusters of industry views. First, there was a bloc
of modern firms, whose managers strongly favored trade
liberalization as their competes were well positioned to take
advantage of increased opportunities in foreign markets. A
second cluster of companies, still most dependent on domestic
sales, was less enthusiastic about trade talks, though with
support and a new generation of investment would be able to
compete should highly-efficient foreign firms enter the
market. Problems arose, however, with regard to the third
cluster of firms, which if further market opening took place
would not be competitive no matter how much time they had to
prepare. Fortunately, he said, this third cluster -- which
vehemently opposed the FTAA -- has not been vocal in
opposition to the WTO Doha Round.

FTAA
--------------


9. (C) Ambassador Luiz Filipe de Macedo Soares, Under
Secretary for South America, provided a less detailed and

SIPDIS
less enthusiastic discourse on FTAA negotiations to Shirzad,
Renigar and emboffs. First, Macedo Soares emphasized the
importance of South America in President Lula,s foreign
policy, noting institutional changes within the Foreign
Ministry that reflect its commitment to follow through on
this long-standing Brazilian interest. On the negotiations
themselves, he recapped the main FTAA events leading up to
last year,s Miami Ministerial, as well as the subsequent
Trade Negotiating Committee meeting in February of this year
and smaller group discussions, which failed to reach
agreement on implementation of the Miami compromise. Macedo
Soares insisted that Mercosul,s proposal last year to change
the FTAA reflected an interest in finding a way forward for
the negotiations given the paralysis that existed within the
negotiating groups, a paralysis resulting not from Brazilian
interests, but from differing positions between all the FTAA
countries.


10. (C) Although the FTAA negotiations are currently
"dormant," Macedo Soares opined that all parties want to go
on with the negotiations once establishment of the framework
is complete. On timing, he said he "supposed" the
negotiations will be complete next year, after first saying
the GoB was "open to," he then changed to "would like to"
host a ministerial in the first semester of next year. When
asked by D/NSA Shirzad about implications should the FTAA
remain stalled, Macedo Soares noted that the U.S. has active
bilateral negotiations within the region and that it is in
the interests of all that there be an agreement covering
Mercosul as well. He claimed there should be no doubt
Mercosur favors free-trade and said characterization of
Mercosul as "systemically less ambitious" is unfair, even if
there are instances when economic interests and asymmetries
warrant less ambition.

Mercosur-EU
--------------


11. (C) According to Macedo Soares, the GoB has lost no
enthusiasm for reaching a trade deal with the EU, and has
interpreted agreement by the new EU Commission to hold a
meeting shortly after its investiture as signaling a similar
level of commitment from that bloc. (Note: The December 2
meeting in Rio is reportedly only to allow technical staff to
set up a work plan; a Ministerial is planned for next March.
End note.) Macedo Soares confirmed GoB aspirations for
Mercosur to transform into a EU-type common market. He noted
Brazilian interests in strengthening the political dimension
of the bloc, including development of a Mercosur Parliament,
and the on-going work to update the 1994 Ouro Preto protocol
to reflect institutional changes over the last ten years. He
downplayed the bloc,s internal difficulties assuring us that
the EU has had its share of problems without facing collapse,
and rejected recent calls from some quarters for Brazil to
negotiate trade agreements independent from its Mercosur
partners, claiming it is precisely negotiation as a bloc that
prompted EU interest in a trade deal. (Note. Roberto
Gianetti da Fonseca, new head of the Sao Paulo Federation of
Industries, Foreign Trade Department, recently proposed that
Mercosul devolve into a free-trade area allowing its members
to negotiate separate trade agreements.)

State of Play in South America
--------------


12. (C) "Very bad" was Macedo Soares, stark assessment of
the state of affairs in South America. This is one reason,
he noted, for the current push toward regional integration --
to establish a "system" of countries that can act as a
support structure and to foster greater cooperation. (Note.
Unclear if he was referring to the South American Community
of Nations initiative to be signed in Cuzco, Peru on December

9. End note.) He pointed out the substantial physical
barriers to movement between the countries of South America
and identified transportation infrastructure projects as a
priority for the region. He also noted that politically,
countries of the region are becoming much more open to
cooperation, placing aside issues of sovereignty in accepting
assistance from neighboring countries. A case in point was
the solicitation by a number of countries (Costa Rica,
Nicaragua, Ecuador) for Brazilian support during the recent
Rio Group meeting. The GoB is also trying to strengthen
President Mesa of Bolivia by providing deliverables, such as
forgiveness of the Bolivian debt, but Macedo Soares described
his situation as precarious.

Central Bank Governor Meirelles and FinMin Palocci
-------------- --------------


13. (SBU) D/NSA Shirzad also met (separately) with Central
Bank Governor Henrique Meirelles and Finance Minister Antonio
Palocci. Meirelles stated that Brazil is living its best
economic moment in his lifetime. GDP growth rates over the
last three quarters had exceeded six percent, he said, and
the economy was continuing to grow strongly, albeit at a
decreasing rate. While in the past Brazil had experienced
brief episodes of growth (average growth over the last
decade, for example, was only 1.8%),the current expansion,
he argued, was on a much more sustainable footing than past
recoveries, primarily because of the strongly positive
external accounts. The trade surplus, he declared, driven by
booming and well-diversified exports, had led to a strong
current account surplus. Debt levels were falling, as were
risk indicators such as exports as a percentage of GDP. The
trade surplus was feeding the foreign exchange market at the
rate of $150 million/day, he observed, and the dollar was
weakening against the real. The recovery was also capital
goods and consumer-durables led, which suggested increasing
investment.


14. (SBU) According to Meirelles, despite the current
elevated growth numbers, potential GDP growth was only about
3.0 to 3.5%. When inflation began to re-emerge, he continued,
the Central Bank tightened monetary policy to try to bring
growth towards that level. Meirelles felt that an
inflationary bias in the economy still remained from the
period of hyperinflation, when industrialists played the game
of adjusting their prices faster than wages could adjust. He
called such price increases short-sighted, as the erosion in
workers' purchasing power had contributed to subsequent
recessions. It would take continued growth in investment
levels to expand the economy's potential growth capacity, he
concluded.


15. (SBU) Meirelles felt that the GOB's microeconomic
agenda (i.e, bankruptcy reform, judicial reform, creation of
a mortgage market) would begin to improve the business
environment. Central Bank independence would help, he
added, although he was uncertain the proposed legislation to
implement this would be approved next year. Moreover, he
suggested that the Administration's focus on Public-Private
Partnerships (PPPs) as tools to attract necessary
infrastructure investment was overblown, arguing instead that
straightforward concessions made more sense. He was cautious
about how quickly these measures would have an effect,
venturing that "Brazil won't hit sustained 6% growth right
away." But, even sustaining 3.5% growth would be double the
rate of the last decade, he continued, and sustained growth
would, in turn, encourage investment.


16. (SBU) Having just returned from the Berlin finance G-20
meeting, Meirelles was not concerned in the short-run about
the weakening dollar. There is no reason to panic, he said,
although there clearly needed to be an adjustment of the U.S.
current account numbers in the longer term. Finance Minister
Palocci, by contrast, appeared concerned about the manner in
which this adjustment took place. He stated that an
adjustment must be made, and could be implemented either by
the market or by monetary authorities. Palocci said he hoped
the U.S. authorities would do so, in order to ensure it was a
gradual process. It is the uncertainty about the manner of
adjustment, less so than the adjustment itself, that could
hurt open, emerging markets such as Brazil, Palocci opined.


17. (SBU) Palocci assured Shirzad that, while occasionally
the subject of public controversy, there would be no
backtracking on the GoB's orthodox macroeconomic policies.
The task for the future, he stated, was to consolidate the
microeconomic reforms, e.g., improving the business
environment, strengthening credit markets and extending their
reach, and improving the functioning of securities markets.
The tax burden was high, Palocci admitted, noting the GOB was
targetting tax reductions to stimulate long terms savings and
reduce the tax burden on items that are staples for the poor.
He added that tax reductions also would be accorded to small
businesses through a bill, recently sent to Congress, that
would reduce the number and rates of taxes on small
businesses and simplify business registration in an effort to
reduce informality in the economy.


18. (SBU) Turning to regional issues, Palocci admitted that
he had some concerns about Argentina and Bolivia. If
Argentina did not reach a reasonable agreement with its
creditors and its current growth stalled, it could cause some
pain in the region, he said. He did not foresee much direct
effect from an Argentine crisis on the markets' pricing of
Brazil risk, but worried about the liquidity effects as
investors reconsidered their overall appetite for emerging
market risk. Bolivia, is "always tense," Palocci ventured,
adding that the GOB has had an ongoing dialogue with both
President Mesa and the opposition. In addition to urging
moderation, he observed, Brazil hopes to develop useful
relationships that would allow it to play a mediating role,
if necessary.

Slightly Different View from Presidential Advisor Garcia
-------------- --------------


19. (C) In addition, D/NSA Shirzad met with GOB
Presidential Foreign Policy Advisor Marco Aurelio Garcia, a
long-time Workers Party stalwart with close ties to Lula.
Garcia spent much of the meeting discussing the economic
chaos Lula inherited upon assuming office and the steps the
president has taken to right the economy. Although Garcia
cited much the same glowing economic numbers as Central Bank
Chief Meirelles and FinMin Palocci, his presentation differed
in several important respects.

-- While Meirelles merely referred to the possibility of the
GOB declining to renew its Standby Agreement with the IMF,
Garcia stated that a definitive decision had been taken to
forego an IMF program when the current agreement expired in
March 2005,

-- Unlike Meirelles - who thought that the maximum the
Brazilian economy could expand without reigniting inflation
was 3 to 3.5 percent - Garcia opined that sustainable growth
of 4.5 to 4.7 percent was possible. (Garcia noted that
between 1930 and 1980, the country grew at an average growth
rate of 6.7 percent.)

-- In contrast to Meirelles and Palocci, who made clear that
the GOB would maintain high interest rates as long as needed
to staunch inflation, Garcia thought it essntial to lower
interest rates as soon as possible to simulate investment.
BNDES and the state-run commercial banks (Banco do Brasil,
Caixa Economic Federal, and the GOB's Savings and Loan Bank)
could shoulder the burden of financing much-needed public
infrastructure investment, but lower rates overall were
needed to generate a public/private investment boom.

-- Garcia stated that the GOB would likely soon begin
replenishing its international foreign exchange reserves
given that the real had appreciated against the falling
dollar. With the lapse of the IMF Stand-by Program next
year, he said, the GOB would have to do without immediate
access to USD 25 million in potential IMF support -- though
the GOB's estimated USD 9 billion current account surplus
made the problem of foreign exchange supply much less acute.

-- Garcia also proved fairly sanguine regarding the ability
of the GOB to straighten out in short order its social safety
net programs, He thought that the Bolsa Familia program in
which 4.5 million families participated in 2003, could be
expanded to 6 families by the end of 2004 and 40 million by
the end of 2006. Similarly, he foresaw expansion in the
coming months of the GOB's agricultural credit programs for
small farmers -- which help sustain the rural poor.


20. (C) In reponse to a question from D/NSA Shirzad about
GOB plans regarding tax policy, Garcia noted that under the
previous Cardoso Administration taxes as a percentage of GDP
had increased from 28 percent to 38 percent during a span of
8 years. The Lula Administration, he said, planned to
implement a series of targetted VAT tax cuts aimed at
stimulating key sectors -- such as investment and basic
consumer goods. Simultaneously, the GOB planned to simplify
its VAT tax regime by imposing a uniform VAT tax rate across
all its states (i.e., end the current "guerra fiscal,"
whereby states compete in offering ever-sweeter tax breaks
for industry relocation). As for the income tax, Garcia
declared, plans were in the works to make the system more
progressive by increasing the number of tax brackets. (He
did not specify whether the GOB would make this move
revenue-neutral.)


21. (C) Comment. While Garcia's slightly different take on
the sustainable growth rate of the economy and the need for
lower interest rates reflects the traditional PT emphasis on
national development, Palocci and Meirelles remain firmly in
charge of macro-economic policy. Or as Meirelles put in at
one point, "as long as Palocci and I are around we are going
to make sure that economic policy is based upon concrete
data, not wishful thinking. However, if you see us leaving
the government, then I would start to worry."

Dinner with Sao Paulo Business Leaders
--------------


22. (SBU) Sao Paulo Consul General hosted a dinner for D/NSA
Shirzad and Director Renigar on the evening of November 22.
Dinner guests -- senior executives representing Brazilian and
multinational companies in the banking, agro-industry, steel
automobile, and packaging sectors -- noted that they believed
Brazil and other member countries would be better served by
converting Mercosur in a free trade area (as opposed to its
current form of a customs union). This, they observed, would
leave individual membes free to negotiate other deals at
their own pace, without having more protectionist members
hold everyone else back. One participant observed tha
Argentine industry is now merely a shell of what it once was,
commenting that his factory operating there is making a lot
of money because all his Argentine competition went broke.
The same participant criticized the GOB's ill-prepared
negotiating procedures, pointing out that the GOB went into
the recently-failed Mercosur/EU trade talks without
sufficiently consulting and defining positions/strategies,
and subsequently had to regroup after it was too late.
Regarding attempts to resolve bilateral Brazilian/Argentine
trade disputes, this participant was equally critical of the
GOB's lack of consultation and preparation. As a business
member of the Brazilian team negotiating with Argentine
counterparts, he stated that the Foreign Ministry gave the
Brazilian private sector ten points on how to reach an
agreement that were totally unrealistic, yet the MFA did not
want to hear any disagreement. He caustically remarked that
if he ran a business the same way the GOB ran trade
negotiations, he would be broke within a week.


23. (U) This cable was cleared by D/NSA Shirzad prior to
transmission.