MEIRELLES: BRAZIL'S ECONOMY HAS FUNDAMENTALLY

UNCLAS SECTION 01 OF 02 BRASILIA 000928 SIPDIS SENSITIVE NSC FOR DEMPSEY TREASURY FOR OASIA/SEGAL STATE FOR EB/IFD/OMA - O'REILLY USDOC FOR 3134/USFCS/OIL/WH USDOC FOR 4332/ITA/MAC/WH/OLAC E.O. 12958: N/A TAGS: ECON EFIN PGOV PREL BR SUBJECT: MEIRELLES: BRAZIL'S ECONOMY HAS FUNDAMENTALLY CHANGED REFS: A) Rio de Janeiro 363 B) Brasilia 786 C) Brasilia 657 D) Brasilia 613 ¶1. (SBU) Summary. Central Bank President Meirelles, target of sustained political attacks over Brazil's continued high interest rates and unemployment plus popular perceptions that the economy is worsening, has unrepentantly asserted that Brazil's economy not only is growing, but has undergone a fundamental positive shift. For the first time in its history, he told the press on April 5, Brazil's economy, exports and trade surplus are growing at the same time; moreover, the Central Bank is now even predicting a slight current-account surplus this year, second in a row. Meirelles' thesis is that Brazil's maintenance of trade and current account surpluses even with the current double-digit growth in imports results not just from weak growth and the fall in real income but from an evolution in Brazil's economic structure. His implication is that Brazil has already largely freed itself from its historic external financial vulnerability, i.e., the old trade-off between domestic growth and external deficits, which has long contributed to the stop-and-go nature of growth here. End summary. ¶2. (U) As Meirelles departed after speaking to an April 5 Rio de Janeiro Commercial Association lunch (ref A),he commented to the press that economic analysts of Brazil were missing a major point: not only has growth returned, but Brazil is for the first time simultaneously experiencing GDP growth, export growth and trade-surplus growth. Traditionally in Brazil, as growth boosted incomes, demand for goods, sucked in imports and diverted local products from export to domestic markets. Standard result: burgeoning trade and especially current-account deficits. This tension between growth and external deficits has been at the heart of Brazil's stop-and-go growth cycles for thirty years. Its lessening since 2001 amounts to a "fundamental change," and it will take a while for everyone to perceive it, Meirelles said to the press after his speech. ¶3. (SBU) Assessing Meirelles' claim is not straightforward. Brazil's 2003 trade and current account surpluses had a lot to do with depressed import demand resulting from weak economic growth and depressed real incomes. Imports in 2002 and 2003 dropped to $47.2 billion and $48.2 billion, respectively, from $55.6 billion in 2001. Meanwhile, exports were surging, spurred by the competitive effect of devaluation and by rising commodity prices. WTO figures show Brazil's 2003 exports of $73.1 billion moved it up modestly in the rankings to become the world's 25th largest exporter. An economic advisor in the Ministry of Planning has told us that the GoB now is forecasting exports of about $85 billion this year (growth of almost 20%),and imports of about $61.5 billion (up 27.6%),for a trade balance of around $24 billion. In line with that expectation, the first quarter trade surplus, according to the latest figures, was $6.17 billion. A Central Bank director told us that, given these trade surplus results, the GoB is now predicting a small current account surplus this year, which would be Brazil's second in a row. The GoB's original forecast in late 2003 was for a USD four billion current- account deficit. ¶4. (SBU) For Meirelles to be right about the fundamental nature of this shift in Brazil's export competitiveness and orientation, the surge in exports must be accounted for by more than simple devaluation. Former chief economic advisor to the Planning Ministry Jose Carlos Miranda argues that productivity increases in Brazilian industry played a substantial role in export growth in 2002/2003. In a March 23 meeting, Miranda, now head of the Ministry's international department, told us that investments in updated plant and equipment since 2000 had significantly increased productivity growth in Brazil's industry, particularly in machine building. While it is difficult to untangle the competitive effects of devaluation of the Real over 2002-2003 from the productivity growth, Miranda argued that the continuation of double-digit export growth even after the Real's revaluation starting in late 2002 points to the existence of a structural shift, which he attributes to that productivity growth. The fact that Brazil now is exporting tractors to the U.S. and EU exemplifies these productivity increases as well as the growing sophistication of Brazilian industry, according to Miranda. ¶5. (SBU) If Meirelles is right that Brazil's economy is already recovering strongly and will register substantial growth in 2004, then the prospect of a simultaneous large trade surplus (perhaps even a current-account surplus) despite double-digit-import growth this year, would indeed seem a potential watershed. This element in Meirelles' argument is still open to dispute, however. As pointed out in Ref B, various recent data points in this context have been inconclusive or negative. Nor have we yet seen any empirical data to quantify the degree to which export results since 2001 have been gained by other than favorable world-commodity-price and foreign exchange movements. ¶6. (SBU) Perhaps the most striking aspect of Meirelles argument is the light it sheds on his own and the Central Bank's apparent beliefs and motives in persisting with the Central Bank's steady policy of holding the monetary line despite the intensified hail of political accusations that he is an extreme dogmatist out of touch with the real economic world (Refs B, C and D). But, even if Meirelles and Miranda are wrong about Brazil's economy already being in the process of a fundamental and permanent shift, exports' performance this year should at a minimum be good enough to postpone for a while worries about Brazil's external position. ¶7. (SBU) In any case, sustaining strong export growth will require that Brazil implement the sorts of microeconomic reforms that attract significant infrastructure investments, particularly to de-bottleneck the ports and transportation systems. And though Brazil's exports meanwhile continue to benefit from incremental expansions in world markets, its dogmatic negotiating stances in the FTAA and WTO Doha Round will hobble the kind of structural adjustment Meirelles claims is occurring. HRINAK