Identifier
Created
Classification
Origin
05BRASILIA2237
2005-08-19 20:00:00
CONFIDENTIAL
Embassy Brasilia
Cable title:  

BRAZIL SCANDAL: NEW ALLEGATIONS TOUCH FINANCE

Tags:  EFIN PGOV ECON EINV 
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This record is a partial extract of the original cable. The full text of the original cable is not available.
C O N F I D E N T I A L SECTION 01 OF 02 BRASILIA 002237 

SIPDIS

STATE PASS USTR FOR LEZNY
NSC FOR CRONIN
STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/DDEVITO/DANDERSON/EOL SON
TREASURY FOR DAS LEE AND F.PARODI

E.O. 12958: DECL: 08/18/2015
TAGS: EFIN PGOV ECON EINV
SUBJECT: BRAZIL SCANDAL: NEW ALLEGATIONS TOUCH FINANCE
MINISTER PALOCCI AND THE MARKETS

REF: A. BRASILIA 2219

B. BRASILIA 2150

C. BRASILIA 2149

Classified By: Economic Counselor Bruce Williamson, Reasons 1.4
(b) and
(d).

C O N F I D E N T I A L SECTION 01 OF 02 BRASILIA 002237

SIPDIS

STATE PASS USTR FOR LEZNY
NSC FOR CRONIN
STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/DDEVITO/DANDERSON/EOL SON
TREASURY FOR DAS LEE AND F.PARODI

E.O. 12958: DECL: 08/18/2015
TAGS: EFIN PGOV ECON EINV
SUBJECT: BRAZIL SCANDAL: NEW ALLEGATIONS TOUCH FINANCE
MINISTER PALOCCI AND THE MARKETS

REF: A. BRASILIA 2219

B. BRASILIA 2150

C. BRASILIA 2149

Classified By: Economic Counselor Bruce Williamson, Reasons 1.4
(b) and
(d).


1. (C) Summary: Rogerio Buratti, a former advisor to Finance
Minister Antonio Palocci during the latter's tenure as Mayor
of the city of Ribeirao Preto (Sao Paulo State),told police
during a deposition August 19 that Palocci was involved in a
kickback scheme that sent Reals 50,000 per month to PT party
coffers during the 2001-2002 presidential campaign. By
mid-afternoon, Palocci's office had issued a categorical
denial of the allegations. Palocci's statement helped
reassure the markets, which made up lost ground after initial
sharp reactions to the news (the Real fell almost 4% and the
Sao Paulo stock exchange lost over 2% of its value when the
news initially was released). Market participants told
Econoff that Palocci still has significant credibility and
that his statement denying the allegations would be taken
seriously. One analyst argued to Econoff that, barring the
emergence of convincing evidence corroborating the
allegations, Brazil's current solid economic fundamentals
would reassert themselves as the driving forces in the
financial markets. It is clear from this episode that
Palocci's tenure remains a red-line with the markets. End
Summary.

The Allegations
--------------


2. (U) On August 18, former Palocci advisor Rogerio Buratti
was arrested August 18 on charges that he was destroying
evidence of corruption, money laundering and tax evasion.
Buratti, reportedly as part of a deal to try to obtain
leniency by prosecutors, agreed to testify about the schemes
he was involved in. It was during this deposition that
Buratti alleged that in elections from 1994 to 2002 then
mayor Palocci had been involved in a kickback scheme that

sent Reals $50,000 monthly (about US$21,000) to PT party
coffers. In an August 19 press release, federal prosecutors
stated that Buratti named PT Treasurer Delubio Soares as the
ultimate recipient of the funds. The kickbacks allegedly
were paid by a trash collection company and continued to be
paid as late as 2004, through Palocci's replacement as mayor,
Vice-mayor Gilberto Maggione, to Delubio Soares. It is as
yet unknown whether Buratti offered any compelling evidence
to back up his claims. From 1993-1994, Buratti served as
Palocci's Municipal Finance Secretary. Palocci issued a
statement the afternoon of August 19 categorically denying
the charges.

Market Reaction
--------------


3. (SBU) The Real fell sharply (from 2.38/dollar to
2.48/dollar, a 4% drop) immediately upon release of the
prosecutor's statement to the press but then recovered some
lost ground, ultimately trading between Reals 2.44 and 2.48
to the dollar as of mid-afternoon August 19. Stock
valuations exhibited a similar pattern, dropping over 2% when
the news was released and then appreciating, with the Bovespa
down 1.4% at the time of Palocci's statement. Interest rate
futures on the Sao Paulo futures exchange reflected
expectations of higher long term interest rates. Nilson
Teixeira, chief economist at CSFB, told Econoff that
Palocci's statement had helped reassure the markets.


4. (C) BankBoston investment manager Odair Abate, speaking
prior to Palocci's denial of the allegations, said the
accusations had caught the markets off guard since there had
not been any hint during the several months of
scandal-watching that Palocci might be implicated. Arguing
that Buratti was "not the most reputable" character, JP
Morgan President Charles Wortman told EconOff that Palocci
still had credibility in the markets and that he would have
the chance to defend himself. The markets were still working
through their initial reaction to the news, and financial
markets, Wortman pointed out, tend to over-correct. Wortman
also noted that those players that reacted quickly and
negatively to the news had been primarily local investors;
foreign investors had not moved. Speaking to Econoff after
Palocci's statement (and after the sharp market adjustment
had halted),CSFB's Nilson Teixeira commented that there had
been a market over-reaction. Like Wortman, Teixeira
downplayed Buratti's credibility.

What Now?
--------------


6. (C) All three noted that the market uncertainty could well
spill over into next week should additional allegations or
evidence emerge in the weekend news magazines. Abate worried
that Palocci's departure, should it occur, would stretch
beyond the breaking point the already thin credibility of
Lula's denial of knowledge of irregular campaign financing.
Assessing the probabilities of different scenarios, Abate
said he now believed that it was just as likely that Lula
would be forced out as it was that he would serve out the
remainder of his term. Charles Wortman of JP Morgan and
Nilson Teixeira of CSFB were less pessimistic, although
Wortman agreed that markets "would take Palocci's departure
hard." Wortman nevertheless believed Vice-Minister Murilo
Portugal would be a credible replacement for Palocci.
Teixeira predicted that, absent new and plausible evidence
contradicting Palocci's denial of involvement, he would
expect Brazil's solid fundamentals to reassert themselves
with the markets in the days to come.

Comment
--------------


7. (C) Many prosecutors and members of Congress have been
using the political scandal to grandstand, but the
prosecutors in the Buratti case appear to have gone overboard
-- taking aim at a big target with (as yet) very little
ammunition. Buratti, moreover, has some incentive to stretch
the truth, if not lie outright, to strengthen his hand as he
negotiates for leniency with prosecutors on
evidence-tampering charges. While Buratti's credibility has
yet to be established, the market's willingness to take
Palocci's statement at face value speaks volumes about their
faith in the Finance Minister. It also is clear from the
markets' initial reaction to the allegations that the scandal
has at last bumped up against one of their red lines:
Palocci's tenure. His (theoretical) departure, in addition
to immediate effects on the financial markets, may force the
Central Bank to reconsider beginning a widely-expected cycle
of interest rate cuts in the benchmark overnight interest
rate (SELIC) from the current 19.75%, to try to persuade
short-term foreign capital to remain in Brazil. All of which
would augur ill for economic growth in the near term.

DANILOVICH