BRAZIL: ECONOMY HELPING LULA'S REELECTION BID

UNCLAS SECTION 01 OF 02 BRASILIA 001630 SIPDIS SENSITIVE SIPDIS NSC FOR FEARS TREASURY FOR OASIA - DAS LEE, D.DOUGLASS 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/SHUPKA STATE PASS USAID FOR LAC E.O. 12958: N/A TAGS: ECON PGOV PREL EFIN EINV BR SUBJECT: BRAZIL: ECONOMY HELPING LULA'S REELECTION BID REF: A) Brasilia 1151 B) Brasilia 902 C) Brasilia 790 D) Brasilia 608 E) Sao Paulo 643 This cable is sensitive but unclassified, please protect accordingly. ¶1. (SBU) Summary: Economic factors are boosting President Lula's chances of winning reelection in October 2006. Solid expected GDP growth of about 4% this year combined with higher salaries, lower unemployment and inflation under control, mean that the economic "feel-good" factor going into the elections favors Lula. Lula also has bolstered his position through increases in the minimum wage (which also feed through to pension benefits for the poorest) and spending on GOB social programs. These have had their biggest impacts on the pocketbooks of social strata that identify strongly with Lula. While the race is by no means over, opposition Social Democrat (PSDB) candidate Alckmin faces a tough slog to overcome these advantages. The potential conflict between Lula's increased spending (refs A and C) and the need for continued fiscal restraint will remain to be dealt with regardless of who wins. End Summary. Credit, Employment, Wages and Consumption All Growing -------------- -------------- ¶2. (SBU) A confluence of economic events, some influenced by the Lula Administration and others fortuitous, appear to be enhancing Lula's reelection bid. Among the points of good fortune is the favorable timing of the economy's business cycle. Having vanquished stubborn inflationary pressures last year, the Central Bank has reduced interest rates at each of its monetary policy meetings since September 2005, bringing the overnight benchmark rate (SELIC) down from 19.75% to 14.75%, the lowest nominal rate in a decade. With Central Bank survey data showing inflation expectations for the next twelve months running at about 4.4% -- combined with a strong balance of payments position -- there remains room for the Central Bank to continue reducing rates. This is having a clear effect on consumer lending. Overall credit over the twelve months through June 2006 has grown 22.7%, but credit to individuals grew more quickly, by 29.7%. Within the latter category, personal loans were up 31.8% and loans for vehicle purchases were up 34.2%. The average interest rate on such loans is down 5.5 percentage points over the same time period. The only cloud on the credit horizon is that default rates on personal loans also are up. ¶3. (U) Employment and wages have proven to be bright spots for Lula. The Brazilian economy has created over a quarter of a million new jobs in the first five months of 2006. The average official unemployment rate in that period was 10.1%, down from 10.6% at end-2005. Just as crucially, average wages were up 7.7% from May 2005 to May 2006 while total wages paid climbed 8.6% over the same period. This combination of higher wages, lower interest rates and credit growth has helped boost consumer spending. Retail sales in the first five months of 2006 were up 6% over the same period of ¶2005. Growth in the sales of furniture and household appliances/electronics was particularly strong. Taken together, the above factors have contributed strongly to the improved expectations for GDP growth this year, which should border on 4%, up from a lackadaisical performance of 2.3% in 2005. Increased Minimum Wage, Pensions and Cash Transfers -------------- -------------- ¶4. (SBU) While some of the positive economic trends have been fortuitous, Lula is helping himself with some financial engineering as well. As noted in ref A, Lula has increased the minimum wage by BRASILIA 00001630 002 OF 002 13% in real terms since 2004. This also increased the minimum social security pension, which is constitutionally linked to the minimum wage. The social security system, which is also used as a wealth transfer mechanism, effectively has increased the real incomes of poor pensioners. Separately, Lula has been working to expand the reach of his flagship conditional cash transfer program, Bolsa Familia. Raul Velloso, a fiscal expert with ties to the opposition PSDB party, estimated to Econoff that through these three prongs (minimum wage, minimum pension and Bolsa Familia) Lula had been able to increase the real incomes of about 21 million families, or about 60 million people. This socio-economic group, he added, identifies strongly with Lula and his compelling "rags-to-President" Horatio Alger story. ¶5. (SBU) Ref E discusses in detail the increased spending power of the lower-middle/working class and their increased role in the Brazilian economy. In a related point, some analysts argue that the growth in personal loans and credit, often extended by retailers for purchases such as appliances, has benefited working class borrowers in particular. With increased access to credit these working class and lower-income consumers have begun to spend more on items such as electronics. While the lines between the upper middle class and lower middle class/working class are devilish to define, many political analysts and poll-watchers have pointed to these voters as the key election battleground which Alckmin must win in order to be elected. May Emerging Market Financial Turbulence Barely a Blip -------------- -------------- ¶6. (SBU) The Lula Administration's pursuit of responsible macroeconomic policies helped Brazil dodge a bullet in May and early June 2006, when emerging markets were hit by the most serious bout of financial market turbulence since mid-2003. Aided by successive strong current account surpluses and strong capital inflows, the GoB has used the time since 2003 to pay down external debt (ref B), reduce to zero its net exposure to foreign-exchange linked domestic debt, increase international reserves and further reinforce the credibility of its institutional framework. Brazil's solid economic fundamentals meant that the financial market turbulence left the real economy largely unruffled and kept the economy from becoming a negative campaign issue for Lula. ¶7. (SBU) Comment: In contrast to the constant attrition Lula has faced with corruption scandal after corruption scandal wearing down his image, Lula has helped himself on the economic front. His embrace of responsible macroeconomic policies has given him his biggest advantage, a sound economy heading into the elections. His spending on social programs and minimum wage increases have helped poorer Brazilians feel a bit more affluent. The potential conflict between Lula's increased spending (refs A and C) and the need for continued fiscal restraint will remain to be dealt with regardless of who wins. SOBEL