BRAZIL: SECOND QUARTER GDP GROWTH DISAPPOINTS

UNCLAS SECTION 01 OF 02 BRASILIA 002099

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E.O. 12958: N/A
TAGS: ECON ETRD PGOV PREL EFIN EINV BR
SUBJECT: BRAZIL: SECOND QUARTER GDP GROWTH DISAPPOINTS

REF: A) BRASILIA 1630 B) BRASILIA 1151

This cable is sensitive but unclassified, please protect
accordingly.


1. (SBU) Summary: Brazil's economy expanded by a scant 0.5 percent
in the second quarter of 2006, a result below most analysts'
expectations, due primarily to poor results in industrial production
and investment. According to Central Bank survey data, the market
now expects 2006 GDP growth barely to exceed 3%. As one analyst
wryly observed of the news, "it's galling, but the Central Bank
seems to be correct" in its assessment of Brazil's potential
medium-term growth rate (i.e 3% to 3.5%). The Central Bank itself,
however, so far is maintaining a forecast of growth close to 4%, and
argues that the poor second quarter result primarily was due to
one-off factors. Up to now, the ongoing presidential campaign has
focused on corruption scandals and ethics, however, not on the
pro-growth reform agenda that whoever wins the October 29 run-off
will need to pursue. End Summary.


2. (U) According to official GOB data (see chart below),Brazil's
economy posted worse-than-expected growth in the second quarter.
GDP was up 0.5% over the previous quarter and 1.2% over the second
quarter of 2005. On the supply side, industrial production, which
contracted 0.3% from the quarter of 2006, was to blame for the poor
showing. Examined from the demand side, investment was down 2.2% on
the quarter, and the contribution of exports to GDP growth also was
down, by 5.1% from the first quarter. Given the second quarter
results, the markets have adjusted downward from 3.5% to 3.1% their
annual GDP growth predictions over the course of the last three
weeks, according to weekly Central Bank survey data.



Brazilian GDP
Percent Growth - Seasonally Adjusted


Annual/1 Quarterly Growth/2
2004 2005 3Q05 4Q05 1Q05 2Q06

Total GDP 4.9 2.3 -1.2 1.2 1.3 0.5

Supply Side
- Agriculture 5.3 0.8 -2.6 1.0 1.1 0.8
- Industry 6.2 2.5 -0.8 1.3 1.2 -0.3
- Services 3.3 2.0 0.2 0.7 0.6 0.6

Demand Side
- Consumption
(Private) 4.1 3.1 0.9 1.3 0.6 1.2
- Govt. 0.1 1.6 -0.4 0.2 1.2 0.8
- Investment 10.9 1.6 -0.9 1.7 3.7 -2.2
- Exports 18.0 11.6 0.9 0.5 3.4 -5.1
- Imports 14.3 9.5 1.9 -0.5 10.4 -0.1

/1 Percent Change on Previous Year
/2 Percent Change on Previous Quarter, Preliminary
Source: Statistical and Geographic Institute (IBGE)


3. (SBU) Alexandre Pundek, an advisor to the Central Bank (BCB)
Board of Directors, told Econoff August 30 that the BCB believes
that the negative second quarter industrial production result was
influenced principally by one-off factors, and should not
necessarily be seen as a new trend. Principal among these were
maintenance being performed on one of the blast furnaces at a CSN
steel plant and maintenance to seven Petrobras offshore oil
production platforms, he said. The overall scenario for the year

BRASILIA 00002099 002 OF 002


was still good, Pundek argued, and the Central Bank had not revised
its GDP growth prediction of about 4%. Consumer price inflation (as
measured by the IPCA index),he noted, was running at less than 3%
over the last twelve months and would come in at less than 4% for
the year. Credit was doing well, sparking continued strong growth
in consumption, Pundek affirmed. Meanwhile, investment would grow
between 5% and 6%, enough for the overall economy to post growth
between 3.5% and 4%, according to Pundek.


4. (SBU) UN Economist Carlos Mussi, in a conversation prior to the
release of the second quarter data, anticipated that these would
show a GDP growth deceleration. There were many positive signs,
however, which augured well for the rest of the year. Credit growth
was still healthy, Mussi pointed out, a factor which was supporting
consumption. The combination of growing wages and falling inflation
suggested that productivity gains were being passed along to
workers, Mussi noted. Mussi noted wryly that, regardless of how
acrimonious the debate over the level of real interest rates had
been and their effect on investment and growth sometimes became, the
experience of the last several years suggests that the Central
Bank's modeling of maximum potential growth rates, i.e. somewhere
between 3% and 3.5%, is correct. Until the investment rate
increased, he concluded, there was little hope of sustaining higher
growth rates.


5. (SBU) Finance Ministry Economic Policy Secretary Sergio Gomes de
Almeida acknowledged to visiting Treasury officers Bill Block and
Jasper Hoek on September 27 that growth for the year likely would be
lower than the GoB had hoped. While not proffering a prediction of
his own, Gomes de Almeida nevertheless argued that the pessimists
were well off the mark in predicting growth of only 3 percent.
Gomes de Almeida recognized that investment levels were a problem,
and stated the GoB hopes to increase investment by four percentage
points of GDP. He hoped that increased investment in housing
construction would help reach that goal.


6. (SBU) Comment: Debate over where in the 3% to 4% range the
Brazilian economy will wind up this year and about the need for
greater investment is interesting, but beside the point. To achieve
sustainable growth at the higher rates necessary to dent entrenched
poverty, Brazil needs to enact a series of microeconomic reforms
(i.e. expenditure reform, tax reform, social security reform and
labor reform),necessary to enhance productivity growth. Up to now,
the ongoing presidential campaign has focused on corruption scandals
and ethics, however, not on the reform agenda that whoever wins the
October 29 run-off will need to pursue.

SOBEL