SCENESETTER FOR THE VISIT OF ASSISTANT SECRETARY MCMURRAY

UNCLAS SECTION 01 OF 05 BRASILIA 002583

SIPDIS

SENSITIVE
SIPDIS

FOR ASSISTANT SECRETARY CLAUDIA MCMURRAY

E.0. 12958: N/A
TAGS: PGOV ECON SENV BR
SUBJECT: SCENESETTER FOR THE VISIT OF ASSISTANT SECRETARY MCMURRAY


1. (SBU) The United States Mission in Brazil warmly welcomes your
planned December 12-13, 2006, visit to Brasilia. Counselor for
Environment, Science, Technology and Health Patricia Norman and OES
Advisor Lawrence Sperling will greet you upon your arrival in
Brasilia December 12. You are scheduled to hold preliminary meetings
for the U.S.-Brazil Common Agenda for the Environment on December 13
and meet with Brazilian officials. In addition, we have scheduled a
Country Team meeting shortly after your arrival on Dec. 12 here at
the U.S. Embassy to brief you on the current state of affairs in
Brazil.


2. (SBU) Your visit, scheduled right after President Lula's
reelection, comes at a transition point on the political scene.
During the second semester of 2005, congressional deputies from
Lula's governing coalition were accused of accepting bribes, while
officials from the President's party (the PT) were alleged to have
engaged in influence peddling and illegal campaign fund-raising.
These revelations forced the resignation of several members of
Lula's inner circle, including his former Chief of Staff (who was
also expelled from Congress). Another scandal that was revealed in
September 2006 caused the resignations of several top Lula campaign
officials and the head of the PT.


3. (SBU) However, Lula was able to surmount all this and win
reelection with 61 percent of the vote. He is now mulling his
options with regard to which parties his PT banner should ally with
in Congress and who to include in his cabinet.

THE BILATERAL RELATIONSHIP
--------------


4. (SBU) While relations between the U.S. and Brazil are friendly,
often the USG encounters major difficulties in gaining the
cooperation of senior policymakers on issues of significant interest
to the United States. Eager to assert its own influence, the
Brazilian government shies away from cooperation with the USG -
unless it can clearly be characterized as a reciprocal exchange
among equals. Indeed, hyper-sensitivity on issues viewed as
infringing on Brazil's sovereignty can get out of hand and may be
seen as signs of political immaturity. Many Brazilians believe the
U.S. has designs on the Amazon. Our fingerprinting of visitors to
the U.S. drew reciprocal treatment for Americans here; visa and
immigration issues remain sensitive points.


5. (SBU) During recent months, our ongoing dialogue with the
Brazilians has focused on a variety of potentially useful projects
for both sides. We sought to interest the GOB in a Defense
Cooperation Accord, but the Foreign Ministry rejected the proposal
even though the Defense Ministry was supportive. Gaining agreement
on privileges and immunities to be granted U.S. servicemen engaging
in military exercises has been just as tough, as the Foreign
Ministry saw it as "a foot in the door" and linked it with Brazil's
strong opposition to Article 98 agreements. We are receptive to
renegotiation of a stalled bilateral agreement governing space
launches at the country's equatorial base at Alcantara, but the GOB
has moved glacially to re-engage, even though the agreement clearly
serves Brazilian interests. On trade issues, when unscripted,
President Lula has characterized the FTAA as "off his agenda." IPR
is another sore point, as it has become clear that the USG and the
Brazilian government have different views on the degree of
protection to be afforded to intellectual property. Only after much
lobbying have we gotten the GOB to: a) turn the corner on copyright
piracy, and b) persuaded policymakers to pursue negotiated solutions
rather than compulsory licensing of AIDS anti-retrovirals.


6. (SBU) However, not all our conversations are difficult. At the
personal level, Lula has met President Bush several times and the
two have a good rapport. On issues involving matters perceived as
technical in nature - i.e., law enforcement and science (but not
counter-terrorism) - the GOB is eager to engage. For example, from
2003 to 2004, the GOB worked quietly with us on the timing and
details of its shoot-down program to accommodate our statutory
requirements. Brazil's Ministry of Health has expressed its desire
to expand the collaboration it has with the U.S. Centers for Disease
Control and the National Institutes of Health as these agencies work
within the Brazilian medical community to bring newer treatments and
technologies. The Brazilian Ministry for the Environment has asked
the United States for technical support in several key environmental
areas that offer us an important opportunity for closer bilateral
cooperation.


7. (SBU) On development assistance issues, our dialogue is positive
- but constrained. Notwithstanding lackluster results to date, the
Brazilian government's multi-billion dollar poverty alleviation
program -Zero Hunger - receives substantial funding from the World
Bank and IDB. Given USG budget constraints and the fact that Zero
Hunger is, in essence, a cash transfer program (albeit with
conditions),USAID support has been limited. Instead of focusing on

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cash transfers to the poor, USAID has sought to target its efforts
towards promoting sustainable livelihoods - inter alia, through
working with small and medium-sized enterprises. The Embassy's
Public Affairs programs aimed at promoting young leaders take a
similar targeted approach. This difference in focus, broad cash
transfers versus targeted assistance, ends up putting the USG at the
margins of Brazil's overall anti-poverty efforts.

FOREIGN POLICY
--------------


8. (SBU) Reflecting Brazil's ambivalence towards the United States,
President Lula has run an activist foreign policy with a focus on
South America and the Third World, seeking to forge alliances with
other mid-sized powers (South Africa, India, etc.). He has traveled
extensively in pursuit of a higher international profile for Brazil.
Despite prodding from the USG and others, Lula has refused to
condemn Cuba for human rights violations and, in fact, has pushed
for Cuban membership in the Rio Group. Brazil has also advocated a
Cuba-Mercosul trade pact. The GOB has worked to increase both its
economic and political ties with Venezuela. It has agreed to upgrade
Venezuela from associate membership to full membership status in
Mercosul and enhanced integration of the two countries' energy
sectors is high on its agenda. Lula has been especially solicitous
of Chavez. Lula has praised the Venezuelan President's democratic
credentials ("if anything, Venezuela has an excess of democracy")
and declared that the Chavez government had been demonized by its
foes. However, Venezuela's apparent involvement in Bolivia's recent
decision to nationalize that country's oil and gas industry has
dulled the luster on this relationship.


9. (SBU) Given its size and natural resources, Brazil has long seen
itself as the natural leader of the region (even though that
perception is not shared by its neighbors). Brazil's reaction to
Bolivia's May 2006 nationalization of foreign petroleum
installations in that country is a case in point. Shocked that the
Bolivians viewed the Brazilian oil parastatal Petrobras as a "boss,
not a partner," government policymakers have vacillated in response
to President Morales' threats.


10. (SBU) Emblematic of Brazil's efforts to gain greater standing on
the world stage is its tenacious pursuit of a permanent UN Security
Council (UNSC) seat. In fact, many observers point out that Brazil
has "subordinated" other economic and political interests with such
countries as China and Russia in exchange for support (which has not
been forthcoming) for its UNSC aspirations. Brazil and other G4
states (India, Germany, Japan) are, despite recent setbacks,
continuing to press their campaign for a vote on a resolution on
UNSC reform. This stance is at odds with the position of many Latin
American countries, including those which Brazil believes should
follow its "natural leadership."


11. (SBU) Brazil has long seen international fora as a way to
enhance its international stature. Reflecting this, in 2005 it
launched failed national candidates for the top jobs at both the WTO
and the IDB. The failure of both, together with the unlikely
prospects for a permanent seat in the UNSC, has widely been seen in
Brazil as a "political disaster."

AGRICULTURE
--------------


12. (U) Agriculture is a major sector of the Brazilian economy, and
is key for economic growth and foreign exchange. Agriculture
accounts for 13% of GDP (and 30% when including agribusiness) and
33% of Brazilian exports. Brazil is the world's largest producer of
sugar cane, coffee, tropical fruits, frozen concentrated orange
juice (FCOJ),and has the world's largest commercial cattle herd
(50% larger than the U.S.) at 180 million head. Brazil is also an
important producer of soybeans (second to the United States),corn,
cotton, cocoa, tobacco, and forest products. The remainder of
agricultural output is in the livestock sector, mainly the
production of beef and poultry (second to the United States),pork,
milk, and seafood.

ENVIRONMENT
--------------


13. (U) As one of the world's "megadiverse" countries, environmental
issues loom large in Brazil. Of the world's known plant species,
22% exist in Brazil, and the figures for birds (17%),mammals (11%),
and fish (11%) are also significant. The Amazon basin holds 20% of
the world's fresh water. Brazil's Minister for the Environment,
Marina Silva, has secured passage of legislation protecting 20
million hectares of land during her administration and she has
indicated that Brazil would like to follow the U.S. model and
establish public parks on the protected land. Minister Silva has
also passed legislation establishing the first Brazilian forest

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service. The U.S. agencies that work with parks in the U.S. are
poised to collaborate with Brazil on these issues. Brazil and the
United States are also discussing collaboration on the
U.S.-sponsored Coalition Against Wildlife Trafficking. Amazon
deforestation rates for the period August 2004 to August 2005
reflect a 31% drop, and the GOB is predicting another 11% drop this
year. These figures are still affected, however, by the strong
expansion in Brazilian agriculture, particularly the drive for land
by the cattle and soy industries.


14. (U) Internationally, Brazil is an energetic advocate on
environmental issues and treaties including the Kyoto Protocol.
Yet, for many, the Brazilian government has not met the high and
largely exaggerated expectations of many environmentalists during
the first years of the Lula Administration. The early 2005 passage
of a Biosafety law, representing an opportunity to legalize GMO
crops, drew especially strong criticism from environmentalists. The
agricultural industry's lobbying for expansion of the transportation
network in the Amazon has raised additional concern. As in other
policy areas, the Lula Administration is more centrist on
environmental issues than much of its devoted, leftist political
base expected.

ETHANOL
--------------


15. (U) The success of Brazil's ethanol program has made it a model
for the world in terms of alternative energy. Brazil's comparative
advantage is its ability to inexpensively produce ethanol from
sugarcane, which has the highest starch content of any plant stock.
In addition to obtaining five harvests from one planting, cane hulls
(bagasse) are used to produce the thermal energy necessary to power
the conversion process. Cane also requires less processing than
ethanol produced from corn -- which is the method used in the U.S.
to manufacture ethanol. According to the World Bank, at current
prices, Brazil can make ethanol for about US$1 a gallon, compared
with the international price of about US$1.50 a gallon for gasoline.
At the pump ethanol receives favorable tax treatment from the
Brazilian government. It is exempted from the largest federal tax
on gasoline (CIDE) and is subject to lower rates on two other
federal levies (PIS and COFINS). Nevertheless, ethanol prices can
vary substantially from state to state. In contrast, gasoline
prices tend to vary less and are controlled by the government.


16. (U) Since the 1980s, Brazil has attempted, without great
success, to promote ethanol fuel exports to the United States. U.S.
tariffs and charges make Brazilian imports uncompetitive. In
addition to import tariffs of 1.9 to 2.5 percent, the U.S. imposes a
54 cents/gallon charge on ethanol imported for use as fuel. These
charges must be paid by countries not covered by FTAs or other trade
preference arrangements. Given the requirements of its fast-growing
domestic market, whether Brazil will indeed be able to produce
enough ethanol to supply international markets is an open question.
Some estimate that over the next one to two years, the maximum
percentage of Brazil's cane crop which can be devoted to ethanol
production is 54%. If so, this would mean that Brazilian ethanol
production is already running at 95 percent of capacity; and the
country's ability to expand its sugarcane acreage is limited to
perhaps 20 percent over the next 3-4 years.


PRESIDENT LULA
--------------


17. (SBU) President Luiz Inacio Lula da Silva was inaugurated in
January 2003 after a career as a Sao Paulo metalworker and labor
leader. He founded the left-of-center Workers' Party (PT) in 1980
and lost three presidential campaigns before winning in the October
2002 elections. Lula was reelected with a comfortable margin of
victory in October 2006. Elected in large part on promises of
promoting an ambitious social agenda, including a "Zero Hunger"
program, Lula's government has failed to deliver much in this area,
as managerial shortcomings and the public's top concern - crime and
public security - have not improved under this administration.


18. (SBU) As noted above, in the run-up to the October 2006
election, the Lula Administration was beset by a grave political
crisis as interlocking influence peddling/vote-buying scandals
plagued elements of Lula's PT party. Indeed, during the second half
of 2005, the crisis placed Lula on the defensive and politics were
dominated by investigations, accusations and revelations. The
President's Chief of Staff resigned his post and was later expelled
from Congress. Meanwhile, several other congressmen were the
subjects of investigations and expulsion proceedings owing to
bribery allegations. In April 2006, the President's influential
Finance Minister was forced to resign (and remains under criminal
investigation) because of unrelated abuse of power allegations. The
revelation of a new scandal shortly before the presidential election

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involving accusations against members of Lula's campaign who were
his long-time associates briefly seemed to threaten his reelection
prospects, and sent the contest into a second round. But Lula
survived the crisis and, supported by millions of poor voters who
benefit from federal social spending programs, Lula was reelected.

MACRO-ECONOMIC DEVELOPMENTS
--------------


19. (SBU) President Lula and his economic team have implemented
prudent fiscal and monetary policies and pursued necessary reforms.
Brazil's external accounts, aided by a benign international
environment, have improved substantially over the last three years.
Although GDP growth dropped to 2.3% in 2005, down from a strong
performance (4.9%) in 2004, Brazil has experienced booming exports,
healthy external accounts, inflation under control, decreasing
unemployment and reductions in the debt-to-GDP ratio. Economic
activity should pick up in 2006; the markets expect GDP growth of
about 3.0%. Buoyed by exports and investment inflows, the Real has
remained at appreciated levels, allowing the government and
businesses to pay down external debt. The government pre-paid its
IMF obligations, its last remaining rescheduled Paris Club
obligations, and in April 2006 announced it had retired the last of
its Brady bonds. This removes from the books all restructured debt
associated with Brazil's late-1980's default. Based upon the
improving external debt dynamics, Fitch IBCA upgraded its credit
rating on Brazil's sovereign debt in February 2006, to BB (two
notches below investment grade). The economy also has shown
resilience, remaining for the most part unaffected by a major
political scandal and the replacement of the finance minister.


20. (SBU) Despite this considerable progress, key challenges remain.
The public sector-debt-to-GDP ratio is on a downward trend but
remains high, at about 50%. Real interest rates are among the
highest in the world; reducing them will require both reductions in
the government's borrowing requirement and reform of the financial
sector and the judiciary. Income and land distribution remain
skewed. Investment and domestic savings are low, although growing.
The informal sector constitutes between 35 to 40 percent of the
economy, in part because the tax burden (nearly 38 percent of GDP)
is high.


21. (SBU) Sustaining high growth rates in the longer term depends on
the impact of President Lula's structural reform program and efforts
to build a more welcoming climate for investment, both domestic and
foreign. In its first year, the Lula administration passed key tax
and pension reforms to improve the government fiscal accounts.
Judicial reform and an overhaul of the bankruptcy law, which should
improve the functioning of credit markets, were passed in late 2004,
along with tax measures to create incentives for long-term savings
and investments.


22. (SBU) Public-Private Partnerships, a key effort to attract
private investment to infrastructure, also passed in 2004, although
implementation of this initiative still awaits promulgation of the
necessary regulations. Labor reform, additional tax reform and
autonomy for the Central Bank were on the agenda for 2005 to 2006,
but now are unlikely to be addressed at least until the new year
begins. Much remains to be done. The government needs to improve
the regulatory climate for investment, particularly in the energy
sector; to simplify torturous tax systems at the state and federal
levels; and to further reform the pension system.

TRADE POLICY
--------------


23. (SBU) To increase its international profile(both economically
and politically),the Foreign Ministry (Itamaraty) is seeking
expanded trade ties with developing countries, as well as
strengthening the Mercosul customs union with Uruguay, Paraguay and
Argentina. Arguably the GoB has fallen short on this latter
objective. The Brazil-Argentine relationship is rife with trade
disputes, recently leading to adoption of a safeguard mechanism for
bilateral trade. Meanwhile, Uruguay and Paraguay regularly complain
that Brazil and Argentina reap a disproportionate share of benefits
from the bloc, and threaten the group's solidarity in various ways
-- for instance, Uruguay's recent discussions with the United States
regarding a possible FTA (which would contravene Mercosul rules).


24. (SBU) Nonetheless, the bloc remains engaged in certain external
trade negotiations. In 2004, Mercosul concluded free trade
agreements with Colombia, Ecuador, Venezuela and Peru, adding to its
existing agreements with Chile and Bolivia to establish a commercial
base for the newly-launched South American Community of Nations. As
noted earlier, Mercosul is upgrading Venezuela's status from
associate to full membership. In addition to Cuba, the bloc is
currently exploring free trade talks with Israel, the Dominican
Republic, Panama and states of the Gulf Cooperation Council, as well

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as trying to build on partial trade liberalization agreements
concluded with India and South Africa in 2004.


25. (SBU) China, which was offered market economy status by Brazil
as a part of Lula's effort to secure PRC support for Brazil's bid
for a USNC seat, has increased its importance as an export market
for Brazilian soy, iron ore and steel, becoming Brazil's fourth
largest trading partner and a potential source of investment.
However, low-priced Chinese imports, particularly in the textile,
footwear, and toy sectors, are now threatening to displace domestic
Brazilian production. As many Brazilian observers have indicated,
all this effort is aimed at countries which together represent less
than a third of Brazil's foreign trade. Free trade negotiations with
the EU continue to languish.

DOHA AGENDA - WTO
--------------


26. (SBU) While Brazil emphasizes South-South trade through
Mercosul's bilateral negotiations, it uses that Doha Development
Agenda (DDA) negotiations as the main forum for engaging with
developed country partners. The DDA is Brazil's top trade priority,
viewed as the last chance for perhaps 15-20 years to secure
fundamental changes in international trade rules, in particular, for
international agricultural trade. Brazil leads the G-20 group of
developing countries that is pressing for agricultural trade reform
in the DDA. Brazil's assertive leadership of the G-20 was blamed in
some quarters for causing the failure of the WTO Cancun Ministerial
in September 2003. Since then, Brazil has been more constructively
engaged in the Doha Round, initially as a member of the "Five
Interested Parties" and more recently G-6 informal group, although
many of its positions are still at odds with U.S. interests. At the
December 2005 Hong Kong Ministerial meeting, Brazil was key to
brokering the deal - albeit one of limited ambition - coming out of
that session. Brazil can be expected to maintain its assertive
stance in the Doha Round on agricultural trade reform while taking
more defensive postures in the discussions covering industrial
products and services.

FREE TRADE OF THE AMERICAS - FTAA
--------------


27. (SBU) As indicated above, the Lula Administration shows no
serious interest in pursuing the FTAA. Despite serving as co-chair
and having secured in the November 2003 Miami meeting a new
framework for negotiation, Brazil has shown no inclination to move
the process along and has so far declined to convoke the next FTAA
Ministerial - which is now overdue.

WILLIAMSON