BRAZIL INVESTMENT CLIMATE 2006

UNCLAS SECTION 01 OF 11 BRASILIA 000324

SIPDIS

SIPDIS

STATE FOR EB/IFD/OIA
TREASURY FOR DO/BRESNICK
USDOC FOR ITA/SMATHEWS
STATE PASS TO USTR FOR EDUNLOP
STATE PASS TO OPIC FOR CCOUGHLIN

E.O. 12958: N/A
TAGS: EINV OPIC KTDB USTR BR
SUBJECT: BRAZIL INVESTMENT CLIMATE 2006

REF: 05 STATE 202943


1. This cable transmits Mission Brazil's submission of the 2006
Investment Climate Statement. This document has already been
forwarded to USDOC by e-mail.

Openness to Foreign Investment
--------------


2. Brazil is open to and encourages foreign investment. The
Brazilian Congress approved constitutional amendments in 1995 to
eliminate the distinction between foreign and national capital.
Foreign investors have been permitted to invest in the Brazilian
stock market since 1991; new rules, which liberalized considerably
foreign investment in equities and put foreign investors essentially
on an equal footing with Brazilians, took effect in 2000. The 1962
Foreign Capital law and subsequent amendments govern most foreign
investment. During the high point of the privatization program,
Brazil was the second largest destination for foreign investment
among emerging markets, with a peak inflow of $32.8 billion in 2000;
the country remains a leading investment destination.


3. Constitutional amendments passed in 1995 opened formerly closed
sectors, such as petroleum, telecommunications, mining, power
generation, and internal transport to foreign investors. In 2002,
Congress approved a constitutional amendment permitting foreign
investors to own up to 30% of media companies. Restrictions remain
on foreign investment in a limited number of sectors: nuclear
energy, health services, media, rural property, fishing, mail and
telegraph, aviation and aerospace. Law 10,610 (2002) limits foreign
ownership in media outlets to 30 percent, including the print and
"open broadcast" (non-cable) television sectors. Brazil's
legislature is considering extension of this restriction to cover
Internet Service Providers, pay TV channels and operators, and
content producers and distributors; such a change would pose a
serious threat to a number of U.S. companies operating in Brazil as
content producers/distributors.


4. New or expanded foreign investment in the banking sector is
technically forbidden by the Constitution of 1988. However, since
1995 entry or expansion has been approved on a case-by-case basis;
the vast majority of requests for entry or expansion have been
granted. Foreign banks currently account for 27% of the net worth
of the banking system and 23.4% of total banking system assets.
Since 1996, the insurance sector has been open to foreign investors,
and most major US firms are already represented, mainly via joint
venture arrangements. Brazil maintains a government-owned
reinsurance monopoly, the Brazil Reinsurance Institute (IRB). The
Lula administration has not pursued privatization of the IRB but it
has proposed legislation, sent to Congress in May 2005, which would
dismantle the IRB's monopoly and permit new entrants in the
reinsurance sector. The Congress has not acted on the bill.


5. In 1991, Brazil embarked on the world's largest privatization
drive, selling off more than US$ 100 billion worth of assets. Since
2002, however, privatization has virtually stopped. Through 2005,
Brazil realized $87.8 billion in sales revenue and another $18.1
billion in debt transfer as a result of the national privatization
program. Foreign investment accounted for $42 billion, or 48% of
the total. One third of the foreign investment was from the US ($14
billion). With the exception of power-generation sector, in which
the majority of power generation capacity remains in government
hands, most of the largest state enterprises have been sold in whole
or in part. Privatization activity has slowed substantially since
2001; in 2002, it totaled only US$ 2 billion; in 2003 there were no
privatizations. The Lula administration has carried out two
privatizations, the 2004 sale of the State Bank of Maranhao for US$
26.6 million and the December 2005 privatization of the State Bank
of Ceara for US$ 302 million. In December 2004, the Congress
approved and the President signed a Public-Private Partnership (PPP)
investment law that promotes joint ventures in otherwise marginally
profitable infrastructure investments; the first such projects may
be bid in 2006. The law creates a federal guarantee fund to protect
investors in federal PPPs.


6. In December 2004 and April 2005, Brazil conducted its first
auctions of long term energy supply contracts under a new energy

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regulatory framework advanced by the Lula administration. Under the
new model the federal government now plays a more central role in
establishing energy demand forecasts and energy prices. Although a
central goal of the new model is to attract private investment in
power generation, several investors that bought energy assets during
the now-halted energy sector privatization were disadvantaged by the
transition to the new regulatory system. Analysts, companies and
investors also have expressed concern that the more centralized
government role and low auction prices will inhibit private
investments. A majority of power generation capacity remains in
public hands.


7. During the early 1990s, foreign direct investment (FDI) was a
crucial source of financing for Brazil's balance of payments.
Dramatic growth in Brazil's exports has produced trade surpluses
since 2001 and current account surpluses since 2003 have
dramatically reduced the importance of FDI as a source of external
financing. Moreover, the winding down of the privatization program
has seen FDI fall from a 2000 peak of $30 billion to a low of $10.1
billion in 2003. FDI inflows have since picked up, increasing to
$18.2 billion in 2004 and an estimated $15 billion in 2005.


8. Brazil has undertaken a significant reduction in trade barriers
in recent years. In 2005, Brazil's average Normal Trade Relations
(NTR) tariff was 10.7%, versus 32% percent in 1990, according to the
Foreign Trade Secretariat of the Ministry of Development, Industry
and Foreign Trade.


9. Foreign investors may own real estate, but purchase of land along
the borders by foreigners requires specific authorization.

Conversion and Transfer Policies
--------------


10. There are few restrictions on converting or transferring funds
associated with an investment. Foreign investors may freely convert
Brazilian currency in the unified foreign exchange market wherein
buy-sell rates are determined by market forces. All foreign
exchange transactions, including identifying data, must be reported
to the Central Bank. Foreign-exchange transactions on the current
account have been fully liberalized in practice.


11. Foreigners investing in Brazil must register their investment
with the Central Bank within 30 days of the inflow of resources to
Brazil. Registration is done electronically. Investments involving
royalties and technology transfer must be registered with the patent
office (INPI) as well. Investors must have a representative in
Brazil and register with the Brazilian securities commission (CVM).
Subsequent transactions, such as reinvestment of profits, may also
have to be registered with the Central Bank.


12. Foreign investors, upon registering their investment with the
Central Bank, are able to remit dividends, capital (including
capital gains),and, if applicable, royalties. Remittances must
also be registered with the Central Bank. Dividends cannot exceed
corporate profits. The remittance transaction may be carried out at
any bank by documenting the source of the transaction (evidence of
profit or sale of assets) and showing that applicable taxes have
been paid.


13. Foreign loans obtained abroad no longer require advance approval
by the Central Bank, provided the recipient is not a government
entity (loans to government entities still require prior approval).
Upon concluding the transaction, the loan must be registered
electronically with the Central Bank. In most instances, the
registration is completed automatically. Automatic registration is
not issued when the costs of the operation are "not compatible with
normal market conditions and practices." In such instances, the
loan is reviewed by the Central Bank; if the Central Bank does not
respond within five working days, the registration is considered
complete.


14. Interest and amortization payments specified in the loan
contract can be made without additional approval from the Central
Bank. That also applies to early payments, if there is a provision
in the contract for early payment. If the contract does not have
such a provision, early payment requires prior approval by the

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Central Bank. According to Central Bank officials, this requirement
is to ensure accurate records of Brazil's stock of debt, and all
requests have been approved since the new guidelines were issued in

2000.


15. In addition to payments associated with registered loans and
investments, there are other approved procedures for transferring
funds abroad that in practice can be used for a wide range of
purposes.


16. Capital-gain remittances are subject to a 15 percent income
withholding tax. Repatriation of an initial investment is exempt
from income tax. Beginning in 2000, lease payments were assessed a
15 percent withholding tax. Remittances related to technology
transfers are not subject to the tax on credit, foreign exchange,
and insurance (IOF),although they are subject to a 15% withholding
tax and an extra 10% Contribution of Intervention in the Economic
Domain (CIDE). Loans with terms of 90 days or less must pay the IOF
(5%),while those of longer maturity do not. In 2002, Brazil
eliminated the application of the financial transaction tax (CPMF),
which is currently 0.38%, to stock market transactions. Foreign
cable and satellite television programmers are subject to an 11
percent remittance tax; however, the tax can be avoided if the
programmer invests 3 percent of its remittances in co-production of
Brazilian audio-visual services.


17. Brazil has no double taxation treaty with the US, but does have
such treaties with a number of other countries, including, among
others, Japan, France, Italy, the Netherlands, Canada and
Argentina.

Expropriation and Compensation
--------------


18. There have been no expropriatory actions in Brazil in the recent
past nor any signs that the current Government is contemplating such
actions. In 1999, a state government sought and obtained a court
ruling canceling contractual obligations, signed by the prior state
government, associated with the partial privatization of a state
electricity company. The U.S. investors are appealing the court
ruling. In 2003, a newly inaugurated government in another state
refused to honor a number of contracts the previous state government
had signed with a range of Brazilian and foreign investors; the
parties involved continue to negotiate these contract disputes and
have had recourse to local courts. Some claims regarding land
expropriations by state agencies many years ago have been judged by
courts in US citizens' favor. There remain individuals who have not
yet been compensated because the states have appealed these
decisions.

Dispute Settlement
--------------


19. Brazil is not a member of the International Center for the
Settlement of Investment Disputes (ICSID - also known as the
Washington Convention),but it is a party to the New York Convention
of 1958 on the recognition and enforcement of foreign arbitration
awards. In August 1995, Brazil ratified the 1975 Interamerican
Convention on International Commercial Arbitration, as well as the
1979 Interamerican Convention on Extraterritorial Validity of
Foreign Judgments and Arbitral Awards.


20. Arbitration clauses in contracts are not automatically
enforceable. Foreign arbitral awards require confirmation by a
court of the country in which the award was rendered and by the
Brazilian Supreme Court. This confirmation is procedural in nature,
and not meant to consider the merits of the case. Confirmation by
the Supreme Court allows the claimant to enforce the arbitral award
through Brazilian courts. The Supreme Court has confirmed foreign
arbitral awards between two private parties in multiple cases. Some
companies opt for domestic arbitration as an alternative.


21. There is some legal controversy in Brazil over binding foreign
arbitration between foreign investors and state entities. Some
Brazilian legal interpretations claim this is prohibited under
Brazilian law on the grounds that it infringes the sovereign rights
of the state. The Federal Government nevertheless maintains, in the

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absence of a definitive judicial ruling on the issue, that it can
agree to binding foreign arbitration and routinely enters into
contracts that allow for such arbitration.


22. This legal uncertainty, as well as congressional politics, has
held up ratification of Bilateral Investment Agreements that Brazil
has signed with fourteen countries (not including the US),which
call for arbitration by either ICSID or a panel set up under the
United Nations Rules for International Commercial Law. Given the
doubts about the applicability under Brazilian law of these
international arbitration provisions to Brazilian government
entities, the government in December 2003 withdrew the agreements
from consideration for Senate ratification.


23. Brazil has a functional commercial code that governs most
aspects of commercial association, except for corporations formed
for the provision of professional services, which are governed by
the civil code. In December 2004, Congress approved an overhaul of
the bankruptcy code. The reforms create a system, modeled on
Chapter 11 of the U.S. bankruptcy code, which allows a company in
financial straits to negotiate a restructuring with its creditors
outside of the courts. In the event a company does fail despite
restructuring efforts, the reforms give creditors a better chance at
recovering their debts. An overburdened court system is available
for enforcing property rights but decisions can take years.
Judicial reform measures enacted in December 2004 streamline
administrative procedures, and, by introducing the concept of
binding precedent, should, over time, make judicial decisions more
predictable.

Political Violence (As it May Affect Investments)
-------------- --------------


24. Brazil's major urban centers suffer from significant drug
trafficking-related and organized crime-related violence. Poverty,
gangs, drugs and a lack of government resources have combined to
erode state authority in some urban slums (favelas). There have
been episodes of drug-related violence prompting major police
crackdowns, particularly in Rio de Janeiro. Police have been
implicated in significant human rights violations, including
extra-judicial killings, abuse of prisoners, and other criminal
activity. Since mid-2003 the Landless Workers' Movement (MST) has
continued its aggressive invasions of a variety of agricultural
interests, both domestic and foreign, in its campaign to force
redistribution of land. In rural areas, powerful landowners,
sometimes aided by police or private security agents, have used
violence to settle land disputes, including but not limited to those
with the MST or indigenous peoples, and to influence the local
judiciary.

Corruption
--------------


25. Corruption can be an obstacle to investment in Brazil. In
general terms, businesses find corruption an obstacle in government
procurement and at some levels of the judiciary. 2005 saw a range
of corrupt activities of spectacular scope come to light as
Brazilian Congressional and law enforcement authorities began
multiple investigations into illicit financing by several political
parties of their 2002 presidential campaigns. The campaign
financing investigations uncovered a multi-layered corruption
scandal involving alleged vote-buying in the Congress by elements
within the President's PT party and executive branch, financed by
kickbacks on government procurement contracts and influence
peddling. Brazil is a signatory to the Organization for Economic
Cooperation and Development (OECD) Anti-Bribery Convention. While
Federal government authorities generally investigate allegations of
corruption, there are inconsistencies in the level of enforcement
among individual states.

Performance Requirements and Incentives
--------------


26. Geographic preferences consist of tax benefits for investment in
less developed parts of the country, such as the Northeast and the
Amazon, with equal application to foreign and domestic investors.
These benefits have succeeded in attracting some major foreign

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plants to, for example, the Manaus Free Trade Zone, but most foreign
investment remains concentrated in the more industrialized southern
part of Brazil. Individual states have sought to attract investment
by offering ad hoc tax benefits and infrastructure support to
specific companies, negotiated on a case by case basis. Some
municipalities provide land on favorable terms for industrial
development.


27. In firms employing three or more persons, Brazilian nationals
must constitute at least two-thirds of all employees and receive at
least two-thirds of total payroll. Foreign specialists in fields
where Brazilians are unavailable are not counted in calculating the
one-third permitted for non-Brazilians.


28. On November 21, 2005, Brazil's President signed law 11,196 which
provides tax benefits to qualifying exporters. The law's Special
Regime for the Information Technology Exportation Platform (REPES)
suspends PIS/PASEP and COFINS taxes on goods and services imported
by companies which commit to export software and IT services to the
extent that those exports account for over 80 percent of annual
gross income. The MP's Special Regime for the Acquisition of
Capital Goods by Exporting Enterprises (RECAP) suspends these same
taxes on new machines, instruments and equipment imported by
companies which commit for a period of at least three years to
exports goods and services such that they account for at least 80
percent of overall gross income. The government also has a series
of smaller programs designed to assist small and medium sized
businesses to export.


29. The Special Agency for Industrial Financing (FINAME) of the
National Bank for Economic and Social Development (BNDES) provides
financing for purchases by Brazilian firms of Brazilian-made
machinery and equipment -- capital goods with a high level of
domestic content.

Right to Private Ownership and Establishment
--------------


30. Foreign and domestic private entities may establish, own, and
dispose of business enterprises.

Protection of Intellectual Property Rights (IPR)
-------------- ---


31. Brazil is a signatory to the GATT Uruguay Round Accords,
including the Trade Related Aspects of Intellectual Property (TRIPS)
Agreement, signed in April 1994. Brazil is a member of the World
Intellectual Property Organization (WIPO) and a signatory of the
Bern Convention on artistic property, the Washington Patent
Cooperation Treaty, and the Paris Convention on Protection of
Intellectual Property. In August 1992, Brazil removed its
reservations and fully accepted the Stockholm revision of the Paris
Convention. Brazil has not yet ratified the WIPO Treaties on
Copyright and Performances and Phonograms. As a result of problems
regarding protection of intellectual property rights, principally in
enforcement, Brazil was retained on the Special 301 priority watch
list in the 2005 review.


32. Patents. In most respects, Brazil's 1996 Industrial Property
law brings its patent and trademark regime up to the international
standards specified in the TRIPS Agreement. However, the law
includes local working requirements which may be TRIPS-inconsistent.
The law would theoretically permit the grant of a compulsory
license if a patent owner has failed to "work" (i.e. locally
manufacture) the patented invention in Brazil within three years of
issuance. Invoking TRIPS provisions, Brazil has at times threatened
to issue compulsory licenses for anti-retroviral drugs used in
treating HIV/AIDS if satisfactory supply agreements, including a
reduction in prices, could not be reached with patent-holders; to
date Brazil has not issued such a license. Negotiations were
successfully completed with one U.S. pharmaceutical company in 2005
and are on on-going with two others.


33. Trademarks. The fraudulent use of internationally "famous"
marks has been a problem in Brazil. However, the Industrial
Property Law has provided improvements in Brazil's trademark regime,
including better protection for internationally known trademarks.

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Some foreign firms have been successful in court actions against
trademark infringement. Trademark licensing agreements must be
registered with the National Institute of Industrial Property (INPI)
to be enforceable; however, the failure to register licensing
agreements will no longer result in cancellation of trademark
registration for non-use.


34. Copyrights. Brazil's copyright law generally conforms to
world-class standards. Likewise, its software copyright protection
law contains provisions that introduce a rental right and an
increase in the term of protection to 50 years. Despite passage of
these copyright laws in 1998, widespread piracy of copyright and
trademark material remains a problem. The US private sector
estimates that trade losses from copyright infringements (including
from piracy of videocassettes sound recordings and musical
compositions, books and computer software) were $960 million in

2004. Nonetheless, given progress on enforcement in 2005, the U.S.
Government in January 2006 announced that it would maintain Brazil's
trade benefits under the Generalized System of Preferences after a
review prompted by a 2000 petition from the International
Intellectual Property Rights Association.


35. The Brazilian Congress passed a law in July 2003 that increased
minimum prison sentences for copyright violations and established
procedures for making arrests and destroying confiscated products.
However, the heftier sentences have not acted as effective
deterrents due to the continued ability of judges to commute many of
the prison terms to fines. A much-publicized Special Congressional
Inquiry into IPR piracy completed its report in June 2004, amidst
considerable sensation after a reputed piracy kingpin was arrested
on charges of trying to bribe the chairman of the inquiry
commission. In November 2004, the government created a high-level,
inter-ministerial, National Council to Combat Piracy and
Intellectual Property Crimes. In 2005, the Council developed and
has begun implementing a national plan for combating piracy and
smuggling.


36. Integrated Circuit Layout Designs. A government-drafted bill to
provide protection for the layout design of integrated circuits
(computer mask works) was introduced in the Brazilian Congress in
April 1996. In 2004 the administration asked that the Congress give
the bill greater priority as part of a package of measures to
stimulate innovation and local production of electronics. The draft
law has made it through several Congressional committees but was
still under discussion in 2005.

Regulatory System (as it pertains to investments)
-------------- --------------


37. Although some improvements have been made, the Brazilian legal
and procedural system is complex and overburdened. State courts in
particular can be subject to political influence. The central
government has historically exercised considerable control over
private business through extensive and frequently changing
regulations. The bureaucracy has broad discretionary authority.


38. Taxes are numerous and burdensome, but do not discriminate
between foreign and domestic firms, although in a few instances
there have been complaints that the value-added tax collected by
individual states (ICMS) is set to favor local companies. Taxes on
commercial and financial transactions are particularly burdensome,
and businesses complain that these taxes hinder international
competitiveness of Brazilian products. Brazil has separate
value-added tax systems run by the federal government and individual
state governments. The administration has made some recent efforts
at tax reform, including the conversion of invoice taxes to VATs at
the federal level in 2003 and 2004. A 2004 measure reduces taxes
paid on long term investments. A measure to simplify and harmonize
the state-level VATs (which vary from state to state and product by
product) was proposed but did not pass in 2003.


39. Regulatory agencies for sectors such as telecommunications,
energy and transportation are a relatively young phenomenon in
Brazil. ANATEL, the country's telecommunication agency, handles
licensing and assigns bandwidth. The National Petroleum Agency
(ANP) has been commended by the industry for its fair handling of
auctions of oil exploration blocks and its willingness to assist

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industry in seeking to simplify regulatory procedures such as
environmental licensing. Conversely, in the electric power sector,
some companies have complained about the high level of regulatory
risk, for example the tariff review process and the implementation
of the Brazil's new energy model. The federal government in 2003
passed legislation setting fixed three-year terms for directors of
the regulatory agencies. Congress passed legislation in 2005 to
create a civilian air transport industry regulator (ANAC). The new
agency, expected to begin functioning in 2006, will exercise
regulatory functions previously the responsibility of a directorate
overseen by the Brazilian Air Force. Separate legislation to
further clarify the roles and responsibilities of the regulatory
agencies and consolidate the multiple laws currently governing each
separate regulator was still under consideration by the Congress at
end-2005. Separate legislation will refine the personnel systems of
these agencies.

Bilateral Investment Agreements (BITs)
--------------


40. Brazil has signed Bilateral Investment Agreements (BITs) with
fourteen countries. There are two Mercosul investment-related
agreements: the Buenos Aires Protocol ("extra-bloc") and the
Colonia Protocol ("intra-bloc"); the latter has not been signed by
Brazil. Seven of the bilateral investment treaties have been sent
to the Brazilian Congress, but have not been ratified. All of these
treaties pending ratification were withdrawn from Senate
consideration by the Executive in late 2003. The Executive cited
the need for further review of the treaties so as to avoid potential
juridical conflicts. At issue are the international arbitration
clauses of these treaties, which may not be binding on Brazilian
government agencies under Brazilian law. The US signed an Investment
Warranty Treaty with Brazil in 1965 (OPIC). The US and Brazil
currently have no plans to discuss a BIT.

OPIC and Other Investment Insurance Programs
--------------


41. Programs of the Overseas Private Investment Corporation (OPIC)
are fully available, and activity has increased in recent years.
The size of OPIC's exposure in Brazil may occasionally limit its
capacity for new coverage. For more information on OPIC, please go
to http://www.opic.gov/.


42. Brazil became a member of the Multilateral Investment Guarantee
Agency in 1992.

Capital Outflow Policy
--------------


43. In 2005 the Central Bank introduced a new administrative regime
for foreign currency transactions. The new regulations unified the
foreign exchange market and removed many restrictions associated
with remittances overseas, for example, removing a requirement for
prior Central Bank approval for contracting loans in another
country. The Central Bank maintained reporting requirements on all
foreign exchange transactions. In a related effort, the Central
Bank is working to streamline the regulatory regime for foreign
investment transactions in Brazil.


44. There has been a relaxation since 1991 of the restrictions on
the remittances of royalty payments for patent and trademark use
between subsidiaries established in Brazil and the parent office
headquartered overseas and on remittances of franchise contract
royalties. A 1992 INPI resolution simplified procedures and, in
particular, eliminated a number of requirements (but not all)
concerning technology transfer agreements. No royalties or other
fees may be transferred between related companies for the use of
software.

Employer Federations Play a Significant Role
--------------


45. Investors should be aware that employer federations, supported
by mandatory fees based on payroll size, play a significant role in
both public policy and labor relations. Each state has its own
federation, which reports to CNI (National Confederation of

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Industries),headquartered in Brasilia.


46. The Brazilian labor force comprises nearly 84 million workers in
a wide range of occupations and industries. Nearly half of the
labor force is employed in the service sector, roughly a quarter in
agriculture, and the retail and manufacturing sectors combine to
employ another quarter. The participation of women, who now account
for over 40 percent of the labor force, continues to grow. The
labor market has a high rate of informal sector employment; sources
estimate that approximately 40 percent of all workers are not
formally registered, pay no income taxes, and do not enjoy full
protection under the law. About a quarter of all workers are
self-employed.


47. Unemployment - significant. The Brazilian Institute of
Geography and Statistics (IBGE) calculates an average unemployment
rate for the country based on data collected monthly in Brazil's six
largest metropolitan areas. According to this survey, the
unemployment rate in November 2005 was 9.6%. This average masks
some significant variation, from a high of 15.9% in Salvador to a
low of 7.8% in Porto Alegre.


48. Real wages halt decline, disparities significant. Real wages in
2004 halted an almost decade-long slide and continued on an upward
trend in 2005. Real wages were up 2.1% in November 2005 over
November 2004. The average monthly wage in Brazil's six largest
cities was approximately 974 Reals (approximately $423) in November
2005, and the minimum monthly wage was raised from 260 Reals in
April 2004 to 300 Reals (approximately $130) in 2005. These
averages gloss over some stark wage inequalities, as the wealthiest
50% of the Brazilian population earn nearly 90 percent of total
income. Earnings also vary significantly by region and industry.
The typical industrial worker in Sao Paulo, for example, earns about
three times as much as the average retail worker in the northeastern
state of Bahia.


49. Differences in earnings are caused in part by the regional
disparity in educational attainment and in the availability of
skilled workers. According to a 2002 survey by IBGE, 60 percent of
the population has fewer than 8 years of schooling, with this number
reaching 45 percent in the Southeast (including Rio and Sao Paulo)
and 70 percent in the Northeast (including Recife and Salvador).
Illiteracy rates also exhibit regional disparities. The IBGE
reports that about 11 percent of the population is illiterate, with
7 percent illiteracy in the Southeast and 21 percent in the
Northeast.


50. Unions play a significant role. Labor unions, especially in
sectors such as metalworking and banking, tend to be well-organized
and aggressive in defending wages and working conditions. In more
remote areas with smaller local unions, however, unions tend to be
less effective. Union members account for approximately 12 percent
of the workforce, but unions represent more than twice this number
in collective bargaining. Unions, which are funded largely by a
mandatory tax equivalent to one day's wages per year, are obliged to
represent all formal sector workers in a professional category and
geographical area, regardless of membership status.


51. The Ministry of Labor estimates that there are over 16,000 labor
unions in Brazil, but Ministry officials note that these figures are
inexact. Local unions often associate with state federations and
national confederations in their professional category. In
addition, four major labor federations, known as "centrals," have
emerged: the Workers' Unitary Central (CUT),the Union Force (Forca
Sindical - FS),the Workers' General Confederation (CGT),and the
Social Democratic Union (SDS). Labor unions channel much of the
political activity of the labor movement. They also organize
strikes and salary campaigns involving multiple professional
categories and represent workers in many governmental and tripartite
councils. While some labor organizations and their leadership
operate independently of the government and of political parties,
others are viewed as closely associated with political parties.


52. Extensive regulation, slow legal system. The labor code is
highly detailed and relatively generous; formal sector workers are
guaranteed 30 days of annual leave, an annual bonus equal to one
month's salary, and severance pay in the case of dismissal without

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cause. Brazil also has a system of labor courts that are charged
with resolving routine cases involving unfair dismissal, working
conditions, salary disputes, and other grievances. Currently, over
2.5 million cases languish in the labor court system, where they may
remain unresolved for four or five years. The Brazilian government
is attempting to reduce this backlog and increase the efficiency of
the labor courts through recent initiatives to expedite legal
procedures and increase the number of claims that are resolved
before reaching the courts.


53. Labor courts have the power to impose an agreement on employers
and unions if negotiations break down and either side appeals to the
court system. As a result, labor courts routinely are called upon
to determine wages and working conditions in industries across the
country. The system is tantamount to compulsory arbitration and
does not encourage collective bargaining. In recent years, however,
both labor and management have become more flexible and collective
bargaining has assumed greater relevance. The Inter-Union
Department of Socioeconomic Studies and Statistics (DIEESE) no
longer collects data on the number of strikes each month. Strikes
have been a frequent occurrence, however, particularly among public
sector unions.

Major Foreign Investors
--------------


54. According to the Central Bank's most recent foreign-capital
census (December 2000),the US was the largest single foreign
investor in Brazil followed by Netherlands, Spain, France, Germany
and Portugal. Investment from the Cayman Islands began growing
rapidly in 1995 and is thought to represent mainly repatriation of
Brazilian capital entering the country as foreign investment and, to
a lesser extent, investment activity by other national groups.
Investment from Spain and Portugal surged beginning in 1998 due to
involvement in telecom privatizations and greatly increased
investment in the banking sector by Spain.


55. The stock of direct foreign investment in Brazil stood at $103
billion as of December 2000, the most recent year for which detailed
data is available. Of this, the US had the largest share at about
$24.5 billion (24%). Spain had 11.9% of the total ($12.2 billion)
and The Netherlands 10.7% ($11.0 billion). Investment inflows since
2000 have amounted to about $87 billion, exclusive of depreciation
and capital repatriation. (The Central Bank is expected to publish
updated investment stock figures in 2006.)


56. Despite its leading position among foreign investors, as of 2005
the local operations of only two US companies - Cargill and AES -
were among the top thirty domestic firms in terms of revenues. Four
of the top ten importing firms in 2004 were foreign: Nokia,
Motorola, Bunge, and Ford Motor Co. Six of the top ten exporters --
Bunge, Volkswagen, Cargill, General Motors, Ford and Halliburton --
represented foreign investment.

Efficient Capital Markets & Portfolio Investment
-------------- ---


57. Banking shakeout results in improved system. The Brazilian
financial sector is large and sophisticated, in part a legacy of the
high inflation period when good financial management was critical to
survival. Despite current moderate inflation rates, bank-lending
spreads remain extremely high due to taxation, repayment risk, lack
of judicial enforcement of contracts, high mandatory reserve
requirements and administrative overhead. Brazilian banks have
weathered a difficult period of consolidation and streamlining over
the last decade. The elimination of high inflation in the
mid-1990s, and with it the disappearance of so-called "float
income," led to liquidity problems among many banks. A series of
failures, mergers, and acquisitions took place in the late 1990's.
The surviving banks have returned to profitability. Today, the
financial sector is fairly concentrated, with the 10 largest
institutions accounting for over 65% of financial sector assets.
Acquisitions have contributed to this trend as banks seek economies
of scales, including through partnerships with retail chains.
Lending by the large banking institutions is focused on the largest
companies, leaving small and medium-sized companies underserved.


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58. Most government-owned banks, in particular those that were owned
by state governments, have been privatized. These insolvent
institutions were taken over by the federal government, liquidated,
privatized, or transformed into development agencies. Three
federally owned banks, the largest in the country, still play a
prominent role in the financial system. These federal banks, while
in better shape than their state-level counterparts, were also
undercapitalized and carrying poorly performing loans, many the
result of the loss-making "social" lending. These banks have, to an
extent, recapitalized by selling back government bonds.
Extraordinary bank profits in 2002 - 2004 also have improved the
health of their balance sheets. As part of an effort to prevent
the need for future recapitalizations of these federal banks, the
government now requires that loss-making social lending programs by
any government-owned bank be supported with an explicit government
subsidy.


59. Dealing with the bank failures and consolidations of the last
several years has led the Central Bank to strengthen bank audits,
implement more stringent internal control requirements, and tighten
capital adequacy rules to better reflect risk. It also established
loan classification and provisioning requirements. These measures
are applied to private and publicly owned banks alike. The Central
Bank intervened in medium-sized Banco Santos in late 2004 after
embezzlement left the institution insolvent. Banco Santos was
liquidated in 2005.


60. Stock markets not an option for most companies. Brazilian stock
exchanges serve to raise financing primarily for domestic companies,
although the Sao Paulo Stock Exchange (BOVESPA) aspires to a
regional role. There were 9 Initial Public Offerings (IPOs) on the
Sao Paulo Stock Exchange (BOVESPA) in 2005. In June 2004, Brazilian
airline Gol executed an initial public share offering simultaneously
on the Sao Paulo and New York stock exchanges. The total number of
companies listed on the BOVESPA increased to 382 as of year-end 2005
from 361 in June 2004, compared to 399 in 2002 and 428 in 2001.
Total turnover was about $430 billion in 2005, while total market
capitalization was $482 million at end-2005. Trading is highly
concentrated, with the top 10 stocks accounting for over 50 percent
of turnover. Some 71 Brazilian firms, including Petrobras, Embraer,
Banco Itau, CVRD, Brasil Telecom and Ambev, are also listed on the
NYSE via American Depository Receipts (ADR's).


61. In 2000, with the intent of promoting the stock market and
improving liquidity, the numerous regional stock markets agreed to
consolidate. All stock trading is now done on the Sao Paulo stock
market, while trading of public securities is conducted on the Rio
de Janeiro market. The Sao Paulo stock market also launched a "New
Market," in which the listed companies would comply with strict
corporate governance requirements. As of 2005, the new market had
18 listed companies, down from 31 in June 2004.


62. Until recently, up to two-thirds of a corporation's capital
could be preferred (non-voting) shares, so that it was possible to
achieve majority control of voting shares, in some cases, by holding
only 17 percent of total capital. In 2001, the Congress approved a
law that limits preferred shares for new issuances to 50 percent.
The same proposal strengthens rights for minority shareholders.


63. The Brazilian Securities Exchange Commission (CVM) directly
regulates the stock exchanges, brokers, distributors, pension funds,
mutual funds, and leasing companies. In 2001, new legislation
granted the CVM independence and established stronger penalties
against insider trading.


64. In January 2000, Brazilian regulators removed a number of
remaining restrictions on foreign portfolio investment. As a
result, foreign investors - both institutions and individuals - can
directly invest in equities, securities and derivatives. The
foreign investors are required to trade derivatives and stocks of
publicly held companies on established markets. As of 2005, foreign
investors accounted for 31.9% of the total turnover on the BOVESPA.
Domestic institutional investors were the second most active
category of market participants, accounting for 27.8% of BOVESPA
transactions.


65. Export credit availability. BNDES, the government national

BRASILIA 00000324 011 OF 011


development bank, is the primary Brazilian source of longer-term
credit, and also provides export credits. FINAME (Special Agency
for Industrial Financing) provides foreign and domestic companies
operating in Brazil financing for the manufacturing and marketing of
capital goods. FINAMEX (Export Financing) is a part of FINAME,
which finances capital good exports for both foreign and domestic
companies. An export credit program for capital and some consumer
durable goods, known as PROEX, was established in 1991. PROEX
receives funds from the National Treasury to offer assistance in the
areas of interest rate equalization, capital and other goods
exports, and service exports.


66. Other issues: accounting and mergers. Wholly owned
subsidiaries of multinational accounting firms, including the major
US firms, are present in Brazil. The failure of major banks and
large businesses during 1995, notwithstanding positive financial
statements prepared by the major accounting firms, raised doubts
about the credibility of these financial statements. Beginning in
1996, auditors have been personally liable for the accuracy of
accounting statements prepared for banks.


67. Brazilian law recognizes mergers, in which one company loses its
separate identity by being merged into another, and consolidations,
in which the pre-existing companies are extinguished and a new
entity emerges. The procedures for both are essentially the same.
Sales of Brazilian companies usually result from private
negotiations, rather than stock exchange activities. Acquisitions
resulting in market concentration in excess of 20 percent are
subject to review by the Administrative Council for Economic Defense
(CADE) under Brazil's 1994 Anti-trust Law.

CHICOLA