SCENESETTER FOR THE VISIT OF COMMERCE SECRETARY GUTIERREZ

UNCLAS SECTION 01 OF 05 BRASILIA 000971

SIPDIS

SENSITIVE
SIPDIS

FROM CHARGE CHICOLA FOR SECRETARY GUTIERREZ

E.O. 12958: N/A
TAGS: PGOV ECON BR
SUBJECT: SCENESETTER FOR THE VISIT OF COMMERCE SECRETARY GUTIERREZ



1. (SBU) The United States Mission in Brazil warmly welcomes your
planned June 4-8 visit to Rio de Janeiro, Brasilia, and Sao Paulo.
I will greet you in Sao Paulo airport on June 4 prior to your active
schedule of events at the AACLA meeting in Rio and with Minister of
Development, Industry, and Commerce Luiz Furlan. During your
stopover in Brasilia, we are seeking sessions for you with President
Lula and his Chief of Staff Dilma Rousseff, Minister of Foreign
Affairs Celso Amorim, and Minister of Justice Marcos Thomaz Bastos.
In addition, in Sao Paulo you will meet with regional governors,
young entrepreneurs, and private sector officials concerned with key
issues such as Intellectual Property Rights (IPR).


2. (SBU) Your trip, scheduled right before the soccer World Cup,
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).


3. (SBU) However, "scandal fatigue" has set in, and President Lula
has successfully used the slack time to recover lost political
ground. Recent polls show Lula regaining the lead in the
presidential race, and he is currently engaged in a busy schedule of
visits around the country -- campaigning in all but name -- while
the leading opposition candidate from the PSDB party has stalled in
the polls. The election campaign will commence in earnest after the
World Cup ends in early July, with presidential and congressional
elections set for early October.

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, President 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 they have 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 Brazilians have also eagerly
participated in the dialogue leading up to the first meeting of a
bilateral commission on science and technology, scheduled for June,
2006, in Washington.


7. (SBU) On development assistance issues, our dialogue is positive
-- but constrained. Notwithstanding lackluster results to date, the

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Brazilian government's multi-billion dollar poverty alleviation
program -- Zero Hunger -- receives substantial funding from the
World Bank and the Inter-American Development Bank (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 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 toards the United States,
President Lula has run an activist foreign policy with a focus on
South Amrica and the Third World, seeking to forge alliancs 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 in the recent past. 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 recent 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' actions and continuing threats.


10. (SBU) Emblematic of Brail'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 (Inda, Germany, Japan) are, despite recent setbacks,continuing to press
their campaign for a vote on aresolution on
UNSC reform. This stance s 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."

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


12. (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 is eligible to run for reelection in October

2006. Elected in large part on promises of promoting an ambitious
social agenda, including the "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.


13. (SBU) As noted above, the Lula Administration has been beset by
a grave political crisis as interlocking influence
peddling/vote-buying scandals plagued elements of Lula's PT party.
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

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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. Thus far, Brazilian society -- including the
opposition -- seems disinclined to hold Lula personally responsible
for the scandals, and he has recovered lost ground in public
opinion.

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


14. (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).


15. (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
as trying to build on partial trade liberalization agreements
concluded with India and South Africa in 2004.


16. (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
--------------


17. (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
remaining reluctant to engage on discussions covering industrial
products and services.

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


18. (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.

U.S. EXPORTS
--------------


19. (U) For 2005, Brazil was ranked the 15th largest market for both

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U.S. imports and exports. In 2005, U.S. goods exported to Brazil
totaled US$15.3 billion, representing a 10.4% increase from 2004.
Our top export categories to Brazil include machinery, electronic
machinery, organic chemicals, aircraft and aircraft parts, and
optical and medical instruments. However, the U.S. trade deficit
with Brazil continues to grow as well in spite of the strong
appreciation of the Brazilian real against the U.S. dollar. For the
past four years, the U.S. trade deficit with Brazil on goods has
grown steadily, and reached US$9.1 billion in 2005. However, our
trade in services has held steady over the same period, with the
U.S. exporting about US$5 billion in services to Brazil and
importing about US$2 billion in return.


20. (U) There are a variety of trade matters of concern to U.S.
companies seeking to do business in Brazil. Market access and
investment are major issues for U.S. companies, specifically high
taxes and nominal tariffs, the latter averaging 10.7 percent - much
higher than those in the U.S. In addition, complicated customs,
import licensing and tax regimes combine to make life difficult for
U.S. (and third-country) exporters. Piracy and counterfeiting
continue to be a concern, although the Brazilian government is
slowly making progress in addressing deficient enforcement of
copyright protections. Both U.S. and Brazilian companies complain
about "Custo Brazil," (i.e., factors that increase the cost of doing
business in Brazil such as logistical costs, infrastructure
bottlenecks, and the cumbersome regulatory framework).

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


21. (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.


22. (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.

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


23. (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 3.5%. 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

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political scandal and the replacement of the finance minister.


24. (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 51.6%. 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.


25. (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.


26. (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, but now
look unlikely to be addressed at least until after the October 2006
elections. 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.

CHICOLA