WASTED OPPORTUNITIES -- SAO PAULO BUSINESS TELLS A/S WAYNE

UNCLAS SECTION 01 OF 05 SAO PAULO 000415 SIPDIS SENSITIVE SIPDIS STATE FOR WHA/BSC STATE PASS EB/IFD/OMA MOSS NSC FOR CRONIN TAGS: ECON PGOV PREL ETRD EFIN EINV BR SUBJECT: WASTED OPPORTUNITIES -- SAO PAULO BUSINESS TELLS A/S WAYNE OF GOB'S ECONOMIC INEFFECTIVENESS SENSITIVE BUT UNCLASSIFIED - PLEASE PROTECT ACCORDINGLY -------------- SUMMARY -------------- ¶1. (SBU) E. Anthony Wayne, Assistant Secretary of State (A/S) for Economic and Business Affairs, visited Sao Paulo April 5-6 to participate in the World Economic Forum on Latin America. During his visit, he also had several meetings with Sao Paulo business leaders, who generally agreed that while the Lula Administration's macro-economic policy has brought stability and international respect to Brazil's economy, the GoB has wasted many opportunities to implement meaningful micro-economic reform. They said government inaction has prevented business here from taking full advantage of the global economy, and they do not expect Brazil's economy to reach higher growth rates under the management of the current government. END SUMMARY. -------------- A/S WAYNE MEETS BUSINESS LEADERS -------------- ¶2. (SBU) While in Sao Paulo for the World Economic Forum's Roundtable on Latin America (WEF),A/S Wayne met with three groups of Sao Paulo business leaders to discuss issues of trade, economic policy, and the state of business in Brazil generally. On April 5, he met with the president and several directors of the Industry Center of Sao Paulo State (CIESP),a non-profit trade organization providing technical, legal and other support services to 9,700 member companies. He had lunch with the presidents of the Brazilian or Latin American subsidiaries of four multinational corporations, and with two financial and political risk consultants. The following day, A/S Wayne met with the leaders of the Sao Paulo Chamber of Commerce (ACSP),which directly represents 30,000 businesses of various sizes and sectors in metropolitan Sao Paulo and is part of a network of 150,000 businesses in the state of Sao Paulo. The meeting was followed by A/S Wayne's speech to the Chamber on economic ties between the United States and Brazil. (NOTE: Photos and text of his speech may be found on AMCONSUL Sao Paulo's Website, linked from the Embassy's Home Page at www.embaixadaamericana.org.br. END NOTE.) -------------- --- A LITTLE LESS CONVERSATION, A LITTLE MORE ACTION -------------- --- ¶3. (SBU) A common refrain heard at the meetings between A/S Wayne and Sao Paulo business leaders was that while the Lula Administration may have had good intentions over the last four years regarding macro-economic policy -- and in fact did no damage and actually fostered stability through consistent policy pronouncements -- from a broader business perspective, the GoB under Lula has been largely ineffective in managing the economy. ¶4. (SBU) CIESP leadership challenged the notion that President Lula's macro-economic policy has been an effective stimulant for Brazilian business as a whole. The group acknowledged that Lula's continuation of his predecessor's orthodox macro-economic policies has led to stability and trust in the Brazilian economy. However, they felt very strongly that not nearly enough has been accomplished at the microeconomic level in Lula's term in office, and many opportunities for real growth and development have been wasted. CIESP President Claudio Vaz said that in principle, GoB policies and rhetoric have been encouraging, but the government itself has been badly managed and prone to inaction. "We are headless," said CIESP's Boris Tabacof, when asked by A/S Wayne if there is any debate within the GoB on matters important to business. Sounding a similar note, Regina Nunes, President of Standard and Poor's (S&P) Rating Service in Brazil, said at lunch, "Lula actually did nothing [this term]. He continued good policy, but there was little action on that policy." SAO PAULO 00000415 002 OF 005 ¶5. (SBU) Specifically, CIESP leaders said the minimal progress on structural microeconomic reforms demonstrates that the GoB lacks real economic vision and follow-through. While it is true that some important pieces of legislation have been passed, such as a social security reform bill, in most cases no regulatory or implementing structures have been created, rendering the laws ineffective. Business leaders also complained that Lula's Public-Private Partnerships initiative had produced no tangible results. ¶6. (SBU) Vaz also said that ideology, not practicality, drives government action in Brasilia, to the extent that while the GoB debates heady issues and releases well-worded statements to entice world interest, there is little on-the-ground progress being made by Brazilian companies to exploit the global marketplace. For example, Vaz pointed to the energy sector, where he says the controlling ministry has been so preoccupied with ideological debates that Brazil will face energy shortages in the near-future. S&P's Nunes later corroborated this assessment of Brazil's energy situation by noting that potential shortages remain a chief challenge to Brazil's development. Vaz further stated that Brazil has not taken advantage of the experience and know-how of its counterparts, or of internal investment opportunities. For example, he said that roughly USD 65 billion in financing has been made available by the Brazilian Social and Economic Development bank (BNDES) over the last three years, but only US$45 billion has been tapped, largely because of bureaucratic hurdles and ideological restrictions embedded in loan qualifications. ¶7. (SBU) Franklin Feder, President of Alcoa South America, suggested that some of the perceived government inaction also has to do with the increasing democratization of Brazil and the fact that Brazil is becoming a complex society with a mix of government and quasi-governmental agencies, non-governmental organizations, and an active civil society. He said that compared with only a decade ago or even less, the GoB has "little direct effect on the ground today." On the other hand, Matthew Jansen, President of Archer Daniels Midland of Brazil (ADM),said his company is reducing investments in operations in Brazil, mostly because of the high tax burden. He seemed to echo the sentiment of CIESP's Vaz that the GOB has focused its attention in recent years primarily on export volume at the expense of business in general (see paragraph 10 below). Jansen said corporations today are facing challenges from government decisions made 18-24 months ago regarding exports, exchange rates and taxes. "Regardless of the image of Brazil as FDI (foreign direct investment)-friendly," said Jansen, "ADM is withdrawing." ¶8. (SBU) Interestingly, CIESP's Vaz and S&P's Nunes each used the term "existential" when describing the Lula Administration's poverty reduction programs. They independently faulted the structure of the oft-praised "Bolsa Familia" program which, in their words, simply redistributes wealth by passing cash to some poor people, rather than making effective investments in economic growth which could spur employment and other benefits for needy families. -------------- MARKETS FALL AS THE REAL RISES -------------- ¶9. (SBU) CIESP President Vaz chaired a frank discussion with A/S Wayne on the view from the industrial sector of Brazil's recent economic performance, and on the state of affairs today for large businesses based in Sao Paulo. Vaz comes from the auto parts industry, and with him at the table were representatives of manufacturers of tools, ceramic insulators, electronics, chemicals, and food products. A/S Wayne noted that while Brazil's general macro-economic situation has been stable, many Brazil-watchers are concerned about Brazil's competitiveness in the global economy. ¶10. (SBU) Vaz replied that many business owners are conflicted over the GoB's economic policies. He said that while Brazil's general volume of exports continues to grow, the focus on Brazil's traditional external sectors has resulted in a steep appreciation of its currency, the real, which in turn is making it difficult for SAO PAULO 00000415 003 OF 005 much of the manufacturing sector to compete in global markets. Three years ago the real traded at 3.7 to the dollar; today the exchange rate is 2.1 to 1. Vaz said at this valuation of the real, Brazilian commodity exports such as sugar, soy and oranges remain competitive, but this exchange rate prices most Brazilian manufactured products out of key international markets. It was noted that twenty companies account for 32 percent of Brazil's exports. So for manufacturers, the exchange rate is a bigger impediment to growth than Brazil's chronically high interest rates. Criticizing the Central Bank's implementation of its inflation-targeting framework, he said that 30 percent of Brazil's consumer inflation index (IPCA) is determined by non-market price increases. That is, increases in contract costs as a result of exchange rate movement, as opposed to fluctuating market prices of items such as fuel and rent, require the Central Bank to maintain a tighter monetary policy stance than if the Central Bank targeted a core inflation index of market prices. The resulting higher-than-necessary interest rates reduce investment and lead to exchange rate appreciation, thus limiting Brazilian manufacturers' export opportunities. ¶11. (SBU) Tied to the exchange rate challenge is a Brazilian law requiring companies to convert dollars earned from trade into Brazilian reals within seven months of earnings. Vaz described how this requirement stifles longer-term re-investment into product lines and prevents multinational corporations from integrating their Brazilian units into their corporate financial structure to effectively leverage earnings and plan for greater future investments in Brazil. -------------- -------------- BOXING BRAZIL: ARE BILATS THE WAY FORWARD ON FTAA? -------------- -------------- ¶12. (SBU) In all his meetings, A/S Wayne reiterated that the United States remains interested in the Free Trade Area of the Americas (FTAA),but that he does not see near-term prospects for successful negotiations. CIESP leaders and members of the lunch group both suggested that the only way to move forward on FTAA may be to negotiate bilateral Free Trade Agreements (FTAs) with enough of Brazil's neighbors that the GoB feels isolated in South America. Joseph Tutundjian, Executive Vice President for International Business at the Verdi Group consultancy, said that while he didn't like such an approach, it may be that the GOB will not budge on FTAA until it feels "cornered." He said, "For the government to really get it, they must feel scared." ¶13. (SBU) CIESP's Boris Tabacof, a civil engineer, banker, and entrepreneur in the fields of electronics and chemicals, made similar comments in the industrial sector meeting, saying he feared the GoB is moving along a path of de facto economic isolationism. He pointed to the Lula Administration's "bravado" regarding small trade agreements with countries like Syria and Mozambique, after which it is often declared that Brazilian trade with these nations will double. But, he asked aloud, when the initial trade volume is only in the hundreds of thousands of dollars, what real effect does doubling have? Brazil's economy needs billions of dollars in increased trade, and the GoB needs to view the FTAA and the WTO Doha Round as viable opportunities. Maurice Costin, Vice President of CIESP's International Relations department and head of SKF Tools, lamented that Brazil's economic growth is not keeping pace with the rest of the world, and the situation will only worsen if Brazil is "left behind" by U.S. bilateral agreements with Brazil's neighbors. ¶14. (SBU) Just as CIESP leaders expressed the view that the Lula administration overall is too driven by ideology as opposed to pragmatism, Tutundjian opined that ideology plays too big a role in GOB decision-making on FTAA. By way of example, he described an effort to gauge the public's support for the regional trade agreement through a referendum organized by the Catholic Church in which it was declared that 100 percent of Brazilian Catholics opposed the FTAA. Tutundjian decried both the concept and the results - "How can 100 percent of any group of such size agree on SAO PAULO 00000415 004 OF 005 anything?" He said such efforts demonstrate the extent to which political and ideological motivations play too big a role in the GoB's approach to FTAA. Various businesspeople agreed that the MFA's leadership role in trade negotiations is a problem; they suggested that a Brazilian version of USTR could lead trade negotiations with a focus on business, rather than ideology. -------------- -------------- ALMOST DOHA: BRAZIL READY FOR SECTORAL AGREEMENTS? -------------- -------------- ¶15. (SBU) Regarding multilateral trade agreements, CIESP's Vaz said he thinks that the "level of ambition" in FTAA and WTO negotiations has been too high. He said that even if agreements are eventually reached, "the book of exceptions will be much larger than the rules themselves." Vaz suggested that trade negotiators need to "shoot lower," noting that several of Brazil's industrial sectors are ready for zero tariffs and that sectoral agreements might be viable. Tutundjian said that among industrial sectors, Brazil's petrochemical industry is the most adamantly opposed to the FTAA because of fear that Venezuela will "trounce" Brazil's industry. Tutundjian noted that high-value product manufacturers, such as aircraft manufacturers and paper producers, are amenable to zero tariffs because they are particularly competitive. -------------- MERCOSUL: THE BEGINNING OF THE END? -------------- ¶16. (SBU) When asked by Charge d'Affaires (CDA) about the importance of Mercosul today, CIESP's Tabacof said the trade organization is important, but that it doesn't work. Tutundjian said there is no Mercosul consensus on regional trade, because the member countries have widely divergent interests. Brazil, for example, has more industrial interests at stake than Argentina. Vaz noted that if Brazil wants to re-invigorate Mercosul, it will have to pay a steep price to reach an accord with Argentina. -------------- -------------- GROWTH LIMITED BY ENERGY, INFRASTRUCTURE AND EDUCATION -------------- -------------- ¶17. (SBU) While CIESP's leaders were concerned that Brazil's economic growth is not keeping pace with other countries' and worldwide averages, the CEO and analyst group suggested that Brazil cannot maintain a growth rate anywhere near five percent, mostly because of a lack of energy supply. Tutundjian said Brazil's economy might be able to handle a consistent rate of 3.5 to 4 percent, but above that, energy rationing would be inevitable. Alcoa's Feder admitted that energy supply is one of his company's greatest concerns in Brazil. Nunes from S&P added that Brazil's infrastructure needs to be significantly expanded to support continued economic growth. Infrastructure expansion needs to occur simultaneously with economic expansion, and Nunes doubts that Brazil can achieve the needed levels of public improvement to support a growth rate of five percent or higher. ¶18. (SBU) In addition to energy and infrastructure shortfalls, Nunes said education is the other chief inhibitor to Brazil's development. In response to CDA's suggestion that Brazil also suffers from a shortage of skilled labor, Nunes noted that there are plenty of college graduates, but the quality of their education is insufficient for the modern marketplace. Enrique Usher, President of Motorola South America, said all companies need to work continually with universities and secondary schools to form partnerships and programs to adequately prepare Brazilian youth for the workforce. He suggested that very soon Brazil will see qualified Argentineans coming here to fill high-tech jobs. -------------- COMMENT: BRAZIL'S ECONOMY COMING UP SHORT -------------- SAO PAULO 00000415 005 OF 005 ¶19. (SBU) While Brazil's burdensome tax rates, high interest rates, and cumbersome bureaucracy are well-known, even to the extent that "custo Brasil" (Brazil-cost) is part of the Latin American business lexicon, it's also clear, as described in these meetings with A/S Wayne, that much remains to be done on the microeconomic agenda as well. Despite a 2005 liberalization which extended the amount of time exporters have to convert their dollars into reals, the requirement to convert foreign exchange remains on the books which, combined with the rising value of the real, is creating disincentives for some investment in Brazil. Other recent indicators show Brazil's economy lagging: on April 11, the National Confederation of Industries (CNI) ranked Brazil 22nd among 23 nations in terms of growth in their annual average rate of productivity so far this decade (2001-2004). Brazil ranked fourth from 1996 to 2000, and sixth from 1991 to 1995. The ongoing challenges of energy, infrastructure and education will limit industrial productivity growth and consequently continue to limit Brazilian industry competitiveness in the global marketplace. In this election year, the probing questions are whether the GoB in a second Lula term would take a more active, interventionist approach to economic development, and what changes, if any, should be expected in the event leading opposition candidate Geraldo Alckmin is the next President. A specific discussion of the business leaders' impressions of Alckmin versus Lula follows septel. END COMMENT. ¶20. (U) This cable was coordinated/cleared with Embassy Brasilia and with EB A/S Wayne. MCMCULLEN