SCENESETTER FOR VISIT OF U/S REUBEN JEFFERY,

UNCLAS SECTION 01 OF 03 BRASILIA 001581

SIPDIS

SENSITIVE
SIPDIS

E FOR UNDERSECRETARY REUBEN JEFFERY AND TOM PIERCE

E.0. 12958: N/A
TAGS: EAID ECON ETRD OTRA OVIP PGOV PREL BR
SUBJECT: SCENESETTER FOR VISIT OF U/S REUBEN JEFFERY,
AUGUST 19-22, 2007

REF: 07 Bogota 5894


1. (SBU) Summary: Your visit comes on the heels of a June setback
to the Doha Round discussions, in which talks between the U.S., the
EU, Brazil, and India stalled over disagreements concerning tariff
cuts for goods and services and over agricultural subsidies. The
Brazilian delegation, led by Foreign Minister Celso Amorim, left the
talks early accusing the U.S. and the EU of collaborating in advance
on an agricultural position. All sides have not given up on the
talks, which will continue at a multilateral WTO forum in September.
On other trade issues, President Luiz Incio Lula da Silva has
privately characterized the Free Trade Area of the Americas (FTAA)
as "off his agenda."


2. (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. In contrast, on issues involving matters perceived as
technical in nature - law enforcement, science and biofuels - the
GoB is eager to engage. End Summary.

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MACRO-ECONOMIC DEVELOPMENTS
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3. (SBU) President Lula and his economic team have implemented
prudent fiscal and monetary policies and pursued reform. Brazil's
external accounts have improved substantially over the last three
years. Nevertheless, initially reported 2006 GDP growth was only
2.9% (third worst in the hemisphere). In 2007, Brazil revised its
methodology for calculating GDP and restated its 2006 GDP as 3.7%.
For 2007, Brazil's Central Bank is forecasting 4.7% growth (slightly
higher than most private sector forecasts). Inflation over the next
three years is forecast to be in line with the central bank's annual
target (4.5%).


4. (SBU) Buoyed by exports and investment inflows, the real has
remained at appreciated levels for most of the year, allowing the
government and businesses to pay down external debt. Last year, the
government eliminated the last of its restructured debt from
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-.


5. (SBU) Nonetheless, 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. Income
and land distribution remain skewed. Investment and domestic
savings are low, but growing. The informal sector constitutes over
40 percent of the economy, in part because the tax burden (nearly 38
percent of GDP) remains one of the highest among large developing
economies.


6. (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. 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 appear unlikely to be addressed at in the near term. The
government still needs to improve the investment regulatory climate;
to simplify torturous tax systems at the state and federal levels;
and to further reform the pension system.

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TRADE POLICY AND MERCOSUL
--------------


7. (SBU) The GoB is seeking expanded trade ties with developing
countries and seeks to strengthen the Mercosul customs union with
Uruguay, Paraguay, and Argentina. Still, the Brazil-Argentine
relationship is rife with trade disputes and Uruguay and Paraguay
regularly complain that Brazil and Argentina reap a disproportionate
share of benefits from the block.


8. (SBU) Yet the bloc remains engaged in 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. Mercosul is

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in the process of upgrading Venezuela's status from associate to
full membership (Venezuela has yet to commit to the Mercosul common
trade policy). The block has been drawn into the orbit of Chavez's
suggestion to form a Bank of the South. 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. In an
August 2007 visit to Mexico, President Lula made overtures on
improving the countries' bilateral trade relationship.


9. (SBU) China has increased in importance as an export market for
Brazilian soy, iron ore and steel becoming Brazil's fourth largest
trading partner. Impelled by a stronger real, China is set to
become in 2007, the second largest exporter to Brazil, passing
Argentina and second only to the U.S. Low-priced Chinese imports,
particularly in the textile, footwear, and toy sectors, are now
threatening to displace domestic Brazilian production. Brazilian
industry leaders and GoB officials have underlined that concern over
the impact of Chinese imports on domestic manufacturers is one root
cause behind their unwillingness to agree to the non-agricultural
tariff cuts proposed by both the USG and the EU during the Doha
Round.

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


10. (SBU) While Brazil emphasizes South-South trade through
Mercosul's bilateral negotiations; it has used the Doha Development
Agenda (DDA) negotiations as the main forum for engaging with
developed country partners. Brazil leads the G-20 group of
developing countries in pressing for agricultural trade reform in
the DDA. Even before the June 2007 G-4 meetings failed to reach an
agreement on agricultural subsidies and non-agricultural market
access, Brazil appeared to be hedging its bets by seeking out
bilateral and regional trade agreements, working through the
Mercosul framework.

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BIOFUELS
--------------


11. (U) Brazil's ethanol program is 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 are used to
power the conversion process. Cane also requires less processing
than ethanol produced from corn. 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 vary less and are controlled by
the government.


12. (SBU) Since the 1980s, Brazil has attempted to promote ethanol
fuel exports to the United States. U.S. tariffs and charges make
Brazilian imports less competitive. In addition to import tariffs
of 1.9 to 2.5 percent, the U.S. imposes a 54 cents/gallon surcharge
on ethanol imported for use as fuel, which has led to a strong
Brazilian push to lower or eliminate it. Given the requirements of
its fast-growing domestic market, Brazil may not be able to produce
enough ethanol to supply international markets. Some estimate that
over the next one to two years, the maximum percentage of Brazil's
cane crop that could 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.

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


13. (U) Agriculture is a major sector of the Brazilian economy, and
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 U.S.),pork, milk, and
seafood.

BRASILIA 00001581 003 OF 003



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FOREIGN POLICY
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14. (SBU) Brazil has long seen itself as the natural leader of the
region and covets a permanent UN Security Council (UNSC) seat.
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.)- the 'South-South
Policy.' Lula has refused to condemn Cuba for human rights
violations and, in fact, has pushed for Cuban membership in the Rio
Group and a Cuba-Mercosul trade pact. The GoB has worked to
increase both its economic and political ties with Venezuela.
Enhanced integration of the two countries' energy sectors is high on
its agenda. Lula has been especially solicitous of Chavez. In the
past, Lula has praised the Venezuelan President's democratic
credentials and declared that the Chavez government had been
demonized by its foes. Recently, rifts have appeared over
Venezuela's apparent involvement in Bolivia's decision to
nationalize its oil and gas industry and Chavez's biting remarks to
Brazilian Congress members who condemned the GoV's decision to close
an independent television station.

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ENVIRONMENT
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15. Internationally, Brazil is an energetic advocate on
environmental issues and strongly supports the Kyoto Protocol.
The GoB is actively involved in international climate negotiations
and strongly supports the United Nations Framework on Climate Change
(UNFCCC) where Brazil has taken an active role in the discussion of
reducing emissions from deforestation. Brazil has proposed a
"results oriented" fund, which is not consistent with USG policy on
climate change. Thus far, Brazilian reaction to President Bush's
Global Climate Change (GCC) initiative has been lukewarm - they fear
it will undermine the work of the UNFCCC.

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Intellectual Property Rights (IPR)
--------------


16. On April 30, 2007, the Office of the U.S. Trade Representative
(USTR) elevated Brazil to "Watch List" status in its Special 301
Annual Report as a result of the country's progress, particularly in
copyright protection and IPR enforcement. Included in the USTR
announcement was notice that Brazil will be subject to an
Out-of-Cycle Review to monitor its progress on outstanding IPR
concerns and to evaluate the sustainability of recent enforcement
progress.

--Compulsory Licensing


17. (SBU) On May 4, 2007 the GoB announced the issuance of a
compulsory license for Merck Pharmaceutical's HIV/AIDS medicine
Stocrin. GOB officials cited cost reduction for their free HIV/AIDS
public health program as the motivation for this action. In
contrast, some pharmaceutical Industry representatives feel new
Minister of Health Jose Gomes Temporao was driven more by ideology
than by concern of future damage to Brazil's investment climate as a
result of this action. The current situation between Merck and the
GoB is extremely tense, with bad feelings on both sides.

SOBEL