BRAZIL: TREASURY DAS O'NEILL MEETS WITH GOB AND MDBs ON

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SIPDIS

DEPT PASS USTR FOR KATE DUCKWORTH
DEPT PASS DOC/ITA/MAC/OLAC ANNE DRISCOLL
DEPT PASS TREASURY LUYEN TRAN

SENSITIVE
SIPDIS

E.O. 12958:N/A
TAGS: EFIN ECON EINV BR

SUBJECT: BRAZIL: TREASURY DAS O'NEILL MEETS WITH GOB AND MDBs ON
INFRASTRUCTURE AND OTHER ISSUES

SENSITIVE BUT UNCLASSIFIED - PROTECT ACCORDINGLY


1. (SBU) Summary: Treasury Deputy Assistant Secretary Brian O'Neill
had economic meetings in Brasilia on December 12-13, 2007 with
officials from the Brazilian Central Bank, Ministry of Finance,
Ministry of Planning, as well as the World Bank and the
Inter-American Development Bank. The meetings focused on the recent
abolishment by the Brazilian Senate of the 10-year-old "Contribuicao
Provisoria sobre a Movimentacao ou Transmissao de Valores e de
Creditos e Direitos de Natureza Financeira" (CPMF - a tax on
financial transactions); sovereign wealth funds; and continuing
development and infrastructure challenges faced by the country. DAS
O'Neill's visit was in conjunction with the Economic Partnership
Dialogue reported septel. End Summary.

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Central Bank
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2. (SBU) DAS O'Neill, accompanied by Treasury Attache Bill Block and
Brasilia Econoff, met with officials of the Central Bank to discuss
general economic trends in the country, the demise of the CPMF, and
whether or not Brazil would be implementing sovereign wealth funds.
The Central Bank interlocutors (Marcio Barreira de Ayrosa Moreira,
Head of the International Reserves Operations Department; Ariosto
Revoredo de Carvalho, Deputy Head of the Department; Daniela Silva
Pires, Chief of Division of the External Debt and International
Relations Department; and Luiz Sampaio Malan, Advisor to the latter
Department) expressed optimism about future growth and development
of Brazil's economy, including Brazil's emerging investment sector.
They did not think the CPMF's expiration would have much impact on
or hinder Brazil's growth, and also did not feel that sovereign
wealth funds were going to be a factor in the country's growth and
development. Central Bank officials stated that they had no
information about the possible establishment of a sovereign wealth
fund other than what they have read and heard publicly. Few if any
discussions have taken place between the Finance Ministry and
Central Bank about key issues, such as initial financing or asset
allocations, involved in establishing such a fund.


3. (SBU) Separately, Central Bank officials stated that they believe
long-term currency diversification of Central Bank foreign reserves
made financial sense. Although the U.S. dollar will continue to
play a dominant role in foreign reserve assets, its share is likely
to decline in the future. Central Bank officials also stated that
they are watching developments in the U.S. sub-prime market very
closely. While sub-prime developments have increased risks to
Brazil's economy, Brazil's base case outlook for 2008 remains that
of continued strong growth and a rising, though well-contained, rate
of inflation.

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Brazilian Treasury Expresses Optimism . . .
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4. (SBU) O'Neill then met with Luiz Eduardo Melin, now Secretary of
International Relations of the Ministry of Fazenda (Brazil's
Treasury equivalent). Melin downplayed any potential impact of the
CPMF vote, saying that the fiscal accounts would remain strong and
investment growth should increase in 2008. Melin cited two factors
that would help to offset foregone CPMF revenue: (1)
higher-than-expected revenue-to-GDP elasticity that is expected to
continue in 2008 (and which will help to boost federal revenues),
and (2) a modest reduction in the rate of health care spending.
That said, he said the CPMF not being renewed would mean cuts in the
areas of social benefits and that the GOB would be unable to develop
as quickly as desired in such areas as public health and education.
"Approximately half of what we lose with the CPMF will be regained,"
Melin said, and indicated that eventually he thinks the GOB will end
up in precisely the same position as before, primarily due to what
he characterized as the enormous relatively recent increase in
private investments. Melin stated that the Senate's rejection of
the CPMF renewal was politically motivated, and that the opposition
of some senators was motivated by a desire "to score a political
point against President Lula."


5. (SBU) DAS O'Neill indicated to Melin that Treasury would like to
be helpful with regard to infrastructure assistance. As O'Neill
pointed out, Treasury's view is that in Brazil, the challenges are
more micro rather than macro; that is to say, identifying the
projects and securing the financing are less problematic than the
ongoing execution, logistics, and regulatory impediments. Once
those challenges are overcome, projects should successfully progress

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from conception to implementation. Melin offered that Brazil "has
had a hard time dealing with the fact that you can't monkey around
and mismanage public finance," characterizing this as not just a
federal government problem but a state government issue over the
past 20 years. Nevertheless, he said that both institutionally and
culturally Brazil is getting back on track to support the idea of
growth, with much better expectations for the next year and beyond.
Melin stated that Brazil has lost a substantial amount of its
technical capacity to implement large infrastructure projects since
the 1990's, and that it has taken longer than expected to rebuild
this capacity. However, he believes Brazil's ministries are now
well-positioned to launch projects on a much more accelerated time
frame, and that a substantial increase in infrastructure investment
will begin to be seen starting in 2008.


6. (SBU) Melin said Brazil will host workshops at the upcoming 2008
meeting of the G-20 on 1) competition and financial markets (the
OECD will attend and will possibly be a presenter); 2) climate
change from the perspective of finance ministers and central banks,
which he characterized as a planned "very focused" workshop in
London; and 3) the role of fiscal space in promoting growth and
development, a workshop at which he expects some countries will
share experiences. Melin said Brazil will talk about their
experience leaving infrastructure by the wayside for too long;
success and "not-so-success" stories will be presented as well,
although he thought the meeting would "not be so best-practices
oriented as the OECD." Regarding the Tropical Forest Conservation
Act debt swap initiative (TFCA),Treasury officials stated that
Treasury expects to complete its internal review of Brazil's TFCA
request soon, and that a letter addressed to Finance Minister
Mantega indicating approval was likely within the next 30 days.

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. . . But the World Bank is Less Optimistic
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7. (SBU)DAS O'Neill, Treasury Attache Block and Econoff also met
with John Briscoe, Country Director for the World Bank in Brasilia,
who provided a pessimistic view of the current state and future of
infrastructure development in Brazil. Briscoe said virtually no
planning pipeline exists in Brazil, and that "capacity planning and
process at the government level has almost disappeared." He stated
that efforts by outsiders to accelerate infrastructure investment in
Brazil by "fixing Brazil's government" will never work. Instead, he
recommended working more selectively and closely with state
governments who are, in his view, more capable and dedicated to
implementation of infrastructure projects.



8. (SBU) Briscoe said Minister Dilma Rousseff (chief of staff to
President Lula in the Casa Civil),in a recent meeting with the head
of the World Bank's International Finance Corporation (IFC),flatly
stated that she "no longer believes in PPPs" (public-private
partnerships). In Briscoe's view, this lack of confidence from the
top leadership, combined with tensions among ministries (for
example, Finance and Transportation),makes federal projects very
difficult to implement. Briscoe used the example of the Rio Madeira
hydroelectric project, saying it is needed and would benefit Bolivia
as well as Brazil, but bureaucratic and regulatory challenges have
drastically delayed the project's implementation. Due to
difficulties working at the federal level, the World Bank in Brazil
works primarily with state-level partners with the hope of
eventually working up to success at the federal level. Separately,
Briscoe asked that the U.S. Treasury do what it could to limit USAID
funding for certain, in his view, allegedly "not well-intentioned"
NGO groups (not specifically mentioned by name) in the Amazon
region. He stated that the World Bank has attempted to work
constructively with NGOs in achieving developmental and
environmental goals in that region and had worked effectively with
many.

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IDB Receptive Regarding Infrastructure Cooperation
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9. (SBU) Jose Luis Lupo, head of the IDB Brazil mission, noted his
office is developing the Brazil country strategy paper and, after
talking to Brazilian business and government sources, he predicts
that Brazil is not going to take advantage of its positive macro
environment to put tax reform, labor reform or other reforms in
place. IDB believes Brazilian reforms will be indefinitely
postponed for political reasons. Lupo also felt the PAC was
problematic - Brazil has money, but not the expertise to develop

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programs and projects. IDB can offer technical assistance loans to
prepare programs. IDB could help Brazil invest in projects,
particularly, given its regional expertise, in cross-border PAC
initiatives. Lupo noted that IDB enjoys an almost zero percent
default rate on its loans, while BNDES has a high default rate and
is constrained in cross-border project participation (since BNDES
can only fund Brazilian parts). While the high-speed Rio/Sao Paulo
rail project is the only PAC initiative IDB is currently working on
with the government, IDB has requested Brazil provide its top five
priority PAC projects where the country would like IDB help (no
response yet, per Lupo). Lupo noted that energy, followed by
transportation, were the top regional infrastructure priorities.


10. (SBU) Lupo noted Dilma Rousseff said in a recent meeting that
Brazil would proceed with the Madeira project, but without planned
IDB participation. The government was prepared to handle local NGO
opposition, but felt IDB participation would draw international NGOs
the government did not want to face. In that same meeting with IDB
and BNDES, when BNDES reported a planned 2008 allocation of 4.5 bn
reais for public-private partnerships, Dilma reportedly said the
government now believes PPPs do not work and would not do any more;
future projects would be either all-private, all-public or
concessions. Lupo noted that previously, Brazil was the only IDB
country that would not accept funding for feasibility studies, based
on resistance to outsiders' advice, but the government seemed more
receptive in the current environment to working with World Bank and
IDB, provided the cooperation was not too public. He attributed this
development to government realization that PAC was only going to
succeed if the private sector were willing to participate and the
private sector would only participate if the bottlenecks and redtape
were eliminated. Like World Bank, IDB strategy has been to work at
the state level with hopes to build more productive cooperation at
the federal level over time.


11. (SBU) COMMENT: DAS O'Neill's visit was a productive opportunity
to advance development of an infrastructure initiative. The
similarity in substance, if not tone, of the IDB and World Bank
meetings was striking. Lack of technical expertise in project
planning and implementation in the sectoral ministries clearly needs
to be addressed. Addressing over-bureaucratization and
unpredictability at the federal level, among other factors, will
also be important in attracting private sector foreign investment in
infrastructure. END COMMENT.

This message includes input and clearance from Treasury Attache
based in Sao Paulo.

SOBEL