Brazil: "Sovereign Wealth Fund" aka "fiscal savings fund"

UNCLAS SECTION 01 OF 03 BRASILIA 000793 SENSITIVE SIPDIS STATE PASS USTR FOR DUCKWORTH TREASURY FOR OASIA HOEK AND TRAN USDOC FOR 4332/ITA/MAC/WH/OLAC/ADRISCOLL E.0. 12958: N/A TAGS: EFIN ECON EINV BR SUBJECT: Brazil: "Sovereign Wealth Fund" aka "fiscal savings fund" aka "investment fund" Refs: a) Sao Paulo 53 b) Sao Paulo 264 (SBU)1. SUMMARY: Despite its name, GOB interlocutors from Finance, Planning and Central Bank agree that Finance Minister Mantega's proposal for a "sovereign wealth fund" could more accurately be described as an "investment fund" or a "fiscal savings fund" of about 10 to 20 bn usd. Planning and Central Bank interlocutors appear considerably more relaxed regarding the current formulation of the planned proposal to establish this fund than they were regarding previous iterations (reftels). While Finance hopes President Lula will forward a legislative proposal to congress in June, exact timing remains unclear. Mantega's June 8 press statements that the fund could draw on oil revenues in three to five years to create a 200-300 bn usd fund does not take into account that these fields are not expected to generate revenue in this timeframe and would likely if eventually formally proposed encounter Central Bank and congressional opposition. END SUMMARY (SBU) 2. Alexandre da Rosa, Secretary for International Affairs at Planning Ministry, told Treasury DAS Brian O'Neill June 2 that the current government concept is more accurately described as a "fiscal fund," a countercyclical instrument. Demand is heating in Brazil and the government needs to reduce its own spending as a component of that demand. Da Rosa stated that this leads to the idea that a fund that can absorb excess dollars would be helpful. Da Rosa indicated that Singapore had come to Brazil and explained its sovereign wealth fund, and that Finance had discussed sovereign wealth fund structures with relevant Gulf states. Da Rosa underlined that reserves were off the table as a funding source for the fund, and that Brazil hoped to increase the primary surplus target by 0.5% of GDP (or about usd 13 billion/year) to fund this mechanism. He acknowledged that how the resources would be used remains undefined - one possibility would be to use the funds to buy down BNDES (the National Development Bank of Brazil) debt. (SBU) 3. In a separate meeting, Alvaro Vereda Oliveira, Finance Ministry Assistant Secretary for Financial Organizations and Regional Integration, noted Brazil is dealing with an issue that would have been inconceivable twenty years ago - how to deal with an excess of dollars coming into its economy. Vereda noted that the structural evolution of Brazil in international trade has financial consequences and this is the real rationale for the "sovereign wealth fund" - it is a structural tool to deal with this situation. (SBU) 4. In a meeting with SFRC Senior Professional Staff Member Carl Meacham on June 4, Deputy Secretary of the Finance Ministry's National Treasury, Cleber Ubiratan de Oliveira noted that while the primary surplus target is 3.8%, as of end-April the surplus was 4.23% (allowing the GOB to estimate that 0.5% of GDP would be available to stock the fund). Describing the fund as a "key public policy alternative fund" given the positive fiscal environment, Ubiratan explained the GOB would like to propose expanding the primary surplus to 4.5% and use these receipts to expand the fund. Responding to Meecham's question, Ubiratan noted that, while Petrobras currently contributes about 35% of the primary surplus, recent finds (that will take years to exploit) are not expected to dramatically affect Petrobras' contributions in the short-term and do not figure particularly into the rationale behind proposing a sovereign wealth fund. He stated Brazil was unique in that the rationale for a sovereign wealth fund was not based on commodity revenues, but on its robust reserves and good fiscal position, and therefore was not comparable to other countries SWFs. Ubiratan characterized the fund as a "fiscal savings fund" using primary surplus funds that can be invested on more favorable terms with more profitable returns than reserves can generate. He asserted the National Treasury would manage the fund through a financial institution, but acknowledged that no regulations or operating procedures had been drafted or "appropriate structure and apparatus" decided yet. Ubiratan said the fund's investment policy was not decided yet but that BNDES would probably "be involved." Visibly nervous answering questions, Ubiratan claimed that all signs indicated the Congress would pass the proposal (other interlocutors were more realistic). Finance confirmed the proposal was expected to go forward as a legislative proposal rather than as a "provisional measure." ¶5. (SBU) Alexandre Tombini, the Central Bank's Deputy Governor for Financial System Regulation and Organization, told Treasury DAS O'Neill that the Central Bank buying reserves (around 200 bn usd at present) helps "soften" the effects of the floating exchange rate, BRASILIA 00000793 002 OF 003 and no major foreign exchange shocks are foreseen for 2008. He considered the Finance Ministry announcement proposing to request an increase in the primary surplus target would have a positive effect in controlling exchange rates. He believed that the Finance Minister's proposal "as it is now" is fine from the Central Bank's perspective. Noting this is a "fiscal fund" or an "investment fund" rather than a classic "sovereign wealth fund" proposal, Tombini felt the fund might help Brazil control demand if funds were invested abroad, although it would be costly as a demand management tool. (SBU) 6. In a separate discussion with econoff June 4, Alexandre Pundek, senior Advisor to the Central Bank board, noted Mantega had wanted the fund as a tool to control the foreign exchange rate - to help FIESP and to provide additional funding for BNDES beyond the FAT (the workers' fund that is the primary revenue source for BNDES). He said Central Bank at this point is not worried about Mantega's fund and feels more comfortable supporting the proposal because: 1) the level of the 2009/2010 primary surplus is set in the 2008 budget law and Finance can not change at this point - they set 0.5 percent of GDP as the funding target because they can not raise more now; 2) Mantega envisions between ten billion and twenty billion usd going to this fund. From Central Bank's perspective, the Finance-controlled fund would only be an important player if the fund were bigger than the Central-Bank managed reserves (200 bn usd) - otherwise, any foreign exchange intervention Finance attempts could be immediately countered by Central Bank reserve activity if necessary; and 3) any attempt to raise the primary surplus above the current 3.8 percent in order to fund the mechanism is highly unlikely to survive Congress. In an election year, Congress will not agree to a proposal that decreases public spending at a time they want to fund programs popular with the electorate. He added that Central Bank head Meirelles thinks the fund is a good proposal in the sense that it would prevent the government from spending at even higher levels now that in-coming revenues are higher. (SBU) 7. Officials at Brazil's National Treasury (Otavio Ladeira, Director of Public Debt Strategic Management, and Lena Oliveira, Director of Research) strongly defended the establishment of the Wealth Fund in a meeting with the Treasury Financial Attache on June ¶3. They stated that the Fund's overriding purpose was to provide the Finance Ministry with room to intervene in Brazil's foreign exchange market, helping to manage appreciation of the Brazilian real. However, they do not believe this objective will conflict with the Brazilian Central Bank's mandate to target inflation at 4.5%. A secondary purpose of the Fund is to help finance large Brazilian export firms via BNDES credit lines and BNDES purchases of debt issued by these firms. The firms that will receive this support will be selected by an intra-governmental committee that will include the Finance Ministry, Planning Ministry, Ministry of Industry and development, and BNDES. Participation by the Central Bank is uncertain. The Fund will initially be financed by fiscal resources. Ladeira, however, stated that it is possible the Fund will borrow in the future to help increase the size of its asset base. Assets will consist of foreign currency instruments. Details about the specific instruments that might be purchased, however, remains under internal discussion. (SBU) 8. COMMENT: While variously presented as a tool to cut government spending as a factor in heating demand and as a way to maximize return on government investment, GOB interlocutors clearly view this fund as a tool to manage foreign exchange rates. Although the timing for putting any legislative proposal forward remains unclear (Mantega has said publicly the proposal could go forward by mid-June),the sovereign wealth fund is likely to meet with congressional opposition, both for inserting Finance Ministry into monetary policy and because it would decrease government spending in an election year. Meanwhile, Senator Renato Casagrande (PSB - government alliance) announced May 29 that, when the Government forwards its proposal to the House for its consideration, the Senate will begin to simultaneously consider the SWF proposal he drafted in February which proposes that if Brazil's international reserves pass ten percent of GNP, the amount over that ten percent should be used to establish a fund that would invest in the international market to obtain returns higher than US Treasury bonds. The government proposal is expected to rely on primary surplus funds to buy dollars, without recourse to reserves. Behind the scenes negotiations among Ministries and with the Central Bank appear to be moving GOB toward a proposal that satisfies both Mantega's desire for a central role and Central Bank's ultimate control over monetary policy. Mantega's statements to the press June 8 that the fund will start small but in three to five years be able to draw on new oil field revenues to provide a fund of 200 to 300 billion usd is BRASILIA 00000793 003 OF 003 not realistic given these fields are not expected to begin producing in this timeframe. Any proposal to expand the fund to that size in the future would likely encounter renewed Central Bank opposition and experience difficulty in the congress. END COMMENT. This message was drafted with input from FinAtt Sao Paulo. SOBEL