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### Viewing cable 04BRASILIA2711, BRAZIL AND THE IMF: IS THE DANCE OVER?

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
04BRASILIA2711 | 2004-10-28 15:41 | 2011-07-11 00:00 | CONFIDENTIAL | Embassy Brasilia

`

    This record is a partial extract of the original cable. The full text of the original cable is not available.

` `

    C O N F I D E N T I A L SECTION 01 OF 03 BRASILIA 002711

    SIPDIS

    TREASURY FOR OASIA - DAS LEE AND FPARODI
    NSC FOR DEMPSEY
    STATE FOR EB/IFD/OMA - MOSS
    STATE PASS FED BOARD OF GOVERNORS FOR ROBITAILLE
    USDOC FOR 3134/USFCS/OIO/EOLSON/DDEVITO
    USDOC FOR 4332/ITA/MAC/WH/OLAC/DMCDOUGALL/ADRISCOLL
    USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSON/WBASTIAN

    E.O. 12958: DECL: 10/26/2014
    TAGS: EFIN ECON EINV PGOV PREL BR
    SUBJECT: BRAZIL AND THE IMF: IS THE DANCE OVER?

    REF: A. BRASILIA 2447

         ¶B. BRASILIA 2051

    Classified By: Economic Counselor Bruce Williamson, Reasons 1.4 (b) and
     (d).

    ¶1. (SBU) Summary:  The GOB economic braintrust is currently
    debating whether to follow up Brazil's current precautionary
    IMF Standby Agreement (SBA) when it expires in March 2005
    with another IMF program.  Based on the country's
    fundamentals, there appears to be little need for a follow-on
    program, as all expectations are that Brazil will not require
    balance-of-payments (BOP) support in 2005.  Many private
    analysts believe that the financial markets would look even
    more favorably upon Brazil if it were to graduate from IMF
    tutelage and maintain its responsible macroeconomic policies.
     But, with the memory of contagion from the Asian and Russian
    financial crises still fresh, not to mention the 2002 crisis
    of confidence sparked by Lula's election, the GoB would like
    some form of insurance against unexpected shocks.  It has
    been pushing for IMF creation of a new contingency line of
    credit.  Brazil, however, has not convinced a majority of the
    IMF Board to support the idea.  Absent such a line of credit
    and given the positive economic outlook, the GoB seems
    disinclined to seek a follow-on SBA or other formal IMF
    monitoring for 2005.  While the GoB would face a political
    conundrum should economic winds shift and force it to seek a
    Fund program in the election year of 2006, Lula's proven
    economic pragmatism suggests he would bite the bullet in that
    eventuality.  End Summary.

    Little Economic Rationale
    -------------------------

    ¶2. (SBU) Visiting Regional Treasury Representative and Emboff
    discussed the GoB's dance with the IMF over a follow-on to
    Brazil's current, precautionary, exceptional-access SBA
    during a series of conversations October 8-15 with government
    officials, private sector representatives, and IMF Resident
    Representative Max Alier (please protect).  Central Bank
    director for Economic Policy Afonso Bevilaqua pointed out
    that, judged solely on the economic merits, there is little
    case for a follow-on agreement.  Even using the Central
    Bank's conservative estimates, Brazil in 2005 should enjoy
    another BoP surplus, of about $10 billion.  (Note: private
    sector estimates are as high as $15 billion.)  This strong
    expected performance undermines the traditional BOP-support
    rationale for an IMF program.  Bevilaqua further argued that
    Brazil would build more market confidence by "graduating"
    from its IMF agreement while continuing to pursue responsible
    economic policies.

    Potential Benefits of Graduation
    --------------------------------

    ¶3. (SBU) The private sector, according to Nilson Teixeira of
    CSFB, has already adjusted to the reality of the Lula
    government's responsible policy agenda.  Given the lack of
    need for BOP support, he judged an IMF program "irrelevant."
    Banco Pactual's Guilherme Bacha, by contrast, felt that
    graduating from the IMF program and continuing the same
    policies would significantly reduce Brazil's country risk.
    Bacha nevertheless did not expect that the market would react
    negatively to negotiation of a new program.  Former Central
    Bank President Arminio Fraga, now with Gavea Investments,
    likewise argued that Brazil would gain more in the market's
    eyes from pursuing responsible policies without IMF tutelage.

    GoB Wants Insurance
    -------------------

    ¶4. (SBU) While the GoB,s official line is that there is no
    need to decide about a follow-on program before March 2005,
    when the current program expires, the GoB appears to be
    weighing two alternatives: either no program (so-called
    graduation) or a new type of contingent facility.   For the
    GOB, ideally, a new contingent line for "good performers"
    would combine large, automatic access to IMF resources in a
    crisis with minimal conditionality.  Finance Ministry
    International Secretary Luiz Pereira observed that a new line
    of credit for countries with good policy records would
    mitigate risks of contagion and other external shocks,
    although such a facility would need a decent level of
    automatically-available resources to be credible with the
    market.  He believed the negotiation of an SBA would be too
    slow in a crisis, and that this made the case for a facility
    that granted quick access, followed up by renewed IMF
    monitoring once it was activated.  Pereira acknowledged it
    might be tricky to get the level of eligibility criteria
    right:  too little risked moral hazard, while too much risked
    a repetition of the experience of the now-defunct Contingency
    Credit Line (CCL), which was never used.  Pereira claimed
    "sympathy" from France and Russia for Brazil's position that
    this sort of facility should be part of the international
    financial architecture.  He further stated there would be
    "little demand" for a policy-monitoring program that did not
    carry access to fund resources, implying the GoB would opt
    for no program at all absent the creation of a new contingent
    line.  Treasury Secretary Levy added that the latest proposal
    from IMF staff outlining how such a new line of credit would
    work was not what the GoB had envisioned and unlikely to
    prove effective.

    ¶5. (U) Underlying Pereira's comments is Brazil's experience
    with international financial markets since 1998, when
    contagion from the Asian financial crisis forced it to seek
    an IMF SBA.  Brazil has been on SBAs since then, and these
    facilities have helped it deal with financial turmoil after
    the Russian financial crisis and the 2002 crisis of
    confidence sparked by uncertainty over the policy course that
    then-probable presidential election winner Lula da Silva
    would implement.  The $30 billion 2002 SBA was the IMF's
    single largest program, and granted Brazil exceptional access
    to IMF financing.  (Note: Exceptional access carries an
    expectation of more intensive post-program monitoring.)

    ResRep: GoB Bluffing
    --------------------

    ¶6. (C) IMF ResRep Alier called the GoB's
    new-facility-or-nothing position a "bluff."  The GoB's real
    problem, he argued, is how to deal with the possibility that
    economic circumstances would require it to seek IMF financing
    during the election year of 2006.  It would be politically
    problematic for the Lula administration to "kiss the Fund
    good-bye" in 2005 and then be forced to seek an IMF program
    in 2006.  The GoB, he said, is still weighing that potential
    political loss against the (less theoretical) gains of
    graduating from the current SBA in 2005.  Alier argued that
    in the absence of an IMF program, the GoB should take the
    step of releasing the IMF staff reports generated during
    routine monitoring visits next year as a way to reassure the
    markets.  The GoB has always elected to keep IMF staff
    reports confidential.

    ¶7. (C) Addressing the specifics of Brazil's arguments for a
    new contingent line with high levels of automatic access,
    Alier stated that the Lula Administration financial team,
    while tough negotiators, always fulfilled their commitments.
    This made their case for a new line of credit with large,
    automatic access to IMF resources more credible.  From the
    institutional point of view, however, it made little sense
    for the Fund to create a new facility tailored to the current
    reality of one IMF client.  Moreover, he added, there was no
    guarantee that future GoBs would be as reliable as the
    current one.

    Comment
    -------

    ¶8. (C) The politics of a follow-on program are doubtless more
    complex than the economics.  It seems a bit hasty, however,
    to dismiss the GoB's current all-or-nothing position on a
    follow-on IMF program as a bluff.  Given the low probability
    that the IMF Board will create a new contingent facility per
    the GoB,s wishes, the GoB's real choices are between
    graduation, a follow-on, precautionary SBA or a
    staff-monitored program.  This last option is unpalatable as
    it combines all of the political drawbacks of formal IMF
    policy monitoring with a complete lack of access to IMF
    financing.  With regard to an SBA, the GoB has little to gain
    with the markets at this juncture for signing on to a program
    unwarranted by the economic realities.  It would further face
    the downside of potentially being lumped in with
    poor-performing countries that require prolonged access to
    Fund resources.  That leaves graduation as the GoB's most
    likely choice, and with it the opportunity for the GoB to
    better establish its policy credentials with the market.
    Many in the market are also of the view that Brazil has an
    implicit contingency line from the IMF, as long as it pursues
    its current policy mix.  Alier has a point that the GoB would
    pay a political price for graduating in 2005 if a reversal of
    economic fortunes forced it to seek another IMF program in
    2006, when Lula would be running for reelection.  But, Lula's
    pragmatism and consistent willingness to make tough economic
    decisions and justify them with the electorate mitigates this
    concern.

    DANILOVICH

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