Cablegate: Brazil and the Imf: Is the Dance Over?

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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