Doomsayers predicted financial meltdown when a left-wing candidate won the Brazilian presidency. So far, they are wrong.
The tentative honeymoon between the Brazilian government and the international financial community should last at least through the year’s first half as global investors gauge the newly elected administration’s commitment to the financial high road.
The key issues under the watchful eyes of financial experts include the creation of a monetary responsibility law to insure the central bank’s independence, social security reform and the restructuring of a complex and distorted tax system. Bankers and investors at home and abroad are also monitoring how the government deals with an inflation rate that has crept into double digits, as well as the fiscal targets that the government of Luiz Inacio da Silva (Lula) unveils in a preliminary budget proposal due in April.
How these issues are dealt with will indicate the new administration’s dedication to solving the Latin nation’s financial woes—and whether the rhetoric that has calmed the markets so far will translate into reality.“I think the honeymoon period with the markets will continue for the next nine months,” says Jose Maria Barrionuevo, director of emerging market strategies at Barclays Capital in New York.“As long as the issues are on the table and the government is advancing these issues, the markets will work with them,” he adds.
Experts have lauded the new administration for its initial steps in setting the economy straight since Lula assumed the presidency on January 1 after being elected on the leftist Workers’Party ticket last fall.After making all the right noises after the election to soothe domestic and global investors’ fears about a left-wing administration, the Lula government continues to move in the right direction—from agreeing to the terms of an International Monetary Fund program put in place by the previous administration, to creating a social and economic development council. The council, scheduled to hold its first meeting in February, is meant to collect input from all members of society, including business, labor and nongovernmental organizations. Observers of the Brazilian economy are also encouraged that the administration has set up the beginning of a working coalition in Congress that incorporates Lula’s Workers’ Party at its core.
“Lula’s popularity has increased, and a recent poll shows he has the support of 80% of the population.They expect their living standard to improve, but not immediately... maybe within the next two years,” says Flavio Castelo Branco, chief economist at the Brazilian Confederation of Industry in Rio Janeiro.“I think his popularity will continue through the second half of the year.”
A vital indicator of the government’s dedication to economic stability will be whether it moves ahead on the creation of a monetary responsibility law that will give the central bank formal limited autonomy. A prerequisite to such a law is a constitutional amendment, which has already passed the Brazilian Senate but still needs the stamp of the Chamber of Deputies.
While the central banks of most developed countries have autonomy, the central banks of many developing countries, such as Brazil, do not. Investors will be happier when they know Brazil’s monetary policy will remain free of the whims of elected officials intent on political gain. “If they give the central bank autonomy, then the markets will give them more time on the other reforms,” says Barclays Capital’s Barrionuevo.
Investors also will be watching in April as the government releases its 2004 budget guidelines document to see what fiscal targets the government has decided to meet next year.“It’s the first important macroeconomic document that the Lula government will be proposing,”says Paulo Vieira da Cunha, senior vice president and senior Latin American economist for Lehman Brothers in New York. “It’s an important test that is coming up on the economic side this spring.”Congress must approve the budget guidelines document by the middle of this year. The administration will then submit a 2004 budget to Congress in September.
One of the more complicated reforms that Lula needs to push through is the restructuring of a skewed tax system. Experts say the distortions— which hurt the competitiveness of businesses both at home and abroad—range from cumulative taxes raised on a company’s total sales even if it registered no profits for the tax year, to provisions that give advantages to importers at the expense of exporters.
Any simplification of the cumbersome tax system must also deal with how revenues are distributed to the country’s 27 states—a reform that will undoubtedly face strident opposition from many state officials and their constituents. Tax reform has languished in Congress for at least the past half-dozen years. “To eliminate the distortions implies changes in where the revenues are going, and that opens a can of worms,” says Lisa Schineller, associate director in the sovereign group at Standard & Poor’s in New York.
Another reform that the financial markets are seeking is the revamping of the South American nation’s troubled social security system. The pay-as-you-go system is contributing to the country’s deficit as its revenues remain insufficient to meet its obligations. In addition, the 4 million to 5 million workers in the public sector are receiving much more generous benefits than the 20 million workers in the private sector. “The Cardoso administration [previous Brazilian President Fernando Henrique Cardoso] tried to reform it,” says Schineller, who is also the S&P’s primary analyst for Brazil,“but it’s a politically contentious and difficult reform.”
And financial markets are looking at how the government is going to bring down a rising inflation rate, which has climbed from some 7% to around 12% over the past year.
In February the central bank hiked interest rates twice to curb inflation, despite the pain high rates are causing the economy.
Lehman’s Vieira da Cunha adds that many of the reforms the market is looking for are not new and have been kicking around Congress for many years. “The question is,Will he [Lula] have the curse of Cardoso and do the right things but not get the benefit of it?” he says. “They seem to manage public opinion much better.”
One positive sign in the current economy is that the value of the Brazilian real, which declined against the US dollar by about 40% in 2002, has moved upward by around 10% since the beginning of the year.The country also registered a healthy trade surplus of $13.1 billion in 2002 as exports totaled $60.4 billion and imports tallied $47.2 billion,according to Castelo Branco of the Brazilian Confederation of Industry. The government expects the trade surplus to increase to $15 billion for 2003.
“I’m moderately optimistic.The fears and instability of last year were not good for business and investment, but most of those fears did not materialize,” says Castelo Branco. “So far, the administration has been talking about a sound and solid economic policy.We have to see if they stay true in practice and it’s not just talk. It’s a long journey.”
Paula L. Green