Analysts are on the lookout for events or circumstances that might blemish the favorable image that Brazil currently enjoys in foreign credit markets. The performance of the economy in 2004 was better than most had anticipated a year ago.  Record exports and the consequent trade surplus enabled the country to reduce its current account deficit. 

A smaller portion of debt is denominated in dollars and unemployment has leveled off. Inflation seems under control and the general feeling is one of restrained optimism for 2005. Lula has turned out to be much more reasonable than was expected in the run up to the presidential election in 2002.

His strong support for the conventional fiscal and monetary policies carried out by the Finance Minister and central bank president has enhanced his credibility abroad and among conservative elements locally.

Congress, in a rare display of civic responsibility, has approved the PPP (Partnership between the Public and Private sectors) legislation, which could eventually result in improvement of Brazil’s creaking infrastructure such as ports, highways and railways.

This is a fairly complex concept that envisions investments on the part of private investors who will be guaranteed a “fair” return that will be supplemented by government subsidies should the projects not be economically viable on their own.

In my opinion, it will be difficult to attract true investors other than contractors, interested in creating work for themselves, and the pension funds of big government owned entities such as Banco Central, Petrobras, Banco do Brasil, Caixa Econômica Federal (Federal Savings Bank), Eletrobrás and others.

I hope I am wrong since improvements are direly needed if the country is to be competitive in world markets.  The willingness on the part of the federal government, controlled by Lula’s PT (Workers Party), to recognize that they do not have the means to make these investments and to allow “private” participation is commendable given that many in the government are against the privatization of anything.

Excessive taxation, archaic labor laws and sky-high real interest rates act as impediments to economic growth.  Although some progress has been made in modernizing the judicial system, it will take a long time to reform old habits.  Bureaucracy and an excess of unnecessary formality at all levels of government are suffocating. 

Tax reform has gone nowhere during the first two years of Lula’s reign. The cost for businesses to accompany the even changing rules is enormous.  Few efforts to cut down on waste, inefficiency, and nepotism at the federal level are in evidence.

But this is nothing new.  Lula and his people are no worse than his predecessors in this respect.  For the first time in many years, a special session of Congress was not held during the January and February vacation period. 

This has saved taxpayers money by not rewarding legislators for showing up now and then in Brasília to collect their extra pay.  I do not know if this was deliberate or an accident.  But it is a positive sign.

With Carnaval behind us, Brazil is coming to life.  Congress has reconvened and has elected the leaders of the Senate and Chamber of Deputies.  The choice of the PT dominated government for the lower house, São Paulo deputy Eduardo Greenhalgh, was not elected to the post. 

This defeat could be interpreted as the inability of Lula’s people to control the legislative branch. In my opinion, politics could get messy and eventually erode foreign confidence in Brazil, if observers watch things closely.  The next few months should be interesting.

Inflation continues to be a concern of central bank and treasury authorities.  They argue that raising interest rates and perhaps increasing the bank’s reserve requirements in order to make credit less abundant and more expensive are the best tools control inflation.  So far the PT government has made little progress in reducing its spending. 

Bloated payrolls, the continuing deficit in paying pensions and interest payments account for the deficit that must be financed. Government debt grows each month. While real interest rates of over 12% a year keep the bankers happy, the interest on government debt contributes to its deficit and is a cause of inflation.

Back to Progressive Ideas

With an apparent loss of cohesiveness within the ruling party and its allies, as illustrated by the defeat of Greenhalgh, the PT and Lula may revert to more “progressive” ideas.  The moderation displayed during the first two years of Lula’s term does not seem to have made him popular with the politicians. 

The clamor for a less restrictive monetary policy has picked up steam.  The proposal for granting the central bank autonomy, something that was promised to the IMF and others, is gathering dust in someone’s desk drawer in Brasília and is not likely to be presented to Congress in the near future.

With new money flowing in from abroad in the form of loans and portfolio investment, there exists the temptation on the part of the government not to renew the current agreement with the IMF, which expires in March. 

Finance Minister Antônio Palocci and Central Bank president Henrique Meirelles seem to change their opinion on this subject, which so far has not become an issue that has attracted much attention, frequently. 

Brazil would like the IMF to alter the calculation of the primary deficit or surplus to exclude funds invested in projects that are now counted as expenses.  I seriously doubt if the IMF will agree to this scheme that would in theory allow more “investment” while still remaining within the promised figure for primary surplus as a percentage of GNP.

In order to appeal to the more radical elements of the PT and the fragmented alliance that in theory controls congress, Brazil may decide to go it alone without the IMF.  If this happens, it may affect its image in investment and credit circles abroad. 

Also should the government attempt to maintain a conservative monetary stance, it would not have the IMF to blame if the agreement is allowed to expire.

The real has strengthened to less than R$ 2.60 to the dollar.  How long can this last without hampering exports and reducing the current account surplus?  Traders may start asking themselves these questions and others as 2005 unfolds. 

With the legislative branch apt to be paralyzed for the near term future, except to grant themselves exurbanite increases in salaries and benefits, and the PT dominated government doing nothing except raise taxes and increase government expenditures without benefiting the populace, discontent may grow causing more confusion in the heads of those currently in leadership positions.  Some of this may eventually be perceived abroad.

Richard Edward Hayes first came to Brazil in 1964 as an employee of Chase Manhattan Bank. Since then, Hayes has worked directly and as an advisor for a number of Brazilian and international banks and companies. Currently he is a free lance consultant and can be contacted at 192louvre@uol.com.br.

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