{mosimage}The Brazilian real continues to strengthen against the US dollar, which was recently quoted at its lowest level since 2002. In contrast to a peak of nearly R$ 4.00 to the dollar in the lead up to Lula's election, now fewer than R$ 2.45 will buy a dollar.

The recent bear rally in the dollar against most major currencies has not reached Brazil. The real has appreciated over 20% in relation to the dollar since this time last year.

Amazingly in spite of the unfavorable exchange rate the trade balance continues favorable as exports continue to break records. But some exporters of manufactured goods are beginning to feel the pinch.

Tanneries, manufacturers of shoes, cutlery and automobiles, among others, have been hurt and may soon begin to lay off workers due to fewer export sales. Contracts made in the past when the dollar was close to R$ 3.00 are being honored, causing losses in some cases. 

Commodity exports, thus far, have not been dramatically affected. The lower exchange rate is somewhat compensated by higher prices for many commodities, such as iron ore, and the ability of the large, financially solid companies to obtain low rate pre export financing and then apply the resultant reais in high yield local investments.

It will take some time for this year's lower crop yields to show up in reduced export figures.

It is just a matter of time before cheap imports and dwindling exports might reverse this tendency. Contributing to the strength of the real is the influx of hot money taking advantage of Brazil's extremely high interest rates.

When local interest rate increases cease or are reversed, which is bound to happen before long, we may see these funds depart, especially if the US continues to raise rates to combat inflation. At the moment, yields on Brazilian assets are attractive to speculators, hedge fund managers and brave investors.

Sending Money Home

With a cheap dollar, foreign owned companies that made good profits in 2004 and have cash are stepping up the remittance of profits and dividends and are repaying dollar denominated loans from their head offices or international banks.

Direct foreign investment has slackened due to the exchange rate and the political situation. Therefore we should see a weakening of the real before long.

In most countries, central bank presidents do not have ministerial status. Therefore they may not be nominated or removed at the whim of the politicians.

It is normal that such officials are appointed by the executive branch and approved by the legislature for fixed terms that do not necessarily coincide with changes in government. This in theory gives the monetary authorities autonomy to act immune from political influence.

Central bank autonomy was one of the objectives proclaimed by Lula and was part of the now expired agreement with the IMF. But approval by congress was always doubtful.

To complicate matters, central bank president, Henrique Meirelles was granted ministerial status in an effort to stave off investigations of alleged misbehavior on his part before assuming his present post. This means that central bank autonomy is a dead issue.

Meirelles has been accused of tax evasion, electoral fraud, illegal repatriation of foreign currency and other irregularities. He is now under investigation, a process that is supposed to be concluded within 90 days.

In a normal country, such an important official suspected of such misdemeanors would probably step down until the investigations were concluded.

I find it hard to believe that such an ambitious and fastidious person with further political aspirations, such as Meirelles, would be so careless in his personal affairs as it appears is the case.

One way out for all concerned would be for Meirelles to resign in order to prepare his campaign for the governorship of Goiás, his home state. This could then be viewed as a victory for those opposed to his policy of high interest rates.

A New Central Bank Chief

To keep foreign creditors happy, Murilo Portugal could then be named president of Banco Central. Portugal, a former official at the IFM in Washington, is a conservative, non-political economist and is well respected locally and abroad. 

It may be recalled that Henrique Meirelles, then of the PSDB or "tucanos" that are in opposition to Lula's government, was elected to the Lower House of Congress with the largest vote of any candidate in Goiás.

He resigned his mandate when offered the chance to become president of Banco Central, a post that has given him much more exposure than he would have had in congress.

This move took a fair amount of courage on his part, as no one knew for sure what sort of economic policies Lula would adopt. Several others were offered the job and turned it down before Lula and Meirelles were put together.

Therefore, we should not be surprised if there is a change in the command of the central bank. The investigations are no longer front-page news since more recent scandals and evidence of corruption have taken their place. 

Corruption is very much in the news at present. It is unfair to say that corruption has increased under the rule of the PT. Exposing corruption and attempting to bring perpetrators to justice has increased.

However, at present, the government is fighting tooth and nail to block a joint congressional investigation to probe alleged kickbacks in the procurement process of the postal system.

If this investigation is allowed to take place, it might expand to cover other agencies such as the Brazilian Institute for Reinsurance, a government-controlled monopoly that is accountable to no one, as well as Infraero that administers Brazil's airports.

Lula, foolishly in my opinion, has appointed Finance Minister Antonio Palocci to the task of rounding up support to overthrow the decision of Congress that had signed up sufficient names for an investigation to be started.

The government is using a technicality that will only make them look worse in the eyes of the public that is sick of corruption, excessive taxes that are more that 40% of GNP, and high interest rates.

Palocci should have more important things to do now that economic growth has slowed down. Up until now, Palocci has earned the respect of the business community, even those who do not agree whole-heartedly with some of his policies. But if he is perceived as handing out appropriations in order to gain support for the government, his image will suffer.

It may be a while before the current political turmoil affects markets. Lula and his PT government claim that the CPI (Parliamentary Inquiry Commission) is a ploy of the opposition wishing to discredit those in power in anticipation of the elections in 2006.

The treasury has nearly completely achieved its foreign borrowing requirements for 2005. Only an additional US$ 500 million, in addition to the US$ 6.5 billion already borrowed this year, is needed to enable Brazil to meet its maturing overseas obligations.

So in spite of the antics of the politicians, there should be no crisis of major proportions for a while. Until this investigation issue is resolved one way or another, Lula's credibility and popularity are waning.

One might ask " If the government has nothing to hide, why are they so determined to not let the congressional inquiry happen?"

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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