Industry News

[July 20, 2006]

Brazil risk: Political stability risk

(RiskWire Via Thomson Dialog NewsEdge) COUNTRY BRIEFING


RISK RATINGSCurrentCurrentPreviousPreviousRatingScoreRatingScoreOverall assessmentC48C47Political stability riskB25B25Note: E=most risky; 100=most risky.SUMMARY

The smooth transition to a new government led by a left-wing Workers Party (PT) president in 2002 was a landmark in the consolidation of Brazil's democracy. The adoption by the administration of the president, Luiz Inacio Lula da Silva, of moderate policies, means that there is now no credible policy challenge from the left. A corruption crisis has intensified the discredit of politicians, but political institutions have not been challenged. The executive's power is predominant but is counterbalanced by a strong legislature. Governments in the past decade have expanded trade and other ties within Latin America and with the rest of the world. Brazil generally has good relations with its neighbours and trading partners and plays a leading role in conflict resolution in the region. It will strive to maintain harmonious relations with the US while pursuing Brazil's interests in the field of trade, including with governments in conflict with Washington (such as the administration of Hugo Chavez in Venezuela).


A second da Silva administration takes a populist turn (Low Risk)

The president, Luiz Inacio Lula da Silva, is on track to win re-election to a second term in October, provided no new corruption scandals emerge. However, his mandate will be substantially weaker than during his first term. Our central assumption is that a weakened mandate will be reflected chiefly in the pace, rather than the direction, of policy. It is assumed that reforms needed to improve the business environment and promote more dynamic growth, such as tax reform, strengthening of regulatory agencies and (to a lesser extent) labour market reform, will continue to figure among the government's priorities. However, there is a risk that a second da Silva administration could take a populist turn. Such a risk would increase if Geraldo Alckmin, the main opposition challenger, were to pose a substantial threat to Mr da Silva's re-election. Such a scenario would require a sharp rise in voter support for Mr Alckmin from its currently low level (around 15 to 20 points behind Mr da Silva). This seems unlikely at the moment, but the last two months of the campaign (August and September) will be decisive. Assuming Mr da Silva does win reelection, at best he will be able to rally support in Congress from the centrist PMDB, which is a deeply divided party and will hardly support an ambitious reform agenda. At worst, Mr da Silva will turn his second mandate into an exercise of personal leadership, addressing the masses and paying less attention to Congress and reforms. This would usher in a Brazilian version of populism. More current public spending on civil servant wages and handouts may be coupled with fiscal discipline (with the same targets for primary budget surpluses), but at the expense of reforming the failing social security, health and education systems. As a result, public spending in modernising infrastructure will continue to suffer. This would erode private investors confidence, which would adopt a cautious wait and see attitude.

The government reduces opportunities for foreign business (Moderate Risk)

The da Silva government and its successor are expected to maintain orthodox fiscal and monetary policies. Market pressures make it hazardous to deviate from this path. However, in the microeconomic sphere, the government's policies have sometimes been less orthodox. The PT is not in favour of sales of federal assets, and is under pressure to retain political discretion in the regulation of concessions and public-private partnerships. This could limit the opportunities for foreign business and slow investment in infrastructure. As the October 2006 legislative and presidential elections approach, there is likely to be an increase in political pressure from Brazilian industrialists and trade unions to raise tariff and non-tariff barriers to protect Brazilian industries and jobs. This pressure will intensify if employment growth flags. Although the government has generally tried to resist such pressure, there is a rising possibility of some concessions, such as an increased bias towards Brazilian firms in government procurement contracts. Businesses could improve their prospects by joining the effort to argue the economic case for openness and reduced interventionism with political leaders.


(Background material is updated twice yearly. Last update: March 2nd, 2006)

Political Forces

Luiz Inacio Lula da Silva took over the presidency after securing a landslide victory in the October 2002 election. Mr da Silva leads a political alliance, the core of which comprises his left-wing Partido dos Trabalhadores (PT). The PT's closest allies within Congress are the Partido Socialista Brasileiro (PSB) and the Partido Comunista do Brasil (PCdoB) on the left, and the Partido Trabalhista Brasileiro (PTB) and Partido Liberal (PL) on the right. The centrist Partido Movimento Democratico Brasileiro (PMDB), the right-wing Partido Progressista (PP) and centre-left Partido Democratico Trabalhista (PDT), Partido Popular Socialista (PPS) and Partido Verde (PV), have all been part of the coalition, but had withdrawn by July 2005. Under the constitution, Mr da Silva presides over an executive that is subject to scrutiny by a bicameral Congress composed of elected deputies and senators. The executive is also held to account by a Supreme Court composed of senior members of the federal judiciary. Mr da Silva's term commenced on January 1st 2003 and will expire at the end of 2006.

Multitude of parties makes for unstable coalitions

The political system is notable for the fragmented nature of parties and the efforts that governments must make to forge and to maintain workable congressional coalitions. The PT has a minority in both houses of Congress and relies on a broad range of other parties, not only from the centre-left, but also from the right and far left. However, support from other parties is unreliable. During 2003 the government secured the backing of the elements of the centrist PMDB, providing an important improvement in its position in the Senate. However, by the end of 2004 the PMDB had officially left the coalition (although a large faction continued to work with the ruling coalition), and the PT had also lost the support of some small centre-left parties, including the PPS and PDT.

Despite Mr da Silva's strong personal mandate and authority within the PT, his position has been challenged within the party. The PT, which is in power for the first time, traces its origins to trade union struggles against the military regime in the 1970s and early 1980s. It constitutes a broad political church, embracing individuals whose views range from traditional socialist to more modern social-democrat. Mr da Silva himself has undergone a political transformation. Born into a poor family, he worked as a lathe operator before coming to prominence as a radical union leader. Having lost the previous three presidential elections, he moderated his stance in the 2002 election, taking the PT to the centre. Part of the modern social-democratic wing of the PT, Mr da Silva now espouses a range of pragmatic economic and social policies and accepts that the market and the private sector have an important role to play in the development of Brazil.

These views are not universally accepted within the PT. At the end of 2003 the government demonstrated its determination to carry through its agenda by expelling from the PT those of its legislators who had voted against the social security reform, but there remain strong left-wing factions within the PT. It is possible that he influence of these groups may increase following the July 2005 resignation of the party's president, Jose Genoino, in response to corruption allegations. Mr Genoino was identified with the party's moderate faction; left-wingers are seeking to ensure that his replacement is more critical of the leadership.

The main opposition parties are the PSDB and the PFL, a conservative party that originated in the north-east. The PSDB supported the PT in Congress on legislation that was in line with its own reform agenda, such as social security reform, despite its members' irritation that the PT voted against these measures in opposition. Worried that the PT will usurp its position as the leading party on the centre-left, the PSDB has sought to highlight shortcomings in the PT's record on social policy. A more vigorous opposition is likely to emerge if Mr da Silva's popularity were to diminish. At present, a PSDB candidate remains the most likely rival for the presidency in the October 2006 election. Neither the PMDB nor the PFL have produced candidates who have come close to victory in the presidential race in recent years, so both are likely to enter alliances. The PFL is expected to line up with the PSDB, as in 2002, but it is less clear whether the PMDB will choose to align itself with the PT.

The media

Outside Congress, the media, and television in particular, play a significant role in forming public opinion. Since the advent of democracy investigative journalism has played a decisive role in politics, notably in the impeachment of Mr Collor in 1992. Elements of the broadcast media have not been well-disposed towards either Mr da Silva or his party in the past. Although relations improved following Mr da Silva's victory in the 2002 election, they soured as he entered the second half of his term, with the press reporting a series of corruption allegations.

Trade unions, business and the landless

Mr da Silva draws support from another important extra-congressional political constituency, the trade union movement. The largest union organisation, the Central Unica dos Trabalhadores, has a long history of supporting the PT, and this position is unlikely to change. Employers have argued that Brazil's high level of employment protection for formal-sector employees hampers employment creation, and some reforms have been proposed, but the unions are generally opposed to the introduction of new labour legislation. Objections to proposed trade union reforms, which aim to remove the last vestiges of the old corporatist system of government control of trade unions, are more muted. The proposals would end mandatory union contributions and the monopoly system of union representation and establish independent conciliation services. The Movimento dos Trabalhadores Rurais Sem Terra (MST, the Landless Rural Workers' Movement) has also traditionally been closely aligned with the PT. It had curtailed direct actions using land invasions during the election campaign to help the PT to win over moderate voters, but has since stepped up direct action again in support of its demands for land distribution.

Business organisations, notably the Confederacao Nacional das Industrias and the Federacao das Industrias do Estado de Sao Paulo, have traditionally opposed the PT's policy platform, but the change in the party's stance once it gained power relieved tensions. The business groups have worked productively alongside the government on proposals to streamline tax and administrative procedures, although they have become increasingly critical since the government passed the middle of its term. They have objected to the government's tight monetary policy stance and called for a reduction in the corporate tax burden.

Main political figures

Luiz Inacio Lula da Silva: Having risen through the trade union movement, Luiz Inacio Lula da Silva was elected Brazil's first left-wing president in the October 2002 election. He promised to pursue social justice and to improve opportunities for the poor, while maintaining an orthodox economic policy framework. As proof of his moderation, he formed a cabinet holding broadly centrist political views. So far, investors have been encouraged by his ability to maintain strict economic policy orthodoxy, but his traditional supporters have been disappointed with his record on improving conditions for the poor, and alienated by recent corruption scandals implicating some of his close associates.

Jose Alencar: The vice-president, Jose Alencar, is head of one of Brazil's most successful textile manufacturers. He embarked late on a political career, joining the centre-right Partido Liberal. Mr da Silva adopted Mr Alencar as his running mate in 2002 to demonstrate the moderation of his political ideas and to draw on his business experience.

Antonio Palocci: A standard-bearer for the moderate wing of the Partido dos Trabalhadores (PT), Mr Palocci is a close ally of the president. His conduct as minister of finance has been well received by the markets, with his reputation for prudence and pragmatism enhanced by the government's disciplined fiscal stance.

Guido Mantega: Guido Mantega has been one of the PT's leading economic thinkers for many years. A professor at the prestigious Getulio Vargas Business School in Sao Paulo, he first served in Mr da Silva's government in the central role of minister of planning, and in November 2004 he was moved to head the Banco Nacional de Desinvolvimento Economico e Social (BNDES, the state development bank).

Luiz Fernando Furlan: Like Mr Alencar, Luiz Furlan established his reputation in industry. As a former head of one of Brazil's leading food processors and exporters, Sadia, he has brought to his post as Minister for Development, Industry and Commerce his wide business experience, in particular in export sales.

Celso Amorim: Formerly Minister of foreign Affairs under Itamar Franco and more recently Brazil's ambassador to the UK, Mr Amorim has no ties to the PT. His appointment as foreign affairs minister for a second time demonstrated the extent to which the new government valued experience over ideological conviction.

Fernando Henrique Cardoso: In 1998 Mr Cardoso became the first ever president to serve a second term. His place in history as the architect of Brazil's economic transformation since 1994 is assured, despite his poor second term. As the dominant figure in the Partido da Social Democracia Brasileira (PSDB) he continues to play a major role in politics. There remains speculation that he might stand for re-election in the 2006 presidential contest.

Henrique de Campos Meirelles: The governor of the Banco Central do Brasil (the central bank) is a former senior international banker. Having chosen to pursue a political career, Henrique de Campos Meirelles was elected as a PSDB congressman in 2002. As central bank governor he has pushed for its operational independence and maintained the inflation targeting policy framework. He survived a July 2005 cabinet reshuffle despite the shadow of ongoing judicial investigations into alleged tax evasion.

Political Development

In 2002 fiscal austerity, low growth and a lacklustre campaign took their toll on the prospects of the presidential candidate of the Partido da Social Democracia Brasileira (PSDB), Jose Serra, Mr Cardoso's favoured successor, and Mr da Silva, the candidate of the left-wing PT, took full advantage. Having learned the lessons of the three previous presidential elections, which he had contested and lost, Mr da Silva ran an effective campaign, shifting his PT platform to the centre and capitalising on his party's successful record of running large cities such as Sao Paulo, thereby dispelling fears among the public that the PT would mismanage the economy. Having almost won outright in the first round of the presidential poll on October 6th, Mr da Silva defeated Mr Serra by a wide margin in a run-off on October 27th, gaining 61.3% of the vote. It was a historic victory for the PT, which became Brazil's first left-wing government. In its first year, the new administration exceeded expectations in terms of macroeconomic management. Mr da Silva's orthodox finance minister, Antonio Palocci, affirmed his commitment to the IMF agreement signed by Mr Cardoso. Stringent fiscal targets were surpassed and congressional approval was secured for social security and tax reforms. The new governor of the central bank, Henrique de Campos Meirelles, aggressively raised interest rates during the first half of 2003, enabling him to bring inflationary pressures under control.

The government's tight policy stance had costs in terms of output and employment. An easing of monetary policy in the second half of 2003, combined with a strengthening world economy, helped to produce a return to growth in 2004, but the recovery was dampened by further monetary tightening in 2005. Adherence to orthodox macroeconomic policies created tensions within the PT. The party's leaders took a hard line, expelling from the party legislators who voted against the government on social security reform, but the level of disillusionment has grown, both within the party and among voters who had hoped for more progress on social reform and welfare policies. Although the da Silva administration has made inroads into reducing poverty and unemployment has declined, the levels of both remain high. Until mid-2005 Mr da Silva's popularity remained high despite these disappointments, and his political authority was intact. However, a series of corruption scandals that have implicated his associates threaten his reputation. Part of the PT's distinctiveness has been its fierce criticism of political clientelism, bribery and the misuse of public funds and offices, but in the past 18 months there has been a series of highly damaging allegations of illegal campaign financing, the bribery of representatives of other parties to vote with the PT, and political use of public appointments. These allegations, initiated by investigations by the press, have led to the resignation of some of Mr da Silva's closest advisers. There have been suggestions by some members of the opposition that impeachment proceedings should be initiated against Mr da Silva, but at the time of writing in late August 2005 there seemed to be little appetite for such a move, which would paralyse government and risk damaging the economy.

Important recent events

August 2002: The finance minister, Fernando Henrique Cardoso, signs a new 15-month US$30.4bn stand-by agreement with the IMF in order to allay turbulence in financial markets related to the October general election.

October 2002: Luiz Inacio Lula da Silva easily defeats Jose Serra in the second round of the presidential election.

January 2003: Mr da Silva takes office on January 1st as Brazil's first left-wing president, promising orthodox economic policies and major social reforms.

December 2003: Pensions reform and a tax reform receive final approval by Congress. The IMF approves a US$14.8bn new stand-by credit. The Partido Democratico Trabalhista (PDT) leaves the government coalition.

February 2004: First major scandal about campaign financing weakens the president's chief of staff, Jose Dirceu.

October 2004: The Partido dos Trabalhadores (PT) suffers disappointments in municipal elections in major cities, including Sao Paulo and Porto Alegre, where the PT mayors lose their seats.

November 2004: Reform of the judiciary approved by Senate.

December 2004: The Partido Popular Socialista (PPS) and Movimento Democratico Brasileiro (PMDB) officially leave the government coalition.

February 2005: The government's candidate loses the presidency of the Chamber of Deputies to Severino Cavalcanti, a Partido Progressista (PP) backbencher.

June-July 2005: A series of corruption allegations results in the resignation of major players in the PT, including the chief of staff, Jose Dirceu, and the party's president, Jose Genoino.

International Relations and Defence

A regional giant

As a large federative republic, Brazil has traditionally looked inward, both economically and politically. This stance changed under the leadership of Mr Cardoso, however, under whom the opening up of the economy encouraged a more active role for Brazilian diplomacy, raising the country's international profile. Brazil has been waging a long-standing campaign to become a permanent member of the UN Security Council (alongside three other countries also seeking a permanent seat, India, Germany and Japan). In trade negotiations, the country has also adopted an assertive stance. At the fifth ministerial conference of the World Trade Organisation (WTO) at Cancun, Mexico, in September 2003 Brazil assumed the leadership of a new group of developing countries (initially known as the G22, later the G20) that refused to make concessions to the OECD on the "Singapore issues"--concerning rules of government procurement, investment and competition--unless the OECD cut protectionism, particularly in agriculture. This new assertiveness has changed the nature of multilateral trade negotiations, slowing further liberalisation to the pace achievable through reforms of protection and subsidies within the richer countries.

Within the South American region, Brazil has fostered closer relations with its neighbours since the 1990s. The creation of the Mercado Comum do Sul (Mercosul, the Southern Cone customs union, also known as Mercosur) in 1991 was intended to strengthen economic and political links with Argentina, Paraguay and Uruguay, but persistent trade tensions with Argentina have slowed moves towards regional integration. After a period of strain in 1999-2002, when its members were hit by a series of economic crises, Mercosul appeared to face a more favourable climate with the election of Mr da Silva in Brazil and Nestor Kirchner in Argentina. Both presidents are on the centre-left and claim to be committed to re-invigorating the bloc; however, sectoral interests have re-emerged on both sides.

Brazil is sceptical about the benefits of the US-initiated proposal for a Free-Trade Area of the Americas (FTAA) unless the US makes concessions on farm subsidies and import restrictions on goods such as steel and orange juice. It also wants to negotiate the FTAA as a member of Mercosul rather than bilaterally, and is seeking to impose a gradualist and restrictive approach to trade integration. The differences between the Brazilian and US positions meant that it was not possible to reach agreement by the scheduled completion date of the end of 2004, and the future of the FTAA is in doubt.

The role of the armed forces diminishes

Brazil's armed forces are the largest in the region. In 2004 membership totalled 189,000, of whom 40,000 were conscripts. The 2004 defence budget totalled R27.9bn (US$9.2bn; 2.6% of GDP, down from 3% in 2002). The armed forces' role has diminished since the restoration of democracy, although high-ranking military personnel retain some political influence. During the Cardoso government the minister of internal security, General Alberto Cardoso, was effective in pressing plans for a unified security directorate under the ultimate control of the president.

Brazil maintains good diplomatic relations with its neighbours, and the army's main concern abroad is that violence associated with the drugs trade in Colombia does not spill over into its border to Brazil. Brazilian forces (a total of 1,100 troops) are also currently leading, and providing the core units for the UN Peacekeeping Mission to Haiti, known as Minustah. This contribution was offered shortly after an armed revolt forced the president of Haiti, Jean-Bertrand Aristide, to flee in February 2004. The arrival of the Brazilian-led UN force enabled the US to withdraw its forces, which had temporarily been deployed in Haiti following the departure of Mr Aristide.

There are serious deficiencies in law enforcement. The division of the police force into so-called military and civil branches, responsible respectively for patrolling and investigating crimes, creates inefficiency and, along with low wages, promotes corruption. The government is considering legislation to merge the two forces. The judiciary is slow to act, and the legal system is cumbersome. In an attempt to reduce crime the previous government launched an ambitious national security scheme in 2000, promising extra money, but this scheme did little to improve public security.

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