Bello -Dilma changes course

Nov 29th 2014 Economist

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The appointment of a capable economic team is good for Brazil but signals its president’s weakness

IN 2005 a debate raged between the two most powerful figures in President Luiz Inácio Lula da Silva’s government. Antonio Palocci, the finance minister, proposed taking advantage of faster economic growth to eliminate Brazil’s persistent fiscal deficit—and thus lower its exorbitant interest rates—by capping the increase in federal spending. But Dilma Rousseff, Lula’s chief of staff, thought Mr Palocci’s plan rudimentary and blocked it. Ms Rousseff became Lula’s successor as Brazil’s president in 2011, implementing a “new economic model” that placed full employment and wage increases ahead of macroeconomic rigour.

Fiscal laxity has come back to haunt Ms Rousseff, who won a second term last month by the narrowest of margins. As we went to press she was due to announce that Joaquim Levy, one of Mr Palocci’s deputies in 2005, will become her new finance minister. Nelson Barbosa, the most capable economist in the ruling Workers’ Party (PT), will get the planning ministry. Mr Levy is a Chicago-trained economist who has been running a big asset manager; his presumptive appointment has been welcomed by investors. It seems that Ms Rousseff has at last tacitly accepted the error of her economic ways.

She won the election by pointing to Brazil’s full employment and continuing increase in real incomes. But these achievements were bought by mortgaging the future. Despite mediocre growth, most of Brazil’s economic indicators have moved in the wrong direction under Ms Rousseff. Inflation is over 6%, well above the Central Bank’s target of 4.5%, even though the government held down energy prices. Consumer confidence is at a six-year low. The current-account deficit has widened to 3.7% of GDP and the real has been weakening.

The biggest worry is that the fiscal position has deteriorated by 3-4% of GDP in the past three years. Having missed by a mile its target for a primary surplus (before interest payments) of 1.6% of GDP and thus violated the Fiscal Responsibility Law, the government was this week cynically persuading Congress to change the rules so as to pretend that it had met it. Rating agencies are muttering that if Brazil carries on like this it will lose its investment-grade credit rating.

So the new team’s first task is to restore credibility to economic policy. That means restating Brazil’s commitment to its pre-2010 “tripod”—of independent monetary policy, fiscal responsibility and a floating exchange rate. It also means tightening the budget. In order to minimise the impact on jobs, Mr Barbosa has said this should happen gradually and should focus on reining in a relentless increase in social-security spending.

But how much time will the new team have? Market-watchers expect the Central Bank, whose president, Alexandre Tombini, is bent on showing his independence, to defend the inflation target by raising the benchmark interest rate, which is already at 11.25%. This monetary squeeze will come as fiscal policy turns contractionary and the government curbs rampant lending by state banks. Mr Barbosa’s main job may be to design a crash programme to attract private investment into infrastructure. Even so, growth will fall at first and may not recover for a year or two.

If the new team is to be successful Ms Rousseff will not only have to let them do their job without the meddling of her first term. She will also have to defend an economic programme that will be unpopular in the short run—especially in her own party. Indeed, the programme is closer to that of her defeated opponent, Aécio Neves, than to the one she campaigned on. (Mr Neves likened Mr Levy’s appointment to a senior CIA man taking charge of the KGB.) The president will be supported by a smaller and looser majority in the new Congress than she has been used to. Brazilian legislators are wont to demand pork-barrel spending in exchange for their votes, potentially making the economic team’s job harder.

There is an even darker political cloud on her horizon. Brazilian prosecutors and American regulators are investigating claims that kickbacks worth billions of dollars were funnelled to the PT and allied politicians from contracts placed by Petrobras, the state-run oil company. What makes this so damaging for Ms Rousseff is that she chaired Petrobras’s board during much of the time. That nobody believes she is personally corrupt might not prevent an attempt to impeach her, though that still looks improbable.

No modern Brazilian president has faced a weaker starting point. She has tried to offset that by picking the strongest economic team that Brazilians could reasonably hope for. It is at least a start.