With his stunning victory in Sunday's second round of Brazil's presidential elections, Luiz Inacio Lula da Silva ("Lula") has finally achieved his goal after four attempts. Written off at the campaign's start as an eternal loser, Lula confounded his critics by running a professional campaign to garner support from across the political spectrum.
Here he was helped by the lackluster efforts of his main opponent, Jose Serra, who failed to build on the substantial achievements of outgoing President Fernando Henrique Cardoso. In a country stained by social injustice and the most unequal distribution of income in the world, Lula's victory is an astounding achievement in view of his humble origins and trade-union background.
ILLUSTATION: MOUNTAIN PEOPLE
Governing, however, will not be easier than winning office. Lula's Workers' Party (PT) is in the minority in both houses of congress. His natural allies elsewhere on the left cannot provide a majority. The PT, however, is both the largest party in the lower house and the most disciplined.
That discipline matters because governing Brazil has always been about building coalitions. Lula will face a similar situation to that which confronted President Cardoso, whose Social Democratic Party (PSDB) managed over the course of eight years to push through legislation on the basis of party coalitions that looked highly unstable to outsiders. His control of his party should help him reach the necessary compromises he will need to make with other parties in order to govern effectively.
More troubling for Lula is Brazil's economic condition. Hit hard by the US recession, sluggish growth in Europe, Argentina's collapse, low commodity prices, and protectionist barriers against farm products, steel and textiles, Brazil's economy will do well to grow 2 percent this year. Unemployment is rising and inflows of foreign direct investment have fallen. Although Brazil is running a large trade surplus, this has more to do with cutbacks in imports than export growth.
But the darkest shadow is the threat of a default on the country's US$260 billion debt. Despite prudent fiscal policies and a primary surplus target (i.e. before interest payments) of 3.75 percent, Brazil's debt has continued to grow and for several months has been difficult -- if not impossible -- to refinance.
Brazilian debt now trades at half its face value, which implies a high probability of default. Furthermore, the 40 percent decline in the exchange rate this year and recent increases in the overnight (SELIC) interest rate to 21 percent aggravate the situation, because much of the debt is either linked to the currency or to the SELIC rate.
For once, the IMF cannot be accused of inaction. To avoid contagion from Argentina's financial crisis, the IMF agreed a US$30 billion package with Brazil in August designed to stabilize markets and avoid the need for the Central Bank to exhaust Brazil's reserves defending the currency. Much of this money still needs to be disbursed. So far it has failed to achieve its purpose and Brazil is remains poised on a knife-edge.
What can Lula do? He only takes office in the New Year, but the markets will be watching to see how he responds before then. The choice of his economic team is crucial, because he plans to replace the respected finance minister, Pedro Malan, and the governor of the Central Bank, Arminio Fraga. Giving more independence to the Central Bank would be well received in the markets, as otherwise they will fear Lula will succumb to the temptation to inflate the country's way out of difficulties.
The acid test will come from Lula's approach to fiscal policy. If his administration increases the fiscal surplus through expenditure cuts or new taxes, this may reassure international capital markets. Such actions, however, fly in the face of everything Lula has always stood for and what his supporters demand. They may form the least bad option if he does not want Brazil to go the way of Argentina.
Argentina's collapse (its GDP will drop by around 12 percent this year) is a terrible warning of what can happen if Lula takes a wrong step. In Brazil's case there is a further reason for avoiding default: the country's debt is owed mainly to Brazilians so that the losers in any default would not only be foreign creditors, but Brazilian banks, insurance companies and other financial institutions, putting the entire financial system at risk of collapse.
Whatever happens to the debt, Brazil's democracy won big in this election. At a time when voter apathy and corruption are commonplace across Latin America, Brazilians demonstrated that politics can be relevant and exciting. Moreover, Lula's margin of victory suggests that Brazil's elite has become reconciled to the idea of a left-wing president, even if foreign investors remain troubled.
If Lula survives his economic baptism of fire, he will soon need to turn attention to the controversial issue of hemispheric integration. Armed with Trade Promotion Authority (TPA), the Bush administration is keen to push ahead with the Free Trade Area of the Americas (FTAA). Lula is sceptical that the FTAA can serve Brazil's interests and would prefer to boost MERCOSUL, the customs union linking Brazil with its neighbors.
But contagion from Argentina's crisis has undermined MERCOSUL and Argentina's commitment to the regional project cannot be assured after next year's presidential elections in that country. Balancing regional and hemispheric integration will likely be the second harsh test Lula will face.
Victor Bulmer-Thomas, a specialist in Latin American economics, is director of the Royal Institute for International Affairs in London.
Copyright: Project Syndicate
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