Lula's reforms stand a real chance if foreign creditors keep calm

www.guardian.co.uk Sue Branford Monday January 13, 2003 The Guardian

Will the international financial community give Lula a chance? There is no doubt that Brazil's new left-leaning president is passionately committed to social reform.

As he repeatedly said in his electoral campaign, it is a national scandal that 9m families are going hungry in this vast country, almost the size of the United States. The Workers' Party would love to turn its back on neo-liberalism, as free market economics is called in Latin America, and introduce expansionist policies with an emphasis on economic growth, full employment and wealth redistribution.

Nothing would please it more than to develop the domestic market of 175m people, which has been stagnant for years because the poor have lacked the jobs and the income to be good consumers.

Yet the new government faces a predicament. Under the outgoing administration headed by Fernando Henrique Cardoso, Brazil adopted the familiar package of IMF policies: cuts in state spending, privatisation of state companies, deregulation, and so on.

At first the policies seemed to be working. Foreign investment poured in, growing eightfold between 1995 and 2000, but it did not deliver the promised high rates of economic growth. The abundance of dollars led to an appreciation in the value of the local currency, the real. With exports priced out of the market, Brazil began to suffer heavy trade deficits which the government had to cover by borrowing heavily at home and abroad.

Throughout the 1990s the country was hit by a series of external shocks. Each time government was able to restore confidence only by raising interest rates, which further depressed the economy and made it more expensive to service the internal and foreign debts. In August last year it seemed that Brazil would follow its neighbour Argentina into default but the IMF, fearful of the international repercussions, came up with its largest loan to date, of $30bn.

This loan, most of which is yet to be disbursed, is creating problems for the new government. Among its strict conditions, the IMF is demanding a budget surplus of at least 3.75% this year. If the government agrees, it can wave goodbye to reactivating the economy this year and shatter the hopes of millions of poor Brazilians. As financier George Soros has pointed out, the power of the "market" to determine Brazil's economic policy amounts to a serious infringement of the country's democratic rights.

Even though he confesses that the state of the economy is extremely serious, Lula believes there is a way out of the conundrum. He says that on the macroeconomic front Brazil must respect existing budget constraints for one or two difficult transitional years. Rather than spending more, the government will have to make progress by rooting out corruption and reallocating existing resources.

After consulting military chiefs, Lula has cancelled an order for military aircraft and said the armed forces will play a greater role in tackling social problems such as distribution of food to starving families, rather than preparing for anunlikely war with a neighbour. As his first act in office, the transport minister has frozen highway construction to allow time to review the transport needs of the poorer sectors.

Along with the economic caution, Lula has been radical on the social front. The environment minister, Marina da Silva, who was born into a family of poor rubber-tappers deep in the Amazon forest, has brought many of Brazil's most active environmentalists into her ministry and is preparing new policies for many controversial issues, including the Amazon rain forest.

The education minister, Cristovam Buarque, is a respected leftwing intellectual who is promising a radical overhaul of the country's education system, currently heavily skewed in favour of middle class children. The minister of agrarian reform, Miguel Rossetto, is an ally of the militant landless peasant movement, the MST, and is promising far-reaching agrarian reform.

Can the strategy work? On the plus side are the government's high level of legitimacy, given the enthusiastic backing of the population, and a slight easing of the external constraints because of the better than expected trade surplus, $13bn in 2002. On the down side is Brazil's heavy dependence on foreign money.

Although the markets have reacted calmly to Lula's first fortnight in office, few expect this to last. If the government's radical social reforms begin to alarm foreign creditors, millions of dollars could again start haemorrhaging out of the country. Lula will be faced with the stark choice that he wishes to avoid: back-pedal on the reforms and disappoint millions of poor Brazilians, or impose capital controls and provoke the ire of foreign creditors.

Lula's conciliatory approach deserves a chance. Latin America is seething with discontent after 20 years of free market economic policies that have failed to deliver prosperity or social reform. If Lula fails, Latin America faces a bleak and violent future.

· Sue Branford has co-authored Politics Transformed: Lula and the Workers' Party in Brazil, to be published this month by Latin America Bureau, London