Analysis: Brazil's debt still huge problem

www.upi.com By Bradley Brooks UPI Business Correspondent From the Business & Economics Desk Published 1/27/2003 6:00 PM

RIO DE JANEIRO, Brazil, Jan. 27 (UPI) -- It was an innocuous moment of protest, but in some regards it may foreshadow Brazil's battles in the coming years.

Jose Genoino, the president of the ruling Workers Party, was on the business end of a strawberry-and-whipped-cream pie hurled his way by three activists during a news conference this weekend at the World Social Forum in southern Brazil.

The event was mostly comedic -- the protesters claimed to be representing "Confectioners Without Borders" -- but if external shocks coupled with even a few governing gaffes occur, it may not be the last time Brazil's new government ends up with pie on its face.

Unquestionably, the mood in Brazil and for market watchers outside of the country is bullish.

But local economists who are better informed about looming internal struggles for Brazil's new President Luiz Inacio Lula da Silva are expressing caution that the country -- saddled with its $240 billion of debt -- may not be out of the woods just yet.

"Lula isn't representing the people at (the World Economic Forum in) Davos," yelled the young lady who tossed the pie toward Genoino.

A political statement as blasé as they come.

Yet it is a peep of domestic protest that could turn into a dull roar as Lula approaches an explosive battle on the home front, that of pension reform.

Streamlining the country's money-draining pension system is of utmost importance if Brazil is to remain solvent, especially if a war in Iraq and events in Venezuela continue to send strong external shocks toward the nation.

"You can break down the analysis of the debt path between short and long run," said Gustavo Reis, an economist with the Rio de Janeiro-based investment bank Pactual.

In the short run, Reis said, the government's promise unveiled this weekend at the World Economic Forum of a primary budget surplus -- excluding interest payments -- of 4 percent of gross domestic product may keep the total debt from rising, if the local currency stabilizes.

But there are two key external issues -- war in Iraq and the political uncertainty in oil-producing Venezuela -- that are playing havoc with Brazil's currency, the real, which fell 0.3 percent to 3.63 Monday, a fall of more than 35 percent in the past 13 months.

"Every 10 percent of foreign exchange devaluation means an additional 2 percentage points to the debt-to-GDP ratio," Reis said, noting that that was not taking into account any other factors that might inflate debt.

Economists expect the government to announce this week that debt now accounts for 56 percent of GDP.

"Over the short run, the government is able to trim down expenses a bit and control the debt if the exchange rate devalues at a reasonable pace," Reis said.

"The real problem seems to be with investors' uncertainty about the ... persistence of the current fiscal adjustment into the future."

That is why it is of utmost importance for Lula and the Workers Party to push through reforms to the country's pension system -- whose deficit was about 3 percent of GDP in 2002.

Brazil watchers are following developments on pension reform closely, as it has become a bellwether for whether Lula and his economic team will have the political backing -- or the resolve on austerity -- to push it through.

When it was in the opposition, the Workers Party repeatedly blocked former President Fernando Henrique Cardoso's attempts at pension reform.

Suddenly shifting 180 degrees on the issue, though, means Lula will have to battle against civil servants -- key constituents in his election -- and public unions.

This may very well fracture Brazil's left and further complicate Lula's job of building a coherent coalition government that will be able to push anything through a Congress made up of 18 political parties.

"I think in one year, all these people who voted for Lula will be trying to push him out," said a top economist with Brazil's central bank who requested anonymity.

"We are not out of the game yet, but we are losing."

The economist, who expressed deep pessimism about the paralyzing political standoffs that Brazil may see in the coming years, said he isn't convinced about the new government's real appetite for fiscal reforms and austerity.

"For 20 years, Lula is anti-United States and anti-free market, and suddenly in the last three months, he has changed? I don't know if I believe it," the official said.

That pessimism aside, Lula has come a long way during his first four weeks in office when it comes to winning over the international political and business communities.

"We're encouraged by the economic leadership that President Lula and his new economic team have already shown," said John Taylor, undersecretary for foreign affairs at the U.S. Treasury, while speaking to the Brazil-U.S. Business Council on Monday in Washington.

"There are many reasons to be hopeful about Brazil."

Taylor did note that Lula would have to build legislative coalitions to push through reform, but he sounded a touch more optimistic than local Brazilian economists on the topic.

"The atmosphere of cooperation that dominated President Lula's inauguration speech can provide comfort in this regard," Taylor said.

Which, clearly, is what the U.S government needs to be saying at this point -- unless it wants to see another default in Latin American, one that would dwarf Argentina's.

But for those closely tracking Brazil's fiscal health, there is no room for comfort on the debt question just yet.