WEEKAHEAD-Iraq war clouds seen hanging over emerging debt

www.forbes.com Reuters, 02.02.03, 5:51 PM ET By Susan Schneider

NEW YORK, Feb 2 (Reuters) - Emerging sovereign debt is set for a mixed and troubled week as investors await fresh signals from the United States on the timing of a possible military strike against Iraq, as well as clues to how much international support the nation may have if it goes to war.

Brazil may provide a ray of hope in the midst of the war worries with the government's release of a 2003 primary budget surplus target, widely expected to rise from the 2002 goal, but analysts said the key events would unfold on the geopolitical front.

A key focus for investors will be U.S. Secretary of State Colin Powell's visit to the United Nations Security Council on Wednesday, when he has said he will provide evidence that Iraq possesses banned weapons.

"The reaction of global financial markets (to the global environment) will set the tone for emerging markets, and in particular for Brazil," which is vulnerable to increased risk aversion among investors because of its reliance on capital flows, said Graham Stock, head of sovereign strategy for Latin America at J.P. Morgan.

The Iraq uncertainty has sunk U.S. equities and battered the dollar in recent weeks as investors worry a protracted conflict would pummel an already tepid U.S. economy. The feeble U.S. markets have also weighed on Latin America's currencies and sovereign bonds, erasing a piece of an early January rally inspired by optimism for Brazil's new president and fresh, turn-of-the-year funds.

"The sooner the war happens and is over, the better for the market," said Ricardo Amorim, head of Latin American research at research firm IDEAGlobal. "What can scare the market is if there is any kind of sign after a war starts that it may take longer" than expected.

Another piece of the war puzzle is the magnitude of international support. Investors will be looking for clues that the United States can convince a deeply divided Europe to join an Iraqi mission since it would improve the chances of a shorter war. So far, a number of countries say there is insufficient evidence to justify an attack on Iraq.

"The stronger the coalition, the more likely it is that the war is going to be fast," said Amorim.

Within emerging markets themselves, Brazil is set to be the key focus. Finance Minister Antonio Palocci is widely expected to peg the primary surplus goal above last year's goal of 3.75 percent of gross domestic product, a move that would cement confidence by showing rookie President Luiz Inacio Lula da Silva is sincere about bolstering Brazil's financial health.

"They've suggested it will be between 4.2 percent and 4.5 percent (of GDP), so we would expect it to come in that range," said Stock. "If it comes in toward the bottom end of that range there's room for some disappointment, but that doesn't mean that the final result at the end of the year won't be stronger," Stock added. "What we've seen in the last few years is the government outperforming these targets."

MIXED VIEW OF VENEZUELA Venezuela remains on investors' radars as they look for signs of a resolution to a two-month strike waged by foes of resident Hugo Chavez, said analysts.

The shutdown has strangled oil production, once the source of half the government's revenues, and fueled investor fears the cash-strapped Chavez administration may not have the cash to pay its debts.

But even though oil workers are maintaining their protest, Chavez's use of replacement crews has helped recover some of Venezuela's oil output, allaying such fears. Some restaurants, stores and businesses have also rolled back their participation in the strike in a bid to avert bankruptcy.

While the strike's easing spells good news for Venezuela's finances, it carries a negative note for investors hoping Chavez would be forced from office. The loss of strike momentum suggests Chavez, whose anti-free market sentiment has not made him popular on Wall Strike, is likely to remain firmly in power for the medium-term, said analysts.

On Sunday, Chavez declared victory over the strike while the opposition turned out to sign a petition for early elections.