www.upi.com By Bradley Brooks UPI Business Correspondent From the Business & Economics Desk Published 2/20/2003 6:19 PM

RIO DE JANEIRO, Brazil, Feb. 20 (UPI) -- Less than two months in office, Brazil's new government is beginning to show the strains of trying to push one of the world's largest emerging markets out of the doldrums.

On Thursday, officials close to President Luiz Inacio Lula da Silva were split over the previous day's decision to raise interest rates to 26.5 percent from 25.5 percent.

Some argue that the move will only stifle credit and choke the economy. Others say the hike was needed to help keep inflation at bay.

Adding to the schism, parts of the base of Lula's Workers' Party -- the largest and best-organized leftist party in Latin America -- have been taking to the streets of the capital Brasilia to register their discontent with reforms.

Hundreds of public sector workers -- an integral part of the Workers' Party -- protested in front of the presidential palace on Wednesday.

They voiced opposition to the government's push for pension reforms and a plan to give the central bank more autonomy -- both moves investors are hoping to see passed this year, but which are looking quite unlikely.

Analysts had been optimistic that Lula's entrance into power would help push through reforms to the pension system for public workers.

Many label the pension plan an inefficient scheme that does little more than add to the country's $240 billion debt.

But the problem is reform means taking money out of the recipients' pockets, which is never an easy task for politicians, let alone if it affects their political base.

As for the increased interest rates, Lula's chief of Cabinet on Thursday said they were "incompatible" with economic growth.

"The country cannot survive with these levels of rates," Jose Dirceu told reporters after meeting with Lula on Thursday. "High interest rates and economic growth are incompatible."

Dirceu conceded that the external situation -- a potential war in Iraq -- is keeping inflation at a dangerously high level and making it difficult for the central bank to bring rates down.

"It's a moment of transition. The country needs to halt inflation and prepare itself for a more dangerous internal situation," he said.

But Finance Minister Antonio Palocci stands by the central bank's moves.

Palocci on Thursday discounted the short-term negative effects of high interest rates and the increased reserve requirement for banks -- which jumped from 45 percent to 60 percent.

The government, Palocci said, has been and will continue to take aggressive steps to both dampen inflation and at the same time try to increase investor confidence.

But Dirceu opined that it shouldn't be the job of the central bank to stimulate economic growth.

"It's the government that has to solve the problem of economic growth."

It is tax and pension reforms, as well as some smart funding to production sectors, that will spark a turnaround in Brazil, Dirceu said.

Richard Feinberg, an economist at the University of California, San Diego, and the former president of the Inter-American Dialogue, agrees that high interest rates are needed to battle inflation, but called them a double-edged sword.

The level of interest rates are "brutal," Feinberg said. "They've got to get them down -- that's very critical."

But with 12-month inflation sitting at 14.5 percent in January -- the highest level in six years -- other economists argue that bringing prices down has to be the first priority.

The fallout over Lula's initial economic moves may simply be a signal of healthy and vigorous debate within a party that finds itself in charge of the country for the first time, analysts say.

Or it may be indicative that Lula's base support will leave him, resulting in gridlock and little headway being made in the next four years.

The history of the Workers' Party, though, does tend to point to the sunnier scenario.

Since its founding in February 1980, the party -- made up of far-flung elements of the left and center, each with their own political axes to grind -- has encountered moments of paralyzing internal debate.

The Workers' Party was founded with the notion that democracy should be practiced in the most direct manner possible, with a plethora of voices equaling more political freedom.

The party is structured with several different levels that begin at the grass-roots in nearly every community and lead vertically up to Lula himself. The party hopes this makes it more democratic and responsive.

This at times has led to what is more cacophony than symphony, but as the party's undisputed leader since its inception, Lula has managed to stay mostly above the fray and eventually to push the party in a common direction.

Yet now that the Workers' Party finds itself at the pinnacle of Brazilian politics, many wonder whether the stakes are too high for certain sectors of the organization to acquiesce for the sake of the greater good.

reuters.com Fri February 21, 2003 04:28 PM ET By Axel Bugge

BRASILIA, Brazil (Reuters) - Brazilian President Luiz Inacio Lula da Silva asked powerful state governors on Friday to back key reforms as he opened a new front in his effort to reform public pension and tax systems.

Governors from Brazil's 27 states gathered at a presidential farm outside the capital for the center-left leader's first meeting with them to ensure their voice is also heard on policies that could reshape Brazil's economy.

"The president opened the meeting showing the importance and urgency of the reforms for the country," said a statement from the president's office.

The reforms have become a central element of the policies of the new Workers' Party government -- Brazil's first elected from a left-wing party -- which has pledged to fight for the poor but maintain market-friendly policies.

Success in reforming the public pension system, which costs the government $15 billion every year, would send a powerful signal to financial markets about Lula's resolve to reduce the country's large debts which are seen as a major economic risk.

The president hopes the huge popular backing that swept him into office in January will help him pass the reforms.

Lula has said the reforms are necessary to overcome an economy which faces rising inflation, sky-high interest rates, low growth and reduced government spending. War on Iraq could further undermine investment in emerging markets like Brazil.

But their own states' debts were at the top of the governors minds after many states have pleaded in recent weeks for renegotiation of their dues to the federal government.

Proposals to simplify the tax system worry the states because they fear they could lose out on revenues.

"The states have a lot of debt," said Gov. Eduardo Braga from the tropical forest state of Amazonas. "To a certain extent that makes understanding on tax reform difficult."

The meeting will end on Saturday with a large barbecue which has become Lula's trademark as a host.

Both reforms were discussed for years by former President Fernando Henrique Cardoso but no new laws were passed.

Lula personally went to Congress this week to urge it to quickly pass the government's reforms when legislation is ready, which is expected to be in May.

With the Workers' Party and its allies in Congress holding just a slim Congressional majority, the government will need support from other parties to pass the reforms.

But there are conflicting interests, not least public workers who are traditional supporters of the Workers' Party and have most to lose from cuts to their generous pension benefits. A labor union threatened strikes this week.

The business community overwhelmingly supports the reform and Lula has created a special council of business, labor and social leaders to advise him on the reforms. (Additional reporting by Sarah Rink and Carmen Munari)

ipsnews.net Mario Osava

RIO DE JANEIRO, Feb 21 (IPS) - The Brazilian government is moving to stake a balanced and consistent position on genetically modified products in an effort to reconcile the divergent pressures from environmentalists, scientists and the business community. A working group set up this week, with representatives from nine ministries, will have one month to issue a congruent governmental definition on the matter of transgenics. One of the problems for which the group must find a solution is the expanding illegal cultivation of genetically modified soy in southern Brazil. Official figures state that four million tons of this transgenic crop were harvested in the last year. The debate pitting those who warn of the health and environmental risks of transgenic crops against those who promote further research and development created a deep rift between the ministries of Environment and Agriculture under the previous government of Fernando Henrique Cardoso (1995-2003). The controversy continues under President Luiz Inácio Lula da Silva, with the Ministry of Environment opposed to the introduction of genetically modified organisms in Brazilian territory and the Ministry of Agriculture championing transgenic crops. Transgenics -- plant or animal -- are created in laboratory by introducing the gene of a different species into the organism's own gene make-up. The aim is usually to improve its characteristics, for example, making a plant more resistant to pests or to extreme climates. Cultivation of genetically modified crops is illegal in Brazil due to a provisional court decision, issued in June 2000, which banned the commercial planting of a transgenic soy variety developed by the U.S.-based seed and agro-chemical giant Monsanto. The case, dating back to 1997, should see a definitive ruling within 60 days, marking the end of a long series of postponements filed by environmental organisations and authorities. The ambiguity of the government stance and uncertainties in the legal sphere have apparently contributed to the illegal planting of genetically modified soy in southern Brazil. According to denunciations, eight percent of the national soy harvest this year is from genetically modified seeds, says agriculture minister Roberto Rodrigues. The illegal crops are the result of seeds smuggled in from Argentina, where nearly the entire national soy yield is from transgenic seeds. The Brazilian Institute of Geography and Statistics calculates that the country's total soy production this year will be 48.5 million tons, with nearly four million tons being of genetically modified varieties. Farmers in southern Brazil, however, believe the volume of the transgenic soy harvest is much higher -- more than double -- at 8.5 million tons, and worth 1.74 billion dollars. In Rio Grande do Sul state, which shares an extensive border with Argentina, ”they say that more than 70 percent” of the soy grown is genetically modified, says Carlos Sperotto, president of the local Federation of Agriculture. What to do with the illegal harvest is one of the problems that the inter-ministerial working group must tackle, along with assessing the various ways that genetic engineering can be applied to agriculture. Minister Rodrigues, a defender of biotechnology applications, comments that decision-makers must not forget ”the socio-economic reality” and should not throw out the harvest, jeopardising the approximately 155,000 farmers involved. But six non-governmental organisations are leading the ”Campaign for a Transgenic-Free Brazil”, demanding government action to eliminate illegal genetically modified soy and to penalise those responsible for planting it inside Brazilian territory. Pressure on the government is coming from several fronts, while no conclusive scientific evidence is yet available about the effects of genetically modified organisms on the environment or human health. Researcher Manoel Teixeira Souza, of the governmental Brazilian Enterprise for Agricultural Research (EMBRAPA), says he regrets that the controversy emerged in reaction to the soy variety Roundup Ready, created by Monsanto to withstand the company's herbicide and thus facilitate its application. This new technology became associated with negative factors, such as greater dependence on agro-chemicals and the dominance of a transnational like Monsanto in the national market, according to Souza. ”But the technology could lead precisely in the opposite direction,” said the agronomist, a researcher of the banana genome at EMBRAPA's Genetic Resources and Biotechnology Centre. The debate, stated in these terms, ”hurts research,” paralysing projects and inhibiting investment, comments Souza. He led the development of a genetically modified papaya, the seeds of which could be ruined due to the ban on planting transgenics in Brazil, while a transgenic papaya is being grown for export in the U.S. state of Hawaii. There is no technology that offers ”100 percent security,” but current knowledge allows scientists to create genetically modified foods that are relatively safe and are resistant to pests. ”I prefer to eat transgenic fruit that does not require agro- chemicals to fruit that is treated with pesticides,” he said. But the new president of EMBRAPA, Clayton Campanhola, said when he assumed the post a month ago that the government body -- which oversees 40 specialised research centres -- should respect the principle of precaution in all of its activities. According to the precautionary principle, established in international talks on biotechnology, nations have the right to ban the introduction or development of substances or organisms whose innocuousness has not been rigorously proven. Caution and the need for further research on genetically modified organisms in a country with such rich biodiversity as Brazil are also the arguments wielded by environment minister Marina da Silva in opposition to the commercial production of transgenics in this country. But it will be difficult to resist economic pressures. Six business associations in the Brazilian cotton industry, which includes textiles, defend the cultivation of transgenic cotton as a means to halt the country's declining production and increasing imports. According to cotton producers, genetically modified seeds could represent 60 percent savings in production costs. Without the transgenic variety, and faced with competition from other countries -- particularly the United States, where it is already widely cultivated -- Brazilian farmers will abandon cotton for other crops, they argue. Transgenic cotton cuts to less than a third the volume of agro- chemicals needed to protect the crop, reducing costs and benefiting the health of farm workers and the environment, Helio Tollini, director of the Brazilian Cotton Producers Association, said in a conversation with IPS. Cotton is particularly susceptible to fungus, insect and bacterial infestations -- a list that runs to 250 pathogenic agents -- and therefore requires the intensive application of pesticides or the development of resistant varieties. Tollini, however, is not calling for the immediate release of transgenic seeds, but rather a greater effort in research, ”based on national data”, so the country can take a decision on the matter, ”in three years, minimum.” (END/2003)

reuters.com Fri February 21, 2003 02:40 PM ET By Andrei Khalip

RIO DE JANEIRO, Brazil, Feb 21 (Reuters) - Brazil's electricity sector, in trouble since power rationing in 2001, is sending new distress signals as utilities are running out of cash while the government does little to inspire investor confidence, analysts say.

This week, the head of federal utility Eletrobras ELET6.SA said he could not rule out the nationalization of some assets of cash-strapped U.S.-based power company AES Corp. AES.N which had defaulted on a debt payment in Brazil.

On Wednesday, investors were scared when left-leaning President Luiz Inacio Lula da Silva slammed the failure of regulatory agencies to control utility prices while the country is fighting a surge in inflation.

"This is a very scary change in attitude," said an energy analyst with a big foreign bank who did not want to be named. "The power sector crisis is deepening as many firms have run out of capital flow, unable to pay their bills and creditors."

Before Lula's comments, the energy ministry had agreed in principle to raise power rates by about 30 percent to adjust prices for inflation and foreign exchange rate swings. Up to 40 percent of Brazil's energy comes from the Itaipu dam on the Paraguay border and is priced in dollars.

"We get contradictory signals from different places, and, joined with a total lack of regulation, that aggravates the sector's crisis," said Aline Cardoso of Banco Brascan.

Analysts agreed that many companies would simply go bankrupt if not allowed to readjust their rates soon, while many also needed urgent debt restructuring.

"If the government doesn't intervene, utilities will go bust," said Adriano Pires, director of Brazilian Center for Infrastructure consultancy, adding that the next step after bankruptcy would be nationalization of power utilities.

"Maybe it's part of the government's plan, but they should know that nationalization is the worst thing that could happen. The power sector needs private investment," he added, reminding that in 1993 Brazil had to inject $28 billion into the then state sector to save it from collapse.

In the case of AES, which in January did not pay an $85 million installment on its $1.2 billion debt with state-run BNDES National Development Bank for the purchase of Eletropaulo ELPL4.SA distributor, nationalization is already an option.

A source close to AES-BNDES talks said the U.S. firm was ready to give up 50 percent in Eletropaulo and other assets to settle the debt, but the bank wanted all of Eletropaulo as well as AES Tiete generator, which AES has said it wants to keep.

Even if AES had its way, it would settle only about half of its debt and will have to refinance the other half.

LOW DEMAND FOR POWER, BIG DEBTS

The problem is typical for the sector. Many foreign firms bought Brazilian utilities during privatization in the 1990's, paying in local currency but taking credits in dollars.

The 1999 devaluation of Brazil's currency, the real, inflated their debts, while rates remained under government control. Power rationing that started in 2001 due to Brazil's dependence on often-scarce water resources and lasted for nine months slashed demand and undermined utilities' revenues.

As Brazilians stuck to conservation habits after the end of rationing, demand for power in 2002 slumped to 1999 levels and the price of a megawatt crashed to 4 reais ($1.1) from over 600 reais during rationing.

So far this year, stocks of power utilities have fallen about 18 percent, twice as much as the broader market's fall. Eletropaulo alone slumped 35 percent in the past four weeks.

The most unexpected recent shock came from a relatively well-off company, public utility Copel CPLE6.SA in southern Brazil, after Parana state Gov. Roberto Requiao threatened to tear up contracts under which Copel buys energy because they were too expensive and risked bankrupting the Brazilian firm.

Analysts said the threat was particularly alarming as last week Requiao decreed the state was taking back management control of a local waterworks utility. "This means political risks on the rise for Copel ... which is among the few strong companies," Brascan's Cardoso said.

Analysts agreed the government had to come up with a new model soon for the sector, now fragmented into federal and state generators and mostly private distributors, to prevent collapse and lure back private investors. Lula's administration has promised to come up with a rescue plan by July.

reuters.com Fri February 21, 2003 12:14 PM ET By Carlos A. DeJuana

SAO PAULO, Brazil, Feb 21 (Reuters) - Emerging market sovereign bond prices drifted on Friday as investors held onto their cash awaiting a clearer outlook on a possible U.S.-led attack on Iraq.

J.P. Morgan's Emerging Market Bond Index Plus posted only a 0.08 percent return on the day as market heavyweight Brazil gained 0.85 percent, boosted in part by optimism the country's new government is taking the right steps to bolster its economy.

Although Venezuela continued to be a point of concern given ongoing political turmoil there, analysts said the market was largely glued to the U.S.-Iraq standoff, seeking clues on when and how an attack could take place.

"It's hard to see the market breaking significantly one way or another until we get some clarity on the geopolitical situation," said Jim Barrineau, vice president in emerging markets research at Alliance Capital Management in New York.

Brazil's benchmark C bond BRAZILC=RR gained 0.50 point to trade at 70.625 by midday, a price Suhas Ketkar, the head of emerging markets analysis at the Royal Bank of Scotland in New York, believes could rise.

"C bonds haven't gone up that much largely because of war concerns. As that war premium at some point in time comes off, there will be a significant move up," he said.

"But until then I think we will see this range trading for most emerging market bonds."

Investor sentiment on Brazil has largely U-turned since the end of last year, when the market was gripped by worries the Latin American giant's new center-left government would mishandle the economy and possibly default on its debt.

But President Luiz Inacio Lula da Silva's administration has proved more market-friendly than expected.

On Wednesday, the Central Bank raised interest rates by 1 percentage point to 26.5 percent, its fifth hike in as many months, to clamp down on accelerating inflation. It also raised minimum reserve requirements for banking deposits, another move that should help prop up Brazil's currency and slow inflation.

"In addition to the rate hike, the increase in reserve requirement was a positive because it shows that the Central Bank is willing to use more and different measures than simply hiking interest rates to attack inflation," said Alliance Capital's Barrineau.

Although the return on Venezuela's portion of the EMBI plus index was down 1.68 percent, the country's benchmark bond VENDCB=RR was trading up 0.125 point at 68.875.

"There's just a general sense that the rule of law is breaking down there and that the prospects for further tension are pretty high," Barrineau said.

The conflict between Venezuelan President Hugo Chavez and his fierce opposition flamed up again on Thursday after police arrested a top industrialist for civil rebellion after he led a two-month strike against Chavez.

Opposition leaders, who accuse the former paratrooper of dictator-like tactics, said they would step up demonstrations to protest the arrest, which they allege is illegal.