Those in Lula's camp insist that if elected, Gomes will break
Brazil's heart just as Cardoso did by getting
himself elected on an anti-establishment platform,
but turning to orthodox solutions once in office.

Adam Mendelson

As the Brazilian presidential elections approach, and with a visiting Treasury Secretary Paul O' Neill exuding good will and promises of manna in the near future, the race increasingly hints at a competitive situation which was not previously anticipated. Although presidential candidate Luiz Inácio da Silva, universally known as Lula, has maintained a consistent lead in the polls at roughly 35 percent, he now has been rapidly losing ground to the governor of the northeastern state of Ceará, Ciro Gomes, who currently stands somewhere between 26 and 27 percent in the polls. Meanwhile, José Serra, who is being backed by outgoing President Fernando Henrique Cardoso, has fallen to third in the polls with a weak 13 percent approval rating. Nevertheless, Cardoso and the center-right coalition insist that they will continue to support him and believe that he will be a genuine contender come October.

Over the past few months, the spastic Brazilian economy has been following a precarious path directly towards disaster. On Friday, July 26, the country's risk premium—as measured by yield spreads over U.S. Treasuries, widened 78 basis points to close at a record high of 19.65 percent. The real, Brazil's embattled currency, also closed at an all-time low of R $3.01 against the dollar, down five percent for the week and more than 23 percent for the year.

William Cline, senior fellow at the Institute for International Economics (IIE), suggests that the reason for Brazil's economic quandary is the fear of rising public debt levels. Some investors fear Brazil may be unable to avoid a default on its US $260 billion in public debt. Although at 58.6 percent of gross domestic product, the debt ratio still is nowhere near that of Japan or some other highly leveraged countries. According to Morris Goldstein, a senior fellow at the IIE, "There is something to be concerned about in Brazil behind political uncertainty, and the chances of Brazil having to do a comprehensive debt rescheduling by end 2003 is 70 percent."

The IIE's Cline suggests five primary reasons for the ominous debt levels in Brazil. First, when the Brazilian currency was devalued in 1999, the reals per dollar rose considerably, which in turn increased the reported debt. Second, the primary balance, which is a key fiscal performance standard, excludes interest payments, which eventually must be accounted for in the total figure. Cline said that at 18.5 percent, Brazil's domestic interest rate is one of the highest in the world, and that, "The total nominal deficit is substantial even though the primary balance does not show it."

Third, he suggested that the Cardoso administration formally recognized certain "skeletons," whose belated appearance would increase the already onerous debt levels, once known. Skeletons here are contingent commitments associated with state banks that had been previously unaccounted for by the Brazilian government in debt compilations. Fourth, he noted that, "There has been pretty weak growth over the past few years and revenue growth has fallen short, which helps explain why Brazil has had much difficulty reaching its targets and keeping debt at a sustainable level."

Lastly, he believes that because investors are wary of the fiscal components of Lula's campaign platform, capital flight has escalated causing a decline in Brazil's currency. Because so much of its domestic debt is pegged to the local currency, these declines can have drastic repercussions on debt dynamics. Therefore, fairly or not, lack of investor confidence in Lula has translated directly into increased debt levels.

Why the Skepticism?

Although he reiterated his commitment to fiscal responsibility in the July 23 airing of his election platform, Lula has been relatively unsuccessful in his increasingly forceful efforts to assuage investors' fears of a default on public debt. Typical of the ex-parte batterings, he has been subject to by self-serving ideologues, in a July 30 article published in the Wall Street Journal, Jamie McGeever took his swing at Brazil's economic situation by stating, "Investors in South America's largest economy are increasingly frightened of what might happen if a radical opposition candidate takes power in October's presidential election. The fear is that unorthodox economic policies could potentially result in a default on the country's $90 billion external debt."

The author, like many tendentious financial analysts, has pinned Brazil's recent capital flight not to the accumulated debt level as do many distinguished economists, but to the possibility that Lula may win the presidency. Accordingly, Wall Street firms such as Merrill Lynch and Morgan Stanley have reduced their recommendations on Brazilian bonds within an emerging market debt portfolio, helping to set the stage for a self-fulfilling prophecy.

In a clear display of skepticism, if not political interference, Credit Suisse emerging market strategist Walter Mitchell said, "If the opposition wins, Brazil will head downhill fast." Additionally, in June, U.S. Treasury Secretary Paul O' Neill said, "Throwing the U.S. taxpayers' money at a political uncertainty in Brazil doesn't seem brilliant to me."

Stanley Gacek, the AFL-CIO's assistant director for international affairs, believes that the market's unremitting suspicion is unwarranted. He suggests that anti-Lula analysts are helping to cause capital flight by assessing Brazil's fiscal state based upon Lula's previous political platform and as a result of hearsay, instead of turning to fundamentals and unmanipulated economic indicators. In an interview he noted that, "well over ten years ago there was a position taken not just by the PT (Workers Party) and the left, saying a moratorium on the debt was necessary to get Brazil out of the cul-de-sac that it was in at the time.

However, that position has evolved and both Lula and the PT adhere to the new position." Gacek argues that the press, in its recent frenzy over polling results, has intensified Brazil's economic woes by breezily shrugging off Lula's new political platform and highlighting his former views regarding debt repayment. He opined, "the PT and Lula have evolved but the press does not want to get that point across." Lula's platform does indeed drastically differ from the current administration's.

For example, land reform is one of the cornerstones of his campaign platform. If elected, he promises to distribute land to more than a million landless peasants, who would then receive credit and technical assistance to help them become viable agricultural producers. According to the PT's platform, micro-agricultural enterprises and cooperatives would revitalize small-scale farms, which have been eclipsed in recent decades by the rise of large agribusiness estates. Lula also has promised to introduce a food-stamp program to help feed the 44 million Brazilians living in poverty and invest US $35 billion to build six million low-cost houses.

In addition, he says he will reduce Brazil's exorbitant interest rates to stimulate growth that has averaged only two percent during President Cardoso's eight years in office. The AFL-CIO's Gacek argues in favor of Lula's political platform maintaining that, "Improving public infrastructure, health care, education, fiscal infrastructure and subsidies for Brazilian industry are all part of his social agenda. These as well as agrarian reform are going to contribute to the nation's authentic development and will work to reduce the social and economic costs from hemorrhaging in the urban sector, as is the case in São Paulo."

Who Will Win?

Whether it is warranted or not, the malaise over Brazil's economy has influenced voter opinion. In recent months, Socialist Popular Party (PPS) candidate Ciro Gomes, who is widely being perceived as more moderate than Lula, has been vying for the top spot in the polls. He has ascended to second, but is quickly gaining ground on frontrunner Lula, because he has adeptly convinced voters that he offers a compromise between the PT's platform and that of the current administration. In fact, Gomes has presented a contradictory position by portraying himself as an anti-establishment leftist who insists that Brazil's public debt is unsustainable and must be renegotiated.

However, his strong rightwing support seems to neutralize his leftist tendencies. Also, as finance minister in 1994, Mr. Gomes subscribed to the very neoliberal policies he now criticizes. Regardless of the disconnects in his present position, Gomes appears to analysts as a viable alternative to the PT's Lula. Meanwhile, those in Lula's camp insist that if elected, Gomes will break Brazil's heart just as Cardoso did by getting himself elected on an anti-establishment platform, but turning to orthodox solutions once in office.

Finally, in the event of economic and political uncertainty, voters may reverse themselves and opt for the market-friendly candidate, Serra, who continues to maintain the support of Cardoso. However, in order to renew voter confidence, he must not only prove that Lula's policies will be detrimental to Brazil, but that his own platform, which closely parallels those of the fading Cardoso Presidency, would set Brazil on the right track.

Adam Mendelson, the author, is a research associate with the Council on Hemispheric Affairs (COHA), in Washington, and can be reached at coha@coha.org. COHA is an independent research and information organization interested in the triangular U.S.-Canada-Latin America relationship.

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