Rousseff will struggle to restore Brazil's economic good times

Reuters News
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Posted: Oct 27, 2014 2:15 AM

By Alonso Soto

BRASILIA (Reuters) - President Dilma Rousseff narrowly won re-election by spending heavily and promising to extend the fight against poverty but she will need to restore order to public finances in her second term to get Brazil's stalled economy back in gear.

Rousseff edged out opposition candidate Aecio Neves in Sunday's election runoff, helped by strong support from the poor despite her struggles to tame high inflation, attract investment and revive an economy in its fourth year of lackluster growth.

With the bruising re-election campaign behind her, Rousseff now faces the daunting task of returning the shine to an economy that was once a Wall Street darling but has been hit by policy missteps and global economic headwinds that hurt demand for Brazilian exports.

To do so, she needs to move swiftly to staunch the bleeding in Brazil's fiscal accounts, which has added pressure to inflation and eroded investor confidence in Latin America's largest economy. Failure to clean up public finances could lead to a credit rating downgrade next year.

Rousseff struck a conciliatory tone in her victory speech on Sunday night, pledging to work with political adversaries and business leaders alike to usher in a new era of economic growth.

"We're going to give new impetus to all sectors of the economy, especially industry," she said. "I want a partnership with all sectors, both productive and financial, to take on the challenges ahead."

She also extended an olive branch to investors worried about Brazil's deteriorating finances, saying she was committed to fiscal discipline and to keeping inflation in check.

But the jury is out on whether Rousseff, a leftist who believes in state-led economic growth, is committed enough to fiscal discipline to take on politically difficult tax and pension reforms or cut spending on popular welfare programs.

"Everything will hinge on fiscal policy, but there is not much scope to make a very drastic adjustment in the short term given the rigidity of the budget," said Otaviano Canuto, a World Bank official who some government officials say is a contender to be finance minister in Rousseff's new term.

About 90 percent of Brazil's budget spending is mandated by law, meaning the government does not have much wiggle room to significantly cut expenditures without reducing public investment or social programs.

"Any fiscal action should be accompanied by some medium- to long-term framework to reinforce confidence," added Canuto, who declined to comment on the finance ministry speculation.

Brazil's budget deficit has widened sharply under Rousseff, who increased public spending and granted dozens of tax cuts to struggling industries to bolster the economy.

Despite those measures, industrial output failed to pick up and her government was harshly criticized for using fiscal maneuvers to artificially increase public savings.

The budget hole disguised by those "fiscal tricks," which include delaying payments from social programs and dipping into Brazil's sovereign wealth fund, could be as large as 2 percent of gross domestic product, BNP Paribas estimated in a recent research report.

'IDEOLOGICAL BAGGAGE'

Rousseff's headaches won't be limited to the fiscal realm. After keeping fuel and electricity rates artificially low in recent years to help keep contain inflation, the president is under pressure to finally let those prices rise.

An increase would be good news for state-run oil company Petrobras and power distributors, but it would also complicate Rousseff's anti-inflation efforts and could end up eroding her popularity with working-class Brazilians.

A slump in commodity prices due to a slow global economy and higher U.S. interest rates could also weigh on efforts to boost the pace of economic growth.

Investors are far from convinced that Rousseff will act decisively to tackle Brazil's many economic challenges head on in her second term, which starts on New Year's Day.

Still, some hold out hope that the threat of a credit downgrade could force Rousseff to take a more market-friendly tack.

Local stock and currency markets slumped whenever Rousseff advanced in opinion polls during the campaign, and could be headed for another selloff on Monday.

"She didn't make any changes during her first term so I don't think she will change her ways in a second term," said Raul Velloso, a Brasilia-based economic consultant. "She has heavy ideological baggage and that won't change overnight."

Although Rousseff has promised to replace widely-criticized Finance Minister Guido Mantega, markets remain skeptical that she will change course drastically and be less interventionist.

Local businesses have long lobbied for bold reforms to cut Brazil's red tape, simplify its Byzantine tax code and overhaul a pension system that is piling pressure on public finances.

Rousseff agrees that many of those reforms are needed, but so far has shown little desire to engage in the political give-and-take required to push initiatives through Congress.

Even with a clear majority in Congress, Rousseff has struggled to pass legislation to unify minor taxes and slightly lower the pension burden. An even more fragmented Congress in a second term will further complicate any efforts to lower the staggering cost of doing business in Brazil.

Brazilian companies on average spend 2,600 hours a year calculating what they owe in taxes, according to the World Bank's annual Doing Business study, which compares business practices around the world. That is almost 15 times the amount of time needed to do taxes in the United States.

Mexico and Colombia, which have embarked on more ambitious reforms to open their economies, are growing at a rate more than two times that of Brazil.

The Brazilian economy is expected to barely grow at all this year and expand just 1 percent in 2015 - a far cry from the 7.5 percent growth rate in 2010, just before Rousseff took office.

"I don't think Brazil can afford to stay far away from the global trend for reforms" said Jorge Mariscal, chief investment officer for emerging markets at UBS Wealth Management, which oversees about $1 trillion in investments.

"It no longer has external demand to drive its economy."

(Editing by Todd Benson and Kieran Murray)