By Brian Winter and Anthony Boadle
BRASILIA (Reuters) - The "new Dilma" is starting to produce results.
By embracing power-sharing deals and budget cuts that she shunned during her first term in office, President Dilma Rousseff has begun to ease the economic and political crisis plaguing Brazil, congressional leaders and economists say.
Rousseff's decision this week to hand formal responsibility for negotiating with Congress to Vice President Michel Temer, a leader of the Brazilian Democratic Movement Party (PMDB), was a milestone that should help ease tensions with the biggest party in her coalition and dissuade it from sabotaging her economic agenda as it did earlier this year, legislators said.
Brazil's stock and currency markets rallied as investors hoped the more stable political climate, and new signs that Rousseff is shifting toward more market-friendly policies, will eventually help Latin America's largest economy recover from what is expected to be a moderate recession this year.
Observers warn the truce in Rousseff's conflict with the PMDB is still tentative, and could be reversed. Even in the best case, an economic recovery isn't expected until late this year or early 2016, and would fall far short of the vigorous growth Brazil enjoyed last decade.
Ratings agency Fitch warned on Thursday of a possible downgrade due to rising government debt and bleak economic prospects, a reminder of challenges still ahead.
Nevertheless, allies say Rousseff deserves credit for making concessions that would have been unthinkable just a few months ago - although, with her popularity at the lowest level of any Brazilian leader in two decades, and inflation and unemployment rising, some wonder if she had much choice.
"Sometimes things don't work out the way we want them to, so we have to change," said Senator Gleisi Hoffman, a leader in Rousseff's Workers' Party who was the president's chief of staff during much of her first term.
"She has adapted to new circumstances and corrected some of the mistakes," Hoffman told Reuters.
Renan Calheiros, the president of the Senate who led the PMDB's insurrection against Rousseff last month, went even further, telling reporters Wednesday that she was making "bold" moves and "turning her government around."
The PMDB's dispute with Rousseff erupted after several of its leaders including Calheiros were included on a list of about 50 politicians investigated in a corruption scandal at state-run oil company Petroleo Brasileiro SA.
Some in Congress say the party lashed out in order to convince Rousseff to remove its members from the list, which the president's allies say she has no power to do.
Others say the PMDB, an amorphous group with no unifying ideology, simply felt underrepresented in Rousseff's new Cabinet after her second term started on Jan. 1 - a grievance they say has now been addressed after Temer gained new responsibilities.
That decision was a bitter pill for Rousseff to swallow.
Some presidential aides had previously told Reuters she did not trust Temer, a smooth-talking 74-year-old career politician who excels at the back-room negotiations Rousseff generally detests. Despite being her running mate in two elections, Temer was not part of her inner circle.
Having already handed control of economic policy in January to Finance Minister Joaquim Levy, who is much more orthodox than she is, Rousseff opened herself to ridicule that she is delegating away all her power.
Senator Aecio Neves, who lost to Rousseff in last year's election, accused her on Wednesday of making a "backdoor resignation." O Globo newspaper ran a front-page cartoon with Temer proudly wearing her presidential sash.
Even so, Rousseff doubled down, declaring on Thursday that Temer would have "autonomy." He will also have the power to name political appointees to federal jobs, another key PMDB demand.
"She has played her trump card," Leonardo Picciani, the PMDB's leader in the Chamber of Deputies, told Reuters. "Success is her only option now, because there is no one left to resort to."
SIGNS OF PROGRESS
Rousseff's allies hope that, with the PMDB at bay, the government can build on tentative signs of economic stability.
Levy has made progress pushing through Congress budget cuts and tax increases that, all told, should save the government about 100 billion reais ($32 billion).
Recent rains in Brazil's southeast have reduced the possibility of electricity or water rationing, which as recently as February were seen as near certainties. Standard & Poor's decision in late March to affirm Brazil's credit rating also reduced the odds of it losing investment-grade status.
The main risks associated with Brazil "seem in some ways to be dissipating," said Arthur Carvalho, chief Brazil economist for Morgan Stanley. He said the improved scenario seems to be "here to stay."
Brazil's real has strengthened 7 percent since hitting a 12-year low on March 20, while the Bovespa stock index is up about 5 percent since then as well.
Other observers have noted tentative signs that Rousseff is backing off from some of her interventionist policies.
For example, they say government officials have asked diplomats for advice on how to get foreign companies more involved in infrastructure project concessions - and have vowed Rousseff would not try to dictate rates of return on such projects as she did in her first term.
"It's a new philosophy, a new Dilma," a senior diplomat in Brasilia said. "The change is striking."
(Additional reporting by Silvio Cascione; Editing by Todd Benson and Kieran Murray)