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Ready, set, grow: Brazil's bustling economy shrugs off a political crisis and prepares for presidential elections ahead.

Brazil's economy started 2006 on an optimistic note. And it couldn't have been any other way. What happened in 2005 proved that Brazil has achieved economic fundamentals solid enough not only to guarantee more growth but also to make the nation less vulnerable to political crisis, something unthinkable in the past. "The big difference between the Brazil of yesterday and that of today is that now there's no room for politicians to become populists in order to gain popularity," says Mailson da Nobrega, a former finance minister who is now with Tendencias consultancy.

President Luiz Imicio Lula da Silva and his political party, the PT, have been wrapped up in one of Brazil's most serious political crises as corruption scandals rained down from Brasilia, some of them as yet unresolved. Brazil nevertheless achieved its lowest overall inflation rate ever (the IGP-M index of consumer, wholesale and construction prices, rose just 1.21%); country risk fell below 300 points; the real strengthened and the stock market leapt to an unheard of 35,000 points from 23,000 points. Economic output (GDP) grew only modestly--current estimates are 2.5% growth--but the increasingly open economy has meant new records for trade. Exports ended 2005 at US$118.30 billion with a trade surplus of $44.80 billion, a 33% gain on the year.

As trade rose, politicians kept a tight grip on spending, cutting Brazil's debt to 51.6% in 2005 from 61.7% three years earlier while hard-currency reserves rose to more than $55 billion, more than double the debt obligations maturing this year. Brazil further burnished its image by paying off early more than $15 billion in debt with the International Monetary Fund (IMF) and $2.60 billion owed to the Paris Club.

Domestically, attention is now turning from the economy to the unfolding of presidential elections in October. All signs point to a divisive race between the incumbent Lula and a candidate as-yet-unnamed from the PSDB, the party of former Brazilian President Fernando Henrique Cardoso, a strong possibility given voter suspicion of the current administration, which has eroded Lula's popularity. Lula's card: a strong economy under his rule, a force likely to overcome the corruption brouhaha.

"Brazil is already in a sustained growth cycle and the elections won't disrupt the economy as they did in 2002," says Nobrega. Nonetheless, to realize its growth potential and improve employment and income distribution, Brazil needs to advance its reform agenda. "To grow like India and Chile, Brazil needs to improve its political coordination and push through pension, tax and labor reforms. Then the country can take off," says the former minister, pointing out that today Brazil invests just 20% of GDP because so much public spending is absorbed by pensions, government payrolls, education, health and public-debt interest.

The government itself anxiously awaits change. At the end of 2005, Trade, Industry and Development Minister Luiz Fernando Furlan--one of the Lula administration's staunchest defenders but at times one of its fiercest critics--said the leadership was in an administrative paralysis that was keeping it from setting serious goals. Furlan's impatience stems from the administration's slowness in removing bottlenecks to faster growth. "Brazil's domestic cost of doing business is made worse by logistical problems, complicated rules and high taxes," says Furlan. "The current laws, from the post-war era, were written at a time when foreign exchange was scarce. Today, we're facing abundance with tools crafted to manage scarcity." Under Furlan, despite the problems he cites, Brazil has managed to double exports in three years.

Changes. Furlan's main proposals for change include aligning foreign-exchange rules with those of other countries. "We need to let companies hold foreign-currency accounts in banks authorized by Brazil's Central Bank," says Furlan. He cites the case of Brazilian airplane maker Embraer, which he says spends $100 million a year just on currency contracts. "It has to sell dollars from its export sales and then later buy them again to pay foreign suppliers," says Furlan.

Analysts say Brazil's miscellaneous structural problems--its historic lack of infrastructure and high interest rates--are putting the brakes on an economy that is just starting to take off. But Furlan himself, who in 2005 joined the ranks of government leaders who took aim at their own administration's tight monetary policy and surpluses set by Brazil's Central Bank and Finance Ministry, says that the country has already begun to escape from that tight spot, and that it's clear that a debate at the highest levels regarding pushing down lending rates is under way. Furlan has set a goal of $132 billion in exports for this year, while Lula is more optimistic, setting his sights on $150 billion. "Trade is a priority in this government," says Furlan.

Hopes for even better days for Brazil's economy are shared by Guido Mantega, the president of Brazil's National Development Bank, BNDES. In Mantega's view, Brazil is at an unusual point in its history: It's now possible to grow, modernize industrial infrastructure and increase productivity. "Brazil today has outstanding conditions for sustained and more vigorous growth. Inflation is under control, the debt-to-GDP ratio is falling, vulnerability to external shocks is reduced by high trade surpluses and foreign currency reserves are growing," he says. "In 2005, Brazil's net debt was equal to the annual value of exports. In 1998, debt was four times exports."

BNDES, Brazil's government lender, extended a record of nearly $22 billion in loans for investment projects. "This year will be the best of Lula's administration and the economy should grow 5%," Mantega says. "The BNDES should invest about $28 billion, spurred on by large investment projects in industries such as steel and petrochemicals."

One of these projects is a recently approved line of financing of more than $400 million for Grupo Gerdau, the largest producer of long-rolled steel in the Americas, with operations in the United States, Brazil, Canada, Argentina, Chile, Colombia and Uruguay. Grupo Gerdau's President, Jorge Gerdau Johannpeter, says that the financing is part of $3.20 billion in investment planned for 2005 to 2007 and meant to increase installed capacity to 21.4 million tons per year from 16.4 million tons.

Gerdau is a big exporter, but Johannpeter says the company always prioritizes the domestic market and that he is confident the local economy will improve this year. "The market for long steel declined in 2005, and the outlook for 2006 is positive precisely because it is an election year, a time when it's typical to see an increase in national infrastructure investment," he says. Gerdau has also benefitted from strong global steel demand.

Despite big investments by companies like Gerdau, the National Confederation of Industries sees significant obstacles to the expansion of the country's industrial base. "Brazil urgently needs investment. That's why it's so important to encourage all types of investments, to attract private capital," says Congressman Armando Monteiro Neto, president of the trade group.

On the private side, business leaders see lack of planning as the major problem to combat. "The economy's not in bad shape, businesses are earning money and so are banks. The problem is there's just not enough growth," says Milton Goldfarb, president of Construtora Goldfarb, one of Brazil's 10 largest builders. "It's the result of years and years of the absence of a business plan for Brazil's economy." His own company is growing, thanks to its own strategies, says Goldfarb, who plans to invest $18 million this year to expand his empire by 50%, to 3,000 apartment units. Goldfarb says, in addition, that elections won't necessarily be a drag on growth. "The economy has already uncoupled itself from politics," he says.

The view that Brazil has moved beyond politics as usual is a common one. "Today, we have an economy with fundamentals in place and that protects it from the effects of politics," says Marcio Cypriano, president of Brazilian banking giant Bradesco and of Brazil's Banking Federation, Febraban. "Beyond that, all the presidential candidates have a more or less similar line of thinking about the diagnosis and cure. We have to work to lower public debt and to accelerate the decline in lending rates; that's it at its most basic." Bradesco in the first nine months of 2005 earned a record net profit of $1.80 billion, a 102% increase over the same period in 2004. "Falling interest rates, the elections and the World Cup should maintain a positive environment for banking activity this year," says Cypriano. "We are confident."

Obstacle. A drop in interest rates is the big question for businesses in the months ahead. Brazil's base lending rate, among the highest in the world, is considered the biggest obstacle to new investment. But the Central Bank so far has resisted calls for rapid interest-rate cuts because, it believes, inflation will follow; instead, it is signalling a slow and gradual decline. Former Central Bank President Affonso Celso Pastore is optimistic. "The base rate will fall and we will have a favorable environment for GDP growth in 2006," he says. "Once they face facts, the Central Bank will change its position, and they'll end up cutting interest rates more quickly.

High interest rates and currency gains that are attracting foreign investors are tripping up the plans of many Brazilian companies. "Interest rates and the exchange rate are our main problems," says Carlos Zignani, corporate director of Marcopolo, which leads Brazil's market with more than half of all domestic sales of bus chassis and which exports to more than 80 countries. "The government is stimulating consumption outside the country and that's very bad for Brazil," says Zignani. "Our expectation is that this scenario could change this year."

Small and medium-sized companies are also rooting for change, which would come mainly with the approval of new legislation regarding small and medium-sized businesses stuck in Congress for the past three years. "That is our big bet for this year," says Jose Luiz Ricca, the superintendent of Sebrae-Sao Paulo, an organization that supports Brazil's small businesses owners. "In 2005, it was the year of small businesses," says Ricca. The segment saw sales rise 4.1% and employment increase by 3.4%, well above GDP growth.

In 2006, Ricca says, there could be a boom in small businesses as the "great untangling of red tape" commences with the expected legislation. Small businesses have a fundamental role in the economy and act as a kind of social cushion; Brazil's 5.5 million small businesses employ 67% of workers and generate 20% of GDP. Modern laws could help the segment absorb a good part of Brazil's 11 million informal businesses, giving a growing economy even more steam.


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Title Annotation:OUTLOOK
Author:Pfeifer, Margarida O.
Publication:Latin Trade
Geographic Code:3BRAZ
Date:Apr 1, 2006
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