BRAZIL-In the War of the Kleptocrats

At "The Battle of Lava-Jato"

Lula has won some territory in the Battle of Lava-Jato in the War of the Kleptocrats. He had one remaining strategy which he successfully employed yesterday: to negotiate a cabinet appointment that would subject any eventual trial he might have to face to the Supreme Court – the privileged venue for high-level government officials.

Dilma Rousseff today nominated Lula to the position of Chief of Staff – the second most important in the Executive Branch after the Presidency, previously occupied by Dilma. So the titles are now reversed but the roles are likely to revert to their former status: Lula as de facto President and Dilma as de facto Chief of Staff.

Former Chief of Staff (and Lula loyalist), Jacques Wagner was appointed Personal Secretary to “President” Dilma. (It’s a position that allows Wagner to make sure Dilma keeps her end of the bargain with Lula!)

Lula’s appointment gets him out of Judge Sergio Moro’s courtroom but not necessarily out of the Lava-Jato investigation as it focuses on the Petrobrás financial scandal.

His next challenge is to mend fences in the legislature and rebuild a coalition to support his planned initiatives. He can be expected to first seek to stave off Dilma’s impeachment in order to keep Vice-President Michel Temer (PMDB) from being able to assume office. The PMDB has been considering a formal break with the PT. However, if Temer perceives that impeachment won’t happen, he might be willing to live out the rest of his term as Veep.

The Supreme Court is today considering writs submitted regarding the impeachment process. At present, the Lower Chamber can propose an impeachment trial that the Senate can unilaterally reject – end of story. The President of the Senate, Renan Calheiros, has been on-and-off supportive of Dilma in the past and if Lula can lock in enough votes in the Senate to reject the motion to impeach, that issue gets settled. That then neutralizes the threat of a PMDB “betrayal” and suggests its probable return to the coalition.

With impeachment no longer an immediate concern, Lula can turn to the economic situation to try to get the economy moving again. 

Here, Lula is likely to face some serious problems. He has suggested increasing credit, lowering the base interest rate, using Brazil’s foreign currency reserves to fund such measures and moving on some major infrastructure projects.

Many economists suggest that Lula’s “recovery” strategy is seriously flawed. Consumer debt levels remain high and there is little enthusiasm for taking on additional debt. In fact, there is a concentrated effort to work down debt levels. The same applies at the enterprise level and several firms have sought legal workouts to avoid bankruptcy. Unless investors see a sustainable recovery pattern, they are unlikely to invest. However, if interest rates are reduced, there may be some loan switching from high cost to low early on. It won’t necessarily mean increased investment but it will improve corporate margins somewhat.

 

There is little enthusiasm among local economists for using the country’s hard currency reserves to fund growth and a budget deficit and there is little money in the kitty to initiate or conclude major infrastructure projects.

Finally, much will depend on what Lula is able to offer in exchange for support in the legislature. Patronage could prove expensive in terms of the pressure it places on the budget deficit.

Analysis:

I am not sanguine about the prospects for Lula’s proposed economic recovery plan. It is pretty much a repetition of the policies of the past 5 years that clearly did not work. It requires what looks like substantial increases in spending and that has been the main problem all along.

However, working in his favor is a two-year window over which to apply his policies. If Dilma’s impeachment is no longer an issue, I would expect the PMDB to try to negotiate some advantages for itself and forget about abandoning the coalition in favor of “picking rights” at Brazil’s economic carcass.

The two-year window allows time for Lula to apply a measure and then back off if it appears that it won’t succeed. Brazil has been through this before. It means stop-and-go policy volatility and adds to uncertainty. However, it creates short-term windows of opportunity that allow the corporate sector to register some minor gains. I do not believe it is a plan for longer-term sustainable growth and I don’t think anyone else does either.

Another vulnerability is that Brazil could risk further credit downgrades as the economy lurches back and forth. In 2006 Brazil was paying just over 2% on its sovereign debt issues. By the end of 2014 it was reportedly paying just over 4% and was recently cited as having taken down money at over 6%. Brazil’s paper could rapidly slide down the “junk” pile.

I suggest that Lula’s goal is neither to recover the economy nor to create the conditions for sustainable growth but simply to make it to 2018 when he can then propose and promise more substantive measures and try to get elected once again.

I recommend, therefore, that you play down your construction of “political” scenarios based on impeachment or regime change and concentrate on the “politics of economic recovery”. 

My experience in Brazil suggests that Lula will seek to generate brief flurries of activity and improvement that will be followed by policy failure, increased inflation,  the imposition of additional remedial measures (e.g. price controls, minimum wage increases, etc.) that temporarily halt the pernicious effects of the failed policy. Another flurry then will follow in the same pattern.

He only has to play this game for 8 quarters. Your challenge is to figure out what the economy will look like in 2018.

There are numerous precedents for this approach, most especially during the last two military governments and the fallout from the Sovereign Debt Crisis of the 80s that lasted a full decade and ended in hyperinflation.

A final consideration for the foreign investor is what will be happening in the rest of the world. Brazil will be regressing or at best paralyzed over the next couple of years. It will have lost close to 20 or more years of forward motion and a new global economy might be sitting out there by 2018. (At least that is the hypothesis I am presenting in my two-part report for February. Part I has been finished and Part II will soon be released. You can request a copy via my e-mail: jwygand@uol.com.br)

So, for starters, I recommend you switch your primaryfocus to the economic conditions likely to prevail in Brazil over the next two years. Watch, of course, the short-term political machinations, but I suspect that the “fix” is in to avoid Dilma’s impeachment.