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Brazil: A Quick Honeymoon?

Dilma Rousseff must take the unpopular measures needed to keep inflation and account deficits from getting out of control.


Adorned with the green and yellow presidential sash, Dilma Rouseff was sworn in as Brazil's first female president. Her inauguration speech resounded Brazil's intent to play a leadership role in defining Latin America's place in a new multipolar world. She brimmed with self-confidence as she took the mantle from her hugely popular predecessor. The orderly transition of power was a major accomplishment for Lula, who took office in the midst of a major regional economic crisis and without the trust of his country's business class. However, a poll conducted during his last week in office found his approval rating at 87 percent, making him one of the most popular leaders in the world. The ability of a working class labor organizer to become one of the most successful and popular leaders of the world is a true testament to Brazil's tight social fabric. It is little wonder why the inauguration was such an emotional event. However, a series of important domestic and international challenges lie ahead for Dilma, which may shorten her honeymoon period.

On the domestic side, there are growing concerns about Brazil's quickening inflation rate. Consumer prices jumped 5.89 percent in December, skirting the upper edge of the central bank's inflation band. The annual inflation rate, as measured by the IPCA, rose at the fastest rate in two years. Now that the election cycle is finally over, the central bank will take measures to cool down the economy. With the pace of economic activity growing at more than 7.5 percent y/y, it is surprising that the inflation rate was not higher. An important factor that kept consumer prices in check was the appreciation of the currency and the surge in imports. The real appreciated 108 percent during Lula's eight years in office. This led to a gradual deterioration of the external accounts. Only three years ago, on the eve of the Lehman debacle, Brazil had a current account surplus of $7.5 billion. However, this year the shortfall will be more than $50 billion. The onrush of cheap imported goods forced producers to cut prices in order to preserve market share. However, the non-tradable sector was not under the same constraints. Moreover, a sharp increase in consumer credit and government spending gave further impetus to the level of economic activity. Now, Dilma must take the unpopular measures needed to keep the situation from getting out of control.

In her inauguration speech, she pledged to prevent the "plague" of inflation from undermining her plans to eradicate poverty. The market is already betting that her new central bank president, Alexandre Tombini, will have to raise the SELIC rate by 50 bps during the COPOM's next meeting on January 19. The local press is also speculating that the government will soon announce R$30 billion in spending cuts. The tightening of fiscal and monetary policies will make it difficult for the government to reach the 8 percent y/y GDP growth target that it set for next year. It will also put a great deal of strain on the financial sector, which is already under scrutiny in the aftermath of the problems at PanAmericano.

On the international side, Dilma will find it more difficult to carve out a larger space for Brazil. First of all, the BRICs will have less clout than they recently did due to the fact that their economies will be growing at a slower pace. Second, Dilma lacks the charisma and charm of her predecessor.

Hence, it is unlikely that she will play a similar role as he did on the global stage. Third, there are concerns about Brazil's ability to perform during the upcoming World Cup in 2014 and the Olympics in 2016. Efforts to modernize the country's infrastructure are moving at a snail's pace; meanwhile the calendar continues to march forward. A recent McKinsey report showed that less than 30 percent of the R$2.8 billion that was earmarked for the modernization of the country's airport infrastructure had been committed.

Fourth, Dilma will find the international arena less accommodating than her predecessor. The U.S. will try to reassert its will and influence, agreeing only to share the stage with major players, such as the European Union, Russia and China. Likewise, Brazil's attempt to play a bigger role in Africa will surely be met with resistance from the Chinese. Last of all, Brazilian firms will soon have to vie against Chinese multinationals for influence across Latin America, as the Asian behemoth stakes out new ventures in the resource-rich continent. Therefore, Dilma's honeymoon may prove to be short-lived. She has a difficult domestic agenda, and she may not enjoy such a warm reception within the international arena.

Walter Molano is head of research at BCP Securities.


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