Analysis: Brazil’s Rousseff faces fiscal and currency challenges

By Ana Nicolaci da Costa

BRASILIA (BestGrowthStock) – The same economic boom and free spending that propelled Dilma Rousseff to Brazil’s presidency could become the biggest source of trouble during her first year at the helm of Latin America’s largest economy.

Rousseff will have to tighten the purse of a government whose finances deteriorated this election year, but avoid choking off the rapid growth that has lifted millions of people out of poverty.

She won a runoff election on Sunday with 56 percent of the vote, largely due to the economic successes of her mentor, President Luiz Inacio Lula da Silva.

A former leftist militant who never before had run for elected office, Rousseff will have to manage the consequences of that growth — massive capital inflows which have lifted the real currency to two-year highs, hurting exporters in the commodities powerhouse.

Failure to curb inefficient spending could eat into government funds needed for key infrastructure investment, while continued heavy lending at subsidized rates through state banks could stoke inflation.

“It is urgent that fiscal policy gets back on track. For me, that’s the priority,” said Zeina Latif, senior Latin America economist at RBS in Sao Paulo. “That would be good for the currency, that would be good for the central bank.”

Brazil’s 12-month overall budget deficit fell sharply in September after the government resorted to what many analysts described as creative accounting.

The deficit fell to 2.36 percent of gross domestic product from 3.38 percent the previous month, but was still far above the 1.23 percent in October 2008 — before the global meltdown hit Brazil. The deficit has stayed above 3 percent of GDP for most of the year.

Rousseff has said she would keep government spending under control but ruled out austere budget cuts.

In her first remarks as president-elect on Sunday, she was quick to reiterate her commitment to prudent fiscal spending.

“The Brazilian people do not accept governments that spend more than is sustainable,” she told a cheering crowd in Brasilia. “We will make every effort to improve the quality of public spending, to simplify and ease the tax burden.”

Rousseff could become more fiscally rigorous after she takes office on January 1, judging by key figures in her campaign team such as former finance minister Antonio Palocci, the face of austerity during Lula’s first term.

TAX BREAKS FOR EXPORTERS?

A tighter grip on fiscal accounts would take away some of the stimulus fueling Brazil’s annual economic growth of about 7 percent, while reducing the need for higher interest rates and easing pressure on the currency.

At 10.75 percent, Brazil’s benchmark lending rate is among the highest in the world, above those of advanced economies and double the level of Russia, India and China, its peers in the so-called BRIC group of major emerging economies.

The real has gained nearly 6 percent since late June, even as the government has stepped up intervention in the foreign exchange market (Read more about international currency trading. ) and tripled a tax on foreign investment in local bonds.

“We will probably adopt … more measures like the ones we are adopting to prevent the real from strengthening so much,” Planning Minister Paulo Bernardo told Reuters.

A challenge for Rousseff will be to control capital inflows without compromising a key source of Brazil’s hard earned stability — a floating currency.

One way she could try to get around the currency problem is by making exporters more competitive through tax breaks, said Fernando Ferro, head of the ruling Workers’ Party in the lower house of Congress.

Benefits to exporters could be part of broader efforts to streamline Brazil’s Byzantine tax system, trimming revenues initially but increasing them in the long run. Rousseff’s coalition in Congress will be larger than the one Lula had, increasing the chances of approval.

With the economy growing rapidly and foreign capital likely to keep on coming, Rousseff will have to manage inflows without becoming too dependent on them to finance a growing current account deficit.

Asked what Lula thought were the challenges for the next government, one of his top aides Gilberto Carvalho said: “We need to consolidate the (economic) model and not reverse it.”

(Editing by Brian Winter, Elzio Barreto and Kieran Murray)

Analysis: Brazil’s Rousseff faces fiscal and currency challenges