FACTBOX-Key political risks to watch in Brazil

By Raymond Colitt

BRASILIA, May 31 (BestGrowthStock) – Brazil’s presidential election
in October looks less risky to investors than any other in the
last quarter of a century and the economy has bounced back
after a brief recession, but there are still investment risks
to watch in Brazil this year.

PRESIDENTIAL ELECTION

President Luiz Inacio Lula da Silva’s chief of staff, Dilma
Rousseff, is the ruling Workers’ Party candidate to succeed
him. She has closed the gap on her main rival, Jose Serra, a
former Sao Paulo state Governor Jose Serra from the centrist
opposition PSDB party. [ID:nN17263531]

Most analysts make Rousseff the favorite because she can
count on support from the hugely popular Lula and will be
helped by the rebounding economy. [ID:nN18249294]

Unlike previous elections, there is no clear market
favorite because neither of the main contenders is expected to
break with the mostly market-friendly policies in place for the
past decade: a free-floating currency, inflation control, and
fiscal discipline. Some investors prefer Serra for his party’s
centrist stance and his managerial experience.

In an effort to win over centrist voters and avoid
unsettling investors, Rousseff has emphasized market-friendly
proposals so far in the campaign.

Serra, who believes the government should be active in
economic affairs, has yet to spell out MANY specific policy
proposals. However, he recently called for lower interest rates
and urged an overhaul of Brazil’s costly pension system.
[ID:nN10198404]

Rousseff, who was endorsed by the center-left Workers’
Party in February, has praised the central bank and pledged
continuity. She has said the bank should keep focusing on
controlling inflation in coming years before it could consider
economic and job growth when setting monetary policy.

Serra wants the central bank to look at the broader economy
and not just inflation when setting interest rates. He says the
central bank should have cut interest rates more aggressively
during the 2008 global financial crisis.

There is also some doubt about how firmly the candidates
would push for a second generation of structural reforms to
ensure Brazil’s international competitiveness if elected.

Both agree on the need to overhaul Brazil’s complicated tax
system to encourage investment but have not provided many details.
Serra wants to reform the pension system by cutting benefits for
some civil servants, while Rousseff favors a piecemeal reform that
would raise more money to finance the growing pension deficit and
alter some retirement rules.

Neither proposes nationalizing private companies. But
Rousseff, and to a lesser extent Serra, favor a strong role for
state firms in the economy, a position that gained support
after low-cost loans by state banks helped Brazil’s economy
recover from the global crisis. Larger state companies could
weaken private sector participation in sectors such as banking,
oil, and utilities.

Rousseff has said growth of state banks would not infringe
on private banks, which she said were necessary to drive
economic expansion and spur competition.

Government plans to revive state-owned telephone company
Telebras (TELB4.SA: ) to expand broadband Internet access have
sent its shares sharply higher, but further moves to strengthen
Telebras could depress shares of private telecoms. Lula also
wants to strengthen state-owned power company Eletrobras
[ELET6.SA], though the intent may be to expand mostly abroad.

Serra, who launched his candidacy in April, is widely
believed to be the tougher of the two main candidates on fiscal
discipline and has said he would cap current expenditures,
potentially paving the way for swifter interest rate and tax
cuts. [ID:nN25443706] [ID:nN26210019]

What to watch:

— Serra and Rousseff will name their economic advisors in
coming weeks. A left-wing choice could unnerve investors and
send jitters through financial markets.

— Details of Serra’s economic proposals, particularly
fiscal and monetary policy.

GOVERNMENT SPENDING

The government is expected to maintain a high level of
spending before the election, putting pressure on the central
bank to raise interest rates to curb inflation. Public spending
rose sharply in 2009, eroding the primary budget surplus to an
eight-year low of 2 percent of gross domestic product. Finance
Minister Guido Mantega has pledged to pursue a surplus of 3.3
percent of GDP in 2010 but inflation still remains on track to
surpass the center of the government’s year-end target.

What to watch:

— Weak monthly primary surplus figures would indicate
worsening fiscal discipline and could push up interest rate
futures. (0#DIJ:: )

— Lula and Mantega could put increasing pressure on
central bank chief Henrique Meirelles to keep expected interest
rate hikes to a minimum so as not to jeopardize the economic
recovery in an election year.

OIL AND GAS

Congress is expected to approve by the end of the year
government-proposed legislation that would increase state
control over some of the world’s biggest recent oil finds. The
overhaul seeks to ensure proceeds from vast new fields flow to
the state to help bankroll investments in areas like
infrastructure, education and poverty-reduction programs.

The measures will likely reduce competition in the sector
while boosting the role of state energy giant Petrobras
(PETR4.SA: )(PBR.N: ), offering fewer but still attractive
opportunities for foreign investors. [ID:nN01485799]

Critics say the laws threaten the efficiency of Brazil’s
successful oil sector by stifling investment and increasing the
dangers of political interference and corruption.

Brazil’s Chamber of Deputies has approved the four
legislative proposals but they could be delayed in a scheduled
June vote in the Senate, where the government only has a narrow
majority. Analysts give the entire legislative proposal about a
60 percent chance of approval this year.

What to watch:

— A bill allowing a $60-100 billion capitalization of
Petrobras, including $15-20 billion in cash; uncertainty over
its approval in Congress has already pushed the company’s share
price lower.

— Disagreement in the Senate over how to distribute oil
revenue between the federal government and states could hold up
parts of the legislative proposal, particularly after the
beginning of the World Cup soccer tournament in mid-June and
election campaigning by legislators in August. [ID:nN26161706]

POLICY STAGNATION

Nearly a dozen cabinet members resigned in April to
campaign for public office in the Oct. 3 election. Most have
been replaced by career civil servants who typically lack the
political capital to push the government’s agenda.

What to watch:

— If Lula’s successor fails to win a clear majority in
Congress, reforms needed to improve Brazil’s long-term
competitiveness may face difficulty getting approval. These
include reforms to an unwieldy tax system, costly pension
benefits and rigid labor laws.

— Strong pledges from Serra or Rousseff to cut spending
and boost efficiency could help reduce inflation expectations.

CORRUPTION

Mud-slinging and corruption scandals tend to surface during
Brazilian election campaigns. They could paralyze Congress and
harm the camp of either of the leading candidates. Lula himself
came close to facing impeachment proceedings in 2005 when his
party was involved in an illegal campaign-financing scandal.

FOREIGN POLICY

If elected, Serra is likely to cool ties with some of
Lula’s left-wing allies in Latin America. That could affect
energy investments in Bolivia and Venezuela, where Lula had
prodded Petrobras to invest to foster regional integration.

Serra recently accused the Bolivian government of turning a
blind eye to cross-border drug trafficking. Some analysts think
Serra could also take a harder line in trade disputes with
Argentina and the South American trade block Mercosur.

Rousseff, by contrast, has pledged to continue current
foreign policy and could name the current deputy foreign
minister, Antonio Patriota, as Brazil’s top diplomat.

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(Additional reporting by Brian Ellsworth; Editing by Kieran
Murray)

FACTBOX-Key political risks to watch in Brazil