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FACTBOX-Key political risks to watch in Brazil
BRASILIA Dec 2 (Reuters) - President Dilma Rousseff's biggest challenge in the coming months is to engineer a "soft landing" for Brazil's economy and insulate it as much as possible from the burgeoning euro zone debt crisis.
A likely cabinet reshuffle in the New Year will allow her to put her own stamp on the government after scandals brought down six ministers mostly inherited from her predecessor.
Compared to many developed countries, Brazil's expected 3.4 percent economic growth this year looks attractive. But after the boom under former President Luiz Inacio Lula da Silva that culminated in last year's dizzying expansion of 7.5 percent, it feels disappointing.
While cheap credit and rising real wages fueled the consumption boom under Lula, real wages have fallen marginally and lending rates are higher since Rousseff took office on Jan. 1. That has fueled discontent in a middle class that forms the cornerstone of her support base. Bank workers and other unions have gone on strike for higher wages to offset inflation, raising the risk of inflation becoming entrenched.
The bankers ended their strike in October after securing a pay rise of 9 percent. A stoppage at Brazil's state-run energy company Petrobras was averted after the company bumped up oil workers' pay and improved conditions.
The government announced measures to shield the economy from the global financial crisis on Dec. 1, including tax cuts on financial transactions, credit, and home appliances and incentives for exporters of industrialized goods. And a recent easing of the inflation rate has allowed the central bank to cut the benchmark interest rate.
What to watch for:
- More industrial action for wage hikes that could pressure inflation.
- Evidence that inflation will continue to slow.
- Additional measures to stoke the economy, boost credit.
Budget cuts designed to ease inflationary pressures have turned some of Rousseff's allies against her, eroding what was at least nominally a massive majority in Congress. A series of corruption scandals that led to the resignation of five cabinet members exacerbated discontent and caused deep divisions in her coalition. A sixth minister quit after he made disparaging comments about his fellow senior officials.
The rash of scandals, of which the sports minister was the latest victim, have not harmed Rousseff's rating and may even have boosted it as many applaud her tougher stance against endemic graft that was often swept under the carpet by Lula.
Rousseff is widely expected to shuffle her cabinet early next year, after which she could be more vulnerable to being blamed by voters for any ministerial wrongdoing.
Labor Minister Carlos Lupi has so far managed to hang on to his post after accusations that his former aides demanded bribes in exchange for contracts and that Lupi himself took trips in the plane of one of the ministry's contractors. The initial media uproar has subsided but Rousseff's own ethics committee has recommended he step down.
Dilma's refusal to make political appointments to key jobs angered her main ally, the PMDB. The clearest sign of internal divisions was the defeat of a government proposal to implement a financial transaction tax to finance health spending. Her ruling Workers' Party was alone in her 16-party alliance to vote in favor of the bill.
Rousseff, 63, has tried to govern without Congress as much as possible but needs legislators for a series of bills that include reform of an unwieldy tax code, framework legislation for the mining sector and a bill regulating oil royalties, all aimed at easing legal uncertainty and attracting investment.
Other projects on hold include bills aimed at ensuring that Brazil builds stadiums, airports and other infrastructure needed not only for the World Cup and the 2016 Olympics but also to overcome bottlenecks holding back the entire economy.
With the sporting events drawing nearer and a slowing economy exposing problems from unwieldy labor laws to heavy taxes, Rousseff may need Congress to approve structural reforms and emergency bills to speed up government procurement. She may have to ease some of her austerity measures to win support.
What to watch for:
- Signs that Rousseff will increase spending or make appointments to please uneasy allies.
- New media revelations of scandal among top officials.
Inflationary pressures remain strong and are one of the biggest headaches for Rousseff. Annual inflation in the 12 months through mid-November was 6.69 percent, above the 6.5 percent upper limit of the government's target range, but slowing from 7.12 percent the previous month..
The central bank formally forecast year-end inflation at 6.4 percent but one director said it could miss the target.
The bank's monetary policy has been in the spotlight since August when it shocked markets with a 50 basis point rate cut, citing the dangers of a looming global slowdown.
It shaved a further percentage point off the rate through two cuts in October and end-November, by when its strategy had found support among economists as Europe's debt crisis threatened to sharpen a global slowdown.
Industrial action for wage hikes, a depreciating currency that makes imported goods more expensive, and an economy that is still highly inflation-indexed all add to the burden.
This has potentially serious political implications for the government. Inflation tends to hit hardest the poorer and lower-middle classes who form Rousseff's political base and sustained price rises could erode her approval rating.
What to watch for:
- 12-month inflation rate failing to fall significantly.
- Signs of further rate cuts ahead.
Rousseff's government has been active in intervening in the currency market, first to prevent the real from gaining further and more recently to prevent its rapid depreciation amid fallout from global financial turmoil.
Through its interventions, the government has indirectly signaled what it considers a "suitable range" for the currency - a ceiling of 1.6 and a floor of 1.9 against the dollar.
FARMING AND MINING
A proposal changing environmental regulations for farmers passed the lower house of Congress and could become law before year-end. While the Forestry Code, which sets the percentage of native forest that farmers must preserve, will reduce overall environmental liabilities for farmers, they would have to finance costs they have been putting off for years to reforest or invest in protected areas. Environmentalists say the law has conceded too much to farming lobbies who are backing it. The legislation looks likely to pass the Senate, but must then go back to the lower house before being sent to Rousseff's desk.
The government will send a new bill to Congress to regulate the purchase of farm land by foreigners. It has tightened restrictions in the past year but is likely to fine-tune rules to allow for more foreign investment in some farming sectors.
A mining bill Rousseff is expected to soon send to Congress would likely reduce the time companies have to develop mines to discourage speculation in mineral properties. It would also hike royalties and slash taxes to promote mineral processing.
Concerns over Rousseff's health have faded but remain on investors' radar screens since her hospitalization and lengthy recovery from pneumonia in May. Concerns first surfaced in 2009 when she was treated for lymphoma.
She has been given a clean bill of health by doctors but is reported to also suffer from diabetes, hypothyroidism, and high blood pressure. If here health worsened, markets could slump on uncertainty over policy under Vice President Michel Temer.
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