| BRASILIA, Sept 1
BRASILIA, Sept 1 President Dilma Rousseff's
main challenge in coming months will be to maintain a course of
austerity and clean government amid growing dissatisfaction as
Latin America's largest economy slows.
She will have to face rebellious allies, who could stall
her legislative agenda and approve costly bills that may
undermine fiscal discipline. Other risks include resistance to
long-term structural reforms, persistent inflationary
pressures, and renewed intervention in currency markets.
A series of scandals that have forced four of Rousseff's
ministers to resign in less than 3 months has exposed her
government's vulnerability to opposition and media scrutiny. It
has also renewed tensions within Rousseff's ruling coalition,
partly because she fired many officials before concluding an
Agriculture Minister Wagner Rossi resigned in August after
intense media coverage alleging he peddled influence and used
an agricultural firm's corporate jet. The wave of resignations
began in June when Rousseff's chief of staff, Antonio Palocci,
stepped down over an ethics scandal [ID:nN08245414].
If Rousseff, 63, continues her "clean-up" in other
ministries and state agencies, as her aides say she intends to,
the career civil servant risks losing support from some allies
who expect to get "perks" from government contracts and posts.
Already her coalition had been plagued by in-fighting over
key government posts and cuts in pork barrel spending that
legislators traditionally use for public works projects in
their constituencies. Her refusal to make political
appointments to key jobs angered her main ally, the PMDB.
Rousseff's popularity is still high and tackling corruption
and nepotism could boost her standing with middle-class voters.
But her disapproval rating has doubled since March, hit by
rising borrowing costs and slow progress in improving public
services such as health and security.
POLICY SHIFTS, WORKS DELAYS
The resignations, which also included the removal of the
top ranks of the transport ministry, are likely to delay a
series of government projects as incoming ministers and senior
officials take time to settle in.
There are growing signs that the construction of roads,
ports and railways, which form part of Rousseff's flagship
public works program, are already delayed. [ID:nN1E7651GA] This
could hurt the economy, affecting grain exports at
over-stretched ports or the construction of hydroelectric dams
that rely on paved roads to bring in construction materials.
The latest accusations of kickback schemes could also slow
other infrastructure projects, including preparations for the
World Cup in 2014 and the 2016 Olympics, as government
watchdogs step up scrutiny of contracts.
The departure of Rossi could also pave the way for more
nationalist farming policies. Rossi was investor-friendly and
tried to stem efforts within government to limit foreign
investment in the farm sector by banning only speculative but
not productive capital [ID:nN16140439].
Budget cuts, the slowing economy and Rousseff's drive to
cut political favors have upset many legislators. In a symbolic
warning to Rousseff, several allied parties blocked voting in
Congress for several days and could derail her bid to control
spending and pass economic reforms. [ID:nN1E77F1GQ]
Rousseff has tried to govern without Congress as much as
possible but will now have to engage congressional leaders more
pro-actively to push through reforms. They include an overhaul
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. [ID:nN1E75L0H2]
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 glaring problems from unwieldy labor laws to
heavy taxes, Rousseff may need to engage Congress to approve
structural reforms and emergency bills to speed up government
procurement. In doing so, she may have to ease some of the
austerity adopted so far.
What to watch for:
- Signs that Rousseff will loosen spending controls or make
appointments to please allies.
- New media revelations of scandal among top officials.
The risk of government intervention in Brazil's currency
market remains high, as even weeks of global financial turmoil
did little to undermine the strength of the real BRBYBRL=.
By late August, the real was down only around 3 percent from
its 12-year high in July of 1.54 per U.S. dollar. Then the
government imposed a tax on currency derivatives, potentially
the most aggressive measure so far designed to stem the
currency rally [ID:nN1E76Q01I].
If the real tests new record highs, the government could
hike the tax rate on currency derivatives from currently 1
percent to as much as 25 percent and adopt other measures as
well, Finance Minister Guido Mantega has said.
Any fresh measures could hit fixed income and currency
investors, while the stronger real can erode profit margins and
the market share of exporters, particularly manufacturers.
FARMING AND MINING
A legislative proposal changing environmental regulations
for farmers passed the lower house of Congress and could become
law later this year. While the Forestry Code, which sets the
percentage of native forest that farmers must preserve, reduces
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.
A mining bill Rousseff is expected to send to Congress this
year would likely reduce the time companies have to develop
mines to discourage speculation in mineral properties, and
could hike royalties to promote mineral processing.
Consumer price pressure has remained surprisingly resilient
and perhaps one of the biggest headaches for the Rousseff
administration. Annual inflation in the 12 months through
mid-August broke through the 7 percent level, well above the
government's upper limit of 6.5 percent. [ID: nN1E77I06D].
Still, the central bank cut its benchmark interest rate by
50 basis points to 12 percent at the end of August, beginning
an easing cycle after hiking rates five times this year by a
combined 175 points.
The move prompted some concern among investors that the
central bank may have moved prematurely and under pressure by
the government to prevent an abrupt economic slowdown.
Two days before the interest rate cut, the government hiked
its 2011 budget savings target, arguing tighter fiscal
discipline would pave the way for monetary easing.
Inflation tends to hit hardest the poorer classes who form
Rousseff's political base and sustained price rises could erode
her approval rating. Inflation and rising interest rates have
also weighed significantly on the stock market this year.
What to watch for:
- 12-month inflation rate failing to fall significantly.
- Signs of further rate cuts ahead.
Rousseff's hospitalization and her lengthy recovery from
pneumonia in May renewed concerns over her health, which first
surfaced in April 2009 when she announced she was being treated
for lymphoma. [ID:nN01161483] [ID:nN12259498]
She has been given a clean bill of health by doctors but is
reported to also suffer from diabetes, hypothyroidism, and high
blood pressure. Rousseff's health is on investor radar screens.
Were it to worsen, markets could slump due to uncertainty over
economic policy under Vice President Michel Temer.
(Editing by Kieran Murray)