* Coalition strains paralyze Rousseff’s reform agenda
* No sign of improvement in ties with PMDB
By Brian Winter
BRASILIA, June 23 (Reuters) - Weeks after a late-night telephone call almost caused the break-up of her ruling coalition, President Dilma Rousseff’s agenda remains totally paralyzed, endangering everything from a planned tax reform to Brazil’s preparations to host the 2014 soccer World Cup.
Rousseff has tried to heal the strains with the biggest party in her coalition, the PMDB, by appointing new ministers and even inviting obscure party legislators to the presidential palace for lunch.
Yet the PMDB has continued to block even routine legislation, raising the question of when — if ever — Rousseff will be able to pass an overhaul of the tax code and other measures that business leaders say are necessary to ensure that Brazil’s economic boom continues.
“Everything is frozen. It’s bad. And it’s not getting any better,” a senior source close to Rousseff said on condition of anonymity in order to discuss internal politics frankly.
The crisis has its roots in Rousseff’s refusal to appoint PMDB leaders to key government posts since she took office on Jan. 1. Her decision in February to cut $30 billion in government spending, a critical element of efforts to keep the economy from overheating, further angered lawmakers who are still pressuring for their discretionary funds to be restored.
The tensions came to a head last month when Rousseff’s then-chief of staff, Antonio Palocci, telephoned Vice President Michel Temer — the PMDB’s top-ranking official — and threatened to kick his party out of the coalition because it was obstructing critical environmental legislation.
Palocci quickly called Temer back and retracted the threat. He he has since resigned because of a separate scandal.
Ties between the PMDB and Rousseff’s Workers Party continue to be strained by the incident, which was first reported by local media and confirmed to Reuters by an official with knowledge of the conversation. Despite Palocci’s departure, the suspicion remains among some PMDB leaders that he made the threat with authorization from above.
“The truth is that Palocci went crazy,” the senior source said. “But convincing (the PMDB) has been difficult.”
Brazilian financial markets have largely ignored the tensions so far and are focused mostly on events abroad such as the Greek debt crisis. Rousseff’s commitment to fiscal probity, despite the political strains, could even be seen as a net positive for investors worried about inflation.
Rousseff’s brand-new minister charged with relations with Congress — an appointment that was presented almost exclusively as an effort to please the PMDB — has already ruled out releasing more funds for legislators’ pet projects.
“We’re in a difficult year of controlling spending and controlling inflation,” said the minister, Ideli Salvatti.
Yet the tensions could still spell longer-term trouble for Brazil’s economy.
Rousseff has yet to undertake any major reforms despite her 75 percent approval rating and a timid opposition. And while the economy is set to grow 4 percent this year, Brazil does poorly in international rankings of ease of doing business. Manufacturers in particular are suffering from bad infrastructure, high labor costs and complex, onerous taxes.
Continued trouble with the PMDB could not only doom future legislation to fix those problems, but also result in outright rebellion similar to that seen in the first week of Rousseff’s presidency, when some PMDB legislators threatened to approve a large, potentially inflationary increase in the minimum wage.
The PMDB is already holding some initiatives hostage. Party leaders including Senate President Jose Sarney have threatened to reject or modify a bill that Rousseff says would allow construction projects related to the World Cup and 2016 Olympics to proceed more quickly.
Rousseff’s officials have warned that, without the changes, stadiums and other critical infrastructure may not be ready in time for the events. [ID:nN25197934] (Additional reporting by Jeferson Ribeiro; editing by Mohammad Zargham)