Feb. 27 (Bloomberg) -- Brazil's currency rose 1.9 percent against the dollar this week and the benchmark bond due 2040 had its biggest gain in more than a month, suggesting President Luiz Inacio Lula da Silva will surmount a corruption probe and pass legislation to improve the economy, said executives at some of Brazil's largest companies.

``The impact of this crisis will be shortlived,'' said Lawrence Pih, president of Santos, Brazil-based Moinho Pacifico Industria e Comercio, the nation's biggest flour mill, who endorsed Lula in 2002. ``Fundamentals are solid. Markets are already relieved.''

Brazil's stocks, bonds and currency fell last week after Epoca magazine alleged an aide to Cabinet Chief Jose Dirceu sought money from an illegal gambling ring to finance a Workers' Party campaign in 2002.

Lula, whose Workers' Party led congressional inquiries in the 1990s to combat graft in public office, fired the aide, Waldomiro Diniz, and went on radio during this week's Carnival festivities to promise a full probe into the allegations.

No `Crisis'

``Everything that is denounced in this government is going to be investigated,'' Lula, 58, said on his fortnightly show ``Coffee With the President,'' between expressions of concern for Brazil's flooding victims and pleas for moderation over the holiday. ``At no moment can anyone in Brazil imagine that some allegation can cause a political crisis in this country.''

The Brazilian real is this week's best-performer against the dollar among 60 tracked by Bloomberg. It gained 0.5 percent against the dollar today at 4:39 p.m. in New York. The bond due 2040 has climbed to 105 cents on the dollar from a low of 102.8 last week, cutting the yield to 10.2 percent, according to J.P. Morgan Chase & Co. The bond fell 0.5 cent on the dollar today, the second decline in six days, after the U.S. said the economy grew faster in the fourth quarter than previously reported, at a 4.1 percent annual rate.

Brazil's Bovespa stock index also has recovered, gaining for a third session in four to close up 1.4 percent at 21,755.02.

The investigation threatens to undermine Lula's ability to push legislation through congress only if economic growth continues to stall, said Rubens Sardenberg, finance director at Banco Nossa Caixa SA, the Sao Paulo state-owned bank.

The economy shrank in 2003 for the first time since 1992, and unemployment climbed in January for the first month since August, the government statistics agency reported today.

`Positive Signs'

``If we have positive signs in the economy, I think this political turbulence will be prevented,'' Sardenberg said in an interview. ``On the other hand if the economy doesn't show a recovery, the turbulence can have more of a significant impact.'' The government forecasts the economy will grow 3.5 percent this year, led by exports. Today's GDP report showed that the export portion of GDP rose 14 percent in 2003 over 2002.

Brazil's Bovespa stock index, last year's best performer in dollar terms among 59 tracked by Bloomberg, fell as much as 10 percent in dollar terms between Feb. 13 Epoca report and Friday last week, declines that Jose Gabrielli, chief financial officer at Petroleo Brasileiro SA, the state-owned oil company based in Rio de Janeiro, said were overdone.

``There is an overvaluation of a potential crisis,'' Gabrielli said in an interview. ``It will get diluted.''

Fallout

Lula is trying to contain the fallout a year after he helped restore confidence among investors and reverse a plunge in the nation's stocks, bonds and currency by cutting spending and pledging to keep up debt payments. A political cartoon in O Globo newspaper on Wednesday, the day after the two-day Carnival holiday, showed Lula in dark glasses, sitting on a red armchair, with an ice pack on his head and a glass of water in hand. ``Ok, ok, but can you change the subject?''

Among legislation Lula will be trying to push through Congress in coming weeks is a bill on investment plans through 2006, final amendments on pension and tax bills and new rules for the power industry.

Lula's party is ``certainly going to be tainted by all this,'' said John Williamson, an economist at the Institute for International Economics in Washington and a former professor at Rio de Janeiro's Pontifical Catholic University, in a telephone interview. ``It was all going too well -- something had to go wrong.''

Investors such as David L. Babson & Co.'s Maziar Minovi said they are concerned that Dirceu may be forced to step down. Dirceu helped stitch together a coalition in congress that passed legislation to streamline the tax system and reduce spending on pension benefits. Dirceu also helped keep party members in line with Lula's priorities.

Reforms

``Dirceu is seen as the one who rolls up his sleeves and gets things done in congress,'' said Minovi, who helps manage more than $500 million in emerging-market debt, including Brazilian bonds, at David L. Babson in Washington. ``This has the potential to slow down the implementation of reforms and there is concern about that.'' Lula has vowed to keep Dirceu in office.

Rodolpho Takahashi, executive vice-president at Procopio, Brazil-based Cia. Iguacu de Cafe Soluvel, one of Brazil's top three soluble coffee processors, said he doesn't expect the corruption allegations will weaken Lula, although they don't help the country's reputation.

``It reinforces the image that some people abroad have of our country -- corruption crime and so on,'' Takahashi said in an interview. ``That's not good either for the country's image or for business.''

Promises

The allegations come on top of Lula's failure to fulfill promises to boost economic growth and create jobs. Brazil's economy probably contracted 0.2 percent last year, the state statistics agency said. The unemployment rate climbed to 11.6 percent in January from 10.9 percent in December.

Brazil's stocks and currency rose today even after the report, in part because the corruption allegations have subsided, said Alexandre Vasarhelyi, head of the currency-trading desk at the Sao Paulo unit of ING Bank NV.

``No news seems to be good news,'' Vasarhelyi said in an interview. ``We haven't seen new corruption allegations, new strong stories from weekly magazines up to now. So without bad news, the market tends to look to inflows. And Brazil is showing strong inflows.''

Rising Exports

Brazil had a trade surplus of $3.19 billion in the year through the third week of February, up from $2.07 billion in the same period a year earlier, as exports increased faster than imports.

Investors such as Mark Dow of MFS Investment Management in Boston expect Lula will overcome the crisis, keep up his fight against inflation and honor pledges to make debt payments.

OppenheimerFunds Inc., the mutual fund company owned by MassMutual Financial Group, added to its holdings of Brazilian bonds in the past week after a tumble in the market made prices more attractive, Ruggero de Rossi, who manages $4 billion in international bonds for the company, said in an interview.

``The fundamentals in Brazil seem all right, and at least for now, nothing has changed materially,'' said Dow, a former IMF economist who manages about $1 billion in emerging-market debt.

To contact the reporter in this story: Charles Penty in Sao Paulo at cpenty@bloomberg.net and Carlos Caminada in Brasilia at at ccaminada@bloomberg.net

Last Updated: February 27, 2004 16:44 EST