It's been a good start for Dilma Rousseff. The Brazilian President, who took office on Jan. 1, has stepped out from under the shadow of her ebullient predecessor and mentor, Luiz Inácio Lula da Silva, and established her identity as a hard-nosed pol. In February, she jack-hammered through Congress a minimum wage far below the amount demanded by the unions that constitute the base of her Workers' Party. Then her government sent a valentine to the markets by pledging to slash this year's budget. During President Barack Obama's visit, she bluntly called for a more balanced trade relationship with the U.S.
"People are pleased," says Robson Barreto, a corporate lawyer who heads the Rio de Janeiro chapter of the American Chamber of Commerce for Brazil. "She's making her own decisions, and they're not necessarily the ones Lula would have taken." In a Datafolha poll released on Mar. 21, Rousseff had a 47 percent approval rating, higher than Lula's after three months in office.
Yet Brazilians also are starting to feel uneasy about how expensive their emerging-market economy is getting. Rousseff inherited an economy superheated in part by Lula's effort to get her elected. Federal spending exploded in 2010. In February inflation reached its fastest rate—6 percent—since November 2008. Consumers are feeling the pinch. "My grocery bill is getting bigger every month," says Alexandra Camargo, a 26-year-old hairdresser shopping at a C&A Group apparel store in Copacabana. "Services are more expensive. I only buy what's strictly necessary, and I pay in installments." The central bank has raised the benchmark rate from 8.75 percent a year ago to 11.75 percent. Economists expect another half-point hike in April.
With spending cuts imperative, the new President demanded that her coalition support a formula increasing the minimum wage by 6.8 percent, to $324 a month, though the unions called for $360. It was a crucial fight because pensions are linked to minimum-wage levels. The bill passed overwhelmingly, to the unions' dismay. "It was a disaster," says Ricardo Patah, president of the 6 million-member General Union of Workers. "With Lula it was different. He listened to us."
It was hardly a complete victory for fiscal hawks. Under the formula, the wage could rise 13 percent in 2012. The recent announcement of 50.7 billion reais ($30.5 billion) in budget cuts was undermined days later when Rousseff announced a 2.2 billion reais increase in the "Bolsa Familia" welfare program. The Treasury also said it would borrow 55.1 billion reais to lend at heavily subsidized rates to the national development bank, which in turn will lend out the money for infrastructure projects. "The budget cut is positive," says Felipe Salto, an analyst at Tendencias Consultoria Integrada in São Paulo. "But the government's argument that the bank's cheap credits don't pressure inflation is wrong in the short term."
The rising real is another issue. Investors borrow cheaply in Japan and the U.S. and invest the money in Brazil, whose rates pay more. The real has appreciated 8.5 percent against the dollar in the past year and 4.2 percent against the yuan, raising the cost of exports and exposing industry to cheaper imports. Analysts surveyed by the central bank predict growth of about 4 percent this year, vs. 7.5 percent in 2010.
Some investors suspect that the new central bank chief, Alexandre Tombini, may prove softer on inflation than his predecessor, Henrique Meirelles. (Fund managers have dubbed him Pombini, a play on the Portuguese word for dove). In the minutes of its March meeting, the bank's policy board hinted that the next rate increase might be the last for now. Newton Rosa, chief economist at SulAmérica Investimentos in São Paulo, called the report "extremely dovish." To restrain the real and cool credit growth, the central bank says it may rely more on higher taxes on capital inflows and steeper reserve requirements for banks.
Rousseff also needs to grapple with primitive infrastructure, an arcane and burdensome tax system, poor public education, scanty private investment, and a bureaucracy so tangled that the country ranks 127th in a World Bank survey that measures the ease of conducting business. She has indicated that modest tax reform may be her first effort to fix long-standing problems. She's a seasoned player who served as Lula's Energy Minister and cabinet chief. "Her advantage is that she already has the whole government in her head," says Communications Minister Paulo Bernardo. "She knows more about governing than Lula did when he took power." What remains to be seen is the scope of her aspirations and political skill.
The bottom line: Brazilian President Dilma Rousseff's first victories against overspending may be fleeting unless she resists budget-sapping initiatives.