Lula Flouting Brazil Law Undermines Legacy as Investor Billions Flood In

Photographer: Adriano Machado/Bloomberg

Dilma Rousseff, left, chief of staff to Brazilian President Luiz Inacio Lula da Silva, listens during a meeting with Lula, right, and his economic advisers in Brasilia, Sept. 15, 2009. Close

Dilma Rousseff, left, chief of staff to Brazilian President Luiz Inacio Lula da Silva,... Read More

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Photographer: Adriano Machado/Bloomberg

Dilma Rousseff, left, chief of staff to Brazilian President Luiz Inacio Lula da Silva, listens during a meeting with Lula, right, and his economic advisers in Brasilia, Sept. 15, 2009.

On a sunny February morning, Brazilian President Luiz Inacio Lula da Silva is doing what he loves: pumping up his audience by unveiling a multimillion- dollar government dam that’s bringing jobs to their backyard.

Hundreds of workers jam under a white plastic awning near Goiania in the nation’s central region as Lula launches into two favorite subjects: soccer and Brazil’s federal audit court, known by its initials TCU. The watchdog agency, similar to the U.S. Government Accountability Office, has become Lula’s bane, Bloomberg Markets reports in its June issue.

“We will hold in Brazil the best World Cup,” Lula says, referring to the global soccer championship that the nation will host after six decades without a major international sports event. “The one thing I can’t promise is we will win the 2014 World Cup, because maybe the TCU would ask for an audit,” he adds, his voice exploding as sweat drenches his dark blue shirt. The crowd bursts into laughter.

The comment is more than an off-the-cuff joke: Lula and his push for government-funded growth are butting up against calls from political opponents and the TCU to rein in spending -- and the president himself -- as the October presidential election looms.

In the seven-plus years of his presidency, Lula, 64, has steered Latin America’s biggest economy from the edge of default and turned the nation of 193 million into an emerging financial power.

‘Hottest Markets’

The Brazilian real soared 33 percent in 2009, the largest gain among the world’s 16 most actively traded currencies. Annual inflation dropped to 5.17 percent in March from 14.5 percent when Lula took office in January 2003 -- a far cry from the 6,800 percent in April 1990. Gross domestic product growth is forecast to accelerate to 5.8 percent in 2010 from 2.7 percent at the beginning of Lula’s term.

“Brazil is definitely among the hottest markets this year for us,” says William Landers, who helps manage $8.7 billion of Latin American assets at BlackRock Inc. in Plainsboro, New Jersey.

On April 28, Brazil’s central bank raised the benchmark Selic interest rate by 75 basis points to 9.5 percent in an effort to cool the economy and head off inflation. The increase, from a record low 8.75 percent, was the first in 19 months.

International investors are pouring money into Brazil. They added 20.5 billion reais ($11.7 billion) of Brazilian shares to their holdings last year, the most since records began in 1994.

Foreign direct investment this year is on its way to recovering to the 2008 record of $45 billion. And Brazil’s biggest company, state-owned oil giant Petroleo Brasileiro SA, plans to sell as much as $25 billion in stock -- the largest share sale in history, according to Luciano Coutinho, president of Brazil’s development bank.

Adored President

To top it off, Lula, a former labor leader whose tales of growing up in poverty have helped win him an approval rating of 80-plus percent, is one of the nation’s most adored presidents.

Brazil restored democracy in 1985, ending 21 years of military rule. Lula’s Workers’ Party, which defends agrarian reform and agitates for social justice through economic growth, is one of the three main groups that fought the military regime in the early 1980s. Lula himself was jailed for 31 days in 1980 for organizing strikes.

Not everyone is so effusive about Lula. TCU President Ubiratan Aguiar says the president is carrying out public works at any price in the name of development. Former Brazilian President Fernando Henrique Cardoso, who defeated Lula in 1994 and 1998, says Lula is exploiting his popularity to run roughshod over checks and balances that keep spending under control. Cardoso says Lula is using government largess to boost chances of a presidential victory for his handpicked successor, former chief of staff Dilma Rousseff. Rousseff has no leadership skills and doesn’t inspire confidence, Cardoso says.

‘Growth at Any Cost’

Brazil’s electoral court fined Lula twice this year, for a total of 15,000 reais, saying he campaigned for Rousseff ahead of the period allowed by law. Lula was also fined in August 2006 for running ads for the presidential election ahead of the legal starting date.

“You don’t see Lula defending transparency and honesty in government,” says Larry Birns, head of the Washington-based Council on Hemispheric Affairs. “You see Lula defending jobs and growth at any cost.”

Birns says Lula is insensitive to the importance of creating a government with ground rules and combating lapses when they occur.

“All of this eventually is going to come back to haunt this administration,” Birns says.

Environmental Gripes

Environmentalists gripe that Lula’s building spree is worsening deforestation of the Amazon rain forest and risking overdevelopment. On April 12, James Cameron, director of the top-grossing film “Avatar,” traveled to Brazil to protest what would be the world’s third-largest hydroelectric dam, called Belo Monte. It’s planned for the Xingu River in the heart of the Amazon.

“Lula thinks his popularity gives him the right to do whatever he pleases,” says Arthur Virgilio, who leads the opposition Social Democratic Party, or PSDB, in Brazil’s Senate. Cardoso is also a PSDB member. “He is authoritarian and often forgets that Brazil is a democracy,” Virgilio says.

Lula’s biggest battle is with the TCU. Brazil formed the Tribunal de Contas da Uniao 119 years ago to control how the government allocates the federal budget -- which amounts to 1.86 trillion reais for 2010.

‘Arbitrary Decisions’

Every year, the TCU audits a 20 percent sample of public works projects and sends the results to Congress. If the TCU finds evidence of billing fraud, overcharging or other irregularities, it can recommend suspending work. Congress then blocks funding for the projects that are suspended and orders construction stopped.

The TCU audited 219 projects last year that accounted for 35.4 billion reais in public-sector investments. It recommended stopping 41 of them. Thirteen are part of Lula’s spending program called the Growth Acceleration Plan, known as PAC.

The first PAC phase, which runs through 2010, began in 2007 with 504 billion reais of public and private investment. On March 29, Lula unveiled an $886 billion second phase that starts in 2011.

“Lula and his party are really uncomfortable with controls on spending,” Cardoso says. “All these controls prevent exactly what they want to do, which is to make arbitrary decisions based on political inclination and not on technical or market considerations.”

Big Government

Lula’s government hired 57,100 public servants from 2003 to 2009, increasing the number to 542,843 at the end of 2009, the highest since 1996. It cut 25 billion reais in taxes last year. Brazil has posted a budget deficit every month in the 14 months through December 2009. In 2008, the country had a budget gap of 37.7 billion reais, the biggest in 15 years.

Virgilio Castro Cunha, an economist at Bank of America Merrill Lynch in Sao Paulo, says some investors worry that Rousseff may keep up Lula’s spending and hiring spree.

“It could lead to renewed concerns about the government’s fiscal policy and the overall size of the government,” he says.

Rousseff, 62, is picking up Lula’s fight for jobs and growth. The one-time Marxist guerrilla, who has never been elected to office, is campaigning on the assertion that she created the PAC spending program while serving as Lula’s chief of staff. She’s running against PSDB member Jose Serra, governor of Sao Paulo state, Brazil’s wealthiest.

‘New Brazil’

When Serra, 68, officially declared his candidacy on April 10, he pledged to increase government investment in infrastructure and loosen fiscal restraints. Even so, former central bank director Paulo Vieira da Cunha, now a partner at Tandem Global Partners LLC in New York, says Serra may be more likely than Rousseff to put a lid on federal spending by promoting public-private partnerships and curtailing government jobs.

There’s no doubt about Rousseff’s stand. On March 29, when Lula announced the PAC extension, she stood next to him and cried when she spoke of his success.

“The Lula government put Brazil back on the development track,” she said. “You, President Lula, have built this new Brazil for all of us, and we won’t let it escape from our hands.”

Cardoso says he worries Lula and his party are grabbing too much power. Yet even he says Brazil won’t turn into a Venezuela if Rousseff wins and follows in Lula’s footsteps. Authorities in Brazil’s northern neighbor have detained journalists, opposition politicians and the top television network executive for bad- mouthing President Hugo Chavez.

Not a Venezuela

In January, Chavez expropriated supermarkets owned by French retailer Casino Guichard Perrachon SA, saying he was protecting Venezuelans from illegal price increases.

“Brazil won’t be Venezuela because it has strong institutions and a more educated population,” Cardoso says.

All the same, Lula’s association with Bolivian President Evo Morales; Fidel Castro and his brother Raul, Cuba’s president; and Chavez may mean Brazil’s leader is moving to the left, says Juan Carlos Hidalgo, project coordinator for Latin America at the Washington research group Cato Institute. Those ties, and Brazil’s resistance to calls for tougher sanctions on Iran’s nuclear program, may strain its relationship with the U.S., he says.

BlackRock’s Landers says he doesn’t expect either a Rousseff or a Serra presidency to hurt investor appetite for Brazilian assets.

Serra had the backing of 38 percent of voters in an April 17 Datafolha poll; Rousseff had 28 percent support in the poll, which has a 2-percentage-point margin of error. Lula can’t run for a third term.

‘A Few Hiccups’

“There may be a few hiccups here and there on the market during the campaign because investors will watch closely what the leading candidates are saying,” Landers says. “They both want the same thing for the economy: sustainable growth, inflation under control, rising employment and improved access to credit so that Brazil’s consumer base can continue to grow.”

Nobody else has Lula’s ability to make both the people and the international investing community happy. Brazil, which defaulted on its foreign debt twice since 1983 and devalued its currency in 1999, has come storming back under his guidance.

The country got its first investment-grade rating in April 2008 when Standard & Poor’s boosted Brazil’s sovereign debt to BBB- from BB+. That same year, Brazil, which is the world’s biggest exporter of beef, coffee, orange juice and sugar, held so many dollars that it created a sovereign-wealth fund to invest outside its borders.

Economic Stability

Foreign exchange reserves surged to $244.8 billion in April as record commodity exports continued to flood the local market with the U.S. currency.

“The economic stability we see now is not going away,” Landers says.

Lula wants to keep it that way. And he blames the TCU for delays that cost Brazil thousands of jobs.

“We won’t let workers be unemployed because someone suspects something is wrong,” he said on March 12 at a ceremony to unveil the expansion of Petrobras’s Presidente Getulio Vargas refinery in southern Parana state.

The refinery, known as Repar, went online in 1977 and produces 12 percent of Brazil’s petrochemicals. It has moved into low-sulfur diesel fuel and a biofuel called HBIO.

In last year’s audit, the TCU found billing fraud and an incomplete budget for the refinery’s expansion. It recommended work be halted until the issues were addressed. Lula included 1.7 billion reais for the project in the 2010 budget anyway.

“We are talking about 25,000 jobs that would be lost if this project were suspended,” he said.

Challenging the TCU

Lula is the only president who has challenged the TCU --and he has done it twice. In 2005, he defied Congress by ignoring an order to halt construction of Angra III, Brazil’s third nuclear power plant. The facility, based 157 kilometers (98 miles) from Rio in Angra dos Reis, lacked a proper environmental license, according to TCU documents.

When Lula approved Brazil’s 2010 budget, he ignored Congress by including four Petrobras projects that are funded at 13.1 billion reais. The TCU had recommended that Repar and another refinery, a petrochemical plant and a gas pipeline be suspended for overbilling and shoddy measurement of the costs of materials and services.

‘Technical Differences’

At a refinery called Abreu e Lima, which Petrobras is building with Venezuela’s Petroleos de Venezuela SA, the TCU found 145 million reais in billing fraud and no explanation for 1.1 billion reais of expenses. Lula included 6.1 billion reais for the project in the 2010 budget. The TCU said materials used in what will become one of Brazil’s biggest refineries will cost as much as 50 percent more than the market average.

Abreu e Lima, with an initial price tag of $4 billion in 2005, will now cost $12 billion.

Petrobras CEO Jose Sergio Gabrielli denies the irregularities. He says the TCU used different criteria to assess the refinery’s costs. The swampy soil on the coast of Pernambuco, Brazil’s northeastern state, created challenges for construction, he says.

“There are technical differences between us and the TCU, and we are working to clear that up,” he says.

Lula says the projects are essential, especially with the proposed stock sale. Brazil’s government controls 55.6 percent of Petrobras’s voting shares. Nongovernmental shareholders own 77 percent of Petrobras preferred stock and 42 percent of the common shares.

Petrobras Share Sale

Gabrielli is pushing to schedule the sale before July. The government wants to increase Petrobras’s capital so the oil giant can fund a $220 billion plan to increase drilling and improve production and distribution through 2014. On March 2, Brazil’s Lower House approved a bill that would exchange the rights to oil reserves for shares in the company; the Senate had 45 days to consider the measure. Investors are waiting for details on where the oil rights will be as lawmakers squabble over how much their states will get from future production.

“Petrobras’s investment and strategic plan is a top priority,” Cardoso says. “But the government and Congress have reduced the issue to a political debate over who gets how much in royalties.”

Petrobras has become even more important after the 2007 discovery of the Tupi field. The area may hold as much as 8 billion barrels of oil and gas trapped beneath 2 kilometers of salt, according to the company.

‘Stimulating Fraud’

If Tupi and Brazil’s other so-called pre-salt finds of more than a billion barrels apiece pan out, Petrobras says they may make Brazil the world’s fourth-largest oil producer after Saudi Arabia, Russia and the U.S. It’s now 13th, according to London- based BP Plc, which ranks countries by production.

“Revenue from pre-salt oil will go to education and to the fight against poverty,” Lula said on Aug. 31 while an­nouncing a plan to make Petrobras the sole operator of all pre-salt oil fields.

The TCU’s Aguiar says the court will continue to do its job and investigate Petrobras’s contracts.

“We cannot condone companies or people who misappropriate or misuse public funds,” Aguiar, 68, says, speaking from his office overlooking Brasilia’s Square of the Three Powers. “We’d be stimulating fraud and the waste of our own money.”

Skirmishes with the TCU may worsen as the government prepares for the 2014 World Cup -- and the 2016 Olympics in Rio. Banco do Brasil SA, the country’s largest state-owned lender, estimates World Cup-related projects will require 99 billion reais in financing for stadiums, subway lines, railroads and hotels.

Olympic Host

The Olympics will need at least $11 billion in investments, according to the organizing committee. Lula’s PAC program has committed as much as 70 percent of that total for the Olympics.

Lula wants to remove environmental screening and government oversight that could slow projects for the sports events.

“We need to create some accord or code of conduct among the control agencies and the executing agencies in the government so that we don’t give the same treatment to these events -- be it on the financial audits, or the environmental issues, or the internal controls, or at the TCU,” he said on Jan. 13.

For environmentalists, that’s another example of how Lula is overstepping his authority. Already, he has weakened Brazil’s environmental agency Ibama and removed some of its power to review giant hydroelectric power dams proposed for the Amazon.

When Ibama denied environmental permits in 2007 for two plants on the Madeira River, a tributary of the Amazon that runs from the Andes to the rain forest in Brazil, Lula split the agency in two.

Jobs Vs. Environment

Marina Silva, the former environment minister, quit in early 2008, saying she couldn’t protect Brazil’s resources. (For more on Brazil’s environmental damage, see “Plundering the Amazon,” September 2009.)

Rousseff defends Lula’s moves -- especially overruling the TCU. She says the government’s priority is to create jobs.

“This whole story of suspension of public works in Brazil has to change,” she said on March 13 at Sao Paulo’s Jockey Club. “Who will explain to the workers’ families that there will be no more jobs?”

If Lula’s campaign blitz works, Brazil’s workers -- and the country’s investors -- may not have to worry about a change of course for another four years. Brazil’s popular pro-growth president, though, may risk a lasting blot on his legacy.

To contact the reporter on this story: Adriana Brasileiro in Rio de Janeiro at abrasileiro@bloomberg.net

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