Can Cardoso Steer Brazil Away From The Abyss?

President Fernando Henrique Cardoso has plenty to celebrate. After his Oct. 4 election victory, he is close to winning a rescue package worth about $40 billion for Brazil led by the International Monetary Fund. Relieved investors toasted his successes by pushing Sao Paulo's stock index up 16% in the first week of November. And capital flight--which in September drained off over $20 billion, or one-third of Brazil's currency reserves--has slowed to a trickle.

But the party could soon be over. Cardoso must enact a slew of tax increases and spending cuts to implement a three-year, $84 billion austerity program. Opposition from Congress and corporate lobbyists is mounting on measures such as plans to nearly double the tax rate on financial transactions, to 0.38%. But unless he can push the measures through by early next year, investors may again head for the exits and the IMF could back off.

Timing is critical. The transactions tax and other legislation must pass through two rounds of congressional voting and will be approved in January at the earliest. If global financial markets remain calm, that might not matter. But renewed jitters could prompt a speculative run that could force a devaluation of the real. Analysts such as Deutsche Bank economist Dalton Gardiman, reckon it is 15% to 20% overvalued. Worse yet, Brazil might default on part of its $290 billion in public debt.

SKEPTICISM. Much is riding on Cardoso's efforts in Brazil, by far Latin America's biggest economy. His success could be a lifesaver for its neighbors. Recently, other Latin stock markets have coattailed Brazil's, to post their strongest rallies since early September. On the other hand, chaos in Brazil could quickly engulf the rest of the region.

There's plenty to justify investors' skepticism. Last year, after Asia's financial meltdown, Cardoso announced an impressive $18 billion in budget cuts and tax hikes to ward off speculative attacks. But once the markets calmed, he quietly shelved most spending cuts and a public-sector pay freeze. Brazilian lawmakers, too, have embraced austerity before, only to buckle when lobbyists squawked. "A sense of urgency is always subject to local politics," says Walder de Goes, a political analyst in Brasilia.

Cardoso has factored some political wiggle room into his package. He could, for example, accede to a move by Congress to halve the proposed increase in the transactions tax. But that would eliminate $2.5 billion of the $13 billion in new revenues that Cardoso needs next year. There's a risk such concessions could backfire badly if investors and the IMF interpret them as a serious erosion of the plan.

DAWDLING. Brazilian-style politics could well create that impression. Sometimes, Congress will labor over major reforms for years, approve the principle--but dawdle in passing nitty-gritty laws to implement them. That happened this year with measures to make it easier to fire public-sector workers. Often, Congress dodges hot issues altogether, such as drawing up a new tax code to ease the burden on business. And at other times it deals in half measures. For example, on Nov. 4, after four years of dithering, Congress finally approved changes in the social security system, which is running an annual deficit of $35 billion. But then it set the national retirement ages at only 48 for women and 53 for men.

So far, Brazil has kept itself from becoming the next emerging market to fall into the abyss. A deal with the IMF should ease the debt burden and stave off a Russian-style default. But investors, who have waited years for Brazil to cut spending and enact reforms, are losing patience. If Cardoso doesn't deliver now, Brazil won't get another chance.

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