Brazil: A Perilous Course for Lula

Economists are holding their breath as they make their 2003 forecasts for Brazil. In general, they are betting that the new left-leaning government of President-elect Luiz Inácio Lula da Silva will be able to juggle the social agenda on which Lula was elected with the policy needs of a heavily indebted economy--without an Argentine-style collapse.

It won't be easy, though. Lula, who takes office on Jan. 1, inherits a net public debt of about $250 billion, or some 60% of gross domestic product. At the same time, the currency has lost some 35% of its value this year, primarily over worries that Lula's socialist roots could lead to debt default, capital controls, or general economic mismanagement.

The weak currency is helping to push inflation to an expected 10% both this year and next, the highest rate since 1995. All this leaves little room for Lula to develop his election promises to cut joblessness, improve income equality and education, and revive the economy.

Since September, the central bank has raised interest rates from 18% to 22% to combat inflation, with another hike expected in December. As a consequence, growth is set to slow, and the 8.5% jobless rate will rise further. After growth of 1.4% in 2001, economists expect a 0.5% gain in 2002 and little if any headway in 2003.

Investors remain wary, but market-friendly talk from Lula's transition team, upbeat comments from International Monetary Fund officials, and a favorable reading on third-quarter GDP have buoyed the currency in recent weeks. The new administration has pledged to maintain the previous government's policies of inflation targeting, a floating exchange rate, and a surplus primary budget, which excludes debt service.

The chief focus for the markets in coming weeks will be Lula's choice of Finance Minister and central bank president. Crucial decisions early next year by Lula and his economic team on the 2003 budget, the IMF's loan program, and central bank independence will shape Brazil's economy both next year and beyond.

By James C. Cooper & Kathleen Madigan

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