Lula Meant What He Said

So far, the former leftist's shift to the center is a big hit

As a campaign tactic, it was highly effective. Onetime labor leader and three-time presidential contender Luiz Inácio Lula da Silva joked last year that this time around he was running as "Lula-lite"--a brew that blended a progressive social program with a largely conservative economic policy. It worked. Lula--as he is known by all--won the Oct. 27 presidential runoff by a landslide.

But was the radical trade unionist's transformation into a centrist social democrat for real? Well, here's the surprise. Judging by his first two months in office, it was. Indeed, Lula's economic appointments and policies have been so thoroughly mainstream that some of his left-wing supporters are up in arms. Wall Street and the local business community, by contrast, couldn't be more pleased. Brazil's benchmark government bonds, a key gauge of investor sentiment, have climbed more than 20% since October. "The transition--from policy announcements, to appointments, to implementation--has been very good," says Mohamed A. El-Erian, managing director of PIMCO, the big U.S.-based investment firm.

A good indicator of Lula's newfound pragmatism is monetary policy. As the leader of Brazil's Workers Party (PT), Lula denounced the previous government's policy of hiking rates to curb inflation. Yet on Feb. 19, his appointees at the central bank raised the base interest rate by 100 basis points, to 26.5%, the second increase since the new government took office.

Lula had already shown his commitment to fiscal responsibility on Feb. 10, when his government announced it would slash budgeted spending by $3.93 billion this year. The move came just days after the administration had kicked off a nationwide campaign to eradicate hunger. "What we are seeing is financially principled populism," says PIMCO's El-Erian.

It's hard to tell how long Lula's honeymoon with both investors and voters will last. But for now, the 57-year-old former lathe operator enjoys an extraordinary 83% popularity rating, according to a poll taken last month. And in January, Lula drew plaudits at both the World Economic Forum, the annual confab of world leaders held in Davos, Switzerland, and at the concurrent World Social Forum, an antiglobal- ization gathering in Brazil's Porto Alegre.

The international investment community also seems to have fallen under his spell. Goldman, Sachs & Co. (GS ) just retracted a recommendation that its clients reduce their exposure to Brazil. "Our vision was based on the traditional rhetoric of Lula and the PT," it said in a report dated Feb. 3. "We were wrong."

Just a few months ago, Wall Street was fretting that a Lula-led government would default on the country's $250 billion public debt. This fear sent Brazilian markets plunging. But a series of confidence-building moves by the new government is paying off. One was the appointment of Henrique Meirelles, a former president and CEO of BankBoston, to head the Central Bank. Another was the government's announcement that it was aiming for a budget surplus before debt payments of at least 4.25% of gross domestic product for 2003. That's well above the 3.75% target mandated by the International Monetary Fund as a condition for $30 billion in fresh funding.

Lula's conservative course has set militants in his own party railing against the interest-rate increases. Now, there are signs that the malcontents are working to undermine Lula's policies. Legislation that would grant the Central Bank more autonomy was due to be submitted to Congress in March but has been delayed. In an unsuccessful attempt to shame the government, a closed-door meeting at which Finance Minister Antonio Palocci lectured PT legislators on the need for tight monetary and fiscal policies was secretly recorded and the tape was turned over to a news agency.

Even conservative economics won't solve some basic problems. Consumer-price inflation was running at an annualized 17.5% in January and will be difficult to tame even with rate hikes. And a war against Iraq could make investors more averse to risky plays like Brazil.

Undaunted, Lula swears he can increase social spending without running big budget deficits or defaulting on debts. Some $760 million earmarked by the previous administration for new fighter jets has already been redirected into programs targeting Brazil's poor. Ricardo Amorim, head of Latin America research at IDEAglobal, an independent research firm based in New York City, reckons that the government may even wind up with money to spare. "They want to be able to say at the end of the year, `Look, the economy has done so well under Lula that we're able to spend more,"' says Amorim. If that happens, even the President's harshest critics will want to buy a case of Lula-lite.

By Jonathan Wheatley in São Paulo

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