Lula’s exit won’t reverse Brazil’s gains, but the state may loom a bit larger

by Eurasia Group analyst Erasto Almeida

Brazil has navigated the global financial crisis relatively well, and is well positioned to resume economic growth in 2010 and beyond. Responsible macroeconomic policies are probably here to stay, even when a new president takes office in January 2011. New vast oil discoveries will further reduce the country’s vulnerability to external shocks and offer a number of new investment opportunities. So what’s at stake for the markets in the 2010 elections? It will be important to watch the role of the state and national champions in key sectors such as oil, power, and mining.

No matter who wins the presidential election, it is highly unlikely that Brazil will return to the kind of irresponsible macroeconomic policies it had in the past. The country’s largest leftist party, the ruling Worker’s Party (PT), has not only embraced responsible macroeconomic policies but, very importantly, benefited politically from its decision, as shown by President Luiz Inacio Lula da Silva’s reelection in 2006 and 80 percent approval ratings.

Lula’s chosen candidate to succeed him, Chief of Staff Dilma Rousseff, is unlikely to change course. Jose Serra, the governor of Sao Paulo from the opposition Brazilian Social Democracy Party (PSDB), who will probably be her main adversary, is even more market friendly. Rousseff and Serra might differ on how to calibrate policies, but neither one will significantly alter the status quo. The 2010 electoral cycle may contribute to some fiscal slippage and generate noise on monetary policy with the likely departure of central bank governor Henrique Meirelles, who wants to run for office. Yet even if a less predictable candidate emerges and wins the election, a shift away from voters’ preferences for low inflation is unlikely. Brazil remains overall a sound long-term bet for investors.

With macroeconomic stability here to stay, what differentiates the two main candidates is their view on industrial policy and the state’s role in key sectors of the economy. Rousseff has a much more state-centered view than Serra, perhaps even more than Lula. Her view is already present in the current government, where she is the key policy decision-maker, but it would probably become more salient in a new PT administration. Investment from state-controlled energy company Petrobras, for instance, has been a key component of the government’s counter-cyclical policy. More recently, the government seems to have decided to propose that Petrobras be the sole operator of the new deep-sea oil province. There may be similar moves, if on a smaller scale, in the power sector, for example, with a greater role for state-owned utility Eletrobras. Brazil’s National Development Banks (BNDES) will play an increasingly important role in providing financing for companies and projects. Rousseff wants greater private investment as well, but as Brazil’s economy and state revenues grow, she will have more room to push for industrial policies and national champions. If Jose Serra and the PSDB win, however, the state and national champions would have much less involvement.

The big question that remains open, of course, is who will the election. While the presidential race is expected to be tight and it’s still early to make concrete predictions, the odds seem to be in Rousseff’s favor. Although she is behind Serra in current polls, has never run for office, and lacks Lula’s charisma, she signifies continuity — which is likely to be the popular trend. Brazilians are happy with the economy and recent improvements in their lives. Studies show a steady expansion of the lower-middle class, which grew from 42 percent of the population to 52 percent in the past seven years. This progress helps explain Lula’s record high approval ratings, which will also be Rousseff’s main asset. If she wins, she won’t put economic stability at risk, but Brazil will most likely see the state take a heavier hand.

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