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Brazil's Economy Seen as Finally Heating Up

Monetary reforms and an improving trade surplus have spurred growth. Hurdles remain.


After a decade of false starts, optimism is running high that Brazil's economy may finally take off this year and enable the nation to get closer to its ambition of becoming a major global economic power.

But there's a political caveat: the rising popularity of a far-left candidate in this November's presidential election who has said he would reverse some of the economic reforms of the last eight years if elected.

Those economic reforms are one of the reasons for the optimism and are seen as critical to Brazil's turnaround, economists say.

Another key factor behind the positive view is a growing trade surplus, thanks to rising sales for Brazilian exports such as automobiles and orange juice concentrate. Also seen as good news is the decline of inflation due to tough monetary policy enforced by central bank chief Arminio Fraga, a former associate of financier George Soros.

"I'm pretty bullish on Brazil. Almost everything is going well," said Lawrence Krohn, ING Barings economist in New York.

A recovery would help Brazil fulfill its promise as Latin America's second-largest economy behind Mexico.

Political instability, hyperinflation and skyrocketing budget deficits, among other problems, have in the past throttled Brazil's ambition of becoming a leading economic power.

The Brazilian economy is expected to grow 2.5% this year, up from 1.5% last year. That growth comes amid dimmer prospects elsewhere in Latin America, where the regional economy is expected to grow only about 0.6%. Mexico will grow only about 1.5%, according to Merrill Lynch.

Several portfolio strategists are "overweighting" Brazilian stocks because they see them as the biggest profit opportunities in Latin America. A strong market performance is expected as a payoff for sound government economic policy in recent years, the result of tax and spending reforms from the administration of President Fernando Henrique Cardoso.

"The government continues to adopt prudent, well-managed economic policies running primary fiscal surpluses--that's the budget balance not including debt payments--and keeping inflation low," said Jose Carlos Faria, head Brazilian economist in Deutsche Bank's Sao Paulo office. Brazil's inflation rate is expected to be 7.5% this year.

Brazil has shown itself to be virtually immune to the problems of Argentina, whose economy has been in a recession for nearly four years.

But the wild card in Brazil, as so often has been the case, is political. Leftist presidential candidate Luiz Ignacio Lula da Silva has soared in the latest presidential survey, garnering nearly twice the support of government-backed candidate Jose Serra, a former health minister.

Amid recent chaos in Venezuela, the prospect of any country electing another populist firebrand scares investors.

"Lula has expressed the view that he doesn't favor a market-oriented policy, the opening up of the economy or the type of policies that enhance productivity and efficiency in areas such as labor," which Brazil needs, said Sebastian Edwards, a professor at UCLA's Anderson School.

Greg Heywood, senior analyst at Montgomery Asset Management in San Francisco, said the outcome of the presidential election cannot yet be predicted.

Lula "is a populist and he has made statements about wanting to renegotiate foreign debt," which scares the markets, Heywood said. "They have seen that movie before in Argentina."

"Lula would be a disaster for the economy and for the markets," ING's Krohn said.

Brazil, which imports a third of its oil, also has been hurt by rising energy prices and the inflationary pressures that has created. Those pressures have forced the central bank to keep Brazil's benchmark interest rates at about 18.5%--much higher than they and investors would like--so as to dampen consumer demand.

Rates that high choke off credit, demand and potential growth, said Paulo Levy, coordinator at the Institute for Applied Economic Research think tank in Rio de Janeiro.

As a result of the political and inflation fears, Brazil's most closely watched stock index, the Bovespa, is down 2.6% this year in local currency terms, better than the 4.1% drop in the Standard & Poor's 500 but still a disappointment for managers who had bet on a breakout year for Brazil.

Mexico's main share index is up 16.2% in 2002.

Despite the weakness in stocks, Krohn notes that there have been payoffs elsewhere for Brazilian investors. The currency has slowly but steadily rebounded in value against the dollar this year, and Brazilian bonds are among the biggest gainers in emerging markets.

Several years of effective economic management have reduced the tide of Brazil's fiscal red ink. Its current account deficit--the trade balance plus the cost of servicing debt--should fall as low as $20 billion this year from $30 billion in 1999, Levy said.

Because Brazil will receive foreign direct investment matching that deficit, it won't have to borrow foreign capital to finance it, another positive for investors.

Brazil's trade is finally producing the surpluses that observers have been expecting since the country's January 1999 currency devaluation, an event that was supposed to have made Brazil's commodities and manufactured goods big sellers on global markets.

Brazil last year posted a trade surplus of $2.6 billion, its first since 1994. The surplus could go as high as $4.5 billion this year, Levy said.

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