A slow day in the Senate.

Thanks to Lula’s determination to resist the temptation of resorting to irresponsible policies, Brazil is now beginning to enter a virtuous circle of growth. This has significant political implications as Brazil’s first left-wing government enters the second half of its four- year mandate and begins preparing the ground for reelection in 2006. Continuing economic recovery is the key to Lula’s success. Nonetheless, there are some important decisions the government must take soon which could impact the outlook for growth.

There is no sign that Lula will relax the government’s orthodox economic policies. Proof of Lula’s commitment to fiscal orthodoxy was his decision to over-comply with fiscal targets, to set a realistic ceiling for the minimum wage and to continue backing his finance minister, Antonio Palocci. Lula backed Palocci even as he came under heavy fire from within the governing coalition. Now that the economy is accelerating, Palocci’s power within the government has grown even stronger. 

The government needs to attract substantial financing for infrastructure projects, increase foreign direct investment and keep advancing with economic reforms. It would also help if the government could increase the country’s low savings rate by reducing the tax burden and, above all, reducing public spending. Even better, Lula should persevere in his efforts to modernize the country’s constitution and legal framework, since this would create better-functioning institutions.

After a promising start in 2003, when Congress amended the constitution, needed to reform the social security system and the tax regime, the government has lost its reformist impetus. However, expectations for growth depend on the determination of the government to resume its reform agendas. The government must restart the debate over reform of the judiciary and political reform for there to be major advances in labor union legislation and labor market reforms. Further reforms are needed, such as approval by Congress of draft bankruptcy legislation, operational autonomy for the Central Bank, legislation modernizing the regulatory agencies and implementation of Public-Private Partnerships to increase infrastructure investments. The legislative agenda is crowded with important initiatives and, if successfully executed, they will play a major part in shaping expectations over the coming years. Sadly, we are now well into the second half of 2004 and the results from the reform agenda are disappointing (see Lula’s Legislative Agenda, p. 42).

For 2005, in addition to the items listed in the table, we expect Congress to debate the following topics:

  • Labor union and labor market reform
  • National sanitation policy
  • Tax reform (unifying state sales tax rates)
  • Change in personal income tax regulations
  • Central Bank operational autonomy
  • Detailed regulations for 2003 framework for social  
    security reform
  • New rules for drafting and execution of the federal

Tax issues require particularly close attention. A change in the tax regime that Congress approved last year was weak. Principally, Congress extended the “provisional” CPMF financial transactions tax yet again but failed to act in unifying state sales tax rates. This is one of the most controversial items in the original tax package, and is still being debated in the lower Chamber of Deputies. Unfortunately, we have a tax burden comparable to that of the United Kingdom, but a government of almost African quality. A decisive approach by the government is needed to simplify the tax system and, although there was and still is considerable political support for this measure, the government has approached it timidly.

Other challenges facing the Lula government depend fundamentally on its ability to implement its decisions efficiently. In spite of the clear success of its economic, agricultural and export policies, the government has not performed well in critical sectors, particularly in social policy such as land reform, education, job creation and dealing with violent crime. Lula announced before taking office that social policy would be a priority, but results to date have been modest. 

Waiting for Congressional action.

Big Government
The government just seems too big and uncoordinated to deal effectively with so many challenges. Although it has 35 cabinet ministers, there is nobody to coordinate their efforts efficiently. By the end of the first half of 2004, a majority of government departments had not even been able to spend their budget allocations correctly. Ministries do not suffer from a shortage of funds. They lack initiative and administrative competence. Although it is true that the previous government of Fernando Henrique Cardoso also struggled with bureaucratic inefficiency, the Lula government – due more to its inexperience and its ambitious plans – seems to suffer from civil service ineptitude more than its predecessor.

As for politics, the government’s main challenge is to maintain the coherence of its broad and disparate coalition, which squabbles over ideological questions as it does over budget allocations. This challenge is growing with the imminent approach of local elections, which will have some influence on the outcome of the next presidential elections in 2006. Come next year, all government decisions will be focused on winning reelection, which will likely further limit the reform agenda, increase government spending and trigger more infighting within the coalition. There is no guarantee that Lula’s running mate will be José Alencar, his current vice president. Alencar is a textile magnate and a member of the conservative Liberal Party. It is almost certain that other coalition members – the center-left PMDB, the populist PTB, the leftist PSB and Alencar’s PL – will all fight to put one of their own on Lula’s ticket.

Lula’s Allies
The government has put together a wide-based alliance in the Chamber of Deputies but has only a narrow majority in the Senate. Nonetheless, the government was able to win over crucial opposition support for its reforms last year. But winning opposition support for government reforms will be harder than it was in 2003, thanks to the local elections in October and wrangling ahead of the 2006 presidential elections.

To conclude this survey, we should look at the country’s foreign policy agenda. In the Western Hemisphere, formation of a Free Trade Area of the Americas (FTAA) is likely to return to the front burner in 2005. However, impasses in bilateral trade talks with the United States, particularly over agricultural trade and protection of intellectual property, not to mention Argentina’s situation, are all likely to limit any advances in FTAA talks. The result of November’s US elections will also have a considerable impact on this picture. A victory for John Kerry, once a free trade supporter now running as a protectionist, would inject a greater degree of uncertainty into already complex regional negotiations.

The outlook for the two other important trade talks in which Brazil is engaged – with the European Union and the World Trade Organization – is mixed. Uncertainty seems to be prevailing in talks with the EU. But the WTO’s approval in July of a new negotiation framework for the Doha Round of global trade liberalization has increased the chances for agreement in 2005. Brazil has won considerable international admiration for its leadership of the G-20 group of developing countries in the trade talks and the country’s success in winning landmark WTO cases against US and EU farm subsidies.

While engaged in major international trade talks, the government is also trying to expand Brazil’s exports, part of a strategy to reduce the country’s vulnerability to external shocks. This is all the more important at a time when the global economy is at risk from rising US interest rates and volatility in world energy markets caused by high oil prices is increasing. Brazil’s growth next year will be affected by both interest rates and oil prices.

These factors seem to justify optimism over the country’s economic performance. Barring a severe international crisis, the outlook for Brazil is good. However, I do not see much chance of improvement in the government’s ability to coordinate and execute policies efficiently. The ruling alliance lacks a coherent, unifying ideology and organizational ability. These shortcomings are unlikely to kill the government but they will, without doubt, dilute its successes.

Lula should be able to maintain his coalition intact to the end of his term in December 2006. But the approach of elections will reduce the opposition’s incentive to cooperate with the government and increase the likelihood of conflicts within the coalition over Lula’s selection of a running mate. Without opposition support, voting constitutional amendments through Congress will become more difficult despite the government’s considerable majority. Progress with the reform agenda over the next two years depends on a combination of a positive economic outlook, sound political management of the coalition, cooperation from the opposition and, above all, considerable effort by the government.

The government lacks any daring new policy initiatives to attract foreign investment. Its planned Public-Private Partnerships, intended to stimulate infrastructure investments, are moving ahead too slowly. There is little reformist zeal to rewrite the rules governing unions or the labor market and there is no intention to restart the privatization program. Doubts remain over the functioning of regulatory agencies set up under the previous government to oversee the liberalized electricity, telecoms and oil and gas industries.

There is every chance that Brazil will do well over the next 12 months, delivering significant social and economic improvements. However, we are very far from attaining the spectacular growth rates Brazil enjoyed in the 1970s.  LF
* Murillo de Aragão is senior political analyst at Arko Advice, the Brasília-based political consultancy.

Lula’s Legislative Agenda

There are eight major items of legislation in the congressional pipeline.
Some are assured easy passage, others are not.

Chamber of Deputies
Constitutional amendment to expedite Social Security reform  The Chamber has already approved the first reading of the amendment. Members will now vote on line item amendments. Once the Chamber has passed its version of the draft, it must return to the Senate for a further round of votes. Approval is expected in the second half of 2004.

Tax Reform
A Chamber committee has approved unification of state sales tax rates. A floor vote needs to be scheduled, but given the lack of support from state governors for this measure, it is likely to be dropped until next year.

Bankruptcy Law
Final vote is expected in the Chamber in August or September.

Regulatory Agencies
This legislation would redefine the role of these agencies. A committee is due to vote on a draft by Leonardo Picciani of the PMDB. In July, party leaders formally requested the item be treated urgently. If approved by the committee, Picciani’s draft would then go to a floor vote and if approved would be sent to the Senate. Final vote is expected for January 2005.

Reform of Judiciary
The Senate has approved the main text. It must now vote on 160 amendments put forward by senators. If the Senate maintains language approved by the Chamber, imposing among other things, external supervision of the judiciary and adoption of case law, the legislation could be approved this year. Others would have to wait until next year.

Public-Private Partnerships
The Chamber has already approved this measure, but two Senate committees subsequently altered its language. The legislation still has to go through one more committee reading. Parties have agreed to create a bipartisan committee to debate the legislation after the October local elections. It would still have to go back to the Chamber for final approval. Likely to reach final vote in first quarter 2005.

Bio Security
This legislation would establish security and enforcement rules for genetically modified crops. The Senate’s education committee has approved the rule. The constitution, justice and citizenship committee and social affairs committee will debate the measure. Once approved by both committees and a floor vote, the bill goes back to the Chamber for a final vote.

Technological Innovation
This initiative has already been approved by the Chamber and sent on to the Senate, where it should be approved between August and November. However, if the senators make any further changes, the package will have to return to the lower house for a final vote.