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Brazil's President Dilma Rousseff speaks during breakfast with reporters at the Planalto Palace in Brasilia Dec. 27, 2012. (UESLEI MARCELINO/REUTERS)
Brazil's President Dilma Rousseff speaks during breakfast with reporters at the Planalto Palace in Brasilia Dec. 27, 2012. (UESLEI MARCELINO/REUTERS)

Analysis

Rousseff makes controversial bet on Brazil’s economic future Add to ...

President Dilma Rousseff’s big bet in 2013 is that Brazil has matured enough to escape from a financial straitjacket that markets have imposed since the 1990s, when inflation soared beyond 2,000 per cent and the state was virtually bankrupt.

Since that chaotic era, Brazil has played by a more conservative set of rules than most modern economies – with laws that tightly regulate government spending, interest rates exceeding 40 per cent on consumer loans, and other rules and practices designed to reduce financial risks and ensure the bad times don’t return.

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Now Ms. Rousseff, a left-leaning economist who likes to make key financial policy decisions herself, is boldly wagering that Brazil is ready to turn the page.

This year she plans to loosen decade-old rules on public spending; ensure that benchmark rates stay at their current record low of 7.25 per cent, even if the economy accelerates; pressure banks into lending more; and force investors to accept lower returns on infrastructure projects and other investments.

The policies amount to a bet that Brazil’s government has earned enough credibility over the past two decades, and the economy has undergone sufficient structural change, to remove some of the safeguards that protected it from disaster, but may have also restrained growth in recent years.

If Ms. Rousseff is right, her moves could stir the world’s sixth-biggest economy from its recent doldrums and back on course for growth of 4-per-cent-plus in 2013 and in years to come.

If she’s wrong, some of Brazil’s old ghosts – high inflation, low growth and general financial disorder – could rear their heads again.

While a meltdown is unlikely, Brazil could slip further behind its peers in Latin America and the BRICS group of major emerging markets – which includes Russia, India, China and South Africa – and Msd. Rousseff’s re-election for a second term in 2014 could be in jeopardy.

Arminio Fraga, a former central bank president who helped design some of the financial framework that Ms. Rousseff now seeks to modify, is part of an increasingly vocal group warning that some of her government’s efforts may be misguided – or at least premature.

“Brazil has had a good run. Risk has been coming down here and we’ve enjoyed the benefits of that,” Mr. Fraga said in an interview. “But there’s no sense in abandoning the system that has served us so well.”

Mr. Fraga, a founding partner of Rio de Janeiro-based Gavea Investimentos securities firm andis still treated as an oracle in the business world here, said Brazil remains in good shape overall. But he said Ms. Rousseff’s willingness to intervene in the economy and expand the state’s role “resembles a bit of what we had in the 1970s” – when the country began to veer into real trouble.

Financial house of horrors

It seems like ancient history in today’s more stable Brazil, but that period of economic chaos still has a huge impact on day-to-day life.

Gross financial mismanagement by successive governments resulted in inflation that by one measure totalled an almost inconceivable 1.8 trillion per cent from 1968 to 1993.

Repeated attempts at stabilization failed, and Brazil had six different currencies in the eight years to 1994. Only then was former President Fernando Henrique Cardoso able to bring inflation down to single digits thanks to the so-called “Real Plan” – which introduced the real, the currency still in use today.

It was accompanied by reforms that plugged the perennial hole in public finances at the root of Brazil’s problems.

Since then, Brazil’s reputation has done an about-face, with the country widely regarded as a success story. The stability provided by the Real Plan gave many Brazilians access to credit for the first time, leading to two decades of solid economic growth that lifted some 30 million people out of poverty.

Despite its turnaround, Brazil’s government is still treated like a recovering addict, with a number of protections in place to ensure it doesn’t relapse.

Ms. Rousseff wants to change perhaps the most hallowed protection of all – the so-called Fiscal Responsibility Law, which was passed by Congress in 2000 and in part requires the government to compensate for any loss in revenue with an equal cut in spending.

The subject is so taboo that the government revealed its plans on the Friday between Christmas and New Year’s Day – suggesting it wanted as few people as possible to notice.

The change, which must be approved by Congress, would essentially loosen some of the law’s accounting rules. That would give Ms. Rousseff the freedom to sharply cut taxes, which are among Latin America’s highest, without making painful spending cuts, which could damage the economy.

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