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Brazil - Economic Briefing November 2002

Lula Victorious by Overwhelming Majority

Luis Inácio da Silva (‘Lula’), the candidate for the left-wing Brazilian Workers’ Party, won easily over the governing party’s candidate José Serra,. Lula now faces the formidable political challenge of consolidating his electoral alliance of diverging political forces to form a working majority. in the legislature Meanwhile, the deterioration in the currency has raised inflationary expectations and corresponding interest rate hikes threaten to stave off the nascent economic rebound.

Lula wins presidency overwhelmingly
On 27 October, Luis Inácio da Silva (‘Lula’) from the Brazilian Worker’s Party (PT, Partido dos Trabalhadores) won a clear victory in the second round run-off election over his challenger José Serra, from the incumbent president Cardoso's Brazilian Social Democratic Party (PSDB, Partido da Social Democracia Brasileiro). As most polls just prior to the election had indicated, Lula won by a comfortable majority of 61.3% of the vote to Serra’s 38.7%. The president has not yet appointed any members of his cabinet as negotiations to forge a legislative majority are likely to evolve around doling out posts in the incoming administration to new allies. The new president will face a formidable challenge of reconciling diverging interests within his current coalition, which consists of parties strongly in support of Lula’s reiterated commitment to orthodox economic policy and supporters of historically advocated leftist agenda. The incoming president is anticipated to abide by promises to maintain fiscal discipline, preserve price stability and comply with contractual obligations. Nevertheless, on the fiscal front the new government is likely to reorder priorities by pushing for a larger public sector minimum wage increase than envisioned in the current budget, while simultaneously pushing for maintenance rather than lowering of current income tax rates.

Inflationary expectations rise as currency weakening to prompt price adjustments
The accelerated real depreciation and rising international oil prices are beginning to pass through to domestic prices. In October, the National Statistical Office (IBGE) reported that the mid-October consumer price index (IBGE-IPCA 15), which covers monthly price increases up to the 15th of every month, rose 0.6% over September. The October data came in on par with the September increase. The annual inflation rate rose to 7.7% in October from 7.5% in September. Furthermore, the accumulated inflation rate rose to 6.1%, which is now above the 6.0% Central Bank target for this year. Consequently, monetary authorities are likely to overshoot the inflation target for this year. Participants believe that the recent currency shocks are likely to be more permanent than anticipated earlier, which may have a more lasting effect on inflation. Following further deterioration in October prior to the elections - which had brought the real close to the 4.00 reais to the US$ threshold – the real strengthened significantly following the election. By the end of October, the currency had recovered 6.9% and rebounded an additional 3.3% by 8 November. Despite the recent strengthening, the Consensus now expects the real to end the year 10.4% weaker than anticipated last month. Similarly, the forecast for 2003 has been adjusted.

On 1 November, the state-owned oil company Petróleo Brasileiro S.A. (Petrobras) announced its intention to raise fuel prices, including gasoline prices (+12%) and cooking gas prices (+17%). While the cooking gas price hike is roughly in line with assumptions in the October COMPOM report, gasoline prices were hiked well beyond the 9% anticipated by monetary officials. Officials claimed that the recent strengthening of the US$ and higher international oil prices warranted the move. Fuel prices account for approximately 6% of the benchmark consumer price index (IBGE-IPCA), which is anticipated to experience a more pronounced upward jolt in November. As a result of rising inflationary expectations, monetary officials are anticipated to maintain interest rates at their current levels through the end of the year. Participants do not expect inflationary pressures to abate significantly through the end of the year. In fact, the forecast for the annual inflation rate has been revised 1.2 percentage points upward from last month to 8.1%, which is now also well above the Central Bank’s 6.0% target for this year. Despite some moderation in exchange rate volatility next year, participants expect inflationary pressures to mount strongly, as annual inflation is now seen rising. The strong upward revision reflects the fact that retailers are likely to pass-through this year’s exchange rate weakening to consumer prices, as weak domestic demand has so far averted a stronger rise in inflation this year. The Consensus now substantially not only exceeds the monetary authorities’ central target of 4% but even the upper end of the +/- 2.5% band.


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