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Declining Brazilian Economy Comes Amid Political Uncertainty - 2002-07-12

In Brazil, fears are growing that Latin America's largest economy could follow beleaguered Argentina into debt default. Declining economic numbers are coming amid political uncertainty.

First, there was the tango effect. As Argentina's economy continued its meltdown this year, international investors were worried neighboring economies could follow on a steep downward slope.

Now, in Brazil, it is the "Lula effect" that concerns most economists. Populist labor leader Luiz Inacio da Silva, known here as "Lula", has a double digit lead in polls over two main opponents ahead of October presidential elections.

President Fernando Henrique Cardoso is stepping down after two terms of carefully following IMF guidelines. Still, Brazil's government is staggering with a debt of more than $250 billion, or more than 60 percent of gross domestic product.

In recent weeks, the Brazilian currency, the real, has dropped to historic lows against the U.S. dollar. Credit agencies now rate Brazil as the riskiest investment proposition except Argentina, which defaulted on its debts in December.

Sao-Paulo-based economist Jose Augusto Arantes Savasini said investors are fleeing Brazil because they fear Lula and his left-wing Workers' Party will take power. "Everybody is afraid of Lula," he said. "We were used with his party saying that as soon as they arrive into power they are going to review all the contracts and things like that, privatization, debts and things like that."

Mr. Savasini said Mr. da Silva is presenting a more moderate image of himself in his fourth attempt to win Brazil's presidency, but that his economic positions remain unclear.

Economics professor Jose Scheinkman said the Lula effect is worsening an already dim economic picture, combined with insufficient Brazilian exports, U.S. corporate scandals and nervous investors. "I think there are three components to Brazil's problems. One of them of course is the political one but there are at least two others," he said. "One is that there are fundamental problems in the Brazilian economy. That doesn't mean everything is bad but there are some fundamental problems. We have an external sector which is too small. Brazil is to closed toward the economies in the world. And the second set of problems I think are coming from the outside. I think people outside Brazil like in the United States for instance they're worried about the situation in the United States, you know the corporate scandals that you've heard about. That is increasing the risk premium for everyone including Brazil."

For many analysts, Brazil's economy is seen as too big to collapse like Argentina's. The country has low inflation, a huge internal market, and a flexible exchange rate, making it more resilient. And whenever Mr. da Silva's poll numbers go down, the stock market makes slight gains.

Mr. Scheinkman doubts there will be a debt default in Brazil, but he does not rule out the possibility. "Default is always a possibility but I think it's not a likely event given the present situation," he said. "If there was a huge deterioration in the external conditions, if the policies in Brazil change for much worse the economic policy then we could have a higher possibility of default but I don't think it's a likely event at this point."

Brazilians were hoping there would a "football effect" to bolster their economy. The last time Brazil won the World Cup in 1994, the victory sparked a stock market revival. This time around, just weeks after Brazil's unprecedented fifth World Cup crown, economic indicators are pointing in a downward direction.