It's ironic that a former Marxist is now one of the market's most trusted friends. But in Brazil, Antonio Palocci's words and actions offer a rare level of comfort to investors. Perhaps this should not be so surprising: Palocci had to gain the trust and respect of investors from the outset, who were initially sceptical of him and President Lula because of their left-wing leanings.
That trust was tested earlier this year, with Brazil falling into recession and Lula's administration reeling from scandal. But the government's credibility remained intact, and before long analysts were talking Brazil's economy up once again. Much of the credit should go to Palocci and central bank chief Henrique Meirelles.
Both showed they could take the measures required to pull Brazil out of the boom-bust cycles it consistently finds itself in. Today, economic growth is picking up, the debt-to-GDP ratio is falling, the exchange rate has stabilized and exports are at record highs. The key now is to make this recovery sustainable.
Security check
?The main thing is to provide investors with a sense of security for them to inject their resources into new projects,? Palocci tells Emerging Markets, when asked how he plans to achieve long-term growth.
?In order to do that, we need to show that investment will turn into profits over the years. The government has been working in several directions. The fiscal balance has been guaranteed, and important reforms have been promoted to boost large and small entrepreneurs,? he adds.
Critics, though, remain concerned, particularly about the government's spending pledges. Lula came to power promising innovative social programmes to improve the lot of the millions of Brazilians living on next to nothing.
Wage rise
Next year the minimum wage will be raised, causing some analysts to worry about both its potential cost and its impact on inflation. Palocci says the government has done its sums and that economic reform can take place without compromising the business-friendly environment.
?On the fiscal side there were some hard choices to make, but when the president had to increase the minimum wage, for example, he insisted on showing the constraints and the importance of the measure in order to avoid jeopardizing the whole economy,? he says.
In any case, he adds, ?What really matters is to direct public spending where it is most productive in terms of growth and, essentially, wealth redistribution.?
Private investment
One of Palocci's immediate concerns is to raise investment in value-added industries, such as software and pharmaceuticals. ?Private investment is going to be key for growth,? he says, adding that the government is committed to encouraging innovation.
He is also exploring the idea of public-private partnerships (PPP) to help improve the country's infrastructure. ?The adoption of PPP is just one element within a series of measures that the government has been taking,? he says.
International front
Palocci is committed to free and fair trade and says that Brazil is benefiting from opening its markets. ?Our battle to open up international markets ? with more freedom in global trade ? is starting to pay off,? he says. ?This will be good not only for Brazil but also for many poorer countries.?
Interview with Antonio Palocci
EM: The economy is now showing signs of strong recovery in various sectors. How can you make growth sustainable?
AP: The main thing is to provide investors with a sense of security for them to inject their resources in new projects. In order to do that, we need to show that investment will turn into profits over the years. The government has been working in several directions. The fiscal balance has been guaranteed; at the same time important reforms have been promoted to boost large and small entrepreneurs.
EM: The pressure to relax public spending and cut interest rates has been very strong until recently. Has it come down a bit now that results have started to emerge?
AP: There is a very clear understanding within the government that Brazil needs to persist [along the same policy lines]. As far as inflation is concerned, part of the current real increase in wages is a consequence of low inflation. That is the opposite of what happened in 2002, when purchasing power declined and the country entered into recession. On the fiscal side, there are some hard choices to make, but when the president [Luiz Inacio Lula da Silva] had to make a decision to increase the minimum wage, for example, he insisted in showing the constraints and the importance of the measure in order to avoid jeopardizing the whole of the economy. What really matters is to direct public spending where it is the most productive in terms of growth and, essentially, wealth redistribution.
EM: How is the minimum wage going to be increased from next year? And has there been any agreement with the IMF on the methodology to calculate the primary budget surplus (the government has repeatedly asked that some investment in infrastructure would not be considered as public spending)?
AP: The increase in the minimum salary should clearly reflect productivity gains, as measured by the GDP per capita. This is a balanced and fair rule for workers who would have made such gains possible. Now, the issue of the primary budget surplus must be discussed further. For Brazil, it is important to point out a series of projects that would provide high returns in fiscal and economic terms. We need to show how certain investments can generate fiscal revenues over a few years that would make up for their initial impact on the [public] debt.
EM: The debt-to-GDP ratio has started to decline (56% in July). Exports and the trade balance have been breaking record highs. The external debt-to-exports ratio also fell. The exchange rate has stabilized. Nevertheless, can external factors (such as oil prices and US interest rates) hamper the recovery of the Brazilian economy?
AP: Sure, the external environment does include uncertainties ? but that's normal. The main point is for us to remain resistant and have a healthy plan for Brazil. And that's we've managed to get. Thanks to the rise in exports, the proportion of exports compared to debt is at its best level for the last 30 years. As for [US] interest rates, I think the experience of the second quarter of the year served as a good test. I think we need to be on our guard, but we have the instruments to meet such challenges. In this regard, our battle to open up international markets ? with more freedom in global trade ? is starting to pay off. This will be good not only for Brazil but also for many countries that are poorer. And in the end, it will be good for the consumer and the general well-being of developed countries, in spite of a few pockets of resistance. In the medium term, freer trade has a huge impact on growth and macro stability.
EM: Does Brazil need to renew the agreement with the IMF [which expires next December?
AP: This must be decided more towards the end of the year. During the course of the current agreement, we did not draw on the resources that were made available by the Fund. As we said, we consider the current agreement as a preventive one. So, there does not seem to be any need for new agreements.
EM: Will the increase in domestic demand threaten the inflation target for this year or next year?
AP: The real issue to keep inflation under control is for the businessman to decide whether, instead of putting prices up to try and get a short-term benefit, he'd rather gain in the medium term through an increase in investment and production. In order to do this, it's important that the Central Bank remains credible in that it's not going to be lenient with inflation and that there will be an investment friendly environment.
EM: The president of the central bank was given ministerial status. How does this combine with plans towards the autonomy of the central bank? Is there still much resistance to this project [of autonomy]?
AP: The autonomy of the central bank may help lower the cost of capital in Brazil, and the resistance has been declining gradually as people have started to understand how this would work.
EM: There is still a big lack of investment in the country's infrastructure (transport, energy, sanitation and so on) Delays in the congressional approval of the bill on public/private partnerships (PPPs) may jeopardize growth in the medium term?
AP: The adoption of the PPPs is just one element within a series of measures that the government has been taking. It's important that this is well debated in order to move on with greater safety. In the meantime, other measures that may be necessary will be taken, so that PPPs will start in 2005.
EM: Will industrial policy help boost investment? Why did you pick four sectors in particular?
AP: Private investment is going to be the key for growth. Innovation will also be an important factor, as it will allow companies to become more competitive. The four sectors relate to strategic areas where we already have some advantages. Software, semi-conductors and capital goods have an impact across the whole of the economy, and benefit all sectors of industry and agriculture (pharmaceuticals is the fourth sector that has been selected). Meanwhile, other fiscal measures aim at easing corporate access to the financial markets, as well as providing incentives to improve the debt profile ? which is a very important factor to stabilize expectations and to lower interest rates.
EM: Brazil has made several sovereign bond issues this year. What do you make of it so far? When is Brazil planning to go back to the international bond markets?
AP: The 30-year issue at the beginning of 2004 was pretty good. We have also worked towards issuing bonds that are denominated in local currency. This is good, and will pave the way for PPP financing, and we have found some interest in the international markets for that. Such Real-denominated bonds may eventually lower the risks of public concessions and PPPs and give an additional boost to investment in Brazil.
EM: Does Brazil need another tax reform? Is labour legislation going to be changed?
AP: The tax reform needs to be complemented at state level. This is the greatest ambition of the federal government, but it's not something it can do on its own. The labour legislation can move towards a greater representation of the worker. This is an important issue as well, because among other things, it's going to help include more people in the formal job market.