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FACTBOX-Key political risks to watch in Brazil

Source: Thomson Reuters Foundation - Tue, 12 Mar 2013 09:59 GMT
Author: Reuters
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By Anthony Boadle

BRASILIA, March 12 (Reuters) - Brazil's economy grew only 0.9 percent in 2012, a disappointing performance for a once-booming emerging market as industry responded slowly to billions of dollars in tax cuts and the lowest borrowing costs in recent history.

Along with currency losses, the paltry growth last year caused Brazil to fall back behind Britain to the No. 7 spot among the world's largest economies, a symbolic dent in the country's aspirations.

Worse still: inflation is picking up speed. Combined with a stagnant economy despite government stimulus measures, the prospect of rising consumer prices has begun to put President Dilma Rousseff's 2014 re-election plans at risk.

Her government faces a difficult balancing act: how can it control inflation this year while continuing to prod economic expansion to avoid a third consecutive year of poor growth?

Rousseff is seeking greater budget flexibility to kick-start Latin America's largest economy, raising concerns that the left-leaning economist is tinkering too much with policies that have been the basis of Brazil's financial stability since 1994.

Some of her policies are scaring off the very investors she needs to upgrade Brazil's infrastructure, remove bottlenecks and restore robust growth. Rousseff, nonetheless, is actively seeking to win back the confidence of the business class.

ANEMIC GROWTH

The economy grew only 0.9 percent last year, down from 2.7 percent in 2011 and 7.5 percent the year before.

Growth of 1.4 percent on an annual basis in the fourth quarter suggests that Rousseff's flurry of tax cuts and other stimulus measures may finally be bearing some fruit. In the most hopeful sign, investment rose 0.5 percent, snapping a string of four straight quarterly declines.

But financial markets still sagged after the data was released, reflecting disappointment that the rebound was not stronger and a belief that the economy will grow about 3 percent at best this year.

One of the world's most dynamic economies in the previous decade, Brazil has been stuck in a rut of slower growth since Rousseff took office at the start of 2011. Companies in Brazil struggle with some of the world's highest production costs and hurdles such as clogged roads and ports due to years of low investment in infrastructure.

High taxes and a lack of skilled labor have burdened manufacturers already facing a global slowdown. Rousseff has tried to revive activity with lower interest rates, tax breaks and other stimulus measures but companies have not responded as quickly as the government had hoped.

What to watch for:

- Further stimulus measures.

- Reforms to federal taxes PIS/COFINS and interstate ICMS.

- Any changes to Rousseff's economic team.

INFLATION VS MONETARY TIGHTENING

In a country where the hyperinflation the 1980s is still a vivid memory, nothing could unravel Rousseff's 2014 re-election hopes faster than consumer prices reeling out of control.

The latest data set off alarm bells in her government. Consumer prices jumped more than expected in February despite a cut in electricity rates, raising the prospect of an interest rate hike even as policymakers fret about a sluggish economy.

In the 12 months through February, inflation rose 6.31 percent, the biggest increase since December 2011. The central bank targets inflation at 4.5 percent, with a tolerance band of plus or minus 2 percentage points.

The central bank slashed its benchmark Selic interest rate 10 consecutive times between August 2011 and October 2012 to an all-time low of 7.25 percent. At the last meeting, the bank's monetary policy committee (Copom) suggested it could raise the rate if needed to curb inflation.

Yields on interest rate futures <0${esc.hash}2DIJ:> have jumped as traders bet the central bank will lift its overnight lending rate as early as next month. Economists surveyed by the bank expect the Selic rate to end the year at 8 percent.

To attack inflation, Rousseff slashed electricity rates in January, hoping cheaper energy will boost a sputtering economy. But the impact on consumer prices could be neutralized by the increase in gasoline and diesel prices by oil giant Petrobras to stem its losses.

Without the cut in power rates, 12-month inflation would have already topped the target ceiling. In its latest effort to curb inflation, the government will scrap federal taxes on some food staples and toiletries.

What to watch for:

- March IPCA inflation rate on April 10.

- Impact of gasoline and diesel price increase on inflation.

- Rate-setting monetary policy meeting April 16-17.

FISCAL DISCIPLINE

The government faces a dilemma over how to free itself from the constraints of a strict savings goal to boost spending in a sluggish economy without giving the impression that it is losing its fiscal discipline. Last year, it failed to meet the closely watched primary surplus target.

Treasury Secretary Arno Augustin said the government is willing to relax fiscal policy to foster growth. He says Brazil doesn't need to hit the surplus target to keep its finances in good shape, since the economy has matured.

Economists agree the primary surplus target, at 3.1 percent of gross domestic product, is high for a major economy. They believe it could be lowered without harm because Brazil is financially sound, has slashed its public debt and brought interest rates down.

The government has proposed changes to the so-called Fiscal Responsibility Law in Congress to allow room for more stimulus measures. This could rattle investors who fear Rousseff has been too quick to modify bedrock economic principles that have been the basis of Brazil's prosperity over the last decade.

What to watch for:

- Any changes to the primary budget surplus target.

- Further tax breaks or declines in federal tax collection.

- Impact of fiscal slippage on inflationary pressures.

STORM OVER OIL FUTURE

Brazil's hopes of becoming a developed nation rely heavily on tapping huge oil reserves discovered in the sub-salt fields off its South Atlantic Coast. But the granting of contracts to extract the oil has been delayed for years by regulatory debate.

Rousseff's plans to auction off concessions later this year now risk disruption by a bitter squabble between oil producing states and the rest of Brazil over the sharing of royalties.

Representatives from the majority of states overturned a presidential veto and pushed through a royalty sharing bill that will slash revenues of top oil producing state Rio de Janeiro by billions of dollars. That could undermine preparations for the 2014 soccer World Cup and 2016 Olympic Games, global events that Brazil hopes will showcase its advances.

Rio's governor, Sergio Cabral of the PMDB party, Rousseff's main ally, suspended payments to contractors and suppliers pending an appeal to the Supreme Court.

A prolonged legal battle could delay the oil auctions again and scare off investors worried by juridical uncertainty.

What to watch for:

- New moves by oil producing states to pressure Brasilia.

- Supreme Court ruling on oil royalty legislation.

- Sub-salt auctions scheduled for November.

POPULAR PRESIDENT

With her popularity high and the opposition weak, political observers agree Rousseff can lose some ground and still get re-elected. So far, neither a stalled economy nor political scandals that tarnished the reputation of the ruling Workers' Party have dented her ratings.

A CNI/Ibope poll in December showed her popularity is at an all-time high of 78 percent, while approval of her left-of-center government held at 62 percent. Pollsters say that is because unemployment is at its lowest on record and Brazilians continue to buy cars and other goods.

Rousseff has successfully shielded herself from the fallout from a political corruption scandal that led to the conviction of top members of her Workers' Party by the Supreme Court last year.

PRESIDENT'S HEALTH

Rousseff survived lymphoma cancer in 2009 and was pronounced healthy by doctors in a routine check-up in December.

She underwent chemotherapy in 2009 but the cancer went into remission and she appeared to be in good health by the time she staged her winning campaign for the presidency in 2010.

Concerns over her health have faded since then, although a bout with pneumonia and a lengthy recovery in 2011 have kept the issue on some investors' radar screens. (Editing by Kieran Murray and Paul Simao)

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