Investors Edgy In Case Roussef Loosens Her Straitjacket

Investors edgy in case  Rousseff loosens her straitjacket

By Joe Leahy in São Paulo

Fear that economic restraints will be cast aside after election

Afew days ago a strange thing happened to the shares of Petrobras, the Brazilian state-owned oil company.

A rumour swept the stock market that Brazil’s President Dilma Rousseff – whose government has imposed price controls on fuel distributed by Petrobras to try to curb inflation – had fallen in opinion poll ratings about to be released.

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Investors rushed to buy the stock of the beleaguered oil producer, hoping that Ms Rousseff’s once mighty lead against opposition presidential candidates might be waning, opening a chance for Petrobras to return to profitability.

In the event, Ms Rousseff recorded a solid 43 per cent in the opinion polls, enough to win the forthcoming October election easily.

But the mere existence of the rumour was confirmation, if any were needed, that Ms Rousseff, who came to power amid expectations she would be an efficient, chief executive-style president, has failed to win the confidence of the markets.

Critics accuse her government of embarking on a series of economic policy misadventures that this week led Standard & Poor’s to downgrade Brazil’s investment grade credit rating to one notch above junk, placing in jeopardy 15 years of hard-won credibility in financial markets.

Eduardo Campos, an opposition presidential candidate, summed up the problem succinctly in a speech on Tuesday in São Paulo: “There are other countries with more problems than Brazil but there exists here a crisis of expectations and of confidence.”

The government vigorously rejects such criticism, and with some reason. Brazil’s economy grew 2.3 per cent last year, below the country’s earlier average of about 4 per cent, but much better than the mediocre performance some other emerging market peers, such as investor favourite Mexico, as well as Russia and South Africa. Brazil also remains resilient against external shocks, thanks to its large foreign exchange reserves, its relatively solid banking system and domestically orientated economy.

The government argues that it has maintained the three pillar-system that brought economic stability to Brazil after the runaway inflation of the 1980s and early 1990s – inflation-targeting by the central bank, a floating exchange rate and responsible fiscal management. Indeed, inflation has remained within the central bank’s (admittedly generous) band of 4.5 per cent plus or minus 2 percentage points.

But the problem investors have with the Rousseff government is that it has always seemed like a person in a straitjacket – eager to break out of the restraints imposed by market economics. From the beginning, it has been a government obsessed with manipulating the levers of the economy rather than addressing the fundamental problems.

In 2010, when easy monetary policy in the US led to greater foreign fund inflows, Brazil declared a “currency war” on the markets by imposing ad hoc taxes on investors to try to make its exchange rate more competitive. The currency war damaged Brazil’s reputation as a consistent and predictable investment destination.

But probably the most damning case for Ms Rousseff is that of Petrobras. As a former energy minister, Petrobras should have been a strong point of her administration.

Instead, it is a disaster. In spite of having announced the world’s largest offshore oil discovery in decades in 2007, its share price has slumped to all time lows, driven there by an unofficial government policy of suppressing fuel prices to control inflation.

With Ms Rousseff looking like a favourite in the October poll, economists are asking whether her government would continue in a second term with the same, much-criticised, policies or return to the conventional posture of her predecessors.

Either way, most are predicting that Brazil will be forced to undergo an adjustment by ending price controls and returning to budgetary discipline in the next year or two, whether Ms Rousseff likes it or not. The sooner it comes after the election, the less painful it will be.