Main menu

The Lula Effect

June 30, 2002

Recent financial turmoil in Brazil is not the latest demonstration of the “O’Neill Effect” on markets, but reflects growing international awareness of something that Brazilians have known for months. Luiz Inacio Lula da Silva—Lula, a former union leader and a perennial candidate—is a serious contender in October’s presidential elections. Markets hate surprises, and the markets apparently hate Lula, because capital has practically stampeded out of Brazil every time Lula’s substantial lead has been confirmed by public opinion polls.

That this reaction unfairly judges the Lula of 2002 by the actions and words of Lula of 1994 or 1998 is beside the point. Markets are not supposed to be fair; they are supposed to be rational. And, it is hard to argue that the market’s reaction is irrational.

The problem is Brazil more than it is Lula. Or, to be more precise, the problem is Brazil in the current regional and global political, economic, and financial context where uncertainty seems to increase every day. At a time when investors everywhere are desperately seeking safety instead of risk, Brazil is an unlikely destination for capital despite the fabulous returns the market now offers and despite the agile management of the Central Bank. In a world where everything seems to be going wrong at the same time—especially in Latin America—very few want to bet that Brazil will uniquely find its way through the crisis.

First, Brazil. Although the economy has been reasonably well managed in recent years, the country has accumulated a significant external and, even more, internal debt that constantly needs to be refinanced. When international interest rates are low and capital plentiful, a country’s debt burden can easily be handled by technicians. When markets are scared and countries are in transition, a country’s debt burden becomes the most convenient opportunity for crisis.

Second, Lula. The market reasonably assumes that Lula—or any president from the left—would at least try to re-orient Brazilian economic and social policies; presumably, that is why he is running for office. The underlying problem is that Brazil, a country used to rapid growth, has grown too little for too long. Confronted with a weak global economy and constrained by IMF orthodoxy, conservative fiscal and monetary policies have produced only modest growth during the two terms of President Cardoso. Lula’s constituency wants Brazil to grow faster; the markets reasonably assume that Lula will try to make that happen.

The issue is not the idea of a faster growth rate—investors gain when economies grow—but whether Lula has a plan, a team, and the management skills to move Brazil towards a new reality. Unfortunately, Lula cannot answer this question by declaring his allegiance to the neo-liberal economic model or by agreeing that the IMF should have a role in managing Brazil or even by wearing a tie when he visits New York. He can only answer it by winning the election and governing well. Meanwhile, markets do not get paid to hope.

Third, the regional context. Practically every country in the region is beset by political and economic problems: Argentina, Uruguay, Paraguay, Colombia, Venezuela, and Peru are all in trouble. Economies are contracting; currencies, stock, and bond markets are falling; democratic institutions are under pressure; social unrest is growing. Political contests are increasingly between demagogues of the right and left, with the political center being squeezed out of existence. People are looking for solutions, and they are looking beyond established parties, established political philosophies, and established policies—so far without success. This dynamic should scare investors who value certainty and predictability.

Brazil has not yet been caught up in this search, but international markets interpret the poll ratings of Lula and other leading candidates from the left as evidence the search is beginning—and they fear the country will suffer a fate similar to the rest of the region.

Fourth, the international context. Markets everywhere are scared—of terrorism, of weak economic recovery, of the collapse of the confidence in U.S. accounting and governance standards, and of uncertain U.S. political leadership. Most of all, markets fear that the leading industrial nations will be unable to reverse the downward spiral that seems to threaten the global economy. And when markets are scared, capital flees.

Where is all this headed? In the short run, there is likely to be little relief for Brazil. The regional situation will certainly deteriorate; the global context will probably weaken; and capital markets will remain volatile. The challenge to Lula and to the other political candidates is to reduce, as much as possible, the uncertainty that rises with every twitch of the polls. This means defining their programs, their policies, and their people with as much precision as possible—telling the markets how and with whom they will govern.

This is unlikely to be enough of an antidote to keep the real, the BOVESPA, or the Brazilian C-bond from falling further in the next months. But it will give Brazilians, as well as foreigners, a better picture of Brazil’s future. And that could be the beginning of a much needed new stability for Latin America.