May 21: Brazil’s vulnerability

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With violence in São Paulo dominating the headlines last week, few in Brazil were paying much attention to the vertiginous swings taking place on the country’s financial markets. From R$2.06 to the US dollar just two weeks ago, the currency closed on Friday at R$2.20. Markets were spooked by exactly what those analysts not carried away by liquidity-fuelled complacency have been warning against for months. Now that the US Fed, as feared, is being forced into bigger than expected hikes in interest rates, higher-yielding but riskier assets in emerging markets are starting to look a lot less attractive.

Many will see this as just another buying opportunity and Brazilian exporters can be expected to sell dollars en masse this week, perhaps boosting the Real’s value again. But it is getting harder for the complacent to support their positions.

One reason is the announcement by the Brazilian government last week – drowned out by the riots and killings – that it is changing the way it calculates its fiscal balance. This allows it to claim it is still set to meet its 4.25 per cent primary surplus target (the difference between revenues and spending, excluding debt interest payments) while actually, under the standard methodology, aiming at just 4.10 per cent. Even this target is unlikely to be met as it assumes growth in the economy of 4.5 per cent, widely regarded as overly optimistic. This is alarming news. Only by consistently exceeding its 4.25 per cent target in recent years has the government been able to prevent the ratio of debt to gross domestic product from spiralling out of control.

Brazil’s failure to address its fiscal imbalances has been a concern in some quarters for a long time. Look at what has happened to the profile of Brazil’s domestic debt. The first-rate team at the Treasury has worked hard over recent years to reduce the government’s exposure to dollar-linked debt, cutting it almost to zero. Reassured by Brazil’s comfortable trade and current account surpluses, investors have been happy to go along. But similar efforts to reduce the amount of interest rate-linked debt have met a wall of resistance. The reason is that Brazil’s fiscal performance does not warrant such a vote of confidence – far from it.

The benign international environment that has buoyed Brazilian assets along for the past four years is not about to unravel overnight. Nor should the strengthening of certain institutions and the good work done by the Treasury and economics team over the past decade be dismissed. But after a week that brought home the failure of policy on public security and delivered a cowardly cop-out on fiscal policy, there are now more grounds than ever to question the government’s ability to deliver the conditions needed for growth.

Recovering from the violence

The dismal events of the past week in São Paulo can only add to the despair of ordinary Brazilians at the failure of their politicians to devise and implement effective policies for development.

Mismanagement, underfunding and,corruption are so rife in the prison service that there is little authorities can do to prevent gangsters obtaining and using mobile telephones, to devastating effect. The order given to telephone companies to cut signals near high security prisons is a stop-gap measure that only demonstrates the extent of the underlying problem.

Underfunding and lack of training for the police are clear in the fact that, of the 161 people who died in the violence in the week to Friday, 107 were killed by the police. São Paulo’s police seem incapable of taking violent criminals alive. Over the past 15 years they have killed nearly 13,000 people allegedly resisting arrest.

The lack of effective intelligence gathering by the various police and prison services at federal, state and municipal levels – and the almost total failure to share intelligence when any exists – means little is known about the size and structure of the PCC, the organisation that carried out last week’s attacks. Yet whenever the PCC has flexed its muscles in the past, through prison riots, murders and intimidation, it has been met with appeasement. The latest incident, by many accounts, was no exception.

To be fair, Geraldo Alckmin, the former São Paulo governor who stood down recently to run for the presidency in October, spent heavily on expanding the state’s appallingly overcrowded prison system. And sensible local policies have helped halve the state’s homicide rate in recent years – though some of this may be thanks to the PCC, imposing discipline on a previously anarchic criminal class.

Further progress may be in the pipeline. After sitting for two years on a package of measures designed to deal with organised crime, Brazil’s Senate passed the lot in 40 minutes last week. The lower house must now follow suit. But an effective security policy remains a distant dream. There seems as little chance as ever of dismantling the absurd structure of Brazil’s police forces, under which each state has both “civil” and “military” forces that behave more like rivals than partners.

Even the best possible security policy would do little to tackle the root causes of last week’s events. President Luiz Inácio Lula da Silva identified one such cause in a lack of spending on education. That being so, it is even harder to understand why he has overseen what Norman Gall, of the Instituto Braudel in São Paulo, calls the “gutting” of Brazil’s education ministry while diverting money away from essential primary and secondary education and into bloated and inefficient federal universities that provide free places for the children of the rich (the only ones that can afford the tutoring needed to pass the entrance exams) and jobs for the intellectual elite.

Haiti’s challenge

International donors meet in Brasilia on Tuesday to see how they can help the country recover under its newly elected President René Préval. Haiti’s problems are many: a weak and poorly equipped police force and dysfunctional or non-existent judicial institutions being perhaps the two most serious.

A start needs to be made in both areas, although for the immediate future the presence of 9,000 foreign troops and police as part of the United Nations stabilisation mission will underpin security. But the overwhelming priority at this stage is to ensure that aid money already committed is used more effectively.

The problem is that too little has been done with the $1.1-1.5bn that was pledged back in July 2004. Haitians have seen precious little evidence of aid being spent on roads and other necessary rebuilding work. Admittedly the country’s capacity to absorb support and economic aid is limited, to say the least, and there are understandable fears that aid money could be siphoned off in corruption.

Even so, too much of the money that has been spent appears to have financed an endless series of expensive studies. Disbursement seems to be surrounding by a bewildering web of bureaucratic rules. International agencies need to co-ordinate their operations more effectively. And if Mr Préval is to retain the legitimacy which he currently enjoys they need to produce results quickly.

A break for Leonel Fernández

The centre-left but pro-American leader of the Dominican Republic, Leonel Fernández, appears to have scored an impressive and unexpected victory in last week’s legislative elections. With 91 per cent of the vote counted after last Tuesday’s vote, Mr Fernández looks set to increase his centrist Partido de Liberácion’s standing in the senate from just one to 20 seats. The PLN will enjoy a majority in the lower house too, defeating an alliance formed by the two largest traditional parties, the left of centre Partido Revolucionario Dominicano (PRD) and the conservative Partido Reformista (PRSC). Mr Fernández, who won presidential elections back in 2004, should now have a freer hand to confront the country’s economic problems. The two most serious are the debt-ridden electricity sector and the position of the central bank that is still working through losses it incurred as a result of the 2003 banking crisis. Radical market-friendly reforms are not on the cards, however. Mr Fernández may have privatised the electricity distributors in the 1990s during his first period in office, but – as he told the FT recently – he no longer believes that the private sector holds the solution. The election augurs well for governability but don’t expect too much radicalism.

López Obrador’s own goal

Andrés Manuel López Obrador, Mexico’s leftwing presidential candidate for the Democratic Revolution Party (PRD), sent non-Mexicans scrambling for their dictionaries last week when he called Vicente Fox, the president, a “pelele”. Pelele means several things in Spanish – and none of them are the least bit flattering. So what is Mr López Obrador - or Amlo as he is better known - up to? After all, it was his demand several weeks ago that Mr Fox “shut up” that helped erode his once-substantial lead over the rest of the field. As a result, all the main polls now put Felipe Calderón of the centre-right National Action Party (PAN) in first place for the first time since the campaign began in January.

There is no doubt Mr Fox, who belongs to Mr Calderón’s PAN, has pushed to the limit Mexico’s strict election laws obliging public officials to remain neutral – and sometimes beyond. He has toured the country as if on campaign himself and has spoken out in favour of Mr Calderón – albeit in code – in almost every public address he has given. To that extent Amlo’s apparent frustration with the president is understandable. But such attacks do no good for his chances of winning the July 2 election. They go down particularly badly in a country with a high regard for public institutions. They also reinforce the idea – pushed by Amlo’s detractors – that he is a temperamental man with no respect for authority.

With just over a month to go before the vote Amlo should keep his head and concentrate on what he is good at and what Mr Calderón is not good at: appealing to the popular classes. Amlo has two advantages over his main opponent: his claim to be the candidate of the poor; and his claim to be the candidate for change. Mr Calderón cannot touch him on these points. But Amlo’s continuous insults towards the president are changing the battleground on which these elections are being fought. If he doesn’t forget about the president and get back to basics quickly he will be out of a job come July.

Kirchner’s campaign

Is election year starting early in Argentina? A massive rally in the central square of Buenos Aires on Thursday will celebrate three years since President Néstor Kirchner was elected, but looks designed to start drumming up support for the run-up to presidential elections slated for October 2007.

As if that were necessary: Mr Kirchner already enjoys approval ratings of around 70 per cent. But that won’t stop the government from bussing in tens of thousands of supporters from the provinces, and free train and underground rides across the city for the day. As many as 200,000 faithful are expected to attend the jamboree.

It will be redolent with symbolism, as the 25th May marks the anniversary of Argentina’s independence from Spain. Opposition members criticise the government of “hijacking” a day of national celebration for partisan purposes.

Furthermore, the Plaza de Mayo in recent years has been a place of protest rather than support for the government. Most famously, it is where the Mothers of the Plaza de Mayo gather every Thursday, until recently in protest for their “disappeared” children during the military dictatorship of the late 70s and early 80s.

By winning back the “Plaza del Sí” (Square of the Yes), the event will be an important reaffirmation of Peronism - the political movement to which Mr Kirchner belongs - founded by Argentina’s former president Juan Peron in the 1940s. Indeed, there is speculation as to whether Mr Kirchner will make a nod to Peron by imitating his populist practice of talking to the public from the balcony of the presidential palace – the Casa Rosada – even though military dictators have also been fond of the device.

But perhaps election year won’t be starting early after all, instead just a little bit late: it is believed that Mr Kirchner wants to bring next year’s elections forward to April, and may choose Thursday to announce this. Although this would arguably be unconstitutional, it may be a shrewd move. The sooner Mr Kirchner is re-elected, the less chance there will be that the problems that are mounting up in the economy – not least inflation – will boil over beforehand and spoil his otherwise very favourable odds of winning another term.

Notes by Jonathan Wheatley, Richard Lapper, Adam Thomson and Benedict Mander.

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