Brazilian Markets Reel on Leftist’s Win

A leftist candidate’s victory in the first round of Brazil’s presidential election sent markets here reeling Monday, amid deepening pessimism over whether Latin America’s biggest country can avert a debt default and economic implosion that could spill into neighboring countries.

Workers’ Party candidate Luiz Inacio Lula da Silva took 46.4% of the vote in Sunday’s election, short of the 50% needed to win outright but enough to make his ascension to the presidency a virtual certainty after an Oct. 27 runoff.

Investors resumed selling Brazilian bonds, stocks and the nation’s currency after a brief respite in the markets’ losses late last week.

But declines in other Latin American markets were muted. Mexico’s IPC stock index eased 0.3%, Argentina’s main index lost 1.8%, and Venezuela’s fell 1.2%.

In Brazilian markets, however, “the fear factor ... is at an all-time high,” said Lawrence Goodman, managing director of Globalecon, an economics consulting firm in New York. “People fear a reversal of Brazil’s previous [free-market] reforms as well as a re-profiling of its debt obligations.”

Brazil’s most commonly traded government bond, the 10-year C bond, fell 2.5% in price Monday and now trades at about half its face value, with an annualized yield of about 24%.

The Bovespa index of Brazilian stocks dropped 4.3% to close at 8,863.18, falling back toward the three-year low it hit last week. The nation’s currency, the real, slid to 3.675 to the dollar. It has lost more than a third of its value this year.

Statements Disavowed

Worries about a Lula victory have been weighing on markets since April, when his poll numbers began showing him as a possible winner on his fourth try for the presidency. He made statements in previous campaigns that he might seek to renegotiate Brazil’s $260-billion public debt load and rethink the Real Plan, the free-market economic scheme that current President Fernando Henrique Cardoso has implemented.

Although Lula has disavowed those statements and promised in recent weeks to meet Brazil’s obligations and adhere to strict budgetary guidelines laid down as conditions for continued International Monetary Fund assistance, investors remained unconvinced. Many on Wall Street were hoping the populist former metalworker would make statements or staff appointments Monday that would calm markets.

At a news conference here Monday, Lula did nothing to allay investors’ fears. The votes he garnered, he said, demonstrated that Brazilians didn’t share the “exaggerated economic concerns that the analysts have.”

Lula said he was elected to “change Brazil’s economic model,” although he has so far given few details about what his new policies might look like or how he would finance them. He also declined Monday to name any members of his prospective economic team, should he be elected. “First you have to win, then you can give names,” Lula told reporters.

He said that economics in his administration would not be “sacred” and that he had other important appointments to make in social and planning functions. “We want to win mainly to make changes in the social sector,” Lula said.

Domino Effect Feared

Apart from the direct effect a Lula administration would have on Brazil’s economy and markets, investors in the U.S. and elsewhere fear a domino effect on other Latin American economies. Argentina already is in a state of crisis over its shrinking economy, large public debt load and collapsed currency.

Jose Carlos de Faria, an economist with Deutsche Bank in Sao Paulo, said the effect of Brazil’s currency plunge already is being felt by its neighbors.

“There has been a huge depreciation of Brazilian currency, and that affects other countries with trade relations with Brazil,” Faria said. “They may be forced to devalue to level the playing field.”

The devalued real makes Brazilian exports cheaper, threatening competitors in other nations. At the same time, the devaluation has devastated Brazilians’ purchasing power, hurting their ability to buy foreign goods.

Many Brazilian officials have said in recent weeks that investors have been unfairly punishing Brazilian markets. They have pointed out that the country may show a $10-billion trade surplus this year and that it has demonstrated budgetary discipline, excluding the cost of servicing its public-sector debt.

Alvaro de Souza, president of the American Chamber of Commerce here and a former Brazilian head of Citibank, argues that Brazil has made great macroeconomic progress that has been overshadowed by investors’ memories of “what Lula said 12 years ago.”

But he acknowledges that in today’s precarious global environment, investors are steering clear of anything that smells of risk.

One rumor has it that Lula might try to impose controls on capital to keep investors from fleeing Brazilian investments, said Mario Mesquita, an economist with investment bank ABN Amro of Sao Paulo. “That’s why the market is waiting for a [Lula] announcement of a market-friendly economics team that is not inclined to take measures limiting the ability to move capital in and out of Brazil,” Mesquita said.

Analysts say Brazil’s economy is being strangled by sky-high interest rates--the cost the country is paying to retain capital.

Goodman of Globalecon pointed out that Brazilian money market funds must now pay 45% interest to entice investors’ cash. “Under the present circumstances, the right set of policies could readily turn Brazil around,” he said. “But time is running against Brazilian financial markets.”