Investors Warming to a Lula Win in Brazil

Brazil today almost certainly will elect a president from the Workers’ Party who opposes free-trade agreements with the United States and many other policies Washington favors for improving poor economies.

The very prospect of the election of Luis Inacio Lula da Silva -- a labor union leader known universally as Lula -- has had international financiers fearing a default on Brazil’s debts and a collapse of its currency. Many banks in recent months have pulled capital out of the country, and businesses there are starved for funds. Interest rates have skyrocketed to 27%. And many worry that a continued erosion of Brazil’s economy would bring further disaster to South America and rippling damage to the U.S. and the rest of the world.

“It’s looking like a crisis,” says Ross Kaufman, an international attorney in New York who has worked with Brazilian companies for 15 years.

But others are starting to look past such doomsday scenarios -- and for good reason.

Geoffrey Dennis, manager of Latin American investment funds for Salomon Smith Barney, is among those now recommending that investors “overweight Brazil” because many companies listed on its Bovespa stock exchange (some two dozen of which also are listed on the Big Board in New York) have declined sharply in the last two years and could rise “with improvement in the Brazilian economy.”

Josephine Jimenez, manager of Montgomery Securities’ $600-million emerging markets fund, feels similarly. Her San Francisco firm has just increased the Brazilian portion of the fund by about 30% to more than $50 million. Specifically, Montgomery hopes to invest in companies serving the Brazilian domestic market, including supermarkets and banks.

Jimenez traveled to Sao Paulo a few months ago and, having met with Lula’s economic advisors, is convinced that his administration wouldn’t be made up of the socialist caricatures that many have painted. “I’m confident that they will be friendly to business,” she says.

Dennis and Jimenez are on to something. Regardless of his past rhetoric, Lula has no choice but to work with the interna- tional financial community to reform the country’s massively distorted economy.

In Step With IMF

To forestall immediate crisis, the International Monetary Fund, with backing from the U.S. Treasury, is extending $30 billion in financing to Brazil. And Lula already has pledged to pursue noninflationary economic policies that comply with IMF directives.

“The Brazilian economy is fundamentally stronger” than many think, says Lourenco Goncalves, president of California Steel Industries, a Fontana mill that is 50%-owned by Companhia Vale do Rio Doce, a Rio de Janeiro-based iron ore company. (The other 50% is owned by Japan’s Kawasaki Steel.)

During other eras, perhaps, a labor leader like Lula -- a man who rose from poverty by working in the metal trades -- might have made the usual socialist promises of pay raises for the lower class, higher taxes on the rich and a heavy government hand in industry. But the basic structure of Brazil’s economy simply won’t allow for such old-fashioned policies anymore.

Its problem is that two decades of military rule from the 1960s to the mid-1980s, followed by heavy state control of industry, left the country with strange economic ills. For example, civil servants in the federal government, plus 27 state governments, enjoy retirement before age 50 with pension benefits that equal 100% of their earnings and other entitlements.

Taxes are high but not always collected. Experts on Brazil, such as Professor Raul Gouvea, who teaches management at the University of New Mexico, estimate that the country’s “informal” economy of businesses operating outside the tax system is as large as the official $640-billion annual gross domestic product of goods and services.

Brazil’s formal economy is extremely small for so large a country. At more than 3 million square miles, Brazil’s size is equal to that of the United States, while its population of 170 million is about three-fifths as large.

Yet Brazil’s economy is only one-twentieth that of the U.S. Put another way, Brazil’s economic output is only slightly larger than that of Southern California.

Tapping Huge Potential

For his part, Lula knows full well that the huge potential of Brazil’s market has yet to be fulfilled. And for the economy to reach that potential, Brazil needs more than $25 billion a year in foreign business investment. Without that, most people there will continue to earn $1.50 or less a day, and unemployment will continue to rise in the face of 1.5 million additional workers who join the labor force every year.

Last year, Brazil attracted $31 billion in foreign investment, with Spanish companies putting in the most money, followed by U.S. companies. But this year, foreign investment is expected to total only $16 billion.

To get that total back up, Lula’s Brazil must compete with other countries seeking investment funds from Europe, Japan and the U.S. -- including Mexico, which has taken in far more foreign investment than Brazil in recent years because it signed free-trade agreements with the U.S. and the European Union.

Indeed, Brazil is looking enviously at Mexico today, feeling in many ways that it should be the one attracting the most foreign capital that leads to jobs and development. After all, “we are the largest country in Latin America,” says Jose Vicente Pimentel, Brazilian consul general in Los Angeles.

Lula will certainly continue to oppose the all-out opening of Brazil’s economy. “He is distrustful of what the U.S. is offering,” says Gouvea, the University of New Mexico professor.

But in the end, the chances are that Lula and his Brazil will be forced to make some compromise with Washington and the global economy. There is no other way if they are to lift living standards and make the country’s long-declared leadership of South America a reality.

Lula may bark some. But as Goncalves, the steel executive, notes: “Lula won’t bite.”

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James Flanigan can be reached at jim.flanigan@latimes.com.