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Brazil: Political and Economic Challenges Facing the President-elect and the Implications for U.S. Policy in Latin America

Speakers: Luiz Felipe de Alencastro, columnist, Veja Magazine; Professor of Brazilian History, University of Paris, Sorbonne, Andrew Mellon, senior research fellow, John Carter Brown Library, and Walter Molano, senior managing director, Head of research, BCP Securities
Commentator: Kenneth R. Maxwell, Nelson and David Rockefeller senior fellow for Inter-American Studies, director, Latin America Studies, Council on Foreign Relations
Presider: Whitney Debevoise, senior partner, Arnold and Porter
October 30, 2002
Council on Foreign Relations


Washington, DC


Luiz Felipe de Alencastro: And yet you have several elections going on. And in 1970 for the first time you have the expression of the opposition of the citizens against the dictatorship by blank votes and null votes, because you cannot abstain since your vote is obligatory in Brazil. So they knew their votes. And in 1970 and 1974 those electors who voted blank started to vote in the opposition party against the dictatorship. And that was the first big victory; it was in 1974 a very strong movement that repeated later on, on legislative elections, congressional elections, because you have no elections to governor and either the presidency at that time. And so you have…if you take into account about the 4,000 municipal councils, more 20 state assemblies, and you put all that together with the Congress, you have about 50,000 electoral posts being put in ballot regularly every four years at that time. So you have this movement against the dictatorship that made the dictatorship was falling because of the impression of the vote. Also the guerilla warfare and the political violence by some groups at that side against the dictatorship were absorbed in these parties and this political movement at that time. So it's very important to understand that the guerilla didn't stop because of a military defeat, but because political issues appeared that attract people who were involved in those kind of…they like to fight against the dictatorship.

And I must stress that Brazil, it's one of the rare Latin American countries today that's known for the last 20 years had such kind of violent unrest in Brazil, I mean, a kind of political terror or something like that. And that's rare in the…I mean, I teach at the Sorbonne, I'm not talking on international terrorism, but in France you have the Corsicans, the Britons, at all times we have twice a year a [inaudible] at the Sorbonne you had to—because of terrible French political problems, not on terrorist. So it's very important to understand in that sense the appearance of the party as a political and democratic alternative to several players who were outside from the political system during the dictatorship.

In the end of the '70s beginning with the strikes in Sao Paulo, so it's a movement of metal workers where Lula became a leader. And very important too to stress the support of the Brazilian church to that movement. That's the big distinction also with the Church, the whole play by the church in Argentina or Chile during the dictatorship. The Catholic Church in Brazil was much more liberal than the other countries I mentioned, and was from the beginning involved with the workers' movement and peasant movement that was going up during that period. In the beginning the Cardinal of Sao Paulo protected very much these leaders, where it's still being threatened by the dictatorship at that time. I'm talking the beginning of the '80s and end of the '70s. So the Workers Party is born at the junction of trade union, Catholic Church, and the intellectuals.

And you have the party spreading a bit, and Lula appearing as a candidate for the presidency. And this building up of the political career of Lula is very clear. The first time he is presenting the presidency of run-off in 1989, he had 16 percent of votes. The second time in 1994 he had 24 percent. In 1998, the third time, 31 percent. And now in the first round—he had 46 percent. So it's going up. But the breakthrough happened in the year 2000 during the municipal election when the Workers Party won in big state capital like Sao Paulo, Porto Alegre, Campinas, and Belem. [Inaudible]. So it was the moment also of an economic crisis heated the population by the jobless and the fall of the wage at that moment.

And I must mention it was the moment that the American ambassador in Brasilia, Anthony Harrington, started to see that the Workers Party was an important player, and started to, by what I know, to advise the State Department about the possibility of the Workers Party to become a major political player in Brazil. So I must praise this clever opinion of the ambassador at that time, its effect. And so the election is this process going on.

A point I should stress is that some people have been saying that the mistake of Jose Serra was not to defend or become more close from the government of Fernando Henrique. He knew that the population was against the government of Fernando Henrique Cardoso. That is a poll made on the 24th of October showing that 54 percent of the people was against any candidate indicated or supported by the government. Thirty three percent may vote on him, and only 7 percent vote at him by any means.

So there's a very objective reason why. And that's the problem of Serra. He was an irritator of the candidate from the government, but he could not assume and defend the whole politics of the government. And this ambiguity was exploited. And finally the fact that Lula was from the beginning sure to be in first place, all the candidates in the runoff in the first round were attacking Serra to be in second place against Lula. So Lula was preserved of the debate during the electoral campaign, was not attacked to the turnout.

And of course I have to conclude. And I know that there is a lot of interest in Brazil. Today you have an editorial in the Washington Post and another in the New York Times, several articles. And for sure it is not because of the Brazilian political achievements, it is also because Brazil may go bankrupt and frighten a lot of economic players. So I have to conclude my remarks with the idea I can present to you. You have a country, it's not happy [inaudible] but it's like that, the country are also respected by the harm that they can produce. A typical example of this is Russia with nuclear weapons, and so they are respected. Brazil has no nuclear weapons. Of course it is threatened of a bankrupt, it is threatened also.

But it's another point. The other point is the situation in South America is already very complicated. The situation in Argentina, you know it's complicated, in Uruguay, in Paraguay also. Is a fact of Brazilian and Argentinian crisis on these two small countries. But also in Colombia and Venezuela. So a big crisis in Brazil today, to be transformed, that regional crisis is a continental crisis. And the idea of brinkmanship, you have the idea of a positive brinkmanship that means you can threaten the country, because they have military skills to hit your adversary and trip him.

But there's a way to have a negative brinkmanship. Not because of the social and military organization of a country, but because of the social and military disorganization of the country. The disruption of political order in Brazil will allow connections of drug dealers through the Amazon. I mean, all the work the Brazilian state has been doing. And I can elaborate more on it, because we have some states in Brazil who are trading by local drug parties who are involved and threaten the government. So it could become a national issue. So I guess there is some margin in Brazil to play. It's much better to have a regular government playing as a direct adjunct of controlling the violence and installing political order that provokes disruptions that could transform the whole South America in a mess. So thank you very much.

Whitney Debevoise: Thank you, Luiz Felipe. Before we move on to hear from Walter Molano about economics, let me enjoin the audience to do as I did not do, which is turn off any cell phones you may in your pocket. I apologize. Walter Molano is going to tell us about the economic challenges in the new administration. Walter is partner and head of Economic and Financial Research at BCP Securities, an emerging market boutique. He has a Ph.D. from Duke, and started his education at the Naval Academy. He's a prize winning research analyst, and we look forward to hearing his thoughts on the challenges facing the new administration.

Walter Molano: Thank you, Whitney. Let me apologize, I'm kind of coming off a cold, so I'm going to be a little bit hoarse and not very loud. But when talking about Brazil, the economic issues and the financial issues, I think that it really comes down to one issue, and one is debt sustainability. And that is that Brazil has found itself to be in an unsustainable type of situation. Let's just run through some numbers very quickly. At the end of last year, or at the end of 2001, Brazil's public sector debt to GDP ratio is 48 percent. At the end of the first half of 2002, so that means six months later, it was 59 percent. So that's an increase of 11 percent in a time period where the economy barely grew at all. At the end of this year it's going to be well over 60 percent. So what you have is a rapid escalation in debt to GDP. Why is that? Well, because 80 percent of the public sector debt, at least the domestic debt, is indexed either to the dollar or indexed to interest rates.

Now, Brazilians have been very well aware about this, and the markets been well aware about this for a long period of time, that this was a vulnerability to the Brazilian economy. Now, according to the Central Bank's own estimates and studies, as well as several that have been done on Wall Street, in order for Brazil to stabilize its debt to GDP ratio, or it's leverage ratio, it needs to post a growth rate of 4 percent year on year, it has to reduce the real interest rates to below 10 percent, and it has to have an exchange rate below 2.60.

Now, let's look at how Brazil is doing right now against those three benchmarks. The 4 percent growth, well, this year we're lucky if we're going to get zero percent growth, and for the last four years we've had an average of 2 percent growth. When we take a look at real interest rates, instead of 10 percent we have 15 percent real interest rates right now. And instead of having an exchange rate of 2.60, what we have as an exchange rate is at 3.85. So what we have is a situation that continues to get worse.

Now, this is one of the reasons why the IMF decided to give Brazil a rescue package, the famous $30 billion rescue package. Of course the rescue package did not come without strings, there are very stringent strings attached to it. And the most stringent was a primary fiscal surplus of 3.75 percent of GDP for roughly the next two years. Now, let's take a look at how realistic is that surplus. What it really does is it commits the next Brazilian president, i.e., Lula, to a fiscal surplus that's almost twice as high as the fiscal surplus that was posted by President Cardoso. The average primary surplus for the last four years was 2 percent. And as I mentioned before, the average growth rate was 2 percent. So he managed to post a primary surplus that was only half as much as what Lula is required to post. And in a global environment which was much better…remember that Brazil received very large inflows of foreign direct investment during the last few years thanks to the privatization of Telebras and all that of state owned companies that were being sold, and also because of the investment boom that we were seeing globally.

So the point is that there is a serious challenge facing Brazil, and it's not a Lula problem, okay? This would have been the case had Fernando Henrique Cardoso remained for a third term in office, had Serra won, or had we put Alan Greenspan down there. There is no way that Brazil would have been able to confront the problems. A lot of people say Malan and Fraga are the heroes, and what are we going to do when Malan and Fraga leave. Well, I'm sorry to say this, ladies and gentlemen, but they're the ones who actually created this concoction that begins to blow up when the next president comes into office. And unfortunately this is a time bomb that Lula is going to have to diffuse.

Now, out of the candidates that we had in front of us, especially the two primary candidates, Serra and Lula, I think as bondholders…okay, because you have to distinguish Wall Street into different types of areas, you have to distinguish it from the bondholders, the people who actually hold that, and the agents or the investment banks who are just actually doing the capital markets types of transactions, the issues. And the bondholders I think would rather see Lula. Of course the investment banks would rather see Serra, because if Serra would have been president, then their old friends at the Central Bank would have stayed in place and then they could have been as assured of then getting the next mandate.

The reason why I think that bondholders would rather see Lula is, first of all, expectations for Lula are very low. So really whatever he does is probably going to be ahead of expectations. Meanwhile the expectations for Serra were incredibly high. And this was a situation that was going to trip up regardless of who was going to be in the position. The other thing is that Lula has a very low commitment to the banks, the local banks. The main problem in Brazil, as I mentioned before, is the domestic debt, because so much of the domestic debt is indexed to interest rates and to the dollar. The holders of this debt are the local banks.

Guess who was financing Fernando Henrique Cardoso's second reelection campaign, and who was financing Serra's campaign? It was the local banks. So Lula is not going to have any kind of loyalty to them, and therefore he's going to pass most of the costs on to them. If he passes most of the cost on to them, that means that the foreign bondholders at least don't have to bear the brunt of the adjustment as if Serra would have been in office. Now, the thing is, Lula has to establish a reputation. Remember, whoever becomes president, i.e., Lula, he's going to have the possibility of being reelected. As any president who comes in with the possibility of reelection, the first day that they get into the office they already start planning their reelection campaign, so you know Lula's going to be trying to do that.

Now, I think that Brazil is in a very unique opportunity and position. With all this said, and all very negative things and very high challenges, I think that Brazil is in a very good opportunity. One of them is that Brazil can finally get away from the stigma of going left, because it's going left, okay? Every time that we try to do a bond issue…(Laughter)…every time we try to do a bond issue in Brazil, we always can only go out four years out into the future, because you always have to have the little uproar, which means that at the end of four years you have to have your bond mature, because then you could have the possibility of Lula. Well, now we're going to pull Lula out of the closet and we're going to put him in the presidency. (Laughter) And if he doesn't scare us to death, that means that we can now start going out further than four years into the future. This is great news for the Brazilian industry, an industry that is tired of trying to finance itself very short term for long term types of projects.

The other thing is that…so how can Lula try to address this? As I mentioned before, the real focus I think is to try to do the domestic debt adjustment. How do you do that? Well, you could try to do it in a cooperative way, which would probably be the best way. Try to get the bankers in together and say, "Look, gentlemen, you know, you've been having a very good ride for the last four years, so let's come to some kind of agreement. We're going to pay you less for the coupon rate, or we're going to de-index the debt, or something along those lines." That's very well a possibility, and several of the Brazilian banks have intimated that, and especially here in Washington two weeks ago during the IMF meetings. The other way that he can do it if the banks don't want to cooperate, is he can impose capital controls. Once he closes the capital accounts, then the banks are all stuck inside the country, and then he could set whatever interest rates he wants. And therefore he can begin to liquidate the debt.

If Brazil is able to do this, if Brazil is able to stabilize and reduce its domestic debt burden, then I think that Brazil is really going to become a shining star, whoever is the president. And the reason is this, and not to segue, but I think that the ascendancy of Asia again, the growth of China, China's extension into the WTO, is very positive news for Latin American, because Latin American is the provider of commodities to the world, and Asia is the biggest consumer of these commodities.

And one of the biggest producers of these commodities is Brazil. You can just run through the list of commodities, iron ore, sugar, soybeans, coffee, oranges, the whole list, okay? Brazil has double digit types of controls or dominates double digit types of positions in the production of these types of commodities. We're seeing these commodity prices increase already, we're seeing Brazil's trade balance starting to improve. The problem is a timing issue. Brazil has a lot of debt amortizing in a very short time period at very high rates. It also is seeing the price of its products starting to increase very quickly. The thing is, can we get the two close together? And this is going to be the challenge for Lula. Thank you.

Debevoise: Thank you, Walter. We'll now hear some comments from the Council's own Ken Maxwell. Ken has been with the Council since 1989, and since 1995 he's been the holder of the Nelson and David Rockefeller Chair in Inter-American Studies. He started at Yale, Princeton and Columbia, he was educated at Cambridge in England, and got his Ph.D. at Princeton. He's just back from a trip to Brazil where he attended the Presidential debate. So, Ken, tell us how it all unfolds.

Maxwell: Thanks very much. I just wanted to begin with two anecdotes that I thought were sort of revealing. This morning I was watching the NBC…I think it was NBC…which was broadcasting the "Today" show out of Miami. And there was a great deal of discussion about whether the new reformed, improved voting system would work next week on Tuesday, and to overcome the embarrassment of the dangling chads and all this sort of thing that we had in the last presidential election. And it was remarkable to be in Brazil and to see an election where you had 115 million voters all voting with their electronic boxes, and the results were out by I think it was…what?…10:30 or something like that, the same day, with no indication of fraud, no indication of anything going on. There are little boxes with, you know, batteries, that went up the Amazon and so on. (Laughs) It was an incredible achievement.

Then I opened the paper and I see that our inimitable Treasury Secretary as of yesterday I think said, "Well, we have to wait and see if Lula's crazy." (Laughter) And I thought, well, actually Lula needs to wait and see if Washington is crazy. (Laughter) Because also as of this morning I find a letter from the Chairman of the International Relations Committee, that on the last page a letter to the president, says we have to worry about a 30 kiloton nuclear bomb from Brazil, (Laughs) which is absolutely ludicrous, frankly. I mean, one of the great achievements of Brazil, one of the great achievements of the re-democratized Argentina and Brazil in the period of Sarney and Alfonsin was to close down the nuclear program and to sign international treaties. And under Collor, of all people, the corrupt Collor who left government under impeachment, closed down the program completely. So it's extraordinary to see this sort of misinformation or scare information floating around in a serious way here in Washington. I think it's one of concern.

Before I answer and respond to some of the questions, just to underline the extraordinary nature of what happened in Brazil last Sunday, which seems to me not just a personal triumph for the presidential candidate, one, Lula, but also a great triumph for a new rooted party in Brazil, the Workers Party, and for Brazil. And let me just outline some of the extraordinary achievements. Lula got in the vote over 50 million votes, which is only slightly less than another ex-union leader, a man of simple tastes, a man of very clear connection with the public who became one of the most successful presidents of the United States, Ronald Reagan. Lula had the same similar number of votes. The only other democratic president elected in the Western Hemisphere that's slightly more than the 50 million or so that Lula got was Ronald Reagan.

Here's a man who came from the poverty stricken Northeast of Brazil, minimal education, rejected or abandoned by his father, taken by his mother down to the south. Worked his way up, shop floor, shoe shine boy, educated himself and so on, became a union leader, party creator, and now president of Brazil. It's a remarkable event in Latin American history, or indeed the history of any country. And I think one shouldn't ignore that. The only equivalent person would be Lech Walesa, I imagine. Not a good example actually in terms of his effectiveness in government, but nonetheless in terms of where he came from.

We know that Brazil is a hugely unequal country. I mean, the figures are basically that sort of 50 percent of the wealth is held by 10 percent of the people, and the opposite is true for the majority of the people, 50 percent of the population has 10 percent of the wealth. It's the third or fourth most unequal country globally. Nonetheless, we've also known over the years that there's been a remarkable social mobility in Brazil, and that's shown up in all the statistics, and it's extremely interesting. I think Lula in some sense represents that. So the people on the outside in terms of his feeling and connection and ability to connect with people in Brazil is something that's a remarkable shift, a historic shift in many senses.

For the party I think it's a very interesting thing. If one thinks of what the US has been trying to stimulate in new democracies and what the debate about it has been, has always been that many of these countries, and it's certainly true for much of Latin America, lack rooted political parties. The extraordinary thing about the Workers Party is it has over 20 years become a rooted, socially inclusive party. And it's very important to realize that those groups that in many Latin American countries are outside the political system have for 20 years now worked within the political system in Brazil, and now have grown and moderated and understood that they needed to win elections, to move and incorporate not just their base, which as Luiz Felipe said, was originally the church, was the union, NGOs, intellectuals and so on. But to win elections, move towards the center.

And I think the key to the election really in Brazil is very much that the middle class…I don't mean the very rich middle class, but I mean the average middle class in Brazil that was most badly affected in many ways by the economic policies of this current government, and by that I mean high interest rate, the hidden or repressed inflation that's in the situation, the holding down of wages in relation to what's going on, the effect on small business, and therefore a great increase in unemployment.

It's amazing to me that the only voices that one heard about talking about Brazil in the last six months have been panicked, hysterical voices, in my view, from Wall Street. One has not heard anyone else. And clearly these people get paid too much, and fly from helicopter rooftop to rooftop when they travel in Sao Paulo. Everybody is so scared of walking on the street, they fly from building to building if they have a certain amount of wealth. But if you drive around and go around and walk around Sao Paulo, any Brazilian city ten years ago, historically the most dramatic thing has been the people on the streets, the small shops, the small engagement, the small liveliness of the street. You can now drive for mile after mile after mile after mile in this huge megalopolis which is Sao Paulo, the industrial center, financial center…the gross domestic product of the state of Sao Paulo is greater than Argentina or Colombia…and see a desert, no people, little shops closed down, row after row. That to me was one of the great indicators that showed up in the poll I think that Luiz Felipe mentioned, that these people were totally alienated from the government, and very much responded to the moderated reach out to them by the Workers Party.

For Brazil therefore I think it's a great achievement. Because I think it also shows a great deal of sophistication in voting patterns. One of the interesting things about the elections is it was a yes to the individual, Lula, it was a yes to the party federally, but it was not a yes to the party in the states. And people split their vote in a very interesting way. And the four major states in Brazil which have huge influence economically, politically, and will have an enormous influence in the ability that will enforce a negotiate between the federal government and the powerful states of the South, Manaus, Rio, Rio Grande do Sul, and Sao Paulo, all voted for candidates of the government party…I mean, except Rio that went to the wife of Garotinho. But the three major others states went to the Social Democratic Party of Fernando Henrique, the current president's party.

So Brazilians, as in the US, built into the system a balance. The whole notion there's a great wave of the left is constrained by this split vote. And I think that's very important, because that's going to be enormously significant in how this government acts and how the negotiations go, both for good and for bad. So the notion that there was sort of reaction of a neo-liberal policy is again utterly nonsense. Only part of that policy maybe was in fact implemented. But one third of it that was very important which was the fiscal responsibility law which affected and restrained the states from spending, and restrained the amount of debt, or agreed to the amount of debt that they had to assume and pay off to the federal government.

One of the implications of this division of power is that even though it may have a restraining influence on any great…The other side of it is of course these powerful governors will all want to renegotiate these debts, which could then unravel exactly the economic constraints that Walter talked about.

Let me just quickly say that what I see is the very risky, very problematic period between now and December, the two months now before the president is inaugurated. And I think this is going to be quite a critical period where statements of the type I mentioned at the beginning can actually be quite damaging to the very complex internal negotiations that are going on to Brazil now about how will be in the government, what balance of forces, who will pay what, how the states and the federal government will react. All these things must be going on now behind closed doors at a very intense rate with the new president and, as it's called, the cardinals, the four or five men, and probably one woman actually, maybe the current governor of Rio might also be in that group that is now sort of forming what the new government will be.

I would call it a race between fear and utopia, that is, I think that the fear we all know about, we've seen it on Wall Street, Walter has described the enormous constraints that are there. If you look at the logic, the crisis hasn't gone away because of the election. It's there. And how that's handled. And utopia, I think Brazil is going to be, because of who Lula is, because of who the Workers Party is, because of their international connections, it's going to be subject now to a huge amount of inflow attention by those dangerous outsiders, in my view…I don't mean dangerous because they're going to sort of blow people up or anything, but dangerous because they want to impose their own utopias on other countries. We've seen it whenever there's been a situation like this, we've seen it in Nicaragua and so on. If I were responsible, I'd deny them all visas. I think these people don't help anybody.

But anyway, I think that's going to happen. I mean, I do think Brazil is going to get a lot of attention from the Latin American left, from the left in the world, from the anti-globalization people who think this is a great anti-globalist move. And I don't think that's going to help Brazil. So I see fear on the one side, and utopia on the other as being the risk.

The other is this enormous, enormous dichotomy between expectations and resources, for all the reasons that Walter talked about, the enormous constrains, and constraints that are built in regardless of what happens to the IMF agreement, and to the sort of really, I find, inadvised sort of statements coming out various places as to what the government…who is acceptable to the markets, all this sort of stuff, doesn't help at this moment. But that's between the…there's a huge electorate…this enormous expectation among the people, as I said, particularly the middle class, the small businessman and so on who want interest rates to come down, all these sort of things which are essential to growth, but the constraints are enormous on the government to fulfill them.

Remember, the church, one of the key elements in the sort of coalition or support of the PT and of Lula, conducted a referendum not long ago on free trade. It was like a referendum that Saddam Hussein conducted, you know, 99 percent or whatever against. But, you know, you have to satisfy these forces. You have the landless movement out there that's been very negotiated, quite during this period of movement. You had a brilliant election campaign, by the way, I mean, a brilliant campaign on the part of Lula from the point of view of PR, which really needs to be looked at. Lula was transformed into this sweetness and light, and Serra became…well, Serra was himself. (Laughter) That was the problem.

And the fourth I think is the problem of experience. It's true the PT and the people of the cardinals, the people around him, had a lot of experience at the grassroots level. They've had a lot of experience in municipal government, very successful in some places. They've had mixed experience, but some good and some bad in state government. But they have never had real experience, except in Congress, at administering this hugely complex state. And I think what Luiz Felipe said about the debt of the Brazilian political system should never be forgotten. You're not dealing here with a…I mean, the problem of Brazil is not that the state doesn't exist, is that it's a huge cartorial state, (Laughs) you know, endless paper, endless bureaucrats who are all PT and, you know, all want their salaries raised. (Laughs) And it's a federal system with governors, with municipalities and so on. The PT has never really had an experience with that sort of negotiating and dealing and so on, and that's going to be very difficult.

The final thing on foreign affairs is they're also extremely weak in experience on international affairs. Very few of them speak English, very few of them have had external connections. And we hear a lot about Chavez and we hear a lot about Castro. We don't hear a lot about the AFL-CIO. The one key area of connection that the unions in Brazil and Lula have had here in the US is with the powerful unions here. And that is an interesting phenomenon rarely talked about in Brazil, but I think does give the PT a certain amount of understanding of the US system that may or may not ...

I said this the other day and they said, "Well, why did you say that in New York with all these bankers? That will scare them." I said "Because Lula reminded me, if you had George Meany elected president of the United States." And they said, "Don't say that, that will scare everybody more than if there's going to be a crisis with the economy next week." But I think there is an element. He's a negotiator, he's a union man, his international connections are stronger I think in that area than they are in the sort of fear sense of a new axis of evil (Laughs) with Chavez and Castro. No one in Brazil…I mean, it's ludicrous. As I said, Sao Paulo itself is a large economy, a more sophisticated economy than the whole of Argentina, than the whole of Colombia. You could have I don't know how many Cubas in Brazil, and nobody would notice…and that's true of Venezuela. No one sees a model, no sensible person in the party or anywhere else sees either of those countries as a model to be followed.

Debevoise: Thank you, Ken. Why don't we start off our discussion here going back to the political. I'll just give a few data points, and then perhaps Luiz Felipe can educate us on how the political negotiations which will be necessary to run this country may unfold. For those of you who haven't followed the elections in a Congress of more than 500 members, PT has the largest delegation coming into the new Congress in January, they're going to have 91 seats. Of those 91, approximately 26 are associated with the so called radical wing of the party. Then you have the other parties which were formerly part of the government coalition, the president's party, PSDB, PMDB, PFL, which is the party which left the coalition earlier in the year, and others. So they have about 17 percent of the Congress.

Mention was made by Ken of the split nature of the vote. State governorships in the second round, interestingly enough, after everyone knew where things were headed, PT had seven candidates in the second round for governor. Six of them lost, only one prevailed. So clearly the electorate was splitting the vote there. In a country where party discipline, with the exception of PT, has never been a hallmark, and every vote is negotiated item by item, how does Lula proceed?

Alencastro: Yes. I guess that's important…I mean, Americans are very familiar with the Brazilian political system, much more than the Europeans. It's very difficult to Europeans, and to the French, who I teach, to understand the federal system. They don't understand why Ronald Reagan had political experience, because he's a governor of California, or Bush in Texas before. So this kind of apprenticeship by (Inaudible) is very important in Brazil, as it has been for instance in Germany with the Greens—of (Inaudible) in the Greens in Germany and the Greens in France. I mean, the Greens were introduced to the system in Germany.

So in Brazil, the difference with the United States. If you have a multi party system, so an alliance is essential to the presidency, to the federal government to deal with. I mean, it's the basis. It's not the kind of perversion, it's the whole of the system. So he has to negotiate with several parties. We had 16 parties in the other Congress, now we have 9. In four years we will have another electoral law that we oblige the parties to have a percent vote to be allowed to form a (Inaudible). So it's a system like in Germany. So some of these parties will disappear.

The political reforms are very difficult to do in the electoral system, so the negotiations part of the Brazilian system. And you are right, both of you, about the fact that the PT had no governors. But when you see the three governors of the southern states, Parana, Santa Catarina, and (inaudible), they are from the (Inaudible), they are all close to Lula, except (inaudible) of course. But Parana and Santa Catarina, they are on the side. And the parliamentary group of the PT, they already are probably 20 or 30 more representatives that will be the changed party, and they'll go to the PT. We know more or less that already. So, I mean, there's a play there that the Brazilian political system is organized around this.

Debevoise: Are we going to see the resurgence of Meenus(?) [ACM ? ] on the national stage now with Aecio Neves in the governorship?

Alencastro: Sure. Sure. Because there's a renewal of…I was saying that was a defeat for the core of the PSDB, Fernando, and he can say about it, no way to escape from that. Because Alckmin, the governor of Sao Paulo, they have some distance of the federal government in the end of the election. And I asked him, he was very close of Lula. And this kind of meeting they have by accident in the airport was careful planning during the two rounds. They meet by accident in the airport, Lula. And so they had to fight all together because someone is going to play…Who knows the background know that several people organizing this meeting. So for sure.

Debevoise: Let's ask Walter about the economic consequences of that chance meeting. Is Aecio Neves going to be the first state governor to ask Lula to renegotiate the debts of his state?

Molano: Sure.

Debevoise: And what is Lula going to say?

Alencastro: They said already that they are not going to negotiate the debt now.

Debevoise: You think Aecio will not ask?

Alencastro: Yes, they will ask. But it's a box of Pandora. If you open that thing, everyone is going to run on the fiscal budget. I am talking also of the town, because there's a problem with the town, the debts of Sao Paulo and the town. So no one has interests to push too strong on that point now.

Debevoise: Okay. Well, let's take some questions from the audience.

Audience: A small issue, just picking up on something that Ken Maxwell said, and perhaps asking the professor ...

Debevoise: Would you identify yourself, please.

Audience: Oh, Jessica Einhorn. I'm sorry. Jessica Einhorn, SAIS. On Ken Maxwell's point to Professor Alencastro. Lula did give a speech, which was quite strongly reported here, to a military audience in which he talked about the nuclear option.

Alencastro: Yes.

Audience: And that was arresting in a town that is, please, going back to I guess protocol to Treaty of Tlatelolco.

Alencastro: Yes.

Audience: In the fact that Latin America was a nuclear free area. Ken has pointed out that the congressmen who are most interested in this issue have grabbed hold of it, and indeed in a letter that he thinks is somewhat crazy, is already going to Lula on this. Could you let us know why ...

Alencastro: Yes. I guess it's kind of speech of campaign, you see. Because some military was against it. And Lula told at that moment that the treaty, suppose that everyone is going to abandon nuclear weapon. And that was not being done. In that case, it should be reviewed. He talked something like that. But in fact the Workers Party vote for the treaty of nonproliferation in the Congress. And yesterday they gave a new statement, and he said also when his first statement he gave as elected president, he was going to respect this treaty specifically.

Debevoise: Paulo?

Audience: Paulo Sotero from O Estado de Sao Paulo for Mr. Molano. I'd like to understand a little bit better what you said. I'm a journalist. All statements coming out from Lula and from Jose Dirceu too, the president of the Workers Party, seem to suggest, or you can see a clear effort to reaffirm some measure of continuity in economic policy. And we know that they ran against this economic policy. And including indications that the government will try to make a bigger primary surplus than the 3.75, from your remarks I understood that there isn't much they can do. It's kind of hopeless. They either own the internal debt, they get to the banks and so do something nasty to the banks in Brazil. And I wonder if they do that with the banks in Brazil, how the international banks…what the international banks will think. The second thing you said, your second option there, which to me just seemed to impose capital controls, which also I believe would not be very well received, are those the alternative? Do you see another…? Because from what you said, I think that Lula should not try to satisfy the IMF or the international banks, because there is no way he will do that.

Molano: I think that Lula is in a very difficult position right now, because he has two months until he gets into office. He can't impose any kind of policies right now. So if he starts revealing his cards right now, then that gives economic agents two months to act. We've already been seeing a pretty steady drain on international reserves. They've been down, I think it's something like 12 percent in the last month. I repeat again the studies that have been shown how to stabilize the debt, they need 4 percent GDP growth, they need real interest rates below 10 percent, they need an exchange rate below 2.60, okay? That's how you start to stabilize the debt. Growth for this year is zero. And given the global environment the way we have it right now, I don't think it's going to be much better next year. Real interest rates right now in Brazil are 15 percent, and the exchange rate right now is about 3.85, so the situation continues to spiral out of control. So, yes, Lula can try to raise the primary surplus to 4 percent. I believe I've seen some private economists in Brazil talking about raising it to 6 percent.

But what you're going to start doing then is you're going to start killing the economy, okay? This is what Argentina did. In the recession is not the time to start applying a tighter fiscal policy, especially for a politician who just got elected promising to give people three meals a day. And he's going to have to start cutting into very basic social services, social services that are already very thin in Brazil. So I see it as being very impossible for him to do that.

Now, I think the most ideal situation is to come to some kind of understanding with the local banks and the local financial sector. And that may be the case. I mean, I think that Brazilians are very nationalistic people in a good way as well as in a bad way. You know, they're nationalistic in that sometimes they can come together, as they say in academia, "Concertacion," and come into some kind of a pact agreement. However if that doesn't work, then I think that you're going to have to start to talk about capital controls. Of course you could try not to do that. You could try to avert it. But you see what happens when you don't face your realities. And that case is very visible just south of Brazil, it's called Argentina. Argentina is a country that had it started to confront its realities in 1998 and 1999, it wouldn't be in the complete devastation that it is right now.

Maxwell: One of the striking things last week in Brazil, traveling around a good deal, and I hadn't quite realized how intense it was, is the enormous gap among professionals, economists, between the Brazilians and sort of Wall Street, or people on the outside. And not just rhetorically in terms of information. I mean, a quite elaborated response from the Brazilian economists as to why the situation is manageable, whereas one gets a very different and opposite view from the outside. Now, I don't know, I'm not the expert to judge that. But it is striking how I have never seen quite such a divide on this. Now, of course it could be denial on one side and panic on the other. I mean, I think there is a little bit of element of that. But one should say there is this great division.

The other problem though I think is that the positive thing is I think both the outgoing and the incoming government, and people surrounding Lula are enormously aware of this risk. And as we've seen, the other remarkable thing is that Fernando Henrique's government has done is to put in place, based on a US model, a transition team that will bring in, as soon as all the PT people are nominated, or non PT, whoever they are, as part of these deals, to work with people throughout the bureaucracy and throughout the presidency to assure a smooth transition. This has never been done in Brazilian history, and it's a remarkable circumstance. The problem will be if this crisis, you know, (Laughs) because of what again the good and the bad side, in that Lula is now there, so that more voices are entering the discussion of Brazil, and more interests are entering.

In other words, as far as I could see, up until the election it was only really the commercial banks and so on that were speaking. And it was an enormous silence from the multinationals, from the productive side, from people who have long term private investment in Brazil from here and from outside, who did not speak up, but now are in a very direct way. And in fact David Rockefeller gave an incredible interview recently in the major financial press, Valor Economico of Brazil, a several page interview about the long term commitment, or the need for people who were involved in Brazil from the outside, to actually get actively involved in discussions in dealing with these problems. That is a change, and that could indeed bring some positive element I think into it since the election.

Debevoise: A question back here in the back?

Audience: Michael Zarin, Policy Planning Staff of the State Department. I'd like to ask any of the panelists to comment a little bit further about our prospective Lula foreign policy. Moving beyond his well known positions about FTAA and whoever his friends might or might not be in Latin America, but what can you say or speculate on in terms of a foreign policy for Brazil under Lula? What type of a relationship does he want to have with the United States, with his neighbors, with other partners internationally?

Alencastro: Well, I think they have stated that their interests on rebuild the Mercosur. And Serra was very against that from the beginning. That's the point that distinguishes the two candidates. Serra thought that the automobile agreement between Brazil and Argentina was too much favorable to Argentina, and he was not for the Mercosur. But the fact is I guess the PT underestimated the facilities of just building the Mercosur. Because Marco Aurelio Garcia, one of the advisors of Lula on foreign affairs, talked about even the common currency. I mean, I had been living in France for 25 years, I mean, it's so difficult, and takes so much time to do. That's not a program for one government. And so I guess the situation in Argentina is so difficult. And anyhow, there is a policy to be made in that part of the world. The election of Lula was very well received in Argentina and Uruguay and Paraguay. They had polls in Argentina, and Lula won the polls (Laughs) very easily. He has connection with trade union there. And so there's a card to be played there. But I don't think that it could be what they thought before, four years ago, an alternative to the free trade area. It will never be an alternative.

Maxwell: Yes, could I say a word about that. Because I think a lot of it depends…I mean, not a lot of it…a part of it is that there are two sides to the equation, and it depends a lot on how the US actually responds. It seems to me the US is extremely favorably placed at the moment in terms of its representation in Brazil. I think that's quite remarkably maybe accidental, but it's extraordinarily good and useful. There's that famous movie about the coal miner's daughter, you know. There's a steel miner's daughter who is the US ambassador in Brazil, and she's had an extraordinary good relationship with the incoming and outgoing government, and she's had a very good relationship with the press. There's been a very positive change. And the DCM, as you know, is also someone who's gone through similar type of experiences in Europe, and also was in Poland.

So I think the US in terms of its on the ground information from Brazil, I assume is extremely good, which is excellent. But my sense is that both the US and Brazil and the region more broadly are at one of those watershed moments when there needs to be some really serious high level fresh thinking about it on both sides. And on the US side it seems to be it's absolutely high time that policy was not to Latin America, to the region, I'm talking about…not being captive of domestic policy interests. If Brazil fails, and we all know that that chance is not something that we can ignore happening, that is a huge elephant that falls in a region where there is nothing but crises. And for the US I think, and for the financial system, and for the future of democracy, and for drug trafficking and all these other things, this would be a catastrophe.

I was thinking today that, you know, it's incredible, the relationship with Latin America from the perspective of the US. It's as though one looked at the Soviet Union and was obsessed all that period in the Cold War, and was obsessed with Albanian politics. You know, it's as though one looked at China and was obsessed with the casinos in Macao. Or one looked at India and one was worried about the Maldives island politics. I mean, I'm afraid that in many ways that's the way US policy is seen for domestic political reasons that I don't even need to go in. We all know what they are. But Brazil is much too important and the stakes are much too high for that to already go on.

I think on the other side in Brazil there is also an impasse. I think Mercosur has failed for all sorts of reasons. I think there is an illusion, in my view, a delusion in Brazil that somehow it's a regional leader where no one else really…whatever they say to the Brazilians, they don't say that to the US. And we're going to see on the free trade area if it doesn't move forward, obviously a Chile deal by the end of the year, possibly bilateral relationships go on. And the danger then is if you have a problem in Brazil, an isolation of Brazil, and in turning of Brazil, that's no good too. Brazil has to trade more, it has to modernize, it has to become efficient and all these things.

If you read carefully what the PT is saying, actually it's also moved quite dramatically, and even to the degree there is some discussion of actually moving potentially to bilateral free trade relationships or discussions with the US if other things fail. I mean, this has been talked about within the PT. So I think both countries, there is going to be a very delicate moment of redefinition over the next…or should be…over the next six to nine months. The question, in my view, as I say again, is getting from here until January. That's going to be very difficult. Images are important. And who the US ...

You know, the inauguration as far as we know will be January the 1st. There's some discussion to move it forward or back. But we know that of course if heads of state turn up on January the 1st like Castro and like Chavez, and if the US has a delegation that is not of the same protocol, they'll be hidden away in the back rows, and all we'll see is pictures in the international press of Lula with his axis of evil. I mean, this is something the PT is worried about, but it could happen. So the US really needs to…I think actually President Bush and Lula would actually get on quite well. I have a sense that they have a lot of characteristics in terms of person to person time behavior. So, I mean, one would very much hope that on both sides there could be some sense of engagement sooner rather than later.

Audience: (Inaudible). I was going to ask what it looks like at this point in terms of the Lula government's attitudes on negotiation the free trade area of the Americas. Ken has already addressed that to some extent. But the two, US and Brazil, become co-chairs of the negotiating process in a couple of days, and PT and Lula have said some confusing things on these topics up until now. And clearly Brazil has one of the lower export coefficients in terms of gross domestic product in terms of debt among the countries of Latin American in the world. And that's really an opportunity for it to expand its exports dramatically. To do that it's got to have better access to the US market, and to do that it's going to have to have an intense trade negotiation. It's not going to happen any other way either, as (Inaudible) or an FTAA or both. And I just wondered if perhaps since Ken has addressed this already, whether the other two panelists had some thoughts on what the PT and what Lula's thinking is at this point, and how to proceed in this new leadership responsibility it has within the FTAA process.

Debevoise: Well, I guess that they have it, even not skill (Inaudible) to go on by their own in this kind of negotiation. They are going to follow the pattern of the present government. And for this initial month I guess that's the persons of the diplomatic ministry in Brazil in the embassies will follow it, will stay on for some time. I mean, that's a minimum of intelligence. Political intelligence is not to break this kind of complex negotiation if you have no stuff enough to renew negotiation on other basis. So, I guess that there's no change for now. Maybe later on, but not now, I guess. I mean, now, I mean, the next year.

Audience: Quick question. George Folsom with IRI. Two quick questions. First, could you give us your estimate of who's on the short list to be the new Governor the Central Bank of Brazil as well as the Finance Minister? And then, secondly, each one of you here talked about which way is the PT and Lula going to go. Are they going to continue to moderate, or will they be co-opted by some of their other international colleagues? Professor Maxwell, you mentioned that as well. What are your views on this organization called Foro de Sao Paulo, which PT as well as Chavez as well as other folks who are members of, including Colonel Gutierrez up in Ecuador? Is it a phenomena and a movement that should be taken seriously? Or, how do you assess the risks for the Sao Paulo and its relationship with PT? Thank you.

Alencastro: It's interesting. You'll see, because I live, I mean, I live now in France. I had been living in Brazil for 12 years. We never heard about this for Sao Paulo in Brazil. We don't know about it, and it's crazy how that thing grow up and became, that's one journalist known as a guy very conservative from extreme right, who writes in a weekly in Rio, who started with that thing. We never heard about that. The Mayor of Sao Paulo is from PT but she, therefore, I mean, for two years. She's supported by wealthy managers. Their Secretary of Planning is the former Minister of Planning from Sarney.

I mean, the city was bucker up. They rebuked the fine arts. Was a very good example of achievement of the PT in fact. Because Sao Paulo has 12 million persons. The town was broke. And now the final sorrow came, and the Mayor of Sao Paulo had in the polls the best opinion of every time. I mean, the last two years in the population. They start to do things. I mean, it deserves a special study to that affair of Foro de Sao Paulo. I don't think what Kenneth think about it? Because ...

Maxwell: No. I mean, I think there…all these things have to be put in context. Of course, that there is a forum, I mean, and there was a meeting in Havana late last year, where, I think, Lula went and Castro was and so on. And there have been these connections. The part of the extreme, but the landless workers movement has enormous connections internationally on the left. I actually was looking. It was very curious on a Website what Saramago had said about Chiapas. And up comes an Italian site which is the original site of the MST. I hadn't realized.

I mean, if you look around, you can find all these things. But let's remember that Ciro Gomes, who was the candidate of the sort of populist right, I guess, in some senses, ran on a party that was the renamed Communist party of Brazil, that Fernando Henrique Cardoso came out of a much more Marxist background than does Lula, actually.

And that's true of…the curious thing about Brazil is how, and I think one of the things, the positive things that might happen now, will be to shake off all this rhetoric of the left. All the parties in Brazil had a leftist rhetoric in this election, even the parties of the extreme right. And if the PFL, the liberal party, which also has a big chunk, I don't know how many members of Congress, and quite a large number.

Debevoise: Big one.

Maxwell: Big one. Is the big balancing force to the PT other than all these others, small parties, really irrelevant in terms of the two big blocs. My sense is it could be liberated to become a modern conservative party, if there is a, you know, if the government, Lula goes on for the four year or even eight year period. And first time almost in America, certainly, in recent history that it has not been involved in running the state.

It has to stand on its own feet to some degree now, even though, of course, it's governorships and has local thing. So, that might be a very, you might get, actually, a modernization on the right, which could be very positive in Brazil, separated from the…the other things are what is missing. You know, where is the military? We haven't even talked about the military, which is incredible, when you think of the recent history of Latin America, even the recent history of Brazil. So, I think these things are marginal, unless, the worst scenario plays out.

I mean, if the collapse financial occurs, if the pressure from the outside is too intense, and the pressures from the inside are too intense, because of those sorts of connections, then move to the center. But that would be a catastrophe for Brazil, and it would be a catastrophe for the region. That's why I think I would urge that people really realize how important it is that this democratic Left be given the chance to show whether it can govern or not.

Debevoise: I think that we've had an interesting section here. There's no doubt in anybody's mind about the importance of Brazil in the region and the enormous political and economic challenges that face the new government, as it comes into office on the first of January. Thank you all for coming (Applause).

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