Can Lula Lead?

These are trying times for businessmen in Brazil, but Michael Haradom isn't suffering. He owns a prosperous agricultural-chemical factory in So Paulo ($50 million in sales last year), a handsome home and four cars. Haradom might be expected to hold conservative--or at least moderate--political views. But he's a huge fan of Luiz Inacio Lula da Silva, the onetime leftist firebrand who heads the Workers Party (PT) and who, after winning a solid plurality in the first round of voting, seems likely to win a runoff for the Brazilian presidency on Oct. 27. Haradom likes Lula, as Brazilians prefer to call the candidate, "because he wants to help local industry compete with foreigners on a level playing field by lowering taxes and interest rates." To show his support, he's plastered red-and-white lula stickers all over the back of his BMW 750. "We can't be afraid of change," Haradom says. "This is a historic moment, and I'm proud to be part of it."

How times change. Lula, who's lost three previous bids for the presidency, was for many years a bearded, unionist growler and scourge of the Brazilian bourgeoisie. Mario Amato, former head of the powerful So Paulo Federation of Industry, once declared that if the man were elected president, "the country's 800,000 businessmen [would] leave the country." But this time Lula has been courting--and winning--the business vote, largely because nearly everyone in Brazil now seems unhappy with the status quo. Some 650 business leaders recently signed a "manifesto of support" for the PT campaign. That's helped boost Lula's chances of beating the ruling-party candidate, Jose Serra, and succeeding Brazilian President Fernando Henrique Cardoso. Both Lula and Serra are scrambling for reinforcements for the runoff vote, but Lula got the jump on his opponent by gathering endorsements from Anthony Garotinho and Ciro Gomes, two antigovernment candidates who were defeated in the first round. If Lula wins, it would be a political watershed for Brazil. South America's largest country, long led by blue bloods and oligarchs, would be turned over to a migrant's son.

But while the business sector may help Lula win the election, it may not do him much good afterward, when the time comes to manage the country. As Tom Jobim, the classic bossa nova composer, once said, "Brazil is not for beginners." And that's the worry about Lula. He's an experienced party and union boss and has served in the federal Congress, but his executive credentials are otherwise thin. Worse, he scares the international investors who, like it or not, can make or break Brazil. As Lula's internal poll numbers have risen, their fears have steadily driven down the value of the real, and driven up the interest costs of Brazilian government bonds.

Most are skeptical that a longtime leftist can effectively lead a country that's not only the bellwether of Latin America but also in very precarious economic shape. "The country has an economic-growth problem [a sluggish 1.4 percent this year], a foreign-direct-investment problem, a balance-of-payments problem and a internal-debt problem [about $300 billion]," says John Maguire, senior managing director of New York-based Medley Global Advisers. Tackling those problems would challenge the most skilled technocrat with a majority in Congress. Lula doesn't have those advantages. "He's untested," adds Maguire. "If he's elected, how will he communicate to the country? What's his message going to be? You just don't know until he's in there."

Lula, in fact, may find it difficult to reconcile his progressive instincts with the hard economic realities in his country. "Can he be a traditional leftist? I don't think so," says Morris Goldstein, a senior fellow at the Institute of International Economics in Washington. No doubt Lula realizes that himself, which might explain why his campaign policy pronouncements have been either vague or contradictory. He claims to represent an alternative, less Washington-driven economic model, but says he will honor Brazil's commitments to the International Monetary Fund--which has agreed to lend the country $30 billion. He aims to boost social spending (chiefly on health care and housing) and double the minimum wage, yet also maintain the country's budget surplus. He says he'll boost economic output, but is opposed to signing a bilateral trade deal with America, which could boost exports. "No one represents stability like I do," Lula often proclaims on the campaign trail. And yet the specter of instability is almost tangible. J.P. Morgan's economic-risk rating for Brazil, which gauges the government's likelihood of defaulting on its debt, has spiked. For that reason, investors are demanding premiums of up to 20 percent over U.S. Treasury bills to refinance Brazilian bonds--a huge and punitive judgment from the market.

Maybe that judgment is too harsh. Two years ago the Workers Party was railing against the IMF and demanding that Brazil renege on its foreign-debt payments. But the party has since moved steadily to the political center. Dyed-in-the-wool socialists still make a lot of political noise, but these days they're very much a minority faction within the party. PT pols now run several cities, and five state governments, and have a reputation for producing sensible budgets. The PT's brightest minds hail from top-flight universities, where Marx has been bumped off the syllabus by Keynes and the apostles of a gentler brand of capitalism. "Lula has surrounded himself with people from outside the PT, brought the party to the right, and courted business," allows Thierry Wizman, global-emerging-markets strategist for Bear Stearns. "But there is the fear in the capital market that he'll slip back into the old Lula."

Will he? No chance, says the candidate. "Brazil has changed and so have I. We want to offer investors something more serious than high interest rates and an opportunity for speculation," Lula said in a press conference two weeks ago. Analysts say his alliance with the business sector represents not merely political expediency but rather a larger and genuine cultural shift. Though the Brazilian campaign has been heated, and occasionally downright nasty, all the presidential candidates rushed to the political middle. Even the distance between Serra and Lula is one of degree, not of ideology. "There's a gigantic convergence of proposals and intentions," says Winston Fritsch, the Brazilian director of Dresdner Kleinwort Wasserstein Bank. "Never have candidates been so closely in sync." Some see international economics driving this centripetal move. "Fifteen years ago the line between right and left was clearer," says Lawrence Pih, the CEO of So Paulo-based Moinhos Pacifico, a PT supporter and big wheat importer. "Now we have globalization and the Internet. You bring people together and ideology begins to fade. Today you're either center-left or center-right. The extremes are gone."

The problem isn't Lula so much as the challenges that will face him. Goldstein contends that there's about a 70 percent chance that Brazil will default on its debt over the next 12 to 15 months. That may not happen, but no one doubts Brazil's economic situation is fragile. What to do? Goldstein says there are two fairly unappealing alternatives. The first is to tighten fiscal policy by either cutting government spending or raising taxes. Doing either would boost the budget surplus and allow the government to pay down the debt--lowering interest rates. That would please financial types but anger Lula's traditional constituency. The other choice, says Goldstein, is to go ahead and restructure the debt. That would give the next president some room for social spending--important leeway, given that roughly one quarter of the population lives below the poverty line (an income of $65 a month). But restructuring would deal a serious blow to Brazilian banks, which hold most of the country's bonds, perhaps pushing some into insolvency. Goldstein says a chunk of the $30 billion IMF loan could be used to bail out the banks. But as he acknowledges, "there is no attractive path. The next president is going to be quite constrained."

That's the grim macroeconomic picture. The outlook closer to ground level isn't terribly encouraging either. The Cardoso government authored some major reforms-- privatizing money-losing state companies, for example--but left some of the hardest work undone. For one thing, the government must reform its pension system. Brasilia now pays benefits to some 3 million public-sector retirees--an expenditure that amounts to nearly 5 percent of GDP. With an aging population, the burden will only get worse. Cardoso tried to introduce modest tax and pension reforms, but was stymied by Congress--thanks in part to Lula's PT, which was loath to limit entitlements.

Now the PT will be charged with leading the reform agenda. It won 91 seats in the Oct. 6 election (up from 57) and is the largest legislative party in Congress. But it doesn't have a majority, so Lula or Serra will have to cobble one together from among Brazil's famously fractious parties. There are 22 of them. The PT disdains Brazil's traditional crony politics, but playing that game is the only way to get anything done. Each party that throws in with Lula will demand its pound of flesh. Such were the rules of the Cardoso administration, which despite its paper majority had to feed the alliance with pork and promises at nearly every vote. The same trap awaits his successor. "Brazil has to meet quarterly IMF fiscal targets, or else loan disbursements will be suspended," says Amaury de Souza, a political analyst for the So Paulo consulting firm MCM. "And yet Lula brings with him huge demands for public spending. It's going to be a battle." These conflicts are likely to get worse. Cardoso often resorted to issuing a blizzard of temporary edicts--"provisional measures"--just to keep government running. But Congress, miffed at government by fiat, has curbed such discretionary powers.

For all these reasons, Brazil's next president is apt to be the country's weakest in years. If Lula prevails and tries to please the millions who voted him into office by spending heavily, "the markets will tear him apart," warns Maguire of Medley Global Advisers. If he does the opposite and kowtows to the market, the left will make his life miserable.

Is there a silver-bullet solution to Brazil's economic predicament? Maguire says yes, if the new president can negotiate a trade deal with the United States. "That would be a very important change-signaling event and open all sorts of doors. But it's not there now." The odds that Lula could pull off such a deal are low. To get one, he'd have to make a complete turnaround on trade policy, and the United States would have to show more flexibility in its demands. But if his remarkable journey has taught Lula anything, it's that times--and he--can change.