by Ambrose Evans-Pritchard
March 8, 2016

The dream of a BRICS ascendancy has ended in sadness and squalor after the iconic figure of the era was seized by police at his home here, to the rapturous applause of Brazil’s stock exchange.

Luiz Inacio Lula da Silva, or “Lula” to the world, is sacrosanct no more. The once beloved socialist president – and former Fiat car worker – who came to personify Brazil’s seeming rise to prosperity and global stature is under criminal investigation for his role in the ever-spreading Lava Jato (car wash) scandal.

So are his three sons, and his wife. “Nobody is above the law in this country,” said the lead prosecutor, Carlos Fernando dos Santos Lima.

The shock comes as Lula’s economic legacy turns to ruin. Output has been falling for most of the past nine quarters. It contracted 3.8% last year. The OECD expects another 4% fall this year, the deepest slump since national records began in 1901.

It is a cruel twist of fortune for those who thought Brazil had reached the premier league, with deep-sea oil reserves fit for an emirate, and a currency so strong that it cost more for a coffee in Sao Paolo than in Oslo, Tokyo, or Zurich in the glory days of 2008.

That was the year Standard & Poor’s raised Brazilian debt to investment grade, to national jubilation. “Brazil is now treated as a serious country, a country that manages its finances with care,” said Lula at the time. Now he must watch balefully as the same agency returns the debt to junk, with grim warnings of worse to come.

One thing Brazil is not doing is managing its finances with care. Five economic institutes have warned that public debt risks spinning out of control.

Italo Lombardi, from Standard Chartered, said the ratio is rising by 10 percentage points of GDP each year as recession eats into the tax base, heading for 80% in 2017. That is a dangerous level for a Latin American country with shallow bond markets. “It is a time bomb,” he says.

Brazil: Gross Debt & Overall Deficit

Brazil is the first of the BRICS quintet to break down on so many fronts at once, but Russia and South Africa are both in deep crisis, and China is running through $100bn of foreign reserves a month. Only India has the wind in its sails. The BRICS concept has become meaningless.

For Brazilians, the political dam broke last week after a senator at the heart of the Lava Jato money-laundering network spilled the beans in a sworn deposition. He not only implicated Lula, he also accused Brazil’s president, Dilma Rousseff, of obstruction of justice and tampering with judges.

The drive to impeach Mrs. Rousseff suddenly looks unstoppable.

The Bovespa index of equities in the conservative bastion of São Paulo soared as the first revelations emerged. It ended the week 18% higher, with a euphoric spike after Lula was carted away on Friday (3/04) – the “victim of a media spectacle,” in his words. “I expected to be treated with more respect after everything I have done for this country,” he said.

The real (Brazil’s currency) rose 6% against the dollar, to the relief of Brazilian companies saddled with $270bn of US dollar debt.

Brazil 2

Market emotions said it all. Investors are celebrating what they hope to be the Götterdämmerung of the ruling Workers Party (PT), so broken that it cannot keep its grip on power or come back to haunt the opposition in the elections of 2018.

“Suddenly, we have a new situation. If Lula is out of the game, they are dead,” said one São Paulo industrialist. “The only question is how much more destruction they will cause before leaving. We cannot carry on like this, losing 6,000 good jobs a day. We’re near the point of rupture.”

Markets are betting that Brazil’s vice-president, Michel Temer, will soon take charge and break the paralyzing stalemate, grasping the nettles of austerity and reform at the head of a pro-market government.

Brazil Unemployment

This may be premature. The PT’s chief, Rui Falcão, has already denounced the widening investigation as an assault on constitutional democracy. He called on the party base to mobilize for battle. “This is a creeping coup,” he said. “Sectors of the police and the judicial apparatus of the state are trying to subvert the outcome of the elections.”

Prosecutors retort that they have discovered a “criminal organization” at the heart of that same Brazilian PT-run government. It has used inflated construction contracts worth hundreds of millions of dollars from the oil giant Petrobras to fund the PT machine. More than $8m allegedly reached Lula and his foundation through the same conduit.

The inquisitors must move with care. Some of the accusations against Lula border on the trivial. An illicit farmhouse at the center of the probe is almost endearingly modest. Lula still commands a reservoir of deep support, and is not shy about deploying it. “They will have to fight me in the streets,” he vowed.

For all his mistakes, Lula tried to break the curse of “Belíndia,” a term coined in the 1970s to capture the national dichotomy: a wealthy modern Belgium in thriving pockets of the South, surrounded by a vast spread of pre-modern Indian poverty.

He did not succeed entirely. São Paulo remains the world’s helicopter capital. The rich fly above the traffic jams. There is no train to the main airport. Some rely on helicopters to avoid the kidnapping and ransom trade.

Yet Brazil is one of very few countries where the GINI coefficient of inequality has fallen over the past 15 years, though it is still high at 52.9. Infant mortality has dropped to 15 per thousand live births from 51 in 1990.

Brazil GINI

The largesse was, of course, built on the resource boom, supplying ores to China for its manic metal-bashing phase. “The commodity supercycle came as a lottery ticket. Lula could afford to lift 30 million people into the middle class,” said Thomaz Zanotto, from the São Paulo Federation of Industries.

“Everybody knew it couldn’t last. Lula’s circle told him he had to reform but nothing was done. Then he picked Dilma to take over, and that was like taking a child who had been swimming in the pool with arm bands and throwing her in the ocean. It was a disaster,” he said.

“They made huge economic mistakes. They kept the price of gasoline artificially low, and that is what broke Petrobras and broke the sugar industry. They knew they were selling snake oil just to win the election.”

The PT presides over a state where teachers can retire after 25 years’ service in their forties, and others at 55, with a Byzantine tax system and a unreformed labor code based on Mussolini’s “Carta di lavoro” in the 1930s. There are 7.8m open cases in the labor tribunals – compared to 2,000 in Japan – and 100 million cases in the court system.

“It is a backlog until eternity,” said one diplomat, who described the Brazilian power structure as an endless series of fights for the spoils of the state by myriad groupings. Every policy has to be negotiated and traded in a pork-barrel market. “The PT claimed to be different, and now they too have been corrupted by the system,” he said.

As Brazil hits bottom, it is left with a budget deficit of 10% of GDP,  inflation of 11%, and the highest real borrowing costs in the G20. Fixed investment collapsed at an 18% rate last quarter.

The country is caught in a policy trap. Interest payments make up so much of the budget that any monetary tightening risks making the deficit worse. “All the macro parameters indicate a vicious circle of self-perpetuating misery. The policy scope is non-existent,” said Dev Ashish, from Societe Generale.

Swift regime change might break that vicious cycle. Sadly for long-suffering Brazilians, they are just as likely to endure a long and destructive political siege.

— This article originally appeared at To The Point News.