Lula’s playbook: Brazil bets on a return to state capitalism

Beneath the blistering sun, workers in overalls and hard hats are putting the finishing touches to an industrial undertaking that until recently seemed destined to remain uncompleted.

A sprawling mass of smokestacks and pipework, the Abreu e Lima project was originally launched in 2005 by then-president Luiz Inácio Lula da Silva as Brazil’s first new oil refinery in decades. It ended up one of the world’s most expensive. 

After cost estimates ballooned to $20bn — nine times the initial budget — the development would be held up by Lula’s critics as a monument to waste, corruption and incompetence during the rule of his Workers’ party, or PT.

Caught up in a political bribery scheme that stole billions from state-controlled oil company Petrobras, its construction was paused in 2014 under Lula’s chosen successor Dilma Rousseff, with only half the planned facility operational.

Yet after the 78-year-old Lula won a non-consecutive third term as president last year, activity has resumed to finish the plant, located an hour away from Recife, capital of the northeastern state Pernambuco.

The refinery expansion falls into a broader public works programme that is one pillar of the veteran left-winger’s plans to kick-start Latin America’s largest economy and drag it out of a prolonged period of mediocrity.

Since returning to power, Lula — who previously governed between 2003 and 2010 — has looked to strengthen the role of the state in his bid to lift stagnant living standards in the nation of more than 200mn.

Under its blueprint for the economy, his administration has boosted welfare payments, relaxed restrictions on public expenditure, promised infrastructure improvements and unveiled a green agenda aimed at attracting foreign capital. 

“I want to transform this country into a middle-class country where people can eat well, dress well, live well, relax well, take care of their family,” he said in a weekly online broadcast last month. “The investments we are making will help Brazil grow.”

However, detractors say his more hands-on approach threatens to revive a discredited model of statist development that went wrong in the past. 

Brazil rode a global commodities boom fuelled by China in the early 21st century to become an emerging markets darling, before a brutal crash almost a decade ago as prices for raw materials plunged. Opponents said the PT’s overspending and political interference under Rousseff were key factors in the country’s worst recession in a century.

Abreu e Lima oil refinery, under construction in Recife in 2013  © Yasuyoshi Chiba/AFP/Getty Images
Ballooning costs meant the country’s first new oil refinery in decades ended up one of the world’s most expensive © Heudes Regis/Objetiva

Now, says Kim Kataguiri, an opposition lawmaker, “the government is repeating its failed recipe of levying more taxes, indebting the country and spending more on areas that benefit the elites more than the poorest.”

Officials in the year-old administration defend its performance by pointing to positive indicators, such as falling unemployment, inflation and growth. Initial full-year predictions by analysts of GDP growth below 1 per cent in 2023 have been upgraded to nearly 3 per cent ahead of fourth-quarter numbers. 

Situated far from international conflict and with abundant natural resources — from hydrocarbons and minerals to agriculture and renewable energy — Brazil’s advocates say the country is ideally placed to fulfil its long-vaunted potential.

But investors and economists remain sceptical of Lula’s state-driven economic game plan. If he is seen to have lost control of the public accounts, they warn it will be difficult for the central bank to continue cutting its base lending rate, which at 11.75 per cent is exerting a drag on activity. 

“Brazil just suffered its second lost decade for growth since the 1980s, with per capita income yet to return to its 2013 levels,” says Roberto Secemski, chief Brazil economist at Barclays. “The country needs higher productivity and capital investments, which would be more viable under lower interest rates. The problem lies in Brazil’s loose fiscal stance.”

With GDP expansion forecast to cool over the coming year, the president faces a choice: to take a more moderate macroeconomic path — or to double down on spending in a bid to rekindle growth, at the risk of history repeating itself.

“We need to improve what didn’t go right before,” says Abinadade Santos, general secretary of the metalworkers’ union in Recife. On the wall in his office is a black-and-white photo of Lula addressing strikes in the 1970s.

Santos has faith the president can deliver, but says there is no room for complacency. “This is the Lula government’s duty — to see the mistakes of the past and guarantee it doesn’t happen again.”

Perched on the coast of Brazil’s poor north-east, in a state built on the colonial sugar trade, the Recife metropolitan area was a microcosm of the country’s last boom and bust. 

During the PT era, thousands of jobs were created by the refinery and the nearby Atlântico Sul shipyard, which opened in 2008 and was billed as the largest in the southern hemisphere. 

It was part of a signature Lula industrial policy aimed at resurrecting the national shipbuilding industry with orders of tankers and rigs by Petrobras. 

But then, in 2014 a nationwide investigation uncovered a kickbacks-for-contracts scam centred on the oil giant, leading to the imprisonment of dozens of politicians and businessmen. Lula himself served time for a corruption conviction that was later overturned. 

Together with the scandal, a drop in crude prices led Petrobras to cancel a number of vessel purchases, dealing a heavy blow to domestic shipyards already plagued by budget overruns, delayed deliveries and financial problems. 

Mass lay-offs at the Suape port and industrial complex, the vast site home to the refinery and shipyard, reverberated across the local economy. 

“There was a chorus of denunciations and a whole dismantlement of what had been thought of as a very promising future for the region,” says Ecio Costa, a professor of economics at the Federal University of Pernambuco. 

The ensuing national turmoil helped force Rousseff’s removal from office by impeachment in 2016 and tainted the legacy of Lula, a former trade unionist born in Pernambuco before moving to São Paulo as a child. 

During his first stint in office, he won acclaim for lifting 20mn citizens out of poverty in one of the world’s most unequal societies through social benefits. “When Lula was president, it was one of the best times here in Pernambuco — and perhaps in the whole of Brazil,” says John Bezerra da Silva, who worked as a welder at both the shipyard and refinery but now drives a taxi for a living.

The 34-year-old wants to return to his trade. “People here have a lot of hope that the refinery and shipbuilding will really come back.”

The Recife area was a microcosm of Brazil’s last boom and bust. Thousands of jobs were created by the refinery and nearby Atlântico Sul shipyard, but a kickbacks-for-contracts scam in 2014 led to the imprisonment of dozens of politicians and businessmen © Ueslei Marcelino/Reuters

These dreams may yet be realised. Now headed by a Lula ally, Petrobras plans to place orders again with domestic shipyards as it embarks on a massive ramp-up of offshore production forecast to catapult Brazil into the top tier of crude producers.

But to succeed, the industry will have to overcome factors that previously left it struggling to be competitive and meet deadlines. 

Costa argues the government should concentrate on improving the conditions for private enterprise as a whole to thrive: “To have rapid development, you need an environment that is more accommodating to business and investments.” 

This will involve tackling deep structural issues like red tape, poor logistics infrastructure, skills shortages and unwieldy state bureaucracy. Together these factors contribute to what is known as the custo Brasil — the elevated cost of doing business in the country.

The recent passage of a constitutional amendment to simplify the country’s complex tax system was broadly welcomed as a step in the right direction, with S&P upgrading Brazil’s sovereign rating one notch, though it is still below investment grade.

It followed other market-friendly reforms by preceding rightwing governments, including overhauls of the rigid labour code and pensions provision. Under Lula’s far-right predecessor, Jair Bolsonaro, ministers pursued privatisation and smaller government. 

But the challenge is stark. Brazil’s productivity — the output per hour worked, crucial to raising a nation’s prosperity — grew by just 0.5 per cent annually in the four decades to 2022, according to the Getúlio Vargas Institute. 

Carla Argenta, chief economist at CM Capital, says Brazil is likely to benefit in the short term from monetary easing internationally. “But the country’s limited ability to create internal drivers for activity is expected to keep GDP growing at modest rates,” she adds. The economy expanded by an annual rate of just 0.5 per cent on average in the past decade.

In its quest to spur growth, the Lula administration has turned to an old formula.

Unveiled to fanfare in August, the government’s new public works programme — the Growth Acceleration Programme, or PAC — reprised the name of two previous initiatives with chequered records.

Under PAC 1, launched by Lula in 2007, only a quarter of projects were effectively delivered, according to analysis by consultancy Inter B. For PAC 2, rolled out three years later under Rousseff, the figure rose to 36 per cent. 

Officials, however, insist the latest iteration is different. It has a priority to complete unfinished projects and will have greater private sector involvement through concessions and partnerships.

We are talking about a new industrialisation. We are not planning on getting back the industry of the ‘70s or ‘80s. We need a new industry

“It is a planning tool that worked in the past, even though there were critics of specific projects,” says Guilherme Mello, a senior official in the finance ministry.

Of the R$1.4tn ($290bn) of investments targeted by 2026, there is to be $76bn of federal funding. The rest is expected to come from bank financing, private players and state-owned enterprises like Petrobras.

Another key focus is promoting ventures that combat global warming. Brasília hopes to seize on international goodwill from the clampdown on Amazon deforestation. 

“We are talking about a new industrialisation. We are not planning on getting back the industry of the ‘70s or ‘80s. We need a new industry . . . that is combined with the green transformation,” adds Mello.

The strategy aims to reverse a so-called “premature” deindustrialisation, and Lula supporters say the early signs are encouraging. 

Chinese automaker BYD last year announced it will begin producing electric cars in northeastern Brazil as part of a R$3bn investment. The company’s local chair Alexandre Baldy says the decision was down to Lula’s commitment to decarbonisation and his meeting with the company’s founder on a trip to China. “The government’s economic plan is very positive,” says Baldy.

BYD’s arrival shows the nation’s natural resources can be turned into “cutting-edge industry”, according to the executive. “So that we stop thinking of Brazil as the country of the future and invest in Brazil to be the country of the present.” 

To aid domestic production, the government is charging tariffs on imported EVs. However, some mainstream economists are wary of protectionism and corporate handouts, arguing that insulation from overseas rivals historically often led to a lack of competitiveness in Brazilian manufacturing, such as automotive.  

“Subsidies and incentives to sectors tend to last longer than imagined with a smaller impact than expected,” says Gustavo Arruda, an economist at BNP Paribas. 

And there is little room for manoeuvre in Brazil’s federal budget, since some 90 per cent of it is earmarked for non-discretionary items like social security and pensions. 

The administration intends to fund extra spending with increased revenue collection. Finance minister Fernando Haddad has said the intention is to end exemptions, loopholes and avoidance, rather than increase the country’s already elevated overall tax burden.

Brazil’s finance minister Fernando Haddad (from left), President Lula, Brazil’s senate president Rodrigo Pacheco and Brazil’s lower house speaker Arthur Lira during a congressional session promoting the new tax reform © Adriano Machado/Reuters

Besides misgivings over whether this is realistic, the worry in corporate circles is of an uptick in borrowing levels. Public debt, currently at 74 per cent of GDP, is relatively high for an emerging economy. Sceptics warn of potential knock-on effects for inflation and investor confidence.  

“Although we are not expecting [the fiscal situation] to trigger a crisis, increasing indebtedness will continue to expose Brazil’s fragilities,” says Arruda. “The need for fiscal adjustment in the future could curb investments from the private sector.”

“The most critical issue in every long-term or even short-term investor’s mind [is] fiscal stability,” says Paulo Bilyk, chief executive of asset manager Rio Bravo Investimentos. “Everybody will have to keep an eye out on sins of the past that are trying to be repeated.”

Following Rousseff’s impeachment, a constitutional amendment was passed that restricted growth in the budget to inflation. Investors considered it the cornerstone of fiscal credibility. 

Since Lula’s return it has been replaced with a looser set of rules that, while imposing certain limits, requires expenditure to increase in real terms. The new framework also promises gradually rising primary budget surpluses — ie, before interest payments — after balancing the books in 2024. 

While this year’s zero-deficit target is defended by Haddad, Lula has suggested it may not be achieved. He is facing pressure from his own party to spend more ahead of important municipal elections in October.

Simone Tebet, Brazil’s planning minister, defends the new fiscal framework as “sustainable” and says federal investment as a proportion of GDP remains “much below the world average. So there’s no reason to speak about excess or inefficiency in public spending”.

While Lula says his previous stint in office is…

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