Over the weekend both Marcelo and Cláudio put up interesting posts about how Argentina and Brazil have responsibility for their fiscal straits, in large part because of the failure of the political/economic elite to (as Marcelo put it) "act like a damn elite." While I agree with them, an article in today's Wall Street Journal gives creedence to the other side of the story.

The article (sorry, subscription only) discusses last week's drop in the Bovespa, and asks whether it's driven by investors reacting to the corruption allegations swirling around the presidency, or whether it reflects a larger trend in (American) investors reconsidering their exposure:

"Brazil is a proxy for risk appetite," said David Bowers, chief global investment strategist for Merrill Lynch. "This week's activity could just be a pause for profit-taking. But if people are getting nervous about emerging markets, it could mean they are getting nervous about exposure to risk."

The profit-taking theory is driven by the fact that the Bovespa was up 141% (in USD terms) in 2003. That run, combined with the COPOM's recent decisions to slow the easing in interest rates, the political questions reaching out to the once-untouchable Lula, and a likely increase in US interest rates (say before the end of the year), all mean that from Wall Street's point of view, Brazil is becoming much less attractive.

What does this mean for Brazil? Well, calling the C-Bond in April in exchange for less onerous bonds (as was discussed when the C-Bond touched par in January) is now unlikely, but that was much more of a symbolic act than something that would result in an upgrading of the fiscal health of the Federal Government.

I think that lessening portfolio flows means that the next year might be the test for Brazil. Riding the rebound after the regional crises of 2001-2002 provided Lula's government with breathing room during it's honeymoon last year. When growth has to be internally-driven, and can no longer depend on just looking attractive to external short-term investors -as was the case last year- that is when we can see if the left government of the PT can continue and improve on the work of the previous center-right government.

If the PT can keep together it's alliance in Congress, and can keep Washington and New York long-term investors satisfied (i.e., if both the left and the right can be convinced the Lula experiement is working) over the next year, then Lula can ride that consensus to a solid showing in October's elections. And Brazil can ride that consensus to stronger economic performance that will benefit the country as a whole, and establish that it is no longer dependent on "hot" capital flows for growth.

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