Return of Lula Rattles Brazil as Investors See Policy Change (4)

Embattled Brazilian President Dilma Rousseff installed her predecessor Luiz Inacio Lula da Silva at the heart of her government, a high-risk gambit that could rally her party’s base while rattling the country’s economic elite and foreign investors.

The move is designed to help shield the former president from a rolling corruption probe and harness his renowned negotiating skills to defend his protege from impeachment. Only the Supreme Court can indict or try cabinet ministers. Lula has repeatedly denied wrongdoing.

Lula’s political experience and profound knowledge of the country is undeniable, Rousseff told reporters after confirming the appointment at the presidential palace in Brasilia. "Lula’s arrival strengthens the government," she said.

Naming the iconic, and controversial, politician to join her cabinet reflects the dire straits Rousseff is in and runs the risk of backfiring, as it ties her fate to that of her mentor. It has also spooked investors, who fear she and Lula could resort to economic policies that will help her remain in power but further deteriorate public accounts.

"There is no positive spin for Lula coming aboard," said Win Thin, the head of emerging-market strategy at New York-based Brown Brothers Harriman & Co. "Sell Brazil. Period."

Real Fell

Expectations of economic policy change were reinforced by newspaper reports on Wednesday that central bank President Alexandre Tombini could resign as a result of the cabinet reshuffle. The central bank declined to comment on the reports. There were also reports the government could tap its international reserves to boost growth.

Rousseff said neither Tombini nor Finance Minister Nelson Barbosa are leaving the government. "They are more part of it than ever," she said. The president also said that monetary reserves served mainly to provide a cushion to international Volatility , and could have "a role in relation to debt" but are not appropriate for investments.

The real and the Ibovespa initially fell on confirmation of the appointment. They rebounded after the U.S. Federal Reserve scaled back forecasts for how high interest rates will rise this year. Brazilian assets had surged earlier this month on bets the president’s ouster would pave the way for a government with a stronger mandate to revive growth.

Gross domestic product is expected to shrink 3.4 percent in 2016 after contracting 3.8 percent last year, which would mark Brazil’s deepest downturn in over a century.

Lula doesn’t embrace some of his party’s more radical economic policies, such as the use of international reserves to finance public works projects, according to two senior officials with direct knowledge of talks involving Lula’s appointment. But he would support additional stimulus measures such as new lines of consumer credit, they said.

Appointing a founder of her Workers’ Party to head the cabinet’s most influential post is a sign that Rousseff is waging an all-or-nothing bet, said Leonardo Monoli, a partner at Jive Asset Gestao de Recursos in Sao Paulo.

"It shows the party is willing to use what it considers its silver bullet, putting all its cards on the table," he said.

Corruption Probe

The return of Lula, who left government in 2010, comes against the backdrop of a sweeping corruption probe into kickbacks at state-run oil company Petrobras. The scandal has left senior executives and politicians behind bars, and in recent weeks encroached on the Workers’ Party and Lula himself.

A Supreme Court justice on Tuesday accepted a plea bargain from the former government leader in the Senate, Delcidio Amaral, who has alleged that Rousseff tried to interfere with investigations. He also indicated that Education Minister Aloizio Mercadante offered financial assistance to prevent Amaral from testifying. Both Rousseff and Mercadante said the allegations are false.

Opposition leaders say they will challenge the appointment in court as an abuse of power designed to shield Lula from possible arrest.

"It’s her right to name ministers, but I don’t know if it’s the best solution," lower house speaker Eduardo Cunha, a critic of the administration, said Tuesday. "I think it’s highly unlikely that Lula as minister will improve the dialogue between the government and deputies."

(Adds Rousseff comments in third paragraph.)

--With assistance from Paula Sambo Fernando Travaglini and Matthew Malinowski To contact the reporters on this story: Arnaldo Galvao in Brasilia Newsroom at agalvao1@bloomberg.net, Raymond Colitt in Brasilia at rcolitt@bloomberg.net, Anna Edgerton in Brasilia at aedgerton@bloomberg.net. To contact the editors responsible for this story: Vivianne Rodrigues at vrodrigues3@bloomberg.net, Randall Woods

By: Arnaldo Galvao, Raymond Colitt and Anna Edgerton

©2016 Bloomberg News