The scandal threatens to derail Lula's reform agenda, and it could hurt his chances for reelection in October, 2006. It's also unnerving investors. Stocks fell 5% in São Paulo over the two days after the revelations, and the Brazilian real lost 2.5% against the U.S. dollar. The reason? Fear that Lula's government, weakened by accusations and in need of support, could adopt expansionist policies in place of the fiscal austerity that has produced stability and growth for two years.
Lula's immediate reaction to the allegations was to dismiss them. But then he called for a congressional inquiry into the alleged payments. "We will protect nobody," Lula said at the opening of a U.N. conference on corruption in Brasília on June 7, adding that if necessary the government "would cut its own flesh" to get to the truth.
The trouble is that if the inquiry goes ahead, it could occupy Congress' agenda until the second quarter of 2006, when campaigning for the October general elections will begin. That will make it tough for the government to push through big cuts in state pension spending needed to tackle its $340 billion in debt. And Lula would likely have to shelve plans to reform rigid labor laws, overhaul a dysfunctional judiciary, and streamline a bewildering tax system.
So Lula looks like a lame duck in the making. A poll conducted before the allegations showed his approval rating fell over the past six months from 45% to 35%. Meanwhile, the economy is softening. First-quarter gross domestic product grew 2.9% from the period a year earlier, and edged up only 0.3%, seasonally adjusted, from the previous quarter -- well below the expectations of economists. And calls are growing for the government to relax its anti-inflationary policies.
For Brazil, the worst outcome would be if Lula were implicated in the scandal and impeached -- which might spark an economic meltdown. While that seems unlikely, rumors are circulating in Brasília that fresh allegations of corruption by leading politicians will emerge. "What the opposition wants is a weaker Lula," says Walder de Góes, president of Instituto Brasileiro de Estudos Políticos, a research firm. Even if none of the corruption charges ever touch him, Lula's presidency may have been irreversibly weakened. By Jonathan Wheatley in São Paulo