SÃO PAULO — Kilometer by kilometer, workmen are laying tracks across the northern sertão region of Brazil, to create the Transnordestina railroad that will link the arid hinterlands to Atlantic seaports. President Luiz Inácio Lula da Silva revitalized the ambitious transportation project as a centerpieces of his hallmark Growth Acceleration Program three years ago, only to see it fall behind schedule. Now as the burly and popular Brazilian president prepares to embark on rounds of ribbon cutting before leaving office early next year, this rail line will be left off his itinerary.

Brazil has never had a president who has cut such a vibrant swath inside his own country and on the world stage as the grammar school drop-out known as Lula. Since the former steelworker won office in 2002, the South American country has emerged as a global powerhouse in natural resources, an indomitable presence in world diplomacy and the unchallenged economic leader in Latin America. Lula has delivered economic stability and measurable improvement in living standards to Brazil’s 190 million people. His achievements have been celebrated at home and abroad – and there is no sign that the tributes will let up any time before he leaves office in January 2011.

But for all the super-star accolades that Lula has garnered, those on the left say that the president has failed to deliver on progressive promises he made as the Workers’ Party candidate. Many in the private sector insist he has fallen short on implementing changes in tax, pension, labor, educational and spending policies that were part of the pro-business agenda that he came to embrace. Like the Transnordestina railroad, which will be inaugurated by Lula’s successor, this unfinished business is part of Lula’s broader legacy.

Lula revitalized Brazil and, by maintaining the financial policies of his predecessor, President Fernando Henrique Cardoso, managed to make the nation a beacon of stability before and after the global financial meltdown. But for the average citizen, his most obvious achievements have been the strengthening of the domestic market and bringing upward social mobility within reach of millions of Brazilians.

“Brazil is living through a truly extraordinary moment,” said Abilio Diniz, chairman of Pão de Açúcar, Brazil’s largest retail chain. Diniz, who was one of the first Brazilian executives to declare that the country was out of the woods during the financial crisis, said Lula called him during the darkest days to discuss ways to stave off a sharp decline in consumer spending.

“ ‘Abilio,’ ’’ he quoted the president as saying. “ ‘I want to avoid [a situation] where people postpone their purchases because they fear losing their jobs or they are afraid they will not be able to make their credit payments.’

“ ‘We need to replace the decline in external demand with an increase in domestic consumption,’ Diniz said, quoting Lula. “ ‘We need to boost consumer demand.’ ”

With the country’s economy forecast to grow at 5 percent this year, the Latin American giant passed the global stress test. It gained a stronger voice in world economic affairs and even in the overall stewardship of world governance and finance in the G-20, the organization of leading industrialized and developing countries.

But the private sector has said that increasing the economic growth rate above this 5 percent range will be difficult since Lula failed to make much headway against the high cost of doing business in Brazil – commonly referred to as the Custo Brasil. Businesses operating in Brazil routinely complain they are hamstrung and unable to realize their full potential as they grapple with everything from crime and corruption, to the complicated tax system and bureaucracy, the insufficient infrastructure and the lack of a highly trained workforce.

Needed: More and Better Roads and Railroads

In a country that began as quasi city-states along the extensive coastline, few tasks are more daunting than transportation infrastructure, particularly because the need for new roads must be balanced with preserving the environmentally sensitive Amazon.

The ambitious 620-mile Transnordestina railway project (1,100 kilometers) was relaunched at the beginning of Lula’s second term in 2007 to foster economic growth in a depressed region. The railroad is designed to connect the town of Eliseu Martins, in the state of Piauí, with the Atlantic ports of Suape, near Recife, and Pecém, near Fortaleza, presenting the means to move agricultural goods to seaports so that producers can export or reach a larger market. The Transnordestina is just one of a number of ambitious transportation projects. Another is the 1,300-mile north-south railroad, which also aims to increase the amount of cargo handled by rail. Currently just one-fourth of all Brazilian commerce is transported by rail; trucks haul almost 60 percent of all goods in Brazil, one of the highest rates among advanced countries.

Improvements in the transportation infrastructure – even of highways – have been painstakingly slow.

“Our investment in roads still amounts to half what has been invested in Mexico,” said Ivan Zurita, president of the Brazilian subsidiary of Nestlé, who previously worked in Mexico.

“We still have serious barriers to growth,” said Armínio Fraga, who served as the president of the Central Bank under former President Cardoso and is now chairman of BM&F Bovespa. “I am particularly concerned with the infrastructure, which is in terrible shape,” Fraga told the American Chamber of Commerce in February. “We have not been keeping up with new needs, not even with maintenance.”

Water sanitation is also a critical area. More than half of Brazilians lack access to sanitation services and some 40 million people — equivalent to the entire population of Argentina — live without access to potable water, according to official statistics.

The next president will have to address these huge infrastructure needs. Some of these efforts, such as rebuilding substandard housing in slums and bringing high-speed rail service between the megalopolises of Rio de Janeiro and São Paulo, will be on the fast track ahead of the 2014 World Cup and the 2016 Olympics in Rio de Janeiro. These international sporting events will figure prominently in the legacy of the Lula presidency.

Lula’s supporters acknowledge the delays but insist that many of the setbacks have been unavoidable.

“Things are not moving as fast as they should, some of them are moving very slowly indeed,” said Milko Matijascic, an adviser to the president of the Institute of Applied Economic Research, the IPEA. “On the legal side, there are numerous rules and regulations that stand in our way.”

The current president is not the first leader to face opposition or unfavorable rulings from government agencies. But Lula has taken a defiant path. In early 2010, he overruled the Brazilian Audit Court — a government watchdog agency — which had raised questions about four major investments by state-controlled oil giant Petrobras, including a joint refinery with the Venezuelan oil company PDVSA in the Northeast. Lula accused the financial auditors of paralyzing vital development projects and damaging the country; he then cleared the way for the project to continue.

Progress Fails to Placate Critics on Any Side

During the Lula years, real income gains and active social policies have boosted the ranks of the middle class, which today encompasses more than 50 percent of the population, up from 43 percent in 2003, according to Marcelo Neri, from the Getúlio Vargas Foundation in Rio de Janeiro. Meanwhile, some 30 million Brazilians have been lifted out of poverty. Bolsa Familia, a social benefit program, has now been extended to 12 million families and the administration has raised the minimum wage by more than 50 percent in real terms.

This progress forms the basis for Lula’s extraordinary popularity. He is among the most popular leaders in Latin America, with an approval rating above 80 percent. His popularity has not silenced critics, neither from the left nor the right.

Maílson da Nóbrega, who served as finance minister under former President José Sarney, said that social spending should be better targeted. “Brazil spends 30 times more [per capita] on the elderly than it does on children,” Nóbrega said.

Some left-wing intellectuals go further in their assessments.

“[Lula] caved in to the dominant system,” said Francisco “Chico” Whitaker, a Brazilian social-justice advocate.

“His social policies are limited in scope, they are basically compensatory, but they do not go far enough towards structural social change,” said Whitaker, one of the leaders of the World Social Forum, which has emerged over the past decade as an alternative to the pro-business World Economic Forum best known for annual meetings in Davos, Switzerland. Whitaker, part of the secretariat of the Catholic Bishops Justice and Peace Commission, has lambasted the Lula administration for doing little to redress the country’s highly skewed income distribution or environmental issues.

Underlying the discontent over many of the challenges that Brazil still faces was the hope that Lula would reinvent politics. Once a firebrand who advocated renouncing the country’s foreign debt, Lula moderated many of his positions in order to win the October 2002 election. The first leftist victory, less than 20 years after the end of military rule, initially sparked capital flight and other financial woes. But by maintaining continuity in key positions, such as keeping Henrique Meirelles as head of the Central Bank,
Lula managed to calm jittery markets. Lula can still raise eyebrows, such as when he remarked last year that “white, blue-eyed people,” and not indigenous people, caused the financial crisis.

But the Lula administration has never launched the kind of sweeping political reform that Lula the candidate pledged to undertake. To build a congressional majority, Lula put together a broad-based coalition of a dozen political parties, from Communists to center-right groups. In order to hold together the unwieldy coalition, Lula has made a series of political concessions to various political factions and doled out government jobs, the mainstay of old-fashioned political patronage. The centrist Party of the Brazilian Democratic Movement, or PMDB, which has occupied the middle ground in Brazilian politics for decades, was the beneficiary of many of the concessions. Lula also backed the president of the Senate, José Sarney (who was Brazil’s president from 1985 to 1990) despite Sarney’s alleged involvement in a series of financial scandals.

Whitaker said Lula needed to have worked harder to improve the country’s political culture.

“The tradition of seeking to benefit [financially] from politics has not changed. The traditional political culture has not been altered,” Whitaker said. “The type of alliances that Lula was forced to make shows what kind of strategy he has chosen to govern, although he did not need to because he has enjoyed such huge popular support.”

Lula suffered a high-level desertion in 2008 when Marina Silva resigned as his environmental minister over disagreements about environmental policy. In August 2009, she also quit the Workers’ Party, which she had helped found alongside Lula 30 years ago. Silva, no relation, has since become a presidential candidate for the Green Party.

Meanwhile, the business sector has seen its hopes for a wide-ranging tax and labor reforms dashed, much to the regret of executives such as Nestlé’s Zurita. Zurita also points to the need for better stewardship of public funds and for raising the quality of both education and work-force training. “We still face a tremendous challenge in education,” conceded Aloizio Mercadante, floor leader of the Workers’ Party in the lower house of Congress.

On the tax front, businesses have long complained that the rules are too complex and the overall tax burden too high. A 2007 tax reform died quietly in Congress and the government abandoned pledges to cut the payroll tax, which employers say limits their ability to hire additional workers.

Can the Carnival Go On?

The resumption of economic growth has helped dissipate many of the private sector concerns.

After plunging 40 percent in 2009, foreign direct investment is expected to swing back up to $45 billion this year, on par with the record high set in 2008. The surge in foreign investment prompted a warning from Nobel Economics Prize winner Paul Krugman in December that the Brazilian real was overvalued.

But both domestic and foreign firms are positioning themselves to ride the economic wave. In November, France’s Vivendi beat out Spain’s Telefónica to acquire GVT, a small but fast growing Brazilian telecommunications operator. Mega international retailers Wal-Mart and Carrefour, and national giant Pão de Açúcar, have rolled out ambitious expansion plans. Companies such as Coca-Cola and Nestlé have announced new spending.

The market for technology and durable goods is also expanding. “Brazil is on the verge of becoming the world’s third-largest market for computers,” said Paulo Castro, general manager of Terra, a leading Internet company in Latin America.

Brazil is already the world’s fifth-largest market for new cars. General Electric has begun assembling aircraft engines in Brazil and recently announced it would build a new global research and development center there.

This flow of foreign capital into Brazil will be needed to finance a growing current account deficit, which is expected to increase from a modest 1.6 percent of gross domestic product in 2009 to as much as 3 percent over the next few years. Some economists warn that the dependency on foreign capital to finance the current account shortfall may become a source of vulnerability for the next administration, even though the country boasted huge foreign currency reserves of $240 billion as of February 2010.

Government stimulus spending during the 2009 global financial crisis and declining tax revenue have further exacerbated the budget deficit. Last year, the nominal deficit grew to 3.3 percent of GDP, up from just under 2 percent of GDP in 2008. The primary budget surplus —before servicing debt — fell below the government target of 2.5 percent of GDP. Finance officials have pledged to meet the official primary surplus target of 3.3 percent in 2010, yet spending is on the rise in this election year.

While Lula will leave much unfinished business, he has often signaled the importance he attaches to his legacy.
“I want to reach the end of my term in a strong position in order to influence the succession,” he told the newspaper O Estado de São Paulo, in August 2007.
In the first step toward his goal, the Workers’ Party selected his chief of staff, Dilma Rousseff, as the party’s presidential standard-bearer.

Rousseff is a 62-year-old economist who was imprisoned by the military government for three years because of her involvement with leftist guerrillas. In her nomination acceptance speech, Rousseff played her strongest card, pledging to uphold Lula’s market-friendly discipline, floating exchange rate and inflation targets. “We will ensure macroeconomic stability,” Rousseff said on February 20.

Rousseff’s likely opponent is José Serra, a long-standing leader in the center-right Brazilian Social Democracy Party, who lost to Lula in 2002. Serra’s early lead in opinion polls is shrinking as Lula throws his considerable popularity behind his preferred successor.

In sharp contrast to the physically demonstrative Lula, whose greeting typically includes a warm embrace, both Rousseff and Serra look stiff and uncomfortable during public appearances.

Many analysts, among them finance professor William Eid Jr., of the Getúlio Vargas Foundation, predict the rival leading candidates will converge around a centrist economic policy.

“The Workers’ Party and the Social Democrats will govern in very similar ways,” Eid said.

Others see Serra as the more market-friendly candidate. However, given the many weaknesses in the Brazilian economy and social structure – gaping deficiencies that Lula’ singular popular appeal helped paper over – the next president may be challenged just trying to maintain the economic stability the country currently enjoys – never mind tackling Lula’s unfinished reform agenda.

Rising spending commitments could endanger this stability, warn some analysts. Salaries, pensions, health, education and debt service use up a large share of the federal budget; extra spending will increase the deficit. Nóbrega, the former finance minister, said there is little room to maneuver. “Fiscal rigidity is part of the negative legacy that Lula will leave to his successor,” Nóbrega said.

Even without these tests, Lula’s successor will have a tough act to follow as the popular president exits the nation’s political stage. Lula, who has proven to be a shrewd politician, has yet to reveal how he plans to burnish his legacy or what his next role will be.