SAO PAULO
1 of 12. Brazil's President and Workers' Party (PT) presidential candidate Dilma Rousseff celebrates during news conference after disclosure of the election results, in Brasilia October 26, 2014.
Credit: Reuters/Ueslei Marcelino
SAO PAULO (Reuters) - President Dilma Rousseff's narrow re-election victory met with cold reality on Monday as Brazil's financial markets tumbled on doubts that she can restore confidence in the economy and maintain political support in a sharply divided nation.
Rousseff overcame dissatisfaction with a sluggish economy and poor public services to clinch a second term on Sunday by a slim margin, dashing the hopes of investors and nearly half the electorate who bet on her pro-business challenger.
Finance Minister Guido Mantega, whose replacement is the focus of intense speculation, tried to beat back the pessimism with promises to control inflation and close a budget deficit in the four years ahead, although he added that the election showed popular approval for Rousseff's economic policies.
Brazil's currency, the real, extended losses after Mantega's comments, dropping to a nearly six-year low.
Rousseff said last month that Mantega would step down at the end of the year, and government sources say her short list of potential replacements includes a businessman, a former finance ministry official and her current chief of staff.
Whoever takes the reins at the finance ministry, investors are skeptical that Rousseff can pull off a swift recovery after four years of ineffective industrial policies. She now faces the challenge of delivering on campaign promises to expand social benefits for the poor while balancing a strained federal budget.
Major state-run companies whose profits have suffered under Rousseff plunged in Monday trading, including a 12 percent drop for scandal-plagued oil giant Petrobras. The benchmark Bovespa stock index fell 5 percent.
Fitch Ratings warned in a note that it could downgrade credit ratings for Brazilian companies next year due to weak domestic demand, falling prices for the country's raw materials and Rousseff's misdirected industrial policies.
"Clearer signals of reduced state involvement in the private sector during her second term would be important to improving business confidence and reviving investments," wrote Fitch analysts led by Joe Bormann.
Investors hope a more market-friendly finance minister can help restore fiscal discipline, bring transparency to the federal budget and better engage with business leaders. Some believe that Rousseff will be forced by economic realities to soften some of her interventionist policies.
Announcements of new cabinet members are unlikely in coming days, presidential aides said, as Rousseff rests after a demanding campaign that went down to a photo finish.
'BE A BETTER PRESIDENT'
Speaking to a relieved crowd of supporters on Sunday night, Rousseff struggled to raise her voice as she acknowledged the call for change expressed by many voters in remarks that some observers hoped were a sign of a shift to the center.
"I know that I am being sent back to the presidency to make the big changes that Brazilian society demands," she said after winning the runoff with 51.6 percent of the votes. "I want to be a much better president than I have been until now."
Her slim, three-point margin over centrist candidate Aecio Neves came largely thanks to gains against inequality and poverty since the Workers' Party first came to power in 2003.
Using the fruits of a commodity-fueled economic boom in the last decade, Brazil's government expanded welfare programs that helped lift more than 40 million people from poverty despite the current economic woes.
The "Brazilian model" has been adopted by center-left parties across Latin America and Rousseff's victory, however narrow, is a blow for conservatives in the region.
It also means there will be no dramatic improvement in ties with the United States, hit in recent years by trade disputes and U.S. government spying programs that infuriated Rousseff.
About 40 percent of Brazil's 200 million people live in households earning less than $700 a month, and it was their overwhelming support that gave Rousseff victory on Sunday.
Now she pledges to deepen social benefits while working to revive an economy that fell into recession this year.
In her victory speech, Rousseff also renewed her calls for a political reform to reduce corporate influence in campaign finance and restore faith in Brazil's messy multi-party politics. The president will have a tougher time with far-reaching reforms, however, after her coalition lost seats in both houses of Congress this year.
"Such a tight result reduces her capacity to radicalize policies," said Alberto Bernal, a Miami-based economist with Bulltick Capital Markets. "Pretty much half of the country is against what she has been doing."
MORE HEADWINDS
A sluggish economy will also make Rousseff's second term tougher, straining a government model accustomed to high tax revenues to finance social programs and subsidized credit for companies and consumers.
Brazil's economy, after growing by as much as 7.5 percent the year before she took office, is on track to expand less than 1 percent this year. Prior efforts to gun growth, largely through tax breaks and other subsidies for select industries, have largely fallen flat.
Meanwhile, inflation, long a problem in a country with a history of runaway prices, is now hovering above the government's tolerance ceiling of 6.5 percent.
And while unemployment is near record lows, economists don't expect it to remain so for long as plunging investment, slower growth and further uncertainty prompt employers to cut back.
To correct the course, economists say Rousseff must pursue long-pending tax and labor reforms in order to increase productivity and engage further with the global marketplace.
But Rousseff will face gridlock in a Congress increasingly weary of the ruling party, which lost seats in this election along with its most important ally. Leading lawmakers promise to make hay over a snowballing corruption scandal at state-run oil company Petrobras.
"After a brilliantly executed re-election campaign, Rousseff will need brilliantly executed economic policy to get Brazil moving again anytime soon" wrote Citi analysts Stephen Graham and Fernando Siqueira in a note to clients.
"The prospects of that we believe are low."
(Additional reporting by Anthony Boadle, Jeferson Ribeiro and Walter Brandimarte; Editing by Todd Benson and Kieran Murray)
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