BRASILIA, Nov 27 (Reuters) - Incoming finance minister Joaquim Levy faces tough hurdles, including resistance from within the ruling party, as he sets out to restore order to Brazil's messy public accounts, regain investor confidence and get a stagnant economy moving again.
The fiscal conservative picked by President Dilma Rousseff after her narrow re-election will have to deal with a budget that leaves little room for substantial cuts, and fierce opposition to austerity measures from within the ruling Workers' Party.
Party leftists oppose any belt-tightening that could threaten the expansion of social programs that lifted millions of Brazilians out of poverty in the last decade.
Levy's biggest challenge will be to convince skeptical investors that Brazil has a viable plan to balance its books and avert the threat of another credit rating downgrade next year.
In his first comments on Thursday, Levy said the new economic team is already looking at ways to cut public spending and he announced more realistic fiscal savings targets that those missed by outgoing Finance Minister Guido Mantega.
Markets welcomed Rousseff's surprise move to set ideology aside and put a fiscal hawk in charge of Brazil's finances, but investors were disappointed Levy did not announce specific measures.
"We are moving in the right direction, but we want more concrete steps," said Marzo Bernardi, who manages 34 billion reais ($13.20 billion) in assets for Western Asset in Brazil.
"Levy is an orthodox. He will go over the accounts with a magnifying glass. But he needs to take tough decisions and raise taxes to increase revenues if he wants to achieve even his more realistic fiscal savings target of 1.2 percent next year."
Levy said the government will work with a primary surplus target, or government revenue minus spending before debt payments, of 1.2 percent of Gross Domestic Product (GDP) in 2015. But he will seek to raise that to at least 2 percent of GDP in 2016 and 2017.
Although some investors doubt Levy will have enough freedom to make painful spending cuts, others see his appointment as proof Rousseff is ready to adopt orthodox policies after last month's close election that reflected widespread discontent with the country's economic performance.
Years of heavy public spending and dozens of tax breaks for industries have eaten into Brazil's finances and the country risks posting its first primary budget deficit in nearly two decades.
To stanch the fiscal bleeding Levy will have to rely heavily on tax increases. Discretionary spending, where the government can make cuts, accounts for only 10 percent of the budget and includes many of the social programs that Rousseff has vowed not to touch.
A tax on gasoline and other fuels, known as CIDE, could be reintroduced, and taxes levied on manufactured goods raised to bolster revenues. A crackdown on fraud in pension and unemployment benefits is also planned, government officials told Reuters.
But even those hikes may not be enough for the government to reach its more moderate savings goal next year, experts say.
Investors agree Levy needs a multi-year fiscal adjustment plan that details exactly how Brazil will bring back the sizeable budget surpluses that made it a Wall Street darling.
"A medium-term fiscal plan will allow Brazil to gently return to the right path by prioritizing spending and revenue mobilization in a rational way, while at the same time beginning to meet overall fiscal targets rather than missing them," said Jan Dehn, head of research at London-based Ashmore, with over $71 billion under management.
Investors expect to see two years of fiscal tightening to regain market confidence and overcome the risk of credit rating agencies stripping Brazil of its coveted investment grade. Standard & Poor's downgraded Brazil to its lowest invest-grade rating in March.
But they doubt the new economic team will be able to tackle the major reforms that Brazil needs to restore solid growth, such as overhauling the complex tax system and reducing labor market regulation, because they would not get through Congress.
Until such reforms, Brazil will grow well below its potential, crawling ahead at a rate of less than 2 or 3 percent a year, said Fabio Knijnik, managing director of K2 Capital wealth fund in Sao Paulo.
In the meantime, investors hope Levy's policies will avoid a fiscal disaster and gain time with the credit agencies.
"What investors are particularly worried about is the risk of a ratings downgrade and one thing this does is give a bit of breathing space, let the ratings agencies know they have people who are credible in office," said Robert Davis, senior portfolio manager at ING Investment Management.
"But ultimately they need to follow through with action, and that's the case with all emerging markets - India, Indonesia."
1 US dollar = 2.5760 Brazilian real Additional reporting by Walter Brandimarte in Rio de Janeiro and Sujata Rao-Coverley in London; Editing by Frances Kerry