Markets may have reacted positively to the election of Jair Bolsonaro as president of Brazil, but investors would be advised to temper their optimism given the political challenges he will face when he takes office in the New Year.
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Brazil's stock market, government bonds and currency soared in October at a time when global markets were suffering sharp reverses. The ‘Bullsonaro wave’, unleashed by the victory of the eponymous right-wing candidate Jair Bolsonaro in the presidential election, is credited with driving Brazilian assets higher.
However, Tim Alt, director, rates and currencies at Aviva Investors, argues investor relief at the defeat of the left-wing Workers' Party candidate Fernando Haddad rather than confidence in Bolsonaro drove the rally.
The Workers' Party governed Brazil for 13 years until August 2016 and is blamed for the country's worst-ever recession and a spectacular corruption scandal. The episode ensnared senior politicians, state officials and business leaders, including the once popular, former president, Lula da Silva, now serving 12 years in prison.
His successor Dilma Rousseff was impeached in 2016 on the grounds of criminal administrative misconduct and disregard for the federal budget. Michel Temer of the centrist Brazilian Democratic Movement, who replaced Rousseff, is also being investigated for his role in the ‘car wash scandal’.1
The record of his predecessors weighed heavily on Haddad in the election. “Haddad’s policies scared investors, so positions hedged against a Haddad election were quickly unwound once Bolsonaro’s victory seemed assured,” explains Alt.
Jonathan Toub, emerging market equities portfolio manager at Aviva Investors, adds that domestic flows drove stocks higher. “Local investors became more positive on the outcome following the first round, either covering short positions or putting fresh money to work, while most international investors entered the election period in a neutral position.”
The new administration is likely to be more business friendly, which could provide a boost for the economy – at least in the short term. “We are likely to see a reduction in red tape and a streamlining of the highly complex tax system that could involve tax cuts,” says Alt.
Fiona Mackie, regional director for Latin America at the Economist Intelligence Unit, believes the new president can make progress if he acts quickly. “Bolsonaro is riding a huge wave of support and can draw on this political capital to push key reforms, including that of pensions, to rein in the fiscal deficit over the long term,” she explains.
A Bolsonaro presidency is certainly not without risk, however. Mackie notes the former army officer “has followed Trump’s playbook to power”. He made numerous controversial comments during the election campaign, including praising dictatorships. Mackie fears Bolsonaro, dubbed the ‘Tropical Trump’, could adopt ad hoc, populist policies once in office.
Furthermore, the president elect has no executive experience and there are questions about his ability to drive reforms through Congress.
“The political environment in Brazil is fractured with around 30 different political parties in Congress. Gaining the two-thirds majority required to pass key legislation calls for a leader who can build coalitions,” says Alt, who questions Bolsonaro’s ability to play that role.
“Bolsonaro ran for office as an anti-establishment candidate, even though he's been involved in the government for the past 27 years, and his congressional career, which resulted in the authoring or co-authoring of just two bills, was far from distinguished.”
Presidential appointments key to credibility
The president’s ministerial appointments will be crucial given the doubts about Bolsonaro’s temperament and track record, says Toub. Bolsonaro professes ignorance of economics, so the new and well-respected finance minister Paulo Guedes could be an influential figure. Moreover, Guedes is assuming the powers of the ministers of finance, planning, and industry, with the Brazilian press already dubbing him “the superminister”.2
Guedes is considering free-market reforms similar to those implemented by the ‘Chicago boys’ in 1970s Chile.3 The new finance minister’s priorities are to sell off dozens of state companies, rein in the pension-system deficit, deregulate industries, and cut taxes to attract investment and create jobs. It remains to be seen whether Bolsonaro and an unpredictable Congress will allow Guedes to achieve his ambitions. In addition, both Guedes and Bolsonaro have strong personalities, which could be a recipe for conflict, says Alt.
Meanwhile, Bolsonaro’s nomination of economist Roberto Campos Neto to replace the respected central bank governor Ilan Goldfajn, who is stepping down from the office, is viewed as a positive for markets.
“It’s very important to have a credible central bank given the uncertainty on the fiscal side,” says Alt. Campos Neto has been treasury director at Banco Santander and is a known, market-friendly pick, explains Alt. He adds the move does not change the expectation that the easing cycle is over; the central bank having reduced interest rates to a record low of 6.5 per cent in March.4
Investors have also welcomed the elevation of Sérgio Moro, the judge celebrated for leading the ‘car wash’ investigation, to head the justice and public security ministry, although this has proven controversial with the opposition. Alt points out that Moro was responsible for convicting Lula da Silva, so preventing him from participating in the presidential race. The Workers’ Party have claimed Moro’s appointment proves Bolsonaro won through “electoral fraud”, suggesting the political environment will remain corrosive.4
As for foreign policy, Bolsonaro, like Trump, took a highly nationalistic approach on the campaign trail. He gave voice to Brazilian concerns over China’s acquisitions in the country in a typically forthright manner, claiming: “China isn’t buying in Brazil. It’s buying Brazil”.
However, since being elected, Bolsonaro has adopted a far more pragmatic approach, doubtless reflecting China’s position as Brazil’s largest trading partner and by far its largest export market.5 As Mackie points out, “Brazil has far more to lose than China from any breakdown in relations”.
Can markets rally further? Alt says a neutral stance is appropriate overall in fixed income given the uncertainty over economic and fiscal policy, although he believes investors could look to add exposure during any sell-offs. In addition, Alt believes the central bank has come to the end of its monetary loosening cycle, having reduced interest rates to a record low of 6.5 per cent in March.6
Alt adds there may be opportunities in the inflation-linked market, given that the levels of inflation implied in the market are historically low. “Disappointments on the fiscal side, or developments in the external environment, such as trade concerns or a stronger dollar, could push inflation higher,” says Alt.
Meanwhile, Toub believes consumers, rather than business or government, are likely to drive the economy as it recovers from its deep slump, which saw GDP contract by more than seven per cent during 2015 and 2016.7 “Consumer-related stocks and banks could perform well,” says Toub, adding a privatisation programme could also throw up interesting opportunities.
Ultimately, Bolsonaro’s ability to drive through key reforms will determine whether Brazil achieves its potential and rewards investors. In the short-term, Alt believes the focus should be on who Bolsonaro appoints to lead the lower house of Congress, a decision expected in the New Year. That will be crucial in allowing the new president to build alliances that will facilitate the passage of key measures to boost Brazil’s economic fundamentals.
- ‘Brazil’s corruption scandal’ BBC News, April 2018
- ‘Brazil’s superminister’ Bloomberg, October 2018
- ‘New finance minister eyes Pinochet-style’ fix for economy’ Financial Times, November 2018
- ‘Moro appointment proves controversial’ The Guardian, November 2018
- ‘What Bolsonaro’s election means for China-Brazil ties’ The Diplomat, November 2018
- ‘Rates remain at record low’ Reuters, November 2018
- ‘Brazil’s worst-ever recession’, Financial Times, September 2017