Spotlight on Brazil

Spotlight on Brazil

 

Stefan Benedetti, Senior Portfolio Manager Distressed, Stressed and High Yielding Debt, Plenisfer Investments SGR

 

What had been feared after the presidential elections has unfortunately occurred on Sunday. A large crowd of supporters of the defeated former president Jair Bolsonaro has attacked the presidential palace, the Congress building and the Supreme Court building in Brasilia.  In scenes reminiscent of the 6 January 2021 riots in Washington, DC, the crowd smashed their way into the buildings and caused physical damage.  Fortunately, it being a Sunday, there was no physical threat to officials at their place of work.  The crowd was contained by Federal Police.  According to Brazilian news organisations, about 1,500 people have been arrested.

As with the events in Washington, DC, two years ago, the protesters were disputing the legitimacy of the presidential elections in October which had seen the winner, Lula, prevail over Bolsonaro by a narrow 1.8% of the vote.  As in the US, there were no objective indications that anything may have been wrong with the result.  As with the 2020 US elections, the outgoing president never accepted defeat and did not attend his successor’s inauguration, even though he instructed his officials to work with Lula’s staff on the transition.  Bolsonaro was not present at the events in Brasilia and he did condemn the events.  The main difference to the events in the US was that the protesters in Brasilia apparently hoped for an intervention by the Brazilian armed forces to overturn the election result.  Bolsonaro himself had been an official in the Brazilian army before going into politics and is a self-declared admirer of the military government that ruled Brazil from 1964 to 1985.

Thankfully the army stayed loyal to the constitution, proving that the democratic institutions in Brazil are solid.  This is the main piece of good news coming out of this unfortunate turn of events.

Politically, Lula comes out of this weekend stronger than he was.  While it is not clear whether Bolsonaro personally had any involvement, his Liberal Party, which is the largest party in the new Congress, will find it harder to strike alliances with more moderate political forces. Lula’s Workers Party, with only 12% of Congress themselves, will find it correspondingly easier to find the votes to implement his legislative agenda.  This will help political stability, albeit at the cost of more left-ish political choices.

In the longer run, we should be worried about a more politically polarized society emerging.  We were hoping that after the events of two years ago in the US, Politics USA 

 

would look in the mirror and decide to speak a bit less and to listen a bit more.  That did not happen.  So, there is a chance it will not happen in Brazil either.  But it will take a while to find out.

 

What impact did these events have on the financial markets?

The financial markets took the events in their stride.  Equities, bonds and the real (the Brazilian currency) only moved marginally, and certainly less than during days in the last two months when Lula announced his choices for finance minister and head of Petrobras.

Brazil comes out of the Covid years with a 70% debt to Gross Domestic Product (“GDP”) burden which can only increase after the decision in December to remove the constitutional limit on debt increasing more than GDP.  Lula’s legislative priority is a fiscal boost, designed to kick start an anaemic economy and reestablish the welfare programmes of his previous terms in office. Debt reduction is not really part of the programme. The economy is expected to suffer a technical recession in H1 2023, after the monetary tightening of last year.  Due to a lack of money, Lula will find it difficult to return to the full extent of the spending programmes that characterized his tenure in 2003 to 2010.  But he will certainly try.

On the positive side, a fair bit of the national debt is denominated in domestic currency, inflation looks under control and Brazil is the producer of goods, such as oil, gas, food and metals that are in high demand around the world.  Brazilian companies are, in our opinion, well placed to take advantage of global dislocations and to deal with domestic political dislocations at the same time.

Policy interest rates in Brazil have risen significantly in the last two years from 2% to 14%.  They are expected to come down gradually.  Inflation has come down to 5.8% in December after hitting a peak of 12.1% in April.

In this context, we believe that any politically inspired sell offs could offer interesting entry points for increasing exposure to Brazil, especially to corporate bonds.

From our perspective, where we are in the economic cycle offers interesting opportunities with respect to exporters, who earn dollars, with respect to companies relying on the domestic market, who will benefit from the expected fiscal expansion and with respect to local currency sovereign debt, which will benefit from the reduction in interest rates.

The high and increasing level of public debt is one of the main risks to this generally positive outlook and needs to be monitored carefully.

 

 

 

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