Brazil Tests Investors’ Nerves

May 5, 2017

Latin America’s largest economy is suffering its worst recession on record and the deepest corruption scandal in its history. Yet investors piled into the Brazilian stockmarket last year when it became clear the market-friendly Temer was going to replace his, eventually impeached, left-wing predecessor Dilma Rousseff. Not that Temer’s arrival could stop the recession, of course, but markets are forward-looking and investors believed that he would lay the foundations of a recovery.

Reality check

Now, some investors will be wondering if they got ahead of themselves. Initially Temer didn’t disappoint, passing a controversial austerity programme that would cap public spending in nominal terms for twenty years. However, his attempt to follow up with an equally radical public-sector pension cap is being undermined by two different corruption probes. His success in executing the plan, or even remaining as president, now depends on his ability to navigate Brazil’s choppy political waters.

the pension reform is proving even more contentious…

Temer is pursuing austerity on two fronts. First there is a reform of Brazil’s complex labour code, which dates back to the 1940s. The messy labyrinth of employment law is one reason why Brazil’s productivity growth is so slow and why the cost of operating a business in Brazil is one of the most expensive in the world. Despite opposition Temer has succeeded in pushing the labour law through the lower house. However the pension reform is proving even more contentious. It has passed a technical committee yet it remains to be seen if Temer will be able to moot enough votes to get it through Congress. Meanwhile strikes and street protests are mounting. The protests haven’t reached the level of the anti Rousseff demonstrations last year yet pension reform will definitely be watered down, if it is passed at all.

The next challenge stems from the even longer-running Petrobras corruption scandal, Lava Jato (car wash). The electoral court is investigating claims that the 2014 Temer-Rousseff presidential bid received illegal donations. If that is found to be the case it could cause Temer, who was vice president before Rousseff’s untimely departure, to be impeached himself.

Economic green shoots

However, despite the political morass there are signs of economic green shoots. “Brazil’s export growth looks set to rebound this year”, says Adam Collins, Latin America analyst at Capital Economics a London-based consultancy, “this should help to finally pull the economy out of recession.” The export boom will be led by the agricultural sector, says Collins, which has overcome recent headwinds of a drought and meat quality complaints. Meanwhile inflation has been tamed, which should allow the Central Bank to cut rates and ease pressure on Brazil’s beleaguered consumers. If Temer can outmanoeuvre or delay the corruption probes for long enough to pass his pension reform then the market’s optimism will have been rewarded. However, given the high-profile figures that have already been felled by Brazil’s corruption scandals, it is still very early days.