Lula Conviction Fallout Continues

July 27, 2017

Known simply as Lula, the former president is the greatest living Brazilian politician. His 2004 to 2010 presidency was an unmitigated success, as he oversaw strong economic growth, falling inequality and Brazil’s emergence on the global stage. But in July the unthinkable happened and the once super popular president was found guilty of receiving $1million worth of kickbacks in the use of a luxury beachside home. Markets rose on the news, hoping that the conviction could rule him out of next year’s presidential election, where he was widely tipped to be considering a comeback.

Hero to zero

The market reaction underlined the fickle, changing nature of investor sentiment. In the early 2000s Lula, a former trade union boss, was seen as a bogey man by investors who feared his rise to power. In the event the combination of Lula’s populist spending and high commodity prices helped to drive economic growth, rapidly expand the middle class and send the stockmarket soaring. However, times have changed. Low commodity prices have dampened the flow of mega oil and mining projects, while Brazil’s stretched fiscal position means the state has to cut costs. In this new environment the market prefers current President Michel Temer, who is implementing a series of radical cost-cutting reforms.

Removing Lula would create a vacuum on the left that would see more a plethora of new candidates emerge and increase political uncertainty …

Yet investors shouldn’t be so buoyed by Lula’s apparent demise. For starters, he hasn’t actually been put in jail, with the judge deciding that he can remain free until his appeal. If Lula can successfully fight his appeal, or delay it until the 2018 elections begin, then he will be eligible to run for president next year. And although the market may have forgotten its previous love affair with Lula, many Brazilians haven’t. Indeed despite his problems he is currently leading presidential polls. Moreover, even if Lula is ruled out of the elections his absence could pave the way for a candidate that’s even less palatable for the market. Removing Lula would create a vacuum on the left that would see more a plethora of new candidates emerge and increase political uncertainty. Indeed the threat is not just on the left. For example ultranationalist congressman, Jair Bolsonaro, who has supported a return of the military dictatorship, is currently polling in tied 2nd place with 15%.

Corruption quandary

On a deeper level the conviction of Lula adds to the disruption created by Brazil’s ongoing corruption scandal. Since 2014 emboldened federal prosecutors and admirably independent judges have uncovered a series of high-level corruption networks between the country’s leading politicians and its biggest businesses. Corruption has long been a central part of Brazilian life, the oil that greased deals and was essential to getting major projects completed,  but only now has Brazil shown the institutional strength to tackle it head on. That is admirable but it comes at a price. Huge swathes of Brazil’s elite are guilty of corrupt practises and bringing them to account necessarily causes serious economic and political disruption. Brazil has impeached one president, begun corruption charges against a sitting president and just convicted a former president. Meanwhile some of its richest businesspeople are sitting in jail. Over the next few years we will see the emergence of new political leaders in Brazil. The market seems certain that they will be better than the last generation – time will tell.