A short-lived bounce back in Brazil?

Liseth Galvis - 6 September 2017

Recent corruption scandals in Brazil, including bribery accusations against President Michel Temer, cast doubt on the durability of the recent improvement in some of the country’s economic indicators. GDP grew by 0.2 per cent in Q2 2017 compared with the previous quarter, marking a gradual transition after two years of contraction. Annual inflation has decreased substantially from 5.35 per cent year in January 2017 to 2.71 per cent in July, resulting in a restoration of households’ purchasing power.


Brazil’s economy is heavily dependent on soft commodities, which generate approximately 60 per cent of its exports. The deceleration of China’s economic growth has had a severe impact on Brazil, for whom China is the most important trading partner. Although exports by value to China grew by 50 per cent between August 2016 and August 2017, they remain 11 per cent lower than in the same month of 2013.


The Real has strengthened as a result of renewed optimism in Brazil's economy (figure 1), appreciating by 1.8 per cent between August 2016, when Temer assumed the Presidency, and August 2017. This trend can be attributed to the impact of government announcements, such as the planned privatization program and fiscal reforms, bringing encouragement to investors that better times lie ahead. Despite recent protests, the Real actually strengthened as investors priced in the expectation of a more credible government in the future.


Remarkably, portfolio equity net inflows (figure 2) have held steady in recent years at around US$11bn per year. Short-term capital has been enticed with a high nominal interest rate. Even though the central bank cut the base rate by 100 basis points to 9.25 per cent on 26 July 26, the rate is still one of the highest in emerging markets and is attractive for yield-starved European and American investors. Brazil is recognized as the country in Latin America that has the strongest capital inflows, although this reputation is at risk from ongoing concerns about crime and corruption.


Government policy on pensions in Brazil is also a key source of uncertainty. Pension reforms focused on increasing the retirement age are contentious: under the proposals the retirement age would rise from 56 to 65 for men and from 53 to 63 for women. These unpopular measures from Temer generated protests across the country and questioned the legitimacy of the government’s management of the public finances. Meanwhile, hundreds of jobs have been lost as a result of scandals at Petrobras and Grupo Odebrecht and the unemployment rate remains elevated, at 13 per cent. Corruption creates uncertainty in Brazilian financial markets and questions the ability of Temer to deliver the proposed privatisations and other fiscal reforms.


How credible is a Brazilian bounce-back and how imminent? Are expectations of a more credible future government justified, given Temer’s weak showing in the polls? A recent poll suggested that 46 per cent of the population would not vote for him. According to recent data from the Datafolha poll, Lula Da Silva and Marina Silva are the favourites to prevail in the 2018 elections. Lula, from the left, is currently involved in a corruption investigation, and it is likely that he would perpetuate the policies established in his past administration. Marina Silva, from the green party, stands as an anti-corruption candidate.  Given Temer’s unpopularity, it is unlikely that he will continue as President.


Despite the nascent economic recovery, investors’ hopes are likely to be dashed again as political realities dominate the landscape. In one of the most unequal countries in Latin America, there is insufficient appetite for Temer’s reforms. Neither Lula Da Silva nor Marina Da Silva supports privatizations and fiscal cuts.  

Figure 1

Data source: Thomson Reuters Datastream

Figure 2

Data source: The World Bank.


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