Home Politics 2018 elections How the markets now run Brazil

How the markets now run Brazil


By Rob Dwyer

Bankers and investors are increasingly confident that the country’s next president will adopt a programme of fiscal reforms, even though no leading candidates are standing on that platform. Why? Because over the past decade, Brazil has become a ‘marketocracy’.

Brazil’s democracy has added a new feature in the last few years: people can vote for a president, but the markets retain the right to deploy an ‘impeachment put’ if that president is messing up the economy.

For proof, look no further than the fate of former president Dilma Rousseff. Her impeachment in 2016 was legally based on fiscais pedaladas (accounting irregularities). That she was almost alone among powerful politicians not to be cited in the sweeping Lava Jato corruption enquiry was not enough to save her. External forces still found a way to oust her from office.

Now, two years later, few senior market participants even bother to pretend the accounting charge was anything other than a markets-driven constitutional fig leaf to remove a bad president, whose terrible economic policies pushed the country into its deepest ever recession.

Speaking at a Credit Suisse Investors Forum earlier this year, Luis Stuhlberger, chief executive and chief investment officer of Verde Asset Management, said: “The conclusion that one reaches is that any candidate will do [fiscal] reforms in 2019, either proactively or reactively, because if we have a [president] with very different ideas, he or she will be impeached. Because if GDP goes down, the recession will come back, and he or she will be ousted. This has been clearly demonstrated.”

Stuhlberger, an investor revered by many in Brazil, added: “In the past, when I was more pessimistic and I thought [Rousseff’s] impeachment wouldn’t happen, a senator told me: ‘If you are in the presidency without the ability to govern, we will find a way to get you out.’ I think this is clear in the minds of everyone.“

Paulo Guedes, another well-known Brazilian financier, populist candidate Jair Bolsonaro’s economic adviser and potential minister of finance, effectively said the same thing: “It used to be that inflation had to be 2,000% to be impeached, but now if it’s at 10%, the president is ousted.”

Guedes then also compared the impeachment on accounting grounds with Al Capone’s prosecution for tax evasion.

Stuhlberger and Guedes were just saying in public what many are now increasingly happy to say in private.

“Our system has checks and balances, and Dilma was ousted according to the constitution,” one banker tells Euromoney. “One can argue whether the pedaladas were the real reason – and of course they weren’t, she was running the country into the ground and if she hadn’t been impeached in 2016, god knows where we would have been today. At the beginning of 2016, our economic team forecast a 4% contraction in GDP, but they said it might very well be 5%. Can you imagine?”


Everyone is acting like they all went out partying the night before and they all did bad things, everything got fucked up, but now they’re just hiding and no one is speaking out
– Banker, New York

As Euromoney reported in May 2016, powerful business leaders were in fact the ones pushing politicians to remove Rousseff, as refinancing risks threatened to create a wave of corporate defaults throughout Brazil.

In 2012, Brazilian corporates and financial institutions raised $46.8 billion in the international markets – a much cheaper source of finance than local banks or capital markets. By contrast, in 2015, the total raised in the international markets was just $7.2 billion. In the first five months of 2016, no deals had come to those markets. The markets had given their own vote of no confidence in Rousseff.

Banks did the same. Their provisions against the threat of corporate insolvencies spiked; in 2015, 5,500 companies sought bankruptcy protection – the most since 2008 – with forecasts of many thousands more to come as financial market liquidity evaporated.

Pressure built. The vent was impeachment.

To be fair, some were happy to be open about the real reasons for impeachment at the time. A March 22, 2016 tweet from Aécio Neves, Rousseff’s presidential challenger in 2014 and a key advocate of impeachment (who has subsequently been personally engulfed in the corruption scandal), pointed to its political expediency: “Impeachment is the shortest possible route to starting a new phase in the country’s history.”

Today’s increasing frankness about the real reasons for the 2016 impeachment is in part a function of the time that has passed and the clear improvement in the country’s economic trajectory it brought about. It is also a good message for the markets: ‘Don’t worry too much about who gets into the Planalto because if we see the country veering off an orthodox track, we can and will act.’

One banker addresses Euromoney’s questions about the morality of this market ‘put’ being wielded against a democratically elected president: “Look at China. It’s run like a corporate – it’s testing the world for having a non-democratic process that manages very successfully to the benefit of others. They make mistakes, but they correct them and, if you ask people in China, they trust their government.”

Then he gives his point context for a foreign journalist: “If you try to transplant that system to England, it would explode.”

He pauses for emphasis. “But it works for them.”

There is a consensus that the winner will be from the centre-right,” says a head of debt capital markets for a European investment bank in New York. “But if you ask me to explain that consensus, I can’t. I think the variables are too big to make that prediction, but the market is totally fixed that this will be the outcome.”

This quote alludes to the second component of the markets’ phlegmatic view that the next Brazilian president will automatically be a fiscal reformist – a belief that is completely unshaken by the complicating fact that the two individuals leading the early electoral polls are not seen as candidates who would calm the markets.

Nor is it clear who the main market-friendly candidates will be, nor how a potentially crowded field of centrist candidates will avoid splitting the reformist vote and complicate the calculation of who will contend the final run-off election between the top two candidates from November’s first-round poll.

Put simply, the consensus is built on the recognition that the dismantling of Brazil’s leftist Workers Party (PT) has gone far enough beyond Rousseff’s impeachment to prevent its return.

Former president Lula da Silva (in office from 2002 to 2010) is leading the polls for this election but has been sentenced to 12 years and one month in prison for corruption and money laundering. He is quickly exhausting legal challenges that would allow him to stand as a candidate (as well as prevent his incarceration).

Meanwhile, in late February, the PT’s ‘plan B’ should Lula not be able to run, Jaques Wagner, ex-governor of the northern state of Bahia, had his house raided and stands accused of embezzling R$82 million ($25 million) related to the 2014 World Cup.

“There is no left-wing candidate who can be a serious contender present in Brazil. We have never seen the left wing as weak as they are today,” says one senior capital markets banker in São Paulo. “This election is going to be different from previous ones as there is no polarity.”

The left say Lula is being targeted by the elite who want to prevent the PT from returning to office. His opponents say the charges of corruption are just and reflect the massive and systemic practice of channelling money from state-run enterprises to the country’s powerful political parties (the PT’s presidents ran coalitions, and all the leading parties – including the PMDB and PSDB – have been implicated in the Lava Jato corruption enquiries).

The truth is both versions are correct. Lula’s PT embraced existing practices of charging for political patronage from state-owned and private companies that wanted to win government contracts. The scale became supercharged as the size of these companies and contracts grew, fed by the country’s growing financial weight during the commodities boom.

However, people quick to label Lula a crooked aberration conveniently ignore previous administrations’ similar illegal practices and the fact that Brazil’s fragmented (there are currently 28 political parties in congress) and interest-based system almost guarantees corruption because of the need to ‘buy’ votes to get parliamentary majorities.

Since Rousseff’s impeachment, Brazil has been run by her deputy, Michel Temer, a member of the centrist PMDB party, who led the move to oust her and remains in power, albeit with very low approval ratings (they have recently doubled to 6%) amid corruption allegations of his own.

President Temer simply ignored his lack of mandate and unpopularity and initially enjoyed good governability in congress, passing market-friendly labour reforms, as well as other micro reforms like the change of the interest rate applied to state development bank BNDES. But he has since been caught up in corruption allegations, and the government’s time and resources are going into shoring up his political base in congress.


The urgency here is big. Debt levels are getting worrisome and people will soon start to get spooked
– Roberto Sifon, S&P Global

The assumption is that Brazil’s recent market-friendly rule will continue, however unpopular it may be with the electorate: the path forward having been demonstrated when the economic recovery finally arrived with 1% GDP growth in 2017.

However, this could well be tested. Although the economy came out of recession in 2017, the poor have borne the brunt of the downturn. Unemployment remains stubbornly high – at over 12% – and projections that the country’s GDP will take four years to reach 2013’s level, show the size of the economic hole into which it had fallen.

Research from local consultancy Tendencias Consultoria shows that 4.6 million Brazilian households slipped from socioeconomic group C into the lower ranks for D and E between 2015 and 2017 (in contrast to 3.3 million moving up from D and E between 2006 and 2012). A third piece of research shows that the richest Brazilians increased their wealth by 2.2% in real terms during roughly the same period (and paid an effective tax rate of just 6.1%).

Combined, these forces could become powerful.

The fact is the poor remember Lula’s PT presidency as one that took so many Brazilians from poverty and into the middle classes. The PT has been out of power since Rousseff’s impeachment and the disproportionate economic pain of the deep recession since has fallen on the poor.

And there is also the sideshow of a corruption enquiry that is finding proof of corruption among politicians from all of the main political parties but where prosecutions seem to be partial, with a remarkable lack of activity against politicians in the PDSB in particular.

Added together there is clearly potential for widespread disenfranchisement and political instability.

It is these forces that Lula has been tapping into: despite the conviction for corruption, he is leading the polls for the first round, and in projections for the run-off he beats all comers, according to polling data presented by BNP Paribas.

The only other candidate who has double-digit polling numbers for the first round is Bolsonaro, currently the other viable non-centre candidate.

Bolsonaro is running on a populist, socially conservative platform that harks back to military rule. For example, as a congressman, he invoked the name of the general who oversaw the torture of Rousseff as a young woman when voting to impeach her.

He also alarmed many when, arguing with a congresswoman, he shouted that she “wasn’t worthy” of being raped.

He has advocated a mix of conservative and social economic policies, speaking out, for example, against key elements of the proposed economic reform package, such as pension reform and making the central bank independent.

In reality, Bolsonaro could be the markets’ dream solution.

When confronted with economic and financial policy questions, he used to obfuscate, saying he was not an economist and would delegate that aspect to an expert. If he won and followed through by appointing Guedes as finance minister, the subsequent liberal economic agenda – huge cost cutting in state programmes and a large pipeline of privatizations and concessions to raise money to pay down government debt – would have bankers and investors salivating all the way to Brasilia.

Ironically, if Lula is barred from running, political analysts believe Bolsonaro will be weakened.

“For Bolsonaro to grow [his poll numbers], he needs the participation of Lula in the elections because that enhances his ability to create polarization,” says Thiago de Aragao, partner at Arko Advice, a political consultancy in Brasilia.

“If Lula isn’t there, Bolsonaro will have to change his narrative [from simply being the anti-Lula candidate]. He would need to go into a narrative of a multitude of proposals from health to education.”

Aragao also points out the Brazilian electoral system is stacked against Bolsonaro and other candidates that are not backed by a large party.

Candidates are allotted TV time based on the size of parties in parliament – air time cannot be bought. This means that Bolsonaro will likely have around one minute for every 10 the main party’s candidate has – while many other candidates will also have between three and five minutes.

Also, Aragao points out that voters do not know much about the controversial side of Bolsonaro yet, beyond his law and order shtick. If he is a leading candidate during the campaign proper, he will be attacked and his rejection rating is likely to rise. “Plus he has been a congressman since 1991, so his ability to create a perception of being a fresh solution that is not based on polarization is very hard,” says Aragao.

Bolsonaro is the most followed ‘pre-candidate’ on Twitter and Facebook. As elsewhere, social media is going to have a bigger role in this election than before, but Aragao is convinced it will remain marginal.

“It’s not enough to be the sole driver,” he says. “In Brazil, mayors still play a critical role in the getting votes out for candidates, so how many mayors a party has is still critical to getting out the vote in every corner of what is still a highly uneducated country.”

And anyway, even if Bolsonaro did win, the market would retain its ‘put’.

“Let’s say Bolsonaro did win – he runs an excellent campaign and everyone else makes terrible mistakes. Either he would have to be a president who is completely different to what he said as a candidate in order to get the support from the PMDB, PSDB and other parties, by moderating and adapting to traditional politics, including fiscal reform,” says Aragao. “Or, if he didn’t adapt and he challenged the [fiscal and financial reforms], congress would wait for his first minor slip and would do the same to him as they did to Collor in 1992.” That impeachment put again.

Ultimately a lot of the financial world’s consensus about a market-friendly outcome to this presidential election is down to the fact that Brazil is a parliamentary system masquerading as presidential.

Brazilian presidents rule on the “acceptance of the parliament” says Aragao. “The parliament kidnaps the executive, not the other way around.”

Beyond Lula and Bolsonaro, it is hard to see past São Paulo’s governor, Geraldo Alckmin, as favourite – although that is more because of lack of credible contenders than his popularity. Others include São Paulo mayor João Doria, but he is a member of the same party (PSDB) as Alckmin and would likely have to change horse to run for the presidency.

Finance minister Henrique Meirelles would probably be the market’s choice if they could choose outright, but his polling is around 1% and he is struggling to convince his own party, the PSD, to let him run. They would prefer to seek increased power in the next administration’s coalition by immediately partnering with a viable candidate.

Meirelles is reportedly eager to run, but his lack of party (he claims other parties are interested in adopting his candidacy) and popular support mean that, although he may be able to persuade himself to become a candidate, he would convince few others.

His inability to pass pension reform does not help him project a candidacy based on effectiveness, while a report by Buzzfeed, widely publicized in Brazil, of offshore earnings of R$217 million in 2016 for “consultancy work” overshadowed his pitch as a ‘new political broom’ in the eyes of the public.

Marina Silva is the only other viable candidate to emerge to date and although she is probably seen as more leftist than the other main candidates, that consensus believes she would have little choice but to adopt fiscal and pensions reform.

This is the other main plank of the consensus: whoever wins will have to pursue reforms because there is no option. The constitutional spending limit, which freezes public sector expenses in real terms for 20 years, means that without limiting pension payments (currently growing at about 5% a year in real terms) there will be no room for budgetary manoeuvre. Even with pension reform, further cuts will be necessary for the next government to remain under the cap. This is logical. But there are still risks to the downside that the consensus seems to be disregarding.

The first risk relates to the speed and the scale of the reforms that will be needed, especially in light of the failure of the Temer administration to reform pensions.

Roberto Sifon, head of the Americas’ sovereign team at S&P Global in New York, sees greater time pressures than most in the market – also reflected by all agencies continuing to cut the sovereign’s rating deeper into junk territory this year.

“The urgency here is big,” says Sifon. “Debt levels are getting worrisome and people will soon start to get spooked.”

Others point out that the speed of gradual adjustment of the Temer administration will have to be increased.

“Fundamentally, the public sector – federal and local governments – is now more than ever challenged to simultaneously increase its investment and its savings rate (ideally by cutting current spending),” says a report by Goldman Sachs’ economist Alberto Ramos.

“Limited progress on this front is expected for the last year of the Temer administration. The onus is therefore on the next administration to show tangible and decisive progress towards fiscal consolidation and stabilization of the public debt dynamics.”

And quickly.

Since 2014, the private sector has shouldered most of the burden of generating increasing financial surpluses and gradually deleveraging its balance sheet. Also, improvements, such as that in the current account, have been more cyclical in nature than structural.

Even the failed pension reforms would not have been enough according to some.

“Our view is that Temer’s [pension] reforms are only a small step in the right direction,” wrote Neil Shearing, Capital Economics’ chief emerging markets economist, in a client note. “At best they would [have] cut the pension deficit by one quarter; in reality, after various amendments they might [have] cut it by as little as one fifth or one sixth. Most of the heavy lifting will have to be undertaken by the next government.”

UBS’s chief economist and one-time voting member of the Brazilian central bank’s monetary policy board (Copom), Tony Volpon, emphasizes that Temer’s reforms weren’t that substantive.

“The very gradual fiscal adjustment that Brazil is trying to implement has advantages,” he says. “It is more politically viable – but also has risks: any negative developments in the currently favourable domestic or external conditions could hinder the debt-to-GDP ratio’s upward path, exposing structural fiscal rigidity.”

Personalities not policies
And here is the next risk: governability issues will not miraculously disappear in the next term. That will depend on the composition of the new congress, and Aragao says the issue is complicated by an electorate that often votes for candidates for congress that oppose their choice for president, because in Brazil voting decisions are more based upon personalities than policies.

Sifon also points to this risk: “You have had an amazing set of individuals at the helm – Joaquim Levy [Rousseff’s last minister of finance] to name just one. That’s why I am concerned; [Brazil’s problems] have never been because of a lack of good management. It’s not so much which side of the political spectrum the next president comes from – the key thing is not their original plan, it is will they be able to influence congress. The problem is that smart people have tried to make reforms and congress has said no.”

Also, with Lava Jato investigations continuing, it is possible that the next president and his or her ministers could be similarly implicated. Further corruption-inspired deadlock cannot be discounted. After all, every candidate comes from within the system.

“Has anyone within the political system made a mea culpa?” asks one New York-based banker. “Everyone is acting like they all went out partying the night before and they all did bad things, everything got fucked up, but now they’re just hiding and no one is speaking out. In five years of investigations, they haven’t passed one law to clean up the political system in Brazil. That tells you a lot about how rotten and corrupt it is. And that’s a challenge. I’m surprised that in this context you are not seeing a Macri [Argentina’s reformist president].”

Sifon also worries about the typically Brazilian risk caused by a “little rebound”.

GDP growth is expected to near 3% this year and the government’s fiscal position has improved markedly in recent quarters. In January, the consolidated public sector posted an above market-consensus primary surplus of R$46.9 billion.

While all economists point out that short-term improvements will not overcome the longer-term debt dynamics and increasing debt burden (now at 74.5% of GDP), the good numbers might lead the next president to make lower impact, less politically toxic reforms.

Worse, the next president may decide to prioritize other electoral commitments and policy priorities, leaving pensions and other fiscal reform to later. This would increase the severity of the necessary reform when it materializes and make it harder to pass in a congress nearing another set of elections.

As Goldman Sachs’s Ramos notes: “There is also the risk that even if there is no major change in the overall policy mix, there is simply insufficient or not fast enough progress on the fiscal front in 2019/20. That is, market risk would not disappear with the election of an investment-friendly orthodox administration, particularly if the new government is handicapped by weak governability conditions, as that would constrain the capacity to move the needed reforms forward.”

Finally, as Volpon alluded to, external risks may also come into play for the next president. The last few years have seen exceptionally benign financial conditions for EM countries and Latin America in particular.

That should remain, but with the US embarking on a fiscal stimulus in an already-growing economy with low unemployment, a scenario of radically different monetary policy from the Fed cannot be discounted, with potential negative impacts for EMs, especially for those that have financial weaknesses. Plus there are the perennial geopolitical risks from conflicts, trade wars and Chinese-imported financial instability.

Most bankers accept the view that Lula would pass pensions reform. The scenario that Brazil maintains and even accelerates its reformist agenda, securing a good cycle of positive growth rightly remains the favourite assumption. But there also real downside risks that could arise next year, almost regardless of who is president, and it should be noted that asset prices reflect pretty much a perfect outcome.

That is why Brazil’s outlook is more nuanced than the positive, consensus view of a reformist president winning and immediately implementing an effective series of reforms.

Investors should not be overly confident about Brazil’s ‘impeachment put’.

Yes, it remains a reality. But remember, it is only activated when the country is quite clearly already heading in the wrong direction. While it unarguably prevented Brazil from descending further into the abyss, it did not prevent eight consecutive quarters of contraction.

This year’s presidential elections should be interesting. But the first year of the next president’s administration will be critical for the country.