For the last few months Wall Street’s tidy narrative about Brazil has gone as follows: It’s in bad shape now due to bad governance from President Dilma Rousseff’s administration, but not to worry. An election is coming and it will change everything. Buy Brazil!
As hedge fund star Mike Novogratz of Fortress Investments said this spring — it’s “so bad it’s good.”
But what’s more likely is that regime change after October’s election is no cure-all. Latin America is a region where what often looks like change is actually more of the same. In this world, bad never has to be followed by good.
Right now there three candidates are in the running. The incumbent, Dilma Rousseff, Marina Silva of the Socialist Party, and Aécio Neves, a Social Democrat.
Silva — former running mate of late Presidential candidate Eduardo Campos who died in a tragic plane crash last month — has inched above President Dilma Rousseff in polls, but even if Silva wins real change is hardly guaranteed.
“It doesn’t look that clean cut,” economist Claudio Loser of Centennial Group Latin America told Business Insider. “She [Silva] comes from the same place [as the current regime] they have a very difficult road ahead.”
Oppenheimer put it even more succinctly in a recent note saying, “Our thought is that the Brazilian ‘election trade’ will eventually be sniffed out as the farce it clearly is. It does not take much of a sense of history to appreciate the irony that that Ms. Silva is running a reform campaign against a leftist Workers Party candidate, who herself came in under a reform agenda President (Lula). Moreover, Ms. Silva was herself a Workers Party minister from 2003 to 2008 under Lula.”
Does that sound like change to you?
Here’s what Brazil faces right now — an unfortunate cocktail of inflation, a tight labour market, and slow growth.
Morgan Stanley sees the country’s GDP going negative in the first half of 2015, contracting -0.4%.
Inflation has been worsened by the fact that over the years, wages in Brazil have risen at a steady clip and corporate profits have declined.
Former shining stars of the Brazil’s stock market, like state oil company Petrobras, have dimmed considerably. In the last five year’s Petrobras’ stock has fallen almost 60%. It is also embroiled in a kickback scandal involving the current administration of President Dilma Rousseff and Silva’s late running mate.
“A few years ago I said this was the best run oil company in Latin America,” said Loser, “but it has collapsed under the political pressure of the government. They’re wasting a great opportunity in the way they’re managing their oil resources. I’m not saying ‘as goes Petrobras there goes Brazil’ but it is very very important.”
The reforms Brazil needs to change course are no easy task for even the most brilliant political operators. Brazilians have come to expect a certain standard of living, and consumption makes up the largest portion of the country’s economy at 63%.
And it is consumption, precisely, that will be hit hardest by reforms.
To combat inflation, the government must raise interest rates, tighten its fiscal policy, and allow prices to adjust (accelerating inflation before the situation normalizes).
And while reforms could attract investment, that simply isn’t enough to offset the pain of losing the power of the Brazilian consumer.
Morgan Stanley said in a recent note, “…we believe that by the second half of the year  we would witness a rebound of investment-led growth, which would grow by 2.4%Y that year, but this would not be enough to compensate for the weakness in consumption.”
And that’s a rosy scenario — one that would happen if reforms are implemented. Oppenheimer predicts that a rate hike is unlikely. Period. The country has an ugly history with such hikes, and political tensions are running high after protests leading up to and during the World Cup. Brazil is delicate.
“The volatility surface arguably indicates an expectation that a reform agenda may prevail (presupposing both that Silva wins and that it actually matters if she does),” Oppenheimer said in its note. “Again, we say good luck with that.”
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