We're about to find out what Brazil is made of

Brazil is in the middle of a dangerous confidence game.

On Friday, Petrobras, the $US65 billion quasi state oil company that was once the crown jewel of Brazil’s now-struggling economy will report its delayed first quarter earnings. Wall Street expects losses. The question is whether the number (a large one) will be believable — whether or not Brazil is putting all its cards on the table.

If investors believe it isn’t, Brazil will lose the game. See, confidence in this company is very fragile thing.

Here’s why: Petrobras stock fell almost 50% when authorities uncovered a corruption scandal that has reached the highest levels of the country’s government, exposing mismanagement and bribery at a scale unseen in Brazilian history. This year, in hopes the the country can recover, the stock has rallied over 30%.

That’s how fast Wall Street can turn on you.

It all started last August when federal agents raided office buildings as part of ‘Operation Car Wash.’ After that the allegations started flying. The ruling PT party, investigators said, had used Petrobras like its own personal piggy bank. The PT handed out kickbacks, paid for political campaigns, and subsidized energy for the Brazilian people at the expense of Petrobras’ own health.

Again this is a confidence game now. Investors want to know whether or not the country can take the correct, difficult steps to recover. There have been signs that it will. President Dilma Rousseff installed a finance minister named Joaquim “Scissorhands” Levy to slash budgets. High level members of her own party have been arrested.

Then again Rousseff, who was once an executive at the company herself, has basically been granted immunity. She was also reelected by a tiny margin in October.

“Those who have a deeper understanding know that Brazil is one of the most transparent countries in the world,” the country’s Finance Minister Joaquim Levy said at a Bloomberg America’s Summit in New York last month. “Everything is discussed openly… people who do wrong things go to jail… This is why I’m confident about Petrobras, there has been a chance in the way it is managed.”

Levy said that just before the company announced that it lost $US2.1 billion due to the corruption scandal. The market liked that. It thought the whopping number was fair. When we see today’s numbers we’ll find out if the market still believes that — if it still believes that Brazil is being transparent about the work ahead.

Understand that Petrobras isn’t just a company. It’s a mirror in which Brazilians can see themselves. Fixing what’s happened at Petrobras will take sacrifice and patience at a scale to match the scandal.

Angry over this and government corruption surrounding the World Cup and upcoming Olympic Games, some Brazilian protestors have gotten so desperate that they’re calling for military intervention. A military junta ran Brazil from 1964 to 1985. The regime tortured the current Brazilian President, Dilma Rousseff, who was a dissident at the time.

On top of all this, the entire country is in economic trouble. The commodities it exported around the world — like oil and steel — have declined in price. Wall Street believes we’re at the bottom of a commodities super cycle, one in which countries like Brazil will have to find new footing until prices claw their way back up.

After Rousseff’s reelection, Societe Generale analyst Societe Generale analyst Dev Ashish put it like this:

“…the success of monetary policy depends on finding some alternative domestic source sof growth in the absence of greater demand (and prices) for commodities and other Brazilian exports. A lot will depend on how quickly the new government can work to restore investors’ confidence after the 26 October election, which would help not only growth but also to resolve the currency and inflation issues.”

So far Brazil is winning the confidence game. But one misstep and investors will turn. Everyone’s watching.

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