Brazilian Investors Exude Complacency Amid Political Woes

10/18/2017 - 12h49

When Jair Messias Bolsonaro, Brazil's far-right politician, returned from a controversial grand tour of the US last week, he posted a huge "Thank you, USA!" graphic on his Facebook page.

The former army captain-turned-lawmaker is known for choice quotes, such as telling a fellow congresswoman he would not rape her because she did not "deserve it" and that the biggest mistake of Brazil's former military dictatorship was to torture rather than kill its victims.

With Brazil suffering from a political vacuum after a big corruption probe and two-year recession, he was hoping his US trip might help him migrate from the fringe to the centre of politics.

It was also a timely reminder to investors who have been driving Brazil's market up to record heights - with the benchmark Ibovespa gaining nearly 28 per cent this year - of the political risks that lie ahead for one of the world's best-performing emerging markets.

The country is facing one of the most unpredictable presidential elections in its history in October next year. Yet markets have been steadily lulled into complacency by a mixture of accommodating global liquidity conditions and a turnround in Brazil's economy.

This week, the government of President Michel Temer, himself the product of political turbulence after he took power last year following the impeachment of his leftist predecessor, Dilma Rousseff, released on WhatsApp a chart showing the rebound.

Inflation has fallen 6.8 percentage points since April 2016, gross domestic product is expanding slightly after shrinking last year and the economy was adding jobs.

Bellwether stocks, such as state-owned oil company Petrobras, which was the centre of the corruption scandals, have cleaned up governance and their share prices have rebounded.

After the spendthrift days of Ms Rousseff, when the budget deficit seemed out of control, Mr Temer's government has sold investors a narrative of fiscal responsibility and market reforms in the oil, labour and other sectors.

So good has the ride been that some investors are beginning to convince themselves that the next president, no matter who he or she is, will continue with the Temer reforms.

This would make great sense. After all, Mr Temer has not yet been able to deliver the most important thing, a constitutional amendment to overhaul Brazil's generous pension system.

Unless the average retirement age is extended from the mid-50s to the mid-60s within the next couple of years, pension and payroll spending will explode.

But there are two problems with the market's belief that a new more orthodox economic consensus will prevail. First, no one has a clue who will be the next president.

The rise of once peripheral figures such as Mr Bolsonaro shows the extent of the vacuum. The top candidates in opinion polls are former president and leftist firebrand Luiz Inácio Lula da Silva followed by Mr Bolsonaro. Most worrying for markets would be a return of Mr Lula da Silva.

But he has been convicted for corruption and will be prevented from running if he loses an appeal against the ruling. Also, polls show more voters rejecting him than liking him. Mr Bolsonaro would also probably be seen as too socially divisive.

Investors would be more comfortable with São Paulo mayor João Doria, a political newcomer who models himself on New York billionaire Michael Bloomberg, or his former political patron and now rival, the conservative São Paulo state governor Geraldo Alckmin.

But Mr Doria is inexperienced and little known outside his home city. Mr Alckmin is seen as old guard in an election in which voters are expected to reject the political establishment.

The second problem is that Brazilians traditionally favour big governments and social benefits. Populist candidates promising to alleviate the recession through spending programmes could do well.

On the other hand, candidates who talk about pension cuts and privatisations, could end up winning the markets but losing the election.

Investors might do well to remember that Mr Bolsonaro's middle name, "Messias", translates as "Messiah". While voters are expected not to fall completely for a Messianic populist, fiscal and economic responsibility may prove a harder sell than many investors are expecting.

Copyright The Financial Times Limited 2017