Brazil – Be careful what you wish for
In the midst of Brazil’s current political crisis it appears as if the people want change and the markets want change. With the recent rally in Brazilian assets it has begun to look like these wishes may be closer to realisation.
Spurred on by the momentum of millions of Brazilians taking to the streets to protest against the current political system, the impeachment of president Dilma Rousseff has become a real possibility.
At this time however, we’d like to caution investors against any exuberance. The problems in Brazil are bigger than any one individual or group of individuals, the problems are structural. Although the protests have increased the chance of a successful impeachment, they have also weakened the entire Brazilian political system.
It’s important to bear in mind that the protests were not only against Rousseff’s administration, they were against the whole political system, including the opposition. Even if Rousseff leaves, the final political outcome is anyone’s guess, which makes any government transition a volatile proposition for the markets. For investors in particular, it’s very much a case of be careful what you wish for.
Behind all the political hubbub, what Brazil ultimately needs are structural reforms. They need to put fiscal anchors in place and boost investment confidence. Currently, with a fragmented congress in place and 27 parties in the House of Representatives, any coalition and any eventual agreement on structural reforms will be difficult to reach. This leads us to believe that any rally resulting from a change in leadership will be a short-lived one. Unless the new leadership can distance itself from corruption investigations and manages to form a solid coalition with enough political power to push through difficult structural reforms.
Otherwise it might be a long wait as new campaign finance laws come into effect in the 2018 elections, which make it harder for individual parties to raise money. Therefore, this should result in a less fragmented government, easing the decision making process and increasing the probability of enacting meaningful structural reforms.
The current global macro-environment has been supportive for risk assets and the advance in the impeachment process has given Brazil an extra push. In addition, we see the Brazilian real (BRL) outperforming many other emerging currencies year-to-date. While this trend could continue for a while, given still relatively light positioning in Brazil, we believe that the rally is not sustainable, and with the current market volatility it remains a very difficult proposition to time profitably.
Valentina Chen, senior portfolio manager, Vontobel Asset Management