Brazilian election: Prospects for change?
With a runoff now set between incumbent Dilma Rousseff and challenger Aécio Neves, markets seem hopeful for a departure from disappointing policies. Neuberger Berman’s Ram Chandran, senior portfolio manager, Emerging Markets Debt and Marco Spinar, associate portfolio manager, Emerging Markets Equities, comment:
Over the past four years, Brazilian President Dilma Rousseff has employed an interventionist approach in seeking to stimulate growth in South America’s largest economy, which has faced pressure with the receding commodities boom. However, the government’s failure to recognize the changing global environment has placed it in a difficult spot with respect to inflation and fiscal balance.
Capital market results have reflected these problems, as the country’s equities have generally declined and the spread on its sovereign debt has widened relative to the likes of Mexico and Colombia. In addition, inflation breakeven levels have widened and the country’s central bank has been forced to intervene in the foreign exchange market to mitigate volatility.
Sunday’s election contest appeared to raise hope for a change. Although Rousseff, the Workers’ Party candidate, attracted roughly 41% of the vote (with 94% of ballots counted), it was not enough to avoid a runoff election with her nearest rival, Social Democrat Aécio Neves, who appeared to gain momentum with a 34% showing. A senator and scion of a well-known political family, Neves has a reputation as a moderate and competent public servant, who drew praise for his stint as governor of Minas Gerais, Brazil’s second most populous state.
Marina Silva, a popular figure from the Socialist Party, faded to just 21% of the vote, after leading in the polls only a few weeks earlier. A late replacement for Eduardo Campos, who died in a plane crash on August 13, Silva initially benefited from sympathy and her profile as a potential reformist, but faded under pressure from campaign missteps and critical ads from the Rousseff camp.
Markets Shadow Politics
Recent market action has often been influenced by the political race. Along with emerging markets (EM) equities generally, Brazilian stocks rallied starting in February on the back of softening EM currency declines and easier credit tied to lower yields in the U.S. But partially reflecting cheap valuations and low expectations, the country’s equities have primarily moved up (or down) during periods of hope (or pessimism) as to political change, such as when Silva seemed to gain momentum.
In debt markets, the strength of the dollar has recently prompted declines generally. However, polling has influenced the Brazilian yield curve, which flattened with optimism around Silva, only to steepen again as her prospects faded.
With the runoff election set for October 26, Rousseff appears to be the favourite. Despite recent economic weakness, the Workers Party enjoys good will tied to antipoverty programs — and concern that more conservative policies will worsen income inequality.
Still, the situation is fluid, especially given uncertainty as to where Silva’s voting bloc will cast their support. In terms of election tactics, Rousseff will no longer have a dominant hold on TV ads, which prior to the first round were apportioned based on representation in Congress, but will now be equally weighted between the two candidates — helping to level the playing field.
Financial markets have reacted very positively to Neves’ new traction in the election, given his business-friendly profile, and will most likelycontinue to move based on prospects for change.
Irrespective of who wins the election, however, Brazilian growth has been subdued and forecasts remain so for the next year, highlighting the need for economic reforms to recover and sustain growth. If Rousseff does in fact emerge with a victory, we expect to see unenthusiastic equity investors and pressure from widening bond spreads, which could force her to consider more aggressive actions on the economy.