EM managers react to Brazil issue

Emerging markets portfolio managers give their views on Brazil after the Lower House of Congress this week voted in favour of impeaching President Dilma Rousseff.

Gonzalo Pangaro, Portfolio Manager of the T. Rowe Price Emerging Markets Equity Fund

“Investor sentiment towards Brazil has already improved over the last few weeks as the probability of impeachment has risen. A confirmation of this process will likely improve sentiment further.

“Over the last five years, Dilma has been the driver of policies that have ultimately been harmful for the Brazilian economy and damaging for the fiscal and debt dynamics. The possibility of a change in government would at least be a first step in changing policy direction.

“Political change is needed to address the fiscal mess, with Brazil now back in a primary budget deficit for the first time in over a decade. While commodity price movements have been unhelpful, a large part of the fiscal deterioration has been due to government mismanagement.

“There are risks a prolonged extension of the economic downturn could cause further deterioration of the fiscal and debt dynamics and may make monetisation of the deficit unavoidable. Inflation and interest rates would then be anchored at high levels.

“All eyes are now on Vice President Michel Temer, who will take over as acting President. We believe he has no choice other than to move in the direction of market-friendly policies and inspire confidence of an economic revival.

“There will be much political risk, but social security reforms will need to be on the table as an anchor for fiscal consolidation, alongside other revenue raising measures and reforms to encourage investment.

Rob Drijkoningen, co-head of the Emerging Market Debt team at Neuberger Berman

“The impeachment vote constitutes another step forward towards a change in administration; a change we deem to be important considering the political stalemate weighing on the country.

“Economic and fiscal reforms are needed to pull the country out of the most severe recession in decades and adjust the budget balance.

“While the vote was an important step, we expect the impeachment trajectory will be bumpy and lead to volatility in Brazilian bond markets in the coming months.

“Not only is the process likely to take several months with three more voting rounds in the Senate, but protests from supporters of Rousseff’s Workers Party and potential union-led strikes are likely to spark further turmoil in the country.

“In terms of positioning, we have been overweight Brazil across our portfolios, based on a view the risk premia more than compensates for the deteriorating economic fundamentals, especially considering the relatively low levels of external debt and high international reserves.

“We also have an overweight to local rates in Brazil, as we expect inflation to come down from the recent peak. This is driven by weak growth and more stable FX levels. We have been trimming those overweight positions in recent months, taking some profits as Brazil bond markets rallied.

“Events in the coming months are likely to result in further volatility in Brazil bond markets, which justifies a limited risk position at current levels.”

Oliver Leyland, Senior Investment Analyst of the Hermes Global Emerging Markets Fund

“Having just returned from a research trip in Brazil, the mood is tense rather than outright optimistic at this stage. There is a sense of fatigue and animosity towards the political class, particularly given the scale of corruption being brought to light by the Lava Jato graft scandal.

“The economic reality is dire, with Brazil experiencing the worst recession in many decades. Unemployment is soaring, disposable incomes are being squeezed and business is holding off on any meaningful investment.

“The business community and investors are increasingly hopeful a change of government can usher in a period of necessary reform – with fiscal and social security reform the most pressing issues for the country.

“However, there is also an acknowledgement the path to reform will be uncertain and painful – with deep spending cuts required. Should we witness a critical stabilisation of the political backdrop and economy, confidence levels could rebound swiftly.

“We have seen a sharp re-rating of Brazilian markets this year, driven by a reduction in the risk premium. The Brazilian 5-year CDS has fallen from more than 500 points to under 350.

“For the longer-term structural bull case to be come to fruition, the renewed confidence must be followed up with reform and a recovery in corporate profitability from the current single-digit RoE levels.

“While the path is likely to be volatile, a number of the key buildings blocks may now finally be falling into place.”

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