A New Dawn For Brazil?

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Includes: BRZU, BZQ, DBBR, EWZ, FBZ, UBR
by: PIMCO

Anti-establishment candidate Jair Bolsonaro prevailed as expected in Brazil's presidential election on 28 October, having run on a socially conservative "more Brazil, less Brasilia" platform. This included promises to reduce corruption, increase security, allow gun ownership and oppose the legalization of abortion. It was the first time since 2002 that Brazil's Workers' Party (PT) did not win the presidency.

Details on President-elect Bolsonaro's macroeconomic policy plans remain to be seen but are expected to focus on reducing government inefficiency and state intervention in the economy, while keeping state control over more strategic industries. His acceptance speech was constructive and business-friendly, emphasizing the importance of private property and individual freedom. In particular, he plans to focus on employment, income and reining in Brazil's fiscal deficit to curtail increasing debt ratios.

Brazil's markets rallied for some time before the election, particularly after the first round on 7 October, as uncertainty over the outcome declined. The markets also responded positively to the second round results on 29 October: Local yields rallied by 10 to 15 basis points and credit spreads tightened three to five basis points. Meanwhile the Brazilian real, which strengthened initially, weakened as investors took profits and emerging market currencies declined in general.

Despite this reaction, Bolsonaro faces important challenges that should give pause to investors:

  • In spite of his close to 10 percentage-point victory, Brazil remains a highly polarized society with 45% of votes cast for the opposition candidate. This means Bolsonaro will start with a higher rejection rate than previous presidents, and as a result, his honeymoon is likely to be short.
  • Congress remains highly fragmented, with around 30 parties in the Lower House, close to 21 parties in the Senate and a high turnover of seats. This means that passing much-needed social security reform will be difficult, particularly as it will require at least 60% of support in two votes in each house per the usual process. Also, Bolsonaro has promised to build a coalition without the usual pork-barreling and assignment of official positions, which suggests that the negotiation process may be noisier and more drawn out than usual.
  • Bolsonaro's lack of legislative track record is another area of uncertainty for investors and politicians alike, as his approach and position on key issues remain relatively unknown.
  • His military background has also raised concerns about risks to individual liberty and the democratic process, which could result in more social activism from the electorate than usual. Given his lack of constitutional mandate, we view the risks of increasing militarization as low. The strength of Brazil's independent judiciary and its free and open press are positive counterbalances in this regard.

For investors, next to watch are the official announcements of the Cabinet, the minister of finance (widely expected to be market-friendly economist Paulo Guedes) and the governor of the central bank, who is typically appointed by the incoming administration. Our base case is for a business-friendly team with a focus on macro stability and reducing the fiscal deficit. We also expect some form of social security reform to be passed in 2019, but whether this will be piecemeal or the deep-seated reform that Brazil requires is difficult to predict yet.

Is this a new dawn for Brazil? That remains to be seen, but for now, the financial markets are giving Bolsonaro the benefit of the doubt.

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