The Brazilian economy will contract 3.6% this year according to the IMF, which will follow an estimated 4% plunge in 2015. The 33% depreciation of the real in 2015 contributed to an annual inflation of 10.7% in December. National unemployment ended the year around 10% and more than 1.5 million jobs were lost. The road ahead does not look promising. Political impasse and uncertainty are hurting the prospects of fast economic recovery.
In 2009, Brazil was awarded the 2016 Olympic Games. At that time, Brazil had been growing 5% on average in the previous five years. Under the leadership of Lula Da Silva, the country resisted the global financial crisis while many economies were sinking. Then, the Chinese economy slowed down. Obviously, the Olympic committee did not see it coming, and neither Brazil.
The weaker Chinese demand has contributed to the decline of commodity prices—iron ore and soybean particularly affecting Brazil. Low commodity prices now reveal poor labor productivity in Latin America’s largest economy and the unsustainable public spending that has averaged 40% in the last 5 years. The economic crisis will be so deep that, by 2018, Brazil will have the GDP it had in 2010. Fitch and S&P are now rating Brazil’s debt as junk, a debt that according to Barclays might reach 93% of GDP by 2019. All mixes with another problem illustrated in the graph below.
Dilma has been governing with the support of a coalition in Congress formed by her Workers Party (PT) and the Brazilian Democratic Movement Party (PMDB). That coalition has nevertheless been compromised by the weak performance of the economy and the corruption scandals that involve several governmental officials from both parties. There are currently more than 20 lawmakers under investigation for corruption charges.
The division in the governing coalition and Dilma´s declining popularity was fertile ground for a growing opposition faction, which reached more than 100 legislators asking for Dilma’s impeachment. They accused Rousseff for doctoring fiscal accounts, breaking campaign laws and for the corruption in Petrobras.
Dilma had to make important concessions to the PMDB in order to maintain the fragile alliance and avoid the impeachment process. That included giving away several cabinet positions to her own VP Michel Temer’s PMDB; however, that could not prevent the former speaker of the house, Eduardo Cunha, from accepting the impeachment. On December 2, he tried to divert the attention from his own corruption investigation using the Federal Accounts Court ruling on the government’s accounting practices to approve the impeachment request. Cunha went further holding a secret ballot so that coalition lawmakers could vote freely to put Dilma’s opponents on the impeachment committee that was expected to present its recommendations to the lower house for a vote.
On December 17, the Supreme Court declared the impeachment process was legal, but it also increased significantly the chances of blocking it. The court gave authority to the Senate to review the grounds for Rousseff’s impeachment and admit or reject it by simple majority. Rousseff has a much stronger position in the Senate. The court also ruled out the validity of the secret lower house ballot for the impeachment committee, forcing the selection of its members to be redone with an open vote.
Even without the Senate’s support, the impeachment has always had a low probability of moving forward. To start the hearing, 342 votes out of 513 (2/3) would be needed in the lower house. In other words, Dilma needs 172 legislators to block the impeachment. According to the local newspaper The S. Paulo State, the block that supports Dilma has 212 members, enough to stop impeachment.
The impeachment is also unlikely because even if the hearings start, Rousseff would have to step down and Temer, from the PMDB, would assume office during the recession’s darkest hours. It could pay better off to leave Dilma in office and then capitalize the social discontent in 2018 presidential elections.
Last week, we attended in New York a conference on Mexico’s Outlook. The IMF, BBVA, Control Risk and S&P concluded that Mexico is boring. However, boring is good enough for them. On the contrary, the political turmoil in Brazil is having real effects on the economy. In the following table, it is possible to see how several key moments in Brazil have affected the value of the Real and have increased the country’s risk (measured in EMBI+ Brazil spread), thus increasing borrowing costs.
On February 02, lawmakers returned from Christmas recess with a large agenda. They will have to discuss the impeachment process, tax increases and the plan to trim pension benefits. We probably will not see much soon—with the exception of the impeachment decision, which is expected after March. Political parties will wait until October’s municipal elections are put behind to begin taking unpopular decisions.
LATAM PM’s Expectations: Brazil will not be able to avoid a 2010s lost decade. Increased conflict between the President and Congress is preventing key policy changes from happening. Elections later this year do not help either for the implementation of so-much needed fiscal reform. At the end, Brazil will have to go through a process that can last 2-3 years. The good news is that this might already be taking place. In 2015, current account deficit shrank to 60 billion from 104 billion in 2014 and will probably end at 4% of GDP. Unemployment is also showing some signs of improvement in some urban areas. The noise coming from politics will remain relevant, especially regarding fiscal policy. Still, the lack of policy response might compromise Brazil’s solvency in the medium term. We hope not.