U.S. President Donald Trump isn’t the only one facing scrutiny amid allegations of obstruction of justice. His Brazilian counterpart, President Michel Temer, is facing an even graver crisis: Allegations against him on May 17 have quickly led to charges of obstruction of justice and impeachment requests.
Without delving into too much detail about the charges themselves—or passing value judgments on Mr. Temer or his administration—here is what we believe investors should know:
- In the short run, we expect more political turbulence and an economic toll as a result of delayed reforms, though we believe Brazil’s way forward is to follow its constitution and enforce the law.
Unfortunately for Mr. Temer, the revelations about his dealings—and the taped evidence that has surfaced to implicate him—do not bode well for the remainder of his term and the future of his administration. Additionally, the circumstances surrounding the taped evidence are yet unclear and could be the result of a scheme.
Not surprisingly, there are growing political and public pressures to pursue the current investigation to its fullest. There is also a growing chorus of discontent—from street protests to harsh criticisms by branches of government against Mr. Temer’s conduct, and even talk in the media of Brazil “being tested in unprecedented ways.”
Whether or not the president survives this crisis at the helm, we believe that Brazil’s constitution of 1988 and rule of law will bring an ultimate resolution, facilitate an orderly transition of power (if necessary), and pave the way for political and economic stabilization.
For now, the crisis seems to be exacting a temporary economic toll by delaying important reforms (see our previous blog on the subject).
- In the medium term, we remain constructive on Brazil.
Allegations against Brazil’s top political leadership, which amount to a political crisis, are an obviously negative development that investors should watch. But we argue that this crisis is likely to pan out in such a way that would likely not damage the country’s economic prospects to the degree it might seem. As a reminder, this crisis comes on the heels of significant economic advances made over the past few years, including lower inflation and a funded current account deficit. Overall, Brazil’s economy appears resilient, and economic policy is likely to stay on course—especially once the delayed and much-anticipated reforms are enacted.
Ultimately, there is an understanding—especially by Brazil’s congress—that a lack of reform could jeopardize economic recovery or even lead to a full-on economic crisis, with political implications.
- In the long term, this crisis may have a prophylactic effect that will lead to greater transparency and strengthen Brazil’s institutions.
There is already a clamor for more transparency in the economic relationships within and between the private and the public sectors. Additionally, we suspect this crisis to strengthen the public’s rejection of corruption.
From a political standpoint, we don’t think Brazil is likely to reject its traditional party system when it elects its president next year, unlike some of its fellow countries in the emerging and developed world (more in our previous blog on Mexico).
Our Prognosis for Brazil: Politics, Reforms and Economic Policy
In our view, recent political developments do not yet alter the case for investing in Brazil—nor do they revise the narrative of emerging markets at large, which we believe are poised to continue on a path of growth.
We believe this corruption scandal will delay but not derail the reforms, which will likely be enacted once the fate of the administration is determined. In our view, these reforms are critical and will benefit Brazil economically in the longer run.
In the meantime, with two years of economic recession already behind, and expectations of below-target inflation ahead, we believe interest rates will continue to come down from their current double-digits.
Since May 18, we tactically pared our positions in Brazilian assets. We changed our Brazilian local debt holdings by switching some of our positions in Brazilian inflation-linked bonds to positions in local-currency denominated instruments. We maintain our holdings in Brazilian external debt, which include a major state-owned oil company that has been exhibiting improving credit fundamentals.
We continue to be invested in local and external debt of emerging markets. These positions are independent of the current political affair in Brazil, though we’re keeping a watchful eye on developments and will assess future positions accordingly.
Brazil’s finance minister and his team held a conference call on May 22 to reassure investors that the government’s economic policy will not change—and it remains intent on pursuing reforms. Finally, the team emphasized that its current policy is the only one it believes to be the right one for Brazil’s future.
In summary, regardless of what happens on the political front, it is our view that Brazil’s economy will survive and not drift away from its current path.
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