Brazil Politics September 2016


Brazil: Impeachment saga ends, but politics still threaten to hinder economy

September 9, 2016

After an over-six-month saga, Dilma Rousseff was stripped of the presidency on 31 August for breaking fiscal laws, prolonging acting President Michel Temer’s mandate to 2018. The end of the impeachment trial should bode well for the battered Brazilian economy, as the government will now be able to turn its full attention to its reform agenda. While the economic decline appears to have bottomed out—GDP fell at the softest pace in one year in Q2—an unpopular fiscal adjustment is needed to improve the growth trajectory. Gross public debt came in at nearly 70% of GDP and the fiscal deficit at just under 10% in July. However, the end of the impeachment proceedings will not be a magic bullet and a number of unknowns are clouding the reform outlook.

The top priority for the government should be to reduce public spending and implement a badly needed overhaul of the pension and social security system. Temer has advocated market-friendly reforms and his party, the Brazilian Democratic Movement Party (Partido do Movimento Democrático Brasileiro, PMDB), is more right-leaning than Rousseff’s Workers’ Party (Partido dos Trabalhadores, PT), which has helped lift economic sentiment in recent months. Temer has pledged to push privatization plans and proposed a key constitutional amendment to limit federal spending, which still needs to be passed by Congress. Despite this step in the right direction, political risks are still high enough to jeopardize a speedy recovery and Temer’s government could suffer from similar setbacks to those that plagued Rousseff’s administration.

Specifically, it is unclear if Temer has the support needed to push tough reforms through Brazil’s fragmented Congress quickly. Cuts to social spending will be deeply unpopular and there is a large risk of bills being watered down as they pass through Congress. Moreover, Temer’s approval ratings are low and wide-scale protests for fresh elections have been held since he assumed power. His party has also been rocked by the Petrobras corruption scandal that tainted Rousseff’s PT and a new corruption investigation launched in early September targeting state-run pension funds has the potential to increase already high anti-government sentiment. In addition, Eduardo Cunha, the former speaker of the lower house and a member of Temer’s PMDB, is facing a trial over corruption allegations. In a surprising move that has been seen as a loss for Temer, Congress voted not to strip Rousseff of her political rights, meaning that she is still able to run for office or hold a public post again. Despite these risks Gustavo Rangel, Chief Economist for Latin America at ING, has an optimistic outlook:

“I have a fairly constructive view vis-à-vis Temer’s ability to approve a substantive fiscal reform starting with the approval of a spending ceiling bill before yearend. The administration understands that without a fiscal anchor, Brazil’s outlook will deteriorate markedly, eliminating any prospect of a sustained recovery. Congress is likely to resist some unpopular aspects of the reform, but the administration’s large Congressional base and savvy political leadership should help get the reform approved. Without the approval of this reform, I would expect the market to downgrade materially its outlook for Brazil, and the risk of further credit-rating downgrades would rise. As for the risk of political upheaval, I consider it to be limited, and it would tend to drop if economic indicators maintain their (expected) upward trajectory in the coming quarters.”

In addition, Bruno C. Rovai, Economist at Barclays Capital, sees progress being made on economic reforms adding:

“We do expect that the New Fiscal Regime will be approved by the Congress, as we do take into account expenditures growing at the previous year’s inflation rate. On the pension reform, we remain a bit more skeptical, although we do reckon that conditions are here to have it approved: Temer does enjoy a large support base in the Congress, and the pension fund deficit is already at alarmingly levels, making it a present problem – in opposite to reforms that are due to fix future problems. Finally, my concern on the political front is with Eduardo Cunha’s mandate repeal. If the House of Representatives vote to revoke his mandate and then he becomes an ordinary citizen, he loses his parliamentary immunity and could sign a plea bargain with the public prosecutor’s office. While we do not have any information on this, nor on the content with a possible plea bargain, we do concern that it could bring a lot of uncertainty to the Congressional agenda/routine.”

The economy is expected to remain in a deep recession this year and only mildly recover next year, even though the political noise will likely subside. A fiscal adjustment will further dampen consumption in the near-term and the real has strengthened nearly 20% year-to-date, which could hurt export revenues.

Against this backdrop, our panel of analysts see the economy contracting 3.3% in 2016, which is unchanged from last month’s estimate. For 2017, the panel sees the economy growing 1.0%.

Author: Angela Bouzanis, Lead Economist

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Brazil Politics Chart

Brazil Gov Finance July 2016 1

Note: Gross Public Debt (% of GDP) and Fiscal Balance (% of GDP).
Source: Central Bank of Brazil (Banco Central do Brasil).

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