Political deadlock shows Brazilian markets could get even worse

. Apr 24, 2020
Political lockdown shows Brazilian markets could get even worse Photo: Renato P. Castilho/Shutterstock

As outgoing Justice Minister Sergio Moro leveled severe accusations of political interference in the country’s Federal Police, he wasn’t only compromising President Jair Bolsonaro — but also materializing Brazilian investors’ worst-case scenario: an institutional crisis that may paralyze the country during a recession brought about by the worst pandemic in a century.

The market’s reactions to Mr. Moro’s accusations were immediate and severe. Soon after the end of his press briefing, Brazil’s benchmark stocks index, Ibovespa, crashed by 9.5 percent — hovering just above circuit-break levels. The Brazilian Real plummeted to new record nominal lows, bringing the foreign exchange ratio to USD 1 : BRL 5.74, despite the Central Bank’s U.S. Dollar auctions.

</p> <p>State-owned companies, often more sensitive to political shocks, followed the same route. The Banco do Brasil Bank (BBAS3) dropped by 8.3 percent, oil producer Petrobras (PETR4) dove 5 percent while energy holding Eletrobras (ELET6) plummeted an impressive 13 percent.</p> <p>The panic reflects the fear of a worst-case scenario that has taken investors by storm and also the instability that lies ahead, explains Veedha Investimentos economist Camila Abdelmalack. “We have always known politics was an issue interfering with economic policies, but no one was ready for an institutional deadlock amid a global health emergency. It is a severe problem that may become a structural issue for the country. It is the last thing that could happen right now,” she said in an interview with <strong>The Brazilian Report.</strong></p> <p>But this may just be an appetizer of what is yet to come. According to one Brazil-based fund manager, the crisis will paralyze the government, likely worsening the already-sizable economic damages caused by Covid-19.&nbsp; “I think we can expect a government that will perish and keep increasing expenditure, in a moment when you need the government to be aligned with Congress. This is terrible. We will be in a scenario of penury while the political crisis lasts. There will be lots of uncertainty regarding Brazil’s ability to recover from the crisis”, the fund manager said to <strong>The Brazilian Report</strong> under anonymity due to the sensitivity of the matter.&nbsp;</p> <h2>Investors fear a second Argentina</h2> <p>The political chaos has helped make the Brazilian Real the worst-performing currency in the world against the U.S. Dollar–– it has already lost 42 percent of its value since January this year, despite multiple Central Bank interventions. The Argentinian Peso, in comparison, is down by 11 percent this year, even after the country decided to bail on its creditors again.&nbsp;&nbsp;</p> <p>The scenario has been aggravated by the withdrawal of foreign investors from the country — as they need to sell Brazilian assets and purchase U.S. Dollars to retrieve their funds. While many investors argued in the past few days that currency devaluation made Brazilian stocks cheaper to foreigners, an institutional crisis makes them too risky.&nbsp;</p> <p>“The risk is not worth it. We are flirting with an Argentinian scenario, the dynamic is becoming explosive. It is hard for foreigners to invest without an anchor in the currency”, said the fund manager.&nbsp;</p> <div class="flourish-embed flourish-chart" data-src="visualisation/2081799" data-url=""><script src=""></script></div> <p>Indeed, Brazilian bond yields were near limit highs in the morning, a sign that investors are demanding more premiums to keep the assets &#8211; or simply ditching them. Moreover, Brazilian Credit Default Swaps (CDS5), considered as a measure of the likelihood of default by a country and, therefore, how risky it is to invest there, jumped by 4%, to 323 points, bringing the total rise to 11 percent in just a week.&nbsp;</p> <p>This scenario, says Ms. Abdelmalack, will probably intensify the movement of foreign investors’ departure in search of better risk and return relations in other emerging markets, <a href="">as we have already seen</a> over the past few months. It also represents a change in investors’ view that the Central Bank could adopt a more dovish approach on its monetary policy meeting on May 6. As we’ve reported in our <a href="">April 23 Daily briefing</a>, investors took Chairman Roberto Campos Neto’s remarks that the economic scenario had changed after the last meeting as a sign of further monetary easing. But since this morning an explosive uncertainty factor has been added to the mix.</p> <p>“In the past few days, investors were precifying a more aggressive cut (on Selic rate), now it is correcting. If the Central Bank decides to slash it, it will be less aggressive due to the uncertainty. Regarding the forex policy, I believe they won’t change their rationale and will remain making few interventions”, said Ms. Abdelmalack.&nbsp;&nbsp;</p> <h2>Last man standing</h2> <p>After his victory in the 2018 election, President Bolsonaro placed a bet on appointing “superministers” to give political legitimacy to his cabinet.These superministers, Mr. Moro and Economy Minister Paulo Guedes, were seen as the cornerstones of the Bolsonaro administration.&nbsp;</p> <p>A liberal economist educated at the University of Chicago, Mr. Guedes has enjoyed unrestricted support and trust from investors, in order to promote what the minister himself used to portray as a “liberal shock” to Brazil. While the approval of the most comprehensive pension reform in Brazil’s history amounted to a major victory in 2019, the <a href="">minister has had a rocky start to 2020</a>, with several alarming moments that exposed not only his own lack of political skills, but the lack of support he has so far received from the president.</p> <p>Over the course of the Covid-19 crisis, the minister has been largely sidelined, with Congress approving ballooning public expenditures through massive aid packages that passed without the economic team having a say on it. This week, the cracks became increasingly evident as the military wing of the government presented its Pro-Brazil plan — a Brazilian version of the “Marshall Plan,” designed to rescue the economy through infrastructure investments — which <a href="">goes against Mr. Guedes’s plan</a> of sponsoring a recovery with private investments, in order to maintain balanced public accounts.&nbsp;</p> <p>Apprehension about the future of the minister grew this afternoon, as the minister reportedly canceled events and has now scheduled a meeting with Chief of Staff General Braga Netto this afternoon, one of the plan’s supporters. Per Levante Investimentos political analyst Felipe Berenguer, the developments of the plan and Mr. Guedes will be fundamental to predict his future in the cabinet.</p> <p>“Initially, the plan goes against Mr. Guedes’ beliefs, but I believe he may live with it if there are some adjustments, like increasing the participation of the private sector. (&#8230;) We must keep an eye if Guedes and his team will enter in a collision course with Gen. Braga Neto and other sectors that came up with the Pro-Brasil plan”, he told <strong>The Brazilian Report. </strong>“If he falls, then we are speaking of an even more dysfunctional government.”</p> <p>An eventual departure from government, says the fund manager, “is absolutely concerning,” but it wouldn’t be a surprise. “We have always known he has this interventionist style in the economy. [Mr. Bolsonaro] is not a liberal, he has become one to get elected. However, Mr. Moro’s departure had such a bad repercussion that I believe they will not try to oust Guedes right now”, said the source.&nbsp;</p> <p>Without his two mainstays, president Bolsonaro risks putting his neck on the line, deepening the institutional crisis, in Ms. Abdelmalack’s view.&nbsp;</p> <p>“When you have an institutional crisis, this causes a massive apprehension for the markets. It will be even worse if Mr. Guedes leaves. Also, one of the hot topics this morning was the Supreme Court’s <a href="">talking of impeachment</a>. The market now is starting to evaluate possibilities.”

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Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Before joining The Brazilian Report, she worked as an editor for Trading News, the information division from the TradersClub investor community.

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