Brazilian assets were already facing a difficult start to 2021.
The second wave of Covid-19 that struck globally late last year is still rising to the top in the nation of 213 million, with cases at a record high. The cash payments, or corona coupons, that supported much of the population during the pandemic expired last month. Politicians face the unenviable task of cutting them now or breaking a spending ceiling that keeps debt levels and a chronically weak currency within limits.
Now, President Jair Bolsonaro has started his re-election campaign a year earlier. That’s what investors fear, if anything, since the self-described “Trump of the Tropics” fired the CEO of the state oil company.
(ticker: PBR) on February 19.
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The exchange-traded fund (EWZ), which already skipped the emerging markets rally earlier this year, has fallen more than 7% since then.
As the company is known, it is not that important on its own: about 5% of the stock index. Observers for Brazil are concerned that it sets a pattern. The deposed chief’s sin was raising fuel prices in line with crude oil, never a popular development.
If Bolsonaro, who faces voters in October 2022, plays with the crowd during the pending tax debate, the consequences would be more dire. “Bolsonaro’s decision to replace the CEO of Petrobras is dashing hopes that Brazil will return to economic orthodoxy,” conclude analysts at BCA Research.
The optimism about Brazil has been based on the assumption that Bolsonaro would stick to his favorite social issues and leave economic policy to Finance Minister Paulo Guedes, a Ph.D. from the University of Chicago. who loves markets. That worked in 2019: Guedes led a long-overdue pension reform through the country’s cumbersome Congress.
Hope blossomed for more reforms this year, as both houses elected leaders friendly to Guedes in January. The lower house passed a bill on central bank independence, a key liberal goal. But Bolsonaro, whose popularity increased with the generosity of the crown bond last year, may not stay out again.
“Bolsonaro has discovered the wonder of social support payments,” says Thiago de Aragao, who follows Brazil at the Center for Strategic and International Studies.
That makes investors wary despite some tantalizing valuations at the Latin American giant. “Markets were no longer willing to rely on enough tax reforms,” says Aaron Hurd, senior manager of foreign exchange portfolio at State Street Global Advisors. “Now we see that Bolsonaro is not working hand in hand with the finance minister.”
A more optimistic view comes from Malcolm Dorson, Latin America portfolio manager at Mirae Asset Global Investments. Things can be tough in Brazil, but not tough enough to justify a 30% drop over the past year in the shares of its two largest private banks.
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“Delinquent loans are lower than expected, so you should see a quick rise in earnings,” he predicts. Dorson also expects good macro news, as Congress passes a reasonable spending package next month and the underrated public health service ramps up Covid vaccines.
De Aragao anticipates a mix of positive and negative headlines from Brazil this year. Congress could still surprise to the upside with a tax reform bill, but it will struggle to thread the fiscal needle as the pandemic drags on, it predicts.
“It is rare in Brazil for something terrible or terrible to happen,” he says.
That confusion won’t be enough to get the markets excited.