A former left-wing labor leader is set to replace Brazil’s right-wing president and tear up the most important fiscal rule in the world’s 10th largest economy, but foreign investors are largely unfazed.
Their balanced outlook for Brazil, where the local currency and stock market have gained this year, reflects confidence that even a highly polarized election will not ruin the relative haven of Latin America’s largest economy. Polls suggest former President Luiz Inacio Lula da Silva will defeat incumbent President Jair Bolsonaro in October’s election, possibly even in Sunday’s first round, and take office in January.
“We have an overall positive medium-term view of investment opportunities in Brazil,” said Amer Bisat, head of emerging markets fixed income at BlackRock, pointing to an attractive mix of strong corporate earnings, a healthy, as well as large foreign exchange reserves and a current account surplus thanks to strong commodity exports. Lula, whose Workers’ Party took a largely orthodox path when in power from 2003 to 2010, has decried Bolsonaro’s policies, but both promise more generous social protection and more flexible fiscal rules.
Lula spent big on welfare programs for the first time, as a federal budget spurred by a commodity boom gave him breathing room. This time he will have less and he has already pledged to remove the constitutional spending cap. Yerlan Syzdykov, head of emerging markets at Amundi, said at a recent event that it was troubling to see Lula failing to meet Brazil’s current fiscal peg.
“But in the last two years neither has Bolsonaro, so it’s not something that comes as a shock to investors.” He said Lula’s track record in economic policy meant that any regime change would not be truly radical.
The Brazilian real is one of the few emerging market currencies to gain against the dollar which is more generally at multi-decade highs, while local and hard currency bonds are among the best performers in their class. assets. Equities are also up for the year in the local market and barely down in dollars, banks have healthy balance sheets and the labor market is rebounding, while inflation is receding thanks to increases in early and aggressive interest rates.
“The central bank, as an independent institution, has proven its credibility by being one of the world’s first central banks to fight inflation with vigor and determination,” said BlackRock’s Bisat. Central bank chief Roberto Campos Neto, whose term runs until 2024 under a new law establishing the bank’s formal autonomy, oversaw a series of rate hikes before the US Federal Reserve and helped to support the real.
Despite Workers’ Party economists complaining about the central bank’s newfound independence, Lula said he could work constructively with Campos Neto. “It’s important that he (stays) because otherwise what’s the point of having a term as a central bank governor independent of the political cycle,” said Graham Stock, emerging sovereign strategist at BlueBay Asset Management, noting the opportunity for Lula and his team to show that they respect the independence of the bank and the inflation targeting regime.
In what Goldman Sachs called a “hawkish hold,” the central bank paused last week after raising the key rate from a record 2% early last year to 13.75%, with forward guidance hinting at a “high for long”. position. “We are seeing high real returns, which is unheard of in the market right now,” Philip Meier, head of emerging debt at Gramercy Funds Management, told investors, calling Brazil a “great opportunity” through 2023.
Even with the dollar at a 20-year high against a basket of major currencies, the Brazilian real is up 4% this year against the greenback, the best-performing free-floating emerging market currency. Not all investors are so bullish and JPMorgan, which cut Brazilian currency-denominated debt to “underweight” earlier this month, said further upside for the country in global credit markets may be limited.
“Political and political uncertainties are expected to persist ahead of the October election, and fiscal/debt dynamics remain a concern,” said Lupin Rahman, head of sovereign credit in the emerging markets portfolio management team. at Pimco. Valuations for Brazilian equities, however, remain cheap – investors in the MSCI Brazil index are paying around $6 for every dollar in revenue, down from nearly $18 at the 2020 peak.
Investors will be looking for a smooth political transition. Bolsonaro has laid the groundwork to contest a defeat but Brazilian institutions are closing ranks to ensure the integrity of the vote. Lula could make it difficult for Bolsonaro to mount a challenge if he gets more than 50% of valid votes on Sunday, waiving the need for a runoff on October 30. Several recent polls show the former union leader at a striking distance from that threshold.
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