Brazilian markets look for Silva lining
September 23, 2014 8:50 am F.Time
By Joe Leahy in São Paulo
The presidential candidate of the Brazilian Socialist Party, Marina Silva presents her project of government on August 29, 2014 in Sao Paulo, Brazil. Brazil's general elections will take place October 5th. AFP PHOTO/Miguel SCHINCARIOL (Photo credit should read Miguel Schincariol/AFP/Getty Images)
©AFP
Marina Silva’s camp has suggested she would adopt more orthodox economic policies
In investment bank trading rooms in Brazil’s financial hub, São Paulo, a calculation of a different kind is keeping dealers busy these days.
Instead of the usual obsession with economic or corporate data, traders are trying to predict the likely outcome of an epic battle between the two women who are leading this year’s presidential election – the incumbent head of state Dilma Rousseff and upstart candidate Marina Silva.
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Polls show Silva, a former senator, environmentalist and social democrat with a more orthodox economic agenda, will finish behind in the first round run-off of the election scheduled for October 5, but that she retains a narrow 1 or 2 percentage point lead in the second and deciding round on October 26. Ms Rousseff, from the centre-left Workers’ party who is unpopular with markets for her allegedly interventionist policies, is catching up. Every improvement in her chances elicits a violently negative reaction from the markets.
“We have people going crazy up there,” says the head of one foreign bank in São Paulo of the traders on the floor above his office. “People are making bets on the polls and then getting ready to jump out the window if they get it wrong.”
São Paulo’s benchmark Ibovespa stock index has gained more than 10 per cent since January, nearly touching a high of 62,000 points this month, before ceding the advances. The losses follow speculation Ms Rousseff will make a comeback in the polls.
The markets have become so sensitive to the election that local media point to an “electoral kit” of stocks whose fortunes are closely linked to government regulation.
These include Petrobras, the state-owned oil company, which is being forced to offer a fuel price subsidy by the government without compensation, electricity provider Electrobras, which investors worry is also subject to government interference on price controls, and the major banks, Itaú-Unibanco, Banco do Brasil and Bradesco, which have also suffered from intervention over the past four years.
The real has traded at between R$2.20 and slightly above R$2.40 during the year, with recent weakening said to be due more to negative sentiment on emerging markets generally than Brazilian factors.
Many analysts say the central bank maintains a “dirty float” of the real, controlling the exchange rate through a huge swap programme backed by its large store of external reserves.
The capital markets like Ms Silva’s proposed economic programme, which would largely follow the inflation-targeting model of the two most successful presidents in Brazil’s recent history, Luiz Inácio Lula da Silva and Fernando Henrique Cardoso.
Ms Rousseff was criticised for departing from this model by stimulating the economy through ad hoc tax breaks, while trying to control inflation not only through monetary policy but through the currency and fuel and energy prices. During her tenure, the central bank has not sustainably reduced inflation to the centre of its target range of 4.5 per cent plus or minus 2 per cent.
With economic growth slipping into recession in the first half of the year, economists are concerned about what might happen under a second Rousseff administration.
“To us, the real uncertainty is not with how Silva would govern, but with President Dilma,” said Tony Volpon, economist with Nomura, in a note this week.
Ms Rousseff’s government blames an adverse global economy for Brazil’s problems. But economists say no matter who wins the election, the next president will face stark choices.
“The maintenance of the policies observed since 2009 would probably lead to Brazil losing its investment grade status and to another debt crisis after 2016,” says Marcos Casarin, Latin America economist with Oxford Economics.
He says that between 2011 and 2014, government non-financial expenditure outpaced gross domestic product by 2 percentage points, helped by tax breaks for industry. The real was kept artificially strong at below R$2.35 against the dollar to help with inflation.
He adds that if the next government maintains these policies, as well as a policy of allowing minimum wage increases based on the previous year’s inflation plus GDP growth, Brazil would cease booking a primary surplus – a budget surplus before interest payments – in 2016.
By the next election in 2018, public debt would reach 70 per cent of GDP, not excessive by developed country’s standards but problematic for Brazil with its high interest rates.
Economic growth would continue to muddle along at about or under 2 per cent a year and unemployment would begin to rise.
If Brazil, however, began making tough adjustments next year, such as increasing the primary surplus to 2-3 per cent of GDP, it would receive a credit ratings upgrade by 2018. Giving the central bank independence as Ms Silva is proposing would enable it to deliver a shock to inflation, reducing it to about 3.5 per cent in four years. The benchmark Selic interest rate could then fall to an all-time low of about 5.5 per cent.
“Whether or not Brazil experiences a debt crisis by 2016-17 remains to be seen,” Mr Casarin says in a report. “What we know for sure is that it can be avoided, but the adjustment needed will involve some short-term pain.”
The same goes for markets. Few believe that, should Ms Rousseff win, there will be an attack on the real given the central bank’s iron hold on the currency. But any surprises on the positive or negative side will send an already giddy Bovespa reeling further.
