A lot of momentum

Maarten janbakkum
Maarten-Jan Bakkum

Brazil, one of the best markets in 2016, has clearly underperformed in the last few weeks. Meanwhile, we are getting closer to the moment of truth: far-reaching reforms to the Brazilian pension system in order to make the government budget and debt manageable again. By April, it should be clear when exactly Congress will vote on these reforms. Until then, protests will probably swell and uncertainty about dilution of the proposed reforms are likely to rise. This explains why the Brazilian market has recently been under some pressure.

The reforms will ultimately be carried through. The average retirement age in Brazil will inevitably rise from 55 to 65. The same applies to equal rules for men and women (on average, Brazilian women now retire five years earlier than men do). For Michel Temer’s government, these two rules are non-negotiable. There is room for negotiation only around the pace of implementation. Too many concessions may fuel concerns about the manageability of the public debt.

Even if the government were to implement the plans as proposed, then the public debt would still rise from the current 70% of GDP to around 95% of GDP. So a slight alteration of the reforms could quickly push the debt ratio to over 100%. The budget deficit currently stands at 8% of GDP. As a result of rapidly declining interest rates, the deficit has already fallen sharply (from 11% a year ago), but the smallest doubt about the implementation process of the pension reforms would lead to higher interest rates and make debt stabilisation more difficult to achieve.

It is really a wonder that the Brazilian Congress will probably vote on the pension reforms in May, as it seemed unlikely a year ago. Yet this was before the impeachment of President Dilma. There are still many doubts about the legality of last year’s impeachment process, but the fact is that the new government has taken the most urgent reforms forward. They are making progress on all economic fronts: in addition to the essential pension reforms, there are now strict rules to limit government spending, widespread credit subsidies are scaled back, several sectors are being deregulated and privatized, and far-reaching reforms are being prepared on the labour market and taxes.

A team of technocrats will work out all these reforms. They can focus on their particular policy area, because the political game is in the hands of President Temer and his right-hand man, Eliseu Padilha. These two men have proved to be able to get the necessary political support in Congress.

There will be Presidential elections in October 2018, so there is still time for new policies. The interim government seems to have the insights, the intention and political capital to tackle Brazil’s biggest economic challenges. It is therefore likely that confidence in Brazil will continue to improve, with interest rates declining more and growth ultimately recovering. However, risks are still present, like key individuals in the Temer government stepping down because of possible involvement in one of the major corruption scandals, or a correction in commodity prices because of a Chinese slowdown.

In the longer term, the large income inequality and the poor education system remain major challenges. However, the financial risks seem manageable for now. And most importantly, no other market in the emerging world has greater reform momentum than Brazil right now.