Brazil's Window of Opportunity Starts to Close


Photo Credit: Eraldo Peres/The Associated Press

 

Important economic and sectorial reforms are at stake as President Temer’s Government comes to an end and center candidates lose steam ahead of October Elections.

Brazil’s economic outlook has improved significantly since President Michel Temer became Acting President in May 2016 and took office three months later, following the tumultuous impeachment and removal of his predecessor Dilma Rousseff. Since then, his government has survived appalling corruption scandals while approving important reforms such as the modernization of Brazil’s byzantine labor laws and the implementation of a 20 year expense ceiling to control the Federal Government’s rising costs.

However, Temer’s truce with markets has come to an end after he failed to approve other important measures, such as the Pension System Reform, and has preferred to use his remaining political capital to shield himself from further corruption investigations. This is especially alarming to investors, as voter turnout surveys for October’s presidential and legislative elections point to a challenging outlook for center candidates who are particularly impacted by the criminalization of politics and society's outrage at economic mismanagement.

The growing local market volatility comes not only from the worsening prospects for the upcoming elections, but also from the fear that despite recently announcing he will not seek re-election, Temer will give up promoting unpopular, but much needed, economic reforms and choose populist measures to boost his party’s chances on the ballot.

 

It's Not Over Until It's Over

Although fading fast, there is still hope that Temer and his party MDB will choose legacy over opportunism, as a lot can still be done on important microeconomic reforms that have been years in the making but yet to be formally implemented:

  • For instance, the improvement of the “positive credit register” foresees the automatic adhesion of consumers (except for those who explicitly oppose it) to the so-called credit bureaus. These institutions collect information on up-to-date payments from consumers, including consumer accounts, and, using appropriate methods, assign notes to the consumers’ ability to honor their commitments. The objective is to increase access to credit and reduce its cost by raising the ability of financial institutions to identify good payers. This is of great importance to the Brazilian economy as the interest rate spread between inter-bank rates and those paid by consumers is the highest among emerging and developed economies.
  • There has also been talk by the new Minister of Finance, Mr. Eduardo Guardia, of advancing the Tax Reform by simplifying the ICMS, a VAT-like state-level tax on the movement of goods and services that creates a substantial cost for companies to navigate through Brazil’s 27 Federation Units. Even though a profound reform seems unlikely, there is room for editing the existing complementary law to harmonize the tax system and accelerate the use of tax credits.
  • The new Mining Regulatory Framework, which includes the creation of a new Mining Regulatory Agency and has been praised by the sector for bringing a more stable legal framework for future investments, has yet to be fully approved.
  • The reform of the electric sector is the one that seems most at risk. Its new regulatory framework and the conclusion of the privatization of Eletrobras, a major electric utility corporation and Latin America’s biggest power utility company, is pending approval by the Chamber of Deputies. However, the market has already priced in the government’s failure in approving these measures in the coming weeks and a plan B is being drafted to save the least contested parts of the reforms, including the privatization of some of Eletrobras’ subsidiaries. 

This list of measures would have a positive impact on Brazil’s economic outlook and could still be approved before this administration exits, but the window of opportunity to act is closing fast.

 

When Later Becomes Too Late...

The benign international environment that has spared Brazil from an even worse economic performance is now at risk as the US FED’s monetary policy is tightening and new protectionist measures are threating the world’s recent economic recovery. If further implemented, these policies will sooner or later force Brazil’s Central Bank to act by raising its own interest rates, which are at their lowest levels ever.

While some of the more structural reforms are unpopular, none of the microeconomic measures mentioned above face great popular opposition. Their approval would send a clear signal to investors that Brazil’s more centrist political parties are still committed to responsible economic reforms. This would, in turn, raise their prospects at the upcoming elections.

Brazilians, however, are impatient and in a hurry for real change. If that change doesn’t come from mainstream politics, voters may either abstain or gravitate toward the extremes.


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