Rewriting the rules

Markets, currency soar despite deepening recession, political scandal

Events over the past week, in the corridors of power in Brasilia and on the Sao Paulo stock market, constitute an extraordinary narrative, and perhaps evidence of some investors seeking opportunity in the most unlikely places.

Early on 4 March, former president Luis Inacio Lula da Silva was briefly arrested as part of the continuing corruption investigation into state oil giant Petrobras. Within hours, the Bovespa stock index in Sao Paulo was up 5% and the real had reversed months of declines against the dollar.

So far this year, the stock market has soared 25% and the currency is 10% higher. This despite Brazil being mired in its worst recession in a century – with a fiscal deficit of almost 11% of GDP, inflation in double digits, and the major rating agencies having downgraded the country’s sovereign credit ratings to junk status. And President Dilma Rousseff, Lula’s handpicked successor, is facing impeachment.

‘It’s all down to the fact that the markets want to believe Dilma will fall now, inevitably, and that we will have a new government to confront the economic crisis,’ according to one of Sao Paulo’s leading bankers. ‘It’s irrational exuberance, for sure, this time not on Wall Street, but here in Brazil.’

Forecasting what happens next, politically, economically, and in terms of the justice system, is a fool’s errand. The Petrobras scandal has already brought down figures who were once untouchable. Just last week the country’s leading construction magnate, billionaire Marcelo Odebrecht, was sentenced to 19 years in prison for corruption and money-laundering. The speaker of the lower house of Congress, Eduardo Cunha, was charged at the same time on the same counts – with being the ‘bribe pipeline’ from Petrobras to politicians – charges he denies.

Prosecutors are now seeking house arrest for Lula, who stands accused of receiving R$30m ($8m) from Petrobras builders who worked on his home, and lying about a beachfront house he allegedly owns. The fact that a political guru, Joao Santana, who masterminded the presidential campaigns of Lula and Dilma, is also under arrest, and talking, raises the prospect of this scandal going all the way to the top.

‘The good news is that no one in power seems to have the power to stop this investigation,’ says one opposition leader. ‘For Latin America, and the battle against corruption, this scandal and this investigation is breaking new ground. The prosecutors are unstoppable.’

However, the political reality is that the current president and her predecessor have strong cards in any battle to bring down the government. Impeachment requires two-thirds of Congress voting in favour. Despite defections, Dilma and Lula probably have the votes in the short term if they have the will to fight.

And that means economic policy that will not address the soaring fiscal deficit, or wage rises that fuel inflation, or social programmes such as the bolsa familiar (family subsidy) that more than 40% of the population receives, for fear of alienating the ruling Workers party’s base.

‘This is fundamentally a political crisis that has triggered economic meltdown,’ to quote one of the country’s leading pollsters. ‘The last thing we can expect is the Workers party to admit responsibility for the entire mess, and condemn themselves to years out of power.’

Significantly, lead players elsewhere in Latin America are drawing lessons from Brazil’s nightmare. In Argentina, for example, where the new centre-right government of Mauricio Macri is confronting the economic woes of inflation, deficit, and debt, the response has been to view Brazil’s predicament as a learning experience.

‘Brazil had so many good years, of growth and investment, of commodity boom, but they didn’t confront the garbage down below — corruption, lack of infrastructure, overregulation,’ according to one of Macri’s key advisers. ‘We have to learn from their experience, apply the lessons, even as we suffer, because Brazil is our number one market.’

This past weekend, Brazil has been consumed by images of hundreds of thousands of people marching in protest against the government, in almost every major city. There lies the ultimate variable in Brazil’s remarkable narrative of crisis, scandal, recovery, market exuberance bordering on the irrational.

A generation ago, street protests in Brazil brought down a president accused of corruption in a matter of weeks. Within living memory, Brazil has rewritten the rules for toppling a democratically elected leader. And now the country faces the unholy cocktail of political crisis and economic knock-on effects, with potentially as dramatic consequences.

David Smith, OMFIF Advisory Board member, represented the UN Secretary-General in the Americas between 2004 and 2014.



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