The 8 January storming of Brazilian government buildings has exposed the divides present in Brazilian politics, and willingness of Bolsonaro supporters to use disruptive blockades. The economic and market impact will depend on whether there is additional disruption that might undermine Brazil’s critical infrastructure, how quickly the Lula government consolidates the security apparatus, whether the violence of the developments help them reach consensus with Congress and which version of their fiscal and investment program wins out. Overall, market actors, especially locals will remain laser focused on the fiscal out-turns at a time of rising domestic and foreign debt service costs.
I shared some quick thoughts with the anchors at Cnbc at this link. https://www.cnbc.com/video/2023/01/10/bolsonaro-is-a-big-headache-for-the-biden-administration-analyst.html
Overall, the biggest challenges for Brazil and peer EM will be growth and distributional challenges at a time when global liquidity is set to tighten, economic activity to remain uncertain at home and abroad. The growth crunch I feared in 2022 for large EM remains a concern. Brazil’s balance sheet puts it in a relatively strong position in this context, but market scrutiny will not give the government a pass.
The events of 8 January brought to ahead what many Brazil watchers had feared – political violence aimed at showing displeasure with the 2022 election results. Far-right individuals had called for protest and blockades including of Brazil’s energy and other infrastructure. The protests came after the transition of power had already taken place at the beginning of this year, but before the new government had consolidated power and defined how the administration would work with Congress, the legislative agenda or even fully defined how they would deliver on a rather broad set of campaign pledges. The economic impact will depend on how Brazil’s institutions deal with those who stormed the center of Brasilia, whether there are recurrences that impact critical infrastructure, and how the shock impacts the dynamics in Brazil’s divided Congress. It will also likely cloud Brazil’s foreign policy, raising concern but also perhaps increasing common cause with other large continental democracies, including even the US.
In 2022, Brazil’s external balance and inflation trajectory looked good among EM peers benefiting from the BCB’s ahead of the curve response in 2021 and early 2022 while stronger commodity prices across agriculture, metals and energy. Both these trends were a reflection or driver of subdued growth, but made BRL one of the strongest performers in 2022 – we’d anticipated that it would remain a relatively attractive currency even as some of the dollar strength reversed. As is typical for Brazil, much depends on the fiscal outlook, and market actors are unlikely to give the new government a pass. Brazil’s fiscal space remains constrained by high (in an EM context) debt levels and debt service costs, meaning that investors, led by local actors, have been very worried about fiscal expansion and easing of the fiscal caps. Lula ran on a centrist and progressive platform, with actors unclear which policies would win out.
Beyond the direct government spending, market actors should also be watching planned efforts to increase the self-sufficiency of Brazil in energy and fertilizer, two areas that Lula touted on the campaign trail. The latter is set to be trickier to accomplish. Investors will watch the development of these plans, wary if they are state-led via established state development banks like BNDES or newly created entities.
Another potential positive trend is the shift in environmental policies as Lula aims to revamp Brazil’s reputation in the area after several years of some large institutional investors especially Nordic ones being wary of Brazil on environmental grounds. While ESG metrics have rightly come under a lot of scrutiny and criticism, these screening tools may help Brazil. Moreover, developments in this area may forestall those in the US administration who floated the idea of sanctions to restrict forestation. Overall, it remains to be seen how the new efforts to create common cause with other rainforest nations will be more gimmick than actuality, but it could create the opportunity
Brazil, a still-relatively closed large economy, is unlikely to push the US and other allies for more trade liberalization and market access, and may be interested in incentivizing local investment. Lula is likely to find the Biden administration pledge to allow allied democracies more policy space to do what is needed to support economic activity attractive. However, Brazil’s scope to do so is likely to be limited. Moreover, Brazil is one of many countries looking to hedge their roles in key global institutions and chokepoints. This is unlikely to be a time for major structural reforms.
Overall, 2023 is a year in which many EM have limited policy space especially on the fiscal side. Brazil’s monetary stance and external balance keep it well positioned in this period of global monetary tightening, but this could be undermined by perceptions of its fiscal outlook. Large EM will be constrained by rising or high debt service costs which will restrain growth despite the evolution of monetary stance in the US that may come over the course of the year. While a wave of defaults in EM is unlikely and EM asset classes is likely to remain resilient to the defaults in frontier economies.
Ziemba Insights 