How would a possible change in power in Brazil affect the country’s economy?
As Brazil prepares to vote on 30 October, surveys continue to show incumbent leader Jair Bolsonaro trailing his left-wing rival Luiz Inácio Lula da Silva (Lula), although recent polls show how tight the race has become. In the first round, polls predicted a big win for Lula, which dented the credibility of Brazil's polling firms given how close the first round turned out to be, and some are now more hesitant to share surveys ahead of Sunday.
In order to answer how a potential change of power will affect Brazil's economy, it is important to look at where they are coming from. Brazil is a country that has gone from one crisis to another; we've seen everything from environmental destruction to a recession, a president that was impeached, two presidents imprisoned and a pandemic that hit Brazil harder than most other countries. So when the Brazilian people cast their votes over the weekend, people on the ground say many are already looking ahead to the next election in the hopes that new and better candidates will enter the scene.
While Bolsonaro and Lula have polarising visions for Brazil and different agendas as to how to reach a path to prosperity for the country, I don't see this as the "most consequential election in decades" as some have described it. Given the composition of the new Congress and Senate, it is clear that the next President will have to make concessions and alliances in order to push through his agenda in Congress. Radical changes are therefore unlikely. This is good news for investors in the short term, as moderation is more predictable, and markets like predictability. The country's fiscal position is the main concern for investors, as challenges have historically come from populist presidents being under social pressure to redistribute wealth while what they need is stability in the fiscal policy so that spending and inflation remain under control.
The starkest difference between the candidates is that Lula is known for wanting to put the state back at the centre of economic policy making, and use government spending to spur growth. In other words, to raise taxes on the rich to expand services for the poor by widening the social safety net. Bolsonaro, on the other hand, would offer a continuation of the free market, pro-business agenda focused on cutting bureaucracy, promoting privatisation and simplifying labour regulations. However, neither candidate has promised to carry out the more difficult but much-needed structural changes to improve productivity and generate long-term growth. Nonetheless, the majority of SKAGEN Kon-Tiki's portfolio companies in Brazil tell us that they have thrived in periods when both candidates have been in power, and they believe their businesses will continue to do well regardless of the outcome on Sunday.
Which president would be preferred by the market and why?
The Brazilian stock market reacted positively to the first round where Bolsonaro came closer than predicted. Financial markets liked the prospect of Lula diluting his state-centric treatment of the economy. So either the market-friendly Bolsonaro wins a bit of a surprise victory, or Lula prevails in a close race that will encourage or force him to pursue more fiscally responsible policies. I think both outcomes are positive for risk in the aftermath of elections. We just need the elections out of the way.
The good news is that the winner will take over a country on the up. Headline inflation has fallen as the central bank tightened early. Their currency is one of the few that has gained against the USD this year. And the Brazilian equity index is outperforming most other indices this year.
The scenario however that could ruin a positive equity market reaction however is contested results and chaos if the Brazilian democracy is being tested. As long as we don’t see that, Brazil is likely to continue to be a favourite investment destination in the Emerging Markets. It is, however, a country with limited fiscal space so if public finances deteriorate and spending limitations are ignored, then Brazilian assets could reverse course. But we don’t see that as a likely outcome in the short term.
What is the reason the Brazilian stock market is outperforming so many other emerging markets this year? Any thoughts on the market outlook going forward?
Many emerging market central banks raised interest rates to prepare for the Fed tightening but few of them were as aggressive as Brazil. That also means Brazil is basically the first developing nation to herald a peak in inflation. Consumer price growth has eased for three successive months now after their real policy rate climbed to 6.6%. Which also means the debate in Brazil has, contrary to most others, already shifted from interest rate hikes to potential cuts next year. This is in stark contrast to other emerging markets where the average inflation is at a decade high and negative real yields are still the reality in most countries. Since Brazil has been ahead of the curve, it has also become something of a safe haven despite the negative election headlines. Another positive factor is obviously the fact that Brazil is a major commodity-exporting country which helps in times of strong commodity prices. The country is in pretty good shape right now, and their equity market is cheap with a lot of good quality stocks priced at bargain prices, so we are positive in general to investment opportunities in Brazil.