Political and economic worries dent confidence in Brazilian markets


Brazil updates

Investor sentiment in Brazil has been knocked by rising political tensions together with concerns over the recovery and public spending in Latin America’s biggest economy.

The country’s currency and stocks bourse have come under pressure in recent weeks against a backdrop of clashes between Jair Bolsonaro and top judges over the president’s unproven accusations of voter fraud.

A bounce this week has not fully reversed the dip. After a period of relative calm that led to the real appreciating to 4.91 against the dollar in June, the currency has fallen around 6 per cent to 5.25 to the US currency. 

The Ibovespa share index, meanwhile, has tumbled almost 9 per cent since touching a record high 11 weeks ago, though it is slightly up so far in 2021 both in local currency and dollar terms.

“It hasn’t been a great month for emerging markets as a whole, but Brazil has clearly seen a greater degree of increase in risk,” said Pablo Riveroll, head of Latin American equities at London-based asset manager Schroders.

“This year Brazil actually did very well initially and now after the recent sell-off it has lost that outperformance versus [other] EMs”.

Line chart of Real to the dollar  showing Brazil’s currency recedes from recent highs

While external factors like the spread of the Delta variant of coronavirus globally and pressure on certain commodity prices have played a role, market participants say domestic issues are the primary driver.

Paulo Bilyk, chief executive of Rio Bravo Investimentos, which has R$13bn of assets under management, cited the government’s weakened political position.

“They are having a very difficult time governing and the implication of their mistakes is that their popularity has been declining. Consequently we have increasing radicalisation of speeches and acts. None of this is good for markets.”

In addition to making thinly veiled threats against next year’s presidential elections, Bolsonaro has pledged to boost payments under a revamped welfare scheme for the nation’s poorest with his approval ratings on the wane. 

This has stoked concerns that the populist’s administration may not respect a constitutionally mandated spending cap that prevents the budget increasing above inflation — a preoccupation for investors given Brazil’s already high level of public debt, now at 84 per cent of gross domestic product. For many, this carries greater significance than the political ructions

“We see higher risk around fiscal discipline ahead. This is also pressuring the currency,” said Júlia Gottlieb, an economist at local bank Itaú Unibanco.

A rise in government borrowing costs bears this out: the yield on the 10-year local currency bond recently hit its highest point since the 2018 presidential elections.

The debt is now trading with a yield of around 10.3 per cent, down slightly from last week’s high above 11 per cent, but well above the roughly 7 per cent level from the end of last year.

Line chart of 10-year yield (%) showing Brazil's debt has come under selling pressure in 2021

The central bank is seeking to fight inflation, which at 8.99 per cent in the 12 months through July was above the 2021 target of 3.75 per cent. It has lifted the benchmark Selic rate from an all-time low of 2 per cent to 5.25 per cent and market expectations are that it will reach 7.5 per cent by the end of the year, according to a central bank survey.

More expensive financing costs tend to weigh on share valuations and economic activity. Although GDP growth this year is expected to top 5 per cent, according the central bank survey, projections for 2022 have steadily declined.

Developments around the new planned cash transfer programme and next year’s budget, as well as a tax reform bill and possible changes to payments of court-ordered public debts, are likely to have a major influence on investor sentiment towards Brazil in the months ahead.

These variables “will be closely monitored by the market to assess the government willingness and ability to restore, at least partially, the credibility of a sustainable economic policy,” said Cassiana Fernández, Brazil chief economist at JPMorgan. 

She added: “We expect [the real] to remain quite volatile, ending the year closer to 5.40”.

Additional reporting by Carolina Pulice in São Paulo


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