Brunel: Brazil Election Briefing

On Sunday the 30th of October Lula (Luiz Ignácio Lula da Silva) made a momentous comeback, winning his third term as president of Brazil. Myself and the team at Brunel have been saying for several months that this presidential election is less consequential to Brazil’s economic prospects than most assume, for various reasons. Nevertheless it remains important, especially given the huge ideological differences between the candidates. I wanted to share my views on what Lula’s victory means and the likely prospects for investors in different asset classes moving forward.

After tense and bad-tempered campaigns Lula won the election with 50.9% of the vote to Bolsonaro’s 49.1%, winning by a little over 2 million votes. This victory was historic as Bolsonaro became the first sitting president since redemocratization not to win a second term. This is despite his significant leveraging of state apparatus to help his election campaign, which included boosting ‘state-of-emergency’ cash transfer programmes to poorer Brazilians, holding down consumer energy prices, and attempts at voter suppression by the Federal Highway Police. With both candidates reviled by large segments of the population, it was described as a battle for who would have the lowest rejection rate rather than one focussed on policy agendas of the candidates.

Nonetheless, this remains the tightest margin of victory since redemocratization. Lula patently does not have the support he once had and anti-PT sentiment amongst large sections of the population, especially in the economic powerhouse South-East, remains strong. Lula seemed to understand this and his victory speech was conciliatory, promising to govern for all 215 million Brazilians and not just those who voted for him. He stated, "there are not two Brazils".

This division is particularly stark in the Congress and Senate, where centre-right politicians form the majority. The Leader of the House, in his congratulatory speech already intimated that the President is going to have to work with a Congress that breaks markedly to the right on key economic questions. Within this centre-right grouping is the Centr?o (big centre) who famously eschew ideological purity and are prepared to work with whichever party is in power to secure positions and funding. This group will likely be keen to maintain the broad centre-right approach on economic questions, but given their past openness towards striking deals (and Lula’s for that matter), it is less likely to lead to the political deadlock more common in the US when houses are split.?

After almost two days, Bolsonaro made a grudging acceptance speech vowing to abide by the constitution. Meanwhile supporters of his blocked highways across the country protesting the vote. After a campaign in which he frequently sought to question the integrity of the voting system there were (and remain some) concerns about the smooth transfer of power. However, the result (and election process) has been widely accepted by different powers within government and international leaders (with even Bolsonaro condemning road blockages).

Lula’s main pronouncements in his acceptance speech involved rebuilding social programs to combat hunger, extreme poverty, social housing and education. He was vocal about protecting the Amazon Rainforest (with outside help) and rebuilding Brazil’s standing internationally where Bolsonaro had acquired pariah status.

Lula will assume power in a challenging economic backdrop, but due to successful policies of the Brazil Central Bank (CBB) and the current administration, it is?certainly not as alarming as in other parts of the world. The CBB acted quickly to get ahead of inflation, raising rates over 10% from their lowest around 18 months ago, this has seen prices stabilize in recent months and current estimates are that the CBB will start cutting rates next year. The economy remains in reasonable health, expected to grow 2.8% this year, led by a booming export sector (particularly agriculture). The government has been running a primary budget surplus (see chart below) and unlike past debt crises, the majority of government debt is BRL denominated, held by local investors. Certainly, relative to other emerging markets Brazil has some positive tailwinds behind it and equities remain at very discounted valuations.

Things to watch for will be Lula’s ministerial appointments, specifically in finance, which he was coy to announce during the campaign. The expectation is that he will need to reward centrist supporters who helped get him over the line and there are several very prominent liberal economists who supported him, presumably on some assurances as to the direction his government will take. Lula has made it clear that he would look to adjust the spending cap, which has proven a market friendly brake on government spending, to allow for more investment through the cycle. This will be closely watched and it is clear that he does not have a blank check to increase spending without restraint. Lula traditionally maintained good relationships with Faria Lima (Brazil’s Wall St.) and the Bovespa’s best periods of performance were during his first 2 terms (see chart below).

Corruption, most famously the Lava Jato scandal that brought down Dilma, Lula’s successor, and saw Lula spend 18 months in prison before being released as charges were annulled, remains an Achilles' heel for the party. Lula, whilst avoiding admitting complicity in past scandals, promised transparency and an independent prosecution to combat corruption, something that was not apparent in the current administration. One would hope that given the PT's history, the opposition and other arms of government will be vigilant on similar corruption breaches, as well as Lula himself as he fights to secure his legacy.

One significant upside I see is a more positive engagement on the Amazon Rainforest and environmental protection. It was always a source of some frustration that on many levels Brazil is a world leader on conservation (classifying over 30% of national territory as protected vs. around 10% in the US) and renewable energy (c. 75% of Brazil's electricity comes from renewable sources); yet under Bolsonaro the (somewhat justified) reputation for environmental destruction reigned supreme.

Looking briefly across asset classes / sectors, the equity market response has so far been muted, and will wait for more detail on his economic team. Whilst certain state-owned companies saw falls as their chances of privatization fell, most infrastructure privatizations for example are in the hands of state governors and Congress, which remain supportive to further liberalization. We see no reason for a change in government to change rapid growth in renewable energy and Brazil’s tech ecosystem. The biggest driving factor behind local allocation will remain local interest rates, which as they have risen have sucked money into fixed income, but we expect a reversal of that as monetary loosening comes closer.

I had been making the point that this Presidential election was less important for markets than many assumed as much of the backdrop to government spending and economic direction rests with Congress, which remains firmly centre-right. In addition, despite glaring ideological differences and disagreements on social issues, their policies on a lot of economic questions were, in practice, not that dissimilar. I have come to expect the unexpected with Brazil and avoid making firm predictions, yet we continually meet with investment managers, entrepreneurs and executives who trust Brazil’s institutions and are optimistic about the current scenario, irrespective of politics. This gives me confidence and hope for a brighter future for Brazil.