Brazil: Setting the stage for a brighter future?

This post is also available in: Italian, Spanish

Brazil’s newly elected president, Luiz Inácio Lula da Silva (commonly known as Lula), will have to walk a narrow path of expenditures given the budget constraints.

During the first round of elections, Jair Bolsonaro did better than anticipated, with a smaller-than-expected gap to Lula than the polls had suggested. The final runoff Sunday saw a tight race, with Lula just edging out Bolsonaro.

The first round elected a generally more pro-market Congress with elections for all seats of the lower house and a third of the senate. Such congressional composition should limit unorthodox policies in the coming years, in our view.  Elections of governors of large states—which, as key regions, represent a large percentage of gross domestic product—were another strong showing for Bolsonaro. Lula took advantage of the high rejection that Bolsonaro had after the pandemic and won in the usual strongholds of the Northeast, and also moved toward the center by picking his past opponent as the vice-presidential candidate.

The country has made some important achievements in the last few years to protect itself from the likes of the Lava Jato (Car Wash) corruption scandals from previous governments.

There are now several legal and company-specific deterrents for bad management of government-controlled companies, including the assignment of responsibility to individuals for decisions, limiting political appointees and preventing product price manipulation.

In the last few years, Brazil has seen a crowding-in of the private sector. In the financial system, government-controlled banks had the largest share of loans, but that percentage has dropped in recent years, and the private sector has moved in. We think this is one of the most important barometers of market change.

Oil giant Petrobras has been selling non-core assets, and after paying down tens of billions of inherited debt, became one of the world’s largest dividend payers. An oil-industry creation has been replacing a de-facto monopoly.

Brazilian Development Bank (BNDES) went through a profound transformation as well, moving from subsidized loans to market-linked interest rates, which improved the role of this entity to act as the government’s true structurer of and advisor for government assets. Tempering central bank policies was a misdeed of the past; Brazil’s central bank is now independent. Therefore, we and many analysts expect a loose fiscal policy to be met with stiff monetary counterbalance.

Looking forward, we see the seeds of reforms and concessions playing out in Brazil. For example, the sanitation and water legal framework allowed for billions in auctions to take place, with the target of universalizing water and sewage to cover roughly up to half of citizens without proper access.

The rail concession and authorizations should de-bottleneck the Brazilian transportation matrix by doubling the amount of cargo transported by train. Opening the gas transportation sector to private gas pipeline concessions should drop the cost of energy, along with the ongoing wind and solar energy generation projects already granted.

There are expectations that by the end of 2022, the government would have awarded a pipeline of investments in the amount of US$200 billion for the next decade. Such an amount should contribute to Brazil’s economic growth in the years to come. The boom of capital markets of the past years has also helped companies to deleverage, while increasing penetration of the financial market to individuals.

Given the 1980s-1990s hyperinflation, Latin American central banks have been fast to act when necessary. Amid the recent wave of rising inflation, the region has led the world in monetary tightening.

In Brazil, the post-COVID-19 reopening has also brought in strong excess tax collections, allowing the government to reduce taxes in sectors like fuel, electricity, transportation and telecommunications. This has helped tame inflation, and now there is an expectation of a peak interest-rate environment. Therefore, while other countries struggle to hike rates, we could see an inverse and benign cycle of interest-rate cuts in Latin America in 2023.

Looking ahead to 2023, Brazil’s new four-year mandate of the executive branch comes in with an improved governance environment, contracted infrastructure investments already in place, and a possible tailwind from lower interest rates. It also inherits a domestic market with companies that generally possess low leverage and unemployment at a seven-year low.

Challenges ahead for Brazil include the path toward fiscal prudence, the government’s debt trajectory and continuation of needed reforms especially in administrative and tax areas.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. Investments in fast-growing industries like the technology and health care sectors (which have historically been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasizing scientific or technological advancement or regulatory approval for new drugs and medical instruments.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

IMPORTANT LEGAL INFORMATION

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.

Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.

Issued in the U.S. by Franklin Distributors, LLC, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com – Franklin Distributors, LLC, member FINRA/SIPC, is the principal distributor of Franklin Templeton U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.