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.
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