- Lula claims third term as president, narrowly defeating incumbent Jair Bolsonaro
- Political divides remain deep, but the government appears balanced by a newly elected pro-market Congress
- Brazilian consumption is on solid footing with upbeat gross domestic product (GDP) growth, lower inflation, improved confidence and scope for rate cuts
- Equity markets and the Brazilian real have trended higher over the past year
- Infrastructure and green projects promise new opportunities for investors
Brazil’s new—and former—President Luiz Inácio Lula da Silva (“Lula”) wrangled 50.9% of the second-round vote to defeat incumbent Jair Bolsonaro in perhaps the most critical election Latin America’s largest nation has seen in decades. Even as Lula delivered his victory speech, with supporters celebrating in the streets and world leaders sending congratulations, Bolsonaro had yet to concede the tight race or make a public address. Thus far, however, there appear few indications that allies and supporters of Bolsonaro, who has long touted baseless claims of vote rigging,1 would push efforts to dispute the results.
Given the narrow outcome, Bolsonaro appears unlikely to roundly admit defeat, and the defeat is by no means a repudiation of his party. A weaker global economic environment, geopolitical and trade tensions, receding commodity prices and domestic issues like the high (albeit falling) debt burden are some obstacles facing Brazil. However, the recent election wins of the pro-market Congress in October should curb some concerns over Lula and his Partido dos Trabalhadores (PT; Worker’s Party), such as a propensity to fund public social spending with debt or higher taxes. Lula himself pledged to run the country as a moderate, recognizing that “the private sector is extremely important.”
While we believe it crucially important for the next government to be fiscally prudent and watch debt levels, markets often tend to reward policies that prioritize investment over spending. Such an approach will also have better odds of being implemented (compared to fiscal giveaways) with the balance of conservative lawmakers and given the Congressional restraints under which Lula will have to operate.
The Lula win comes at a time when, compared to much of the world, Brazil may find support from still-elevated raw material prices and a fiscal surplus. Public accounts have benefited from booming tax revenues and sizeable dividends from state-owned corporates. The central government primary surplus stood at 1% over 12 months (as of September 2022), and forecasts see the debt-to-GDP ratio falling by 4.1 percentage points this year.2
That is a sharp reversal of an upward trend that saw the ratio swell from around 50% in the mid-2010s to nearly 90% in the aftermath of COVID-19.3 While the (current) government expects to return to a deficit next year, and the tailwind from high commodity prices in 2022 may well turn into a headwind, equity markets and the Brazilian real have shown measured confidence. The US dollar is up roughly 18% against major currencies over the past year, but it has retreated against the real. The FTSE Brazil 30/18 Capped Index has gained 19% (in USD terms) over the same time period, a stunning feat given the dismal returns in both emerging market peers (-28%) and developed markets (-18%) alike.4
A phase of disinflation that manifested during the summer has partly driven the optimism, with inflation subsiding from its spring peak. This could allow Brazil’s central bank, Banco Central do Brasil (BCB), to begin easing in 2023. The Selic Rate, the BCB’s key rate, had held steady since August, setting it apart from other central banks that still appear behind the curve in many cases.5
An important aspect of the bank’s success in reining in inflation may have been its formal autonomy from the government, thanks to a 2021 bill originally supported by Bolsonaro (which he later regretted). Under a Lula presidency, this could act as another guardrail against unchecked spending. A dramatic example has been established before our eyes in the United Kingdom recently. More generally, an independent central bank is an accomplishment in itself that should serve the country well in the future.6 Of course, this does not mean that Brazil is out of the woods yet in terms of inflation. Sunset-claused fuel subsidies and tax cuts have contributed to the falling price pressure, and structural issues like supply chain disruptions and geopolitical risks remain unresolved. If the BCB turns too dovish too soon, pressure on the currency could quickly drive inflation back up.
Finally, commodity-based exports may experience a slowdown as the global economy, and particularly China—Brazil’s top trading partner—enters a lower growth phase, with recession risks looming. It is important to keep in mind, however, that Brazil’s GDP is largely driven by domestic consumption. Stable or falling interest rates, the lowest unemployment rate since 2015, rising real wages and improved confidence mean that Brazilian consumers are arguably in a good shape, especially compared to many markets in the developed world.
The biggest short-term risks are an escalation of political tension or a prolonged sense of market uncertainty. We believe that Lula’s inauguration should see markets look beyond politics and focus on the fundamentals as well as the opportunities brought by the new administration—infrastructure projects, a fresh focus on a green transition, investing in education and bolstering the domestic economy. Lula is a known quantity in Brazil. The economy flourished during most of his prior term, and based on recent performance, both domestic and international investors seem moderately optimistic about his return to power. While they will have to evaluate policies against pledges, Lula is assuming an economy on solid footing with significant long-term potential.
WHAT ARE THE RISKS?
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1. Source: Reuters, “Brazil’s Bolsonaro says he may not accept 2022 election under current voting system,” July 7, 2021.
2. Reuters, “Brazil central govt posts better-than-expected primary surplus in September,” October 27, 2022.
3. Source: CEIC, “Brazil Government Debt: % of GDP,” 2022.
4. Source: Bloomberg, 2022. The FTSE Brazil 30/18 Capped Index represents the performance of Brazilian large- and mid-capitalization stocks. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator of future results. See www.franklintempletondatasources.com for additional data provider information.
5. Source: Banco Central do Brasil, 2022.
6. Source: Central Banking Publications, “BCB independence and Brazil’s inflation battle,” November 16, 2021.