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Temer tantrum

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There are few comparably large, investable countries where political risks are as consistently high as in Brazil. Having just impeached a president at the end of last year and with a former speaker of the lower house in prison, Brazil is a country where the threat of political upheaval presents a consistent risk to the growth outlook. In the latest development, a Brazilian newspaper reported that meat-packing conglomerate JBS disclosed a list of the bribes they paid to politicians over several years and released tapes of recorded conversations with prominent politicians, including a conversation with President Michel Temer. The tapes showed that Temer was aware of JBS’s alleged efforts to thwart an investigation (including bribing justice officials) and the company told prosecutors that bribes were paid to Temer on several occasions. The news sent Brazilian assets tumbling with equities down 9% and the Real dropping 8% (see Chart 10).

Country risk Confidence at risk

What makes Brazil unique is not that corruption exists, but that Brazil possesses an independent judiciary capable of investigating even the highest levels. While undoubtedly positive for the long-term outlook, the combination of systemic corruption and an independent judiciary can contribute to a short-term lack of policy continuity. In this respect, Brazil differs from other EM economies such as China or India in that domestic political risk is far less predictable. In both China and India, stamping out corruption has been identified as core objectives; but their methods of eliminating corruption create far fewer risks to policy continuity and actually serve to bolster reform efforts. China and India are leading anti-corruption efforts from the top of the political establishment; while this means that there is little transparency and systemic corruption may continue to exist, it also presents limited risk to key reformers.

Just as Brazil’s economy started to show positive growth, the scandal increases risks around Brazil’s positive momentum. The outlook for reforms has deteriorated markedly, particularly around crucial pension and labour reforms. The political leadership of Temer until now has been vital to overcome opposition, but the scandal undermines Temer’s position leaving less political capital to pass unpopular reforms. Brazil’s economy has been recovering following a long and deep recession: confidence among both business and consumers had been improving (see Chart 11) and Brazil enjoyed a positive terms of trade boost as the price of commodities rebounded. Furthermore, with inflation falling, the central bank was poised to slash interest rates which would further stimulate economic activity. The current political upheaval threatens this recovery by raising uncertainty and reducing confidence, which can impact on business investment and consumer spending. Additionally, as the scandal now threatens fiscal consolidation, the overall amount of monetary easing could be less than initially expected due to a weaker currency and less-than-expected disinflation. Overall, the fallout from the scandal will ultimately depend on how the scandal plays out; a quick exit by Temer would be substantially better than a prolonged political fight to stay in power. While the economic impact is hard to assess, at a minimum the latest saga is a reminder that Brazilian country risk remains elevated.

Alex Wolf, Senior EM Economist