Good news for Dilma, bad news for Brazil

Although we did not have great expectations that Aécio Neves, the main rival to incumbent president Dilma Rousseff in Brazil’s presidential run-off, could win in the final run-off yesterday, we are nonetheless disappointed by the results and so is the market. The market’s negative reaction signals that investors do not believe that Brazil’s economic situation will improve under Mrs Rousseff’s second term as Brazilian president. Overly lose fiscal policy, interventionist policies, protectionist measures and stubbornly high inflation are likely to continue.

Brazil’s deteriorating fiscal position, the widening of the current account deficit as commodity prices plummet and an unfortunate policy mix have made Brazil very vulnerable to external shocks and shifts in global risk sentiment. The re-election of Mrs Rousseff provides only slight hope that structural reforms will be pushed forward in her new term as president, given that over the past four years in office she has done little, or rather nothing, to revive the slack economy. Due to domestic policy misalignment, Brazil’s dependence on commodity exports and having China as its main trading partner, the outlook for the economy is not particularly rosy, in our view. As commodity prices are likely to stay very low and the outlook for the Chinese economy remains uncertain and rather weak, we expect virtually no growth this year, with only around 0.4% y/y, followed by around 1.4% y/y growth in 2015. We expect inflation to remain elevated and average 6.2% y/y this year and 6.8% y/y in 2015.

The longer term outlook for Brazil and its economic performance is highly dependent on whether economic reforms are implemented. We see a particular need to open up the Brazilian economy aggressively to foreign investment and competition in order to spur Brazilian productivity growth, which has been extremely weak for decades. However, we remain sceptical about Mrs Rousseff’s willingness to push reforms, as she failed in her previous term. This said, the medium-term outlook for Brazil and the Brazilian market is more dependent on global factors such as Fed tightening, weak Chinese growth and lower commodity prices than on whether or not Mrs Rousseff will push reforms through after the elections.

Despite the results of the presidential elections, we maintain our USD/BRL forecasts of 2.55, 2.55 and 2.55 in three, six and 12 months respectively.