Brazil: Economy hit by another political scandal - Rabobank

Mauricio Oreng, Senior Brazil Strategist at Rabobank, explains that the charges against President Michel Temer published yesterday by ‘O Globo’ newspaper trigger a high degree of political uncertainty in Brazil.

Key Quotes

“Until this uncertainty is resolved, the lack of governability will postpone discussions of economic reforms in Congress.”

“A halt in discussions of budgetary reforms – particularly the pension reform – suggests that the risks of more extreme fiscal scenarios have risen (hard to tell how much). Economic reforms are necessary condition to anchor expectations about long-run debt sustainability and eliminate market perceptions on hyperinflationary risks in a more distant future.”

“The bear-market trend will continue for Brazilian assets until there is clarity in the political direction. If the uncertainty and asset-price deterioration linger on, the worsening of monetary conditions and analysts’ expectations could undermine confidence and activity.”

“Even recognizing the lack of clarity and imprecision of models under these circumstances, we simulate scenarios of mild stress (a shorter crisis), leading to FX rate near 3.50. In scenarios of greater stress (a longer crisis), the USD/BRL could head towards 4.45. The numbers only illustrate the obvious: the range of outcomes is quite wide.”

“The process of interest-rate cuts implemented by BCB could also be at risk following this political shock, depending on the swings in FX rate, inflation expectations (and, above all, the outlook for reforms). Current levels of asset prices would not dent the easing cycle too much, but that takes macro reforms (key risk factor for the cycle’s extension and sustainability) as a baseline. Is that the case today? In case of stronger FX shocks, Selic cuts could be paused.”

“The only certainty now is that the Brazilian roller coaster is definitely back on.”