Brazil’s structural problems will take steam out of rally in assets
by: Alberto Gallo/FT
Brazilians love telenovelas, soap operas that air every evening in prime time.
President Dilma Rousseff’s recent impeachment offered all the typical twists and turns. The show involved months of political infighting and media attention, with former president and mentor Lula da Silva turning against Ms Rousseff’s policies — while singers Caetano Veloso and Gilberto Gil took her side, offering unconditional support. In a final turn of events, parliament first nullified the impeachment motion, then nullified the nullification.
Millions cheered as Ms Rousseff left the Palácio, while parliament welcomed Michel Temer’s new government. But the drama is far from over, and in fact, I believe Brazil’s Caipirinha Crisis is just beginning. Mr Temer will inherit an economy suffering from a bad hangover, after years of growth fuelled by generous pensions and government subsidies like Minha Casa Minha Vida (“My House, My Life”).
Mr Temer’s first objective should be reducing Brazil’s nearly double-digit deficit. The good news is Brazil’s central bank is among the few with room for easing. Its newly-appointed head, Ilan Goldfajn, will probably lower the Selic rate from the current 14.25 per cent. The bad news is Brazil’s issues are structural and deep-rooted. Monetary stimulus will only be an anaesthetic, not the cure.
At the heart of the problem is Brazil’s broken growth model. By focusing on energy and mining, Brazil followed China’s investment train over the past decade. Today, however, it finds itself too geared to energy, mining and hard commodities, which account for more than 22 per cent of exports, up from 12 per cent in 2000. China’s demand for commodities is likely to decline in the second half of the year, after recovering on revamped credit stimulus, as policymakers worry about rising debt.
Together with commodity investment, Brazil grew both its public and private debt, which rose by 10 and 23 percentage points respectively since 2007. The resulting overhang in industrial capacity and in debt is now engulfing both the corporate and the financial sector.
Brazil’s state-owned enterprises appear far from efficient, as the Petrobras scandal highlighted. Petrobras, which has a dinosaur named after it — the Petrobrasaurus — has skilfully used periods of market calm to refinance its debt, including issuing 100-year bonds last year. It has not yet fully readjusted its capex plans and will need to do so if it wants to avoid its dinosaur’s fate. Other Brazilian companies appear vulnerable too: most industrial blue-chips invested heavily over the past decade and owe over half of their debt in foreign currency, on average.
Like the borrowers, lenders are vulnerable too. Brazilian banks kept their lending taps open throughout the crisis, some refinancing up to a quarter of loan books every year. This extend-and-pretend strategy has allowed them to contain bad loans below 5 per cent, but it has also delayed restructuring of troubled companies, keeping inefficient businesses afloat.
The hardest challenge for Mr Temer will be to do all that is needed and at the same time retain support for his all-male, all-white cabinet.
For foreign investors, his team means credibility, with former central bank governor Meirelles appointed as finance minister. But austerity, welfare reforms and corporate restructuring are tough medicine, as we have experienced in Europe’s periphery over the past few years. With their confidence sapped by unemployment and inflation nearly doubling over the past two years, Brazilians may not be ready to take more pain.
The risk is that past the Olympic Games this summer, both social unrest on the streets and defections in parliament may eventually undermine Mr Temer. The new president’s name has also been mentioned in some witness testimony relating to operation Lava Jato (“Car Wash”), a two-year investigation on government kickbacks to Petrobras and other companies involving over 200 executives and politicians.
Investors have celebrated Ms Rousseff’s resignation with a rally in stocks, bonds and the real. This is wishful thinking. Rebuilding Brazil’s growth model will take a lot longer than kicking out an unpopular president. After enduring years of corruption, stagnation and a 1-7 loss against Germany at the last World Cup, Brazilians have not lost hope. The telenovela continues, but for now, without a happy ending.
Alberto Gallo is portfolio manager and head of macro strategies at Algebris Investments.
Copyright The Financial Times Limited 2016.