Brazil–Political Uncertainty Will Persist

A convergence of political and economic crises has left President Dilma Rousseff fighting for her political life barely a year after she was sworn in for a second four-year term in early 2015.  With her approval rating near single digits, Rousseff lacks the political authority to pressure lawmakers to approve measures required to create the foundation for an economic recovery, and a looming breakup of the political marriage between Rousseff’s PT and Vice President Michel Temer’s PMDB will leave her with no defense against impeachment proceedings initiated in late 2015.
At this point, a change of government will likely have a positive effect on investor sentiment, but there are no guarantees that Rousseff’s departure will bring an end to political uncertainty and legislative gridlock.  The prospects for restoring stability at the center will be brighter beyond the 18-month forecast period, as the holding of regularly scheduled presidential and legislative elections in the fall of 2018 will create an opportunity for the main opposition PSDB to win a strong mandate with the congressional heft to match.  But even in that case, forming a viable majority coalition may be difficult.
Any government holding power in the near term will of necessity grant high priority to reducing a budget deficit that ballooned to more than 10% of GDP in 2015.  The risk of inaction was highlighted by Standard and Poor’s recent decision to downgrade Brazil’s bond rating for the second time in five months, which was accompanied by a warning that the sovereign rating would be downgraded deeper into junk status if the government fails to bring the deficit under control.  The implied increase in the cost of state borrowing will make it harder to convince investors that the government can get its fiscal house in order, and doubts in that regard will complicate the task of stabilizing the real, which depreciated by more than 30% against the US dollar in 2015, hampering the central bank’s efforts to contain inflation.

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