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From Financial Centres / Americas & Caribbean / Brazil 08 November 2022


DIVIDED BRAZIL SET FOR GROWTH

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© Getty Images

By Charles Gélinet

Brazil’s president-elect ‘Lula’ da Silva will take over an economy in decent
shape and with a central bank which has been ahead of the curve in the fight
against inflation

After a hotly contested race, one-time leftist former president (2003-10) Luiz
Inacio ‘Lula’ da Silva and his PT Party won 50.9 per cent of the Brazilian
presidential vote, the tightest margin in history. As of writing, his opponent
Jair Bolsonaro has not formerly conceded, but agreed to a transition of power.

Economically, Lula’s election will likely see a move away from Mr Bolsonaro’s
free market agenda to a more state-led approach of increasing public spending,
expanding social welfare, and raising taxes. Lula also vowed to resume the fight
against climate change and restore Brazil’s credibility as a steward of the
Amazon, after Mr Bolsonaro publicly promoted illegal development of the
resource-rich rainforest.

We’ll always have Paris

The president-elect has pledged to stop illegal mining, outlined proposals to
subsidise sustainable farming, and plans to establish an agency to ensure Brazil
is in line with its Paris Agreement goals.

As in many recent elections, the close result indicates how divided the country
is and should act as an incentive for the new administration to adhere to more
centrist policies. Initial signs are encouraging. In his first speech
post-election, Lula talked about unifying the country and making a government
for all 215m Brazilians, not just those who voted for him.

The polls correctly predicted the result, but there remains a question mark over
which Lula will take charge. Will he be the pragmatist, who embraces economic
orthodoxy as he did when he first took office in 2003, or will he increase state
intervention and spending as he did in his second term, in response to the
global financial crisis? The forthcoming appointments of his finance minister
and broader cabinet should provide important clues to his economic policy.

Despite the uncertainty, the immediate impact of the result on Brazil’s economy
is likely to be limited. Recent GDP growth has beaten other Latin American
countries and unemployment has declined. Brazil also benefits from today’s
macroeconomic backdrop; here there are similarities to Lula’s first term in
power, when the country benefitted from significant commodity tailwinds, helping
underpin state spending.

Keeping it real

Brazil has also been ahead of the curve in its efforts to combat inflation. The
independent Brazilian central bank has raised the main policy rate to 13.75 per
cent, which has supported the Brazilian real and made it one of the strongest
emerging market currencies this year. This has allowed the central bank to
signal an end to the hiking cycle, which should be supportive going forward. For
these reasons, radical measures may not be necessary. In any case, given the
more conservative composition of Congress, any aggressive economic agenda would
likely face gridlock and need to be moderated.

> Credit metrics for many Brazilian corporates are in robust shape

As investors in emerging market corporate debt, one of our key concerns is the
impact of the elections on Brazilian companies. Credit metrics for many
Brazilian corporates are in robust shape.

However, Lula’s administration might take a more interventionist approach to
business, particularly to large state-owned enterprises that play a major role
in the Brazilian economy. We believe this risk should be somewhat mitigated by
legislation passed in recent years. Typical of this approach is the ‘SOE
Governance Law’ of 2016, which aimed to limit state interference and align
business practices with the private sector, as part of a drive to attract more
investment into key sectors of the economy. These measures should disincentivise
intervention into banks such as Banco do Brasil, majority-owned by the
government, and the oldest bank in the country.

It boasts a good-quality and diversified loan portfolio, stable low-cost
funding, and strong capitalisation, positioning it conservatively to absorb an
uptick in non-performing loans if the economy slows.

Reasons to be cheerful

Energy supply and fuel pricing is another key topic, with state-controlled oil
and gas giant Petrobras maintaining prices in line with international markets.
However, Mr Bolsonaro had put pressure on the company to artificially lower fuel
prices and Lula may also try this. That is why we avoid direct interference risk
in the energy sector and prefer companies with more diversified operations in
biofuel supply chains as well as natural gas distribution and commodity
logistics.

While much will depend on Lula’s next steps, there is reason to be optimistic
about Brazil’s economy. We expect to see some relief in markets and moderation
in risk premium as investors had been previously pricing in greater political
and economic risks. The economy is still expected to grow, albeit more slowly,
and underlying corporate fundamentals are in good shape. After all, the
elections are behind us and the results are not being contested.

Charles Gélinet is portfolio manager of the J. Stern & Co. Emerging Market Debt
Stars Fund


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MORE STORIES

 * Can election fever prove harmful to investors?
 * Brazil learning to cope with growing pains
 * Brazil learning to cope with growing pains
 * European and Japanese equities top Lloyds hitlist
 * Emerging markets down but not out
 * Carnival spirit could turn Brazil’s fortunes around


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