Temer’s Brazil was mistakenly priced for perfection
Henrique Meirelles, Brazil’s finance minister, called it “didactic”: a 2.7 per cent slide in the Bovespa stock market index on Tuesday morning, after investors woke to the news that the government had, apparently, thrown in the towel on its long-awaited pensions reform.
Michel Temer, the deeply unpopular president, quickly tried to reassure investors and the public that he was still in the ring and fighting hard to win approval of the reform. Stocks and the currency have been seesawing since, as the news flow points one way then the other.
Whatever happens next, many investors appear to have accepted that they were previously wrong to price Brazil to perfection.
The country has been one of the strongest lines in the emerging market growth story this year as it has emerged from two years of deep recession. Russia is doing the same. Growth may be slow in some countries, Brazil and Russia included, but it has become general across the emerging world. Trade is picking up, inflation is falling in many economies, and more and more yield-starved, cash-rich international investors have sought EM assets.
Now, however, they may have reached their limit.
“Positioning has become very heavy,” says Simon Quijano-Evans of Legal and General Investment Management, citing strong flows to EM assets from non-dedicated crossover investors in the past 12 months.
“Now we have had shocks in the past couple of weeks out of Venezuela and the Middle East, and these have combined to increase what I call the political spread in places including the Gulf Cooperation Council, South Africa, Turkey and Brazil.”
He warns that the “negativity” hanging over EMs in general would quickly deepen over Brazil if the government fails to deliver on pensions reform.
Yet such an outcome is now widely accepted.
“We don’t know what version of the reform will emerge from Congress,” says Alberto Ramos, economist at Goldman Sachs. “The original proposal would have saved close to R$800bn ($250bn) in net present value over the next 10 years. The government seems willing to give up about 60 per cent of that, so it’s maybe worth R$300bn. That’s not a lot.”
One problem is that even a successful reform would have been fiscally neutral: it would have prevented further deterioration in Brazil’s public accounts rather than delivering any improvement.
With debt service costing about 6.7 per cent of GDP and a primary budget deficit (before debt repayments) of about 2 per cent, according to the IMF, Brazil would still need a daunting fiscal adjustment to avoid sinking back into recession.
There is also the increasing possibility that no version of the reform will be passed at all.
In the past three months Mr Temer, who at about 3 per cent has the lowest approval rating on record for any Brazilian president, has survived two attempts to remove him from office to face trial on graft charges, and then undergone prostate surgery.
Yet he has bounced back this week, appearing on national TV and social media to try to drum up support for the reform, arguing that it will end privileges for the few. Some say that this is a long-overdue change of approach, given that much of the drain on the public finances caused by the current pensions regime is its huge imbalance in favour of public-sector at the expense of private-sector workers, which would be corrected by the reform.
But it is looking like too little, too late. Foreign investors are already heading for the door, taking $1.4bn from Brazilian stocks during October, according to an analysis of market data by Mario Mesquita, economist at Itaú.
“Optimism about Temer’s ability to push through reforms has diminished, his political capital has diminished,” says Neil Shearing, chief EM economist at Capital Economics. “The market is starting to get round to that idea.” Baleia Rossi, leader of Mr Temer’s PMDB party in the lower house of Congress, says that, before the threat of charges against the president, approval of the pensions reform was seen as “imminent”.
Not now. “The reality is that today the picture is different. The government does not have the necessary votes,” he told reporters.
That situation seems likely to worsen. With general elections in October next year, legislators will be increasingly attuned to the career cost of voting in favour of what is a deeply unpopular reform. The three-fifths majority needed to pass the reform, which always looked hard to reach, seems even more unattainable.
Things were very different not long ago. Brazilian stocks more than doubled in price between January 2016 and the end of October, on optimism that Mr Temer would take over from his leftwing predecessor, Dilma Rousseff, and return the country to economic orthodoxy with a sweeping reform plan.
He has delivered part of that promise, putting a cap on public spending and slashing subsidised lending. Brazilian bond yields suggest some optimism remains: the 10-year dollar-denominated benchmark currently yields 4.8 per cent, down from 5 per cent at the start of the year, although up from less than 4 per cent last month.
“At the moment we are in a very benign environment for emerging markets,” says Paul McNamara at GAM. “But there will come a time when that’s not the case and that’s when the absence of a Brazilian pension reform is going to matter.”
Andres Schipani & Jonathan Wheatley