Argentina shows Brazil the way to restore confidence
Brazil in turmoil
The political situation in Brazil is highly febrile, to the extent that within our three days in the country, former president Lula went from political ruin, to revival, to ruin again, amidst political manoeuvring that should provide rich inspiration for the next series of the TV show House of Cards.
We will therefore refrain from offering any kind of political prediction for Brazil.
However, one point of consensus amongst all we met was that the country’s economic crisis – GDP this year is forecast to contract by a similar, if not greater, extent compared to in 2015 – is inextricably linked to its political turmoil.
Resolution of the political crisis is universally regarded as a pre-condition for a return to growth, though opinions varied on the likely timescale.
Another apparent consensus was on the need for fiscal reform. With a fiscal deficit running at around 10% of GDP, Brazil’s government debt is scheduled to climb rapidly over this presidential term, and reductions to that deficit are complicated by the fact that much government spending is mandated by law and so not subject to cuts.
For market confidence to be restored, and if Brazil is ever to regain investment grade status, these laws will have to change.
Key amongst them is social security, a ruinously expensive item driving a huge part of the deficit.
That reforms to this popular plank of government spending appear to have broad political support is encouraging, but it was also clear that no reforms would be forthcoming under a Dilma presidency.
Indeed, there is relatively limited ambition on reform throughout the economy and this is the area we are most concerned about, even assuming a successful impeachment process.
Our overriding impression was that once fiscal reform was accomplished, political will for further changes would be limited, yet Brazil has labour and product markets in dire need of reform, and creaking infrastructure crying out for investment.
We worry that vice president Michel Temer, should he be elected president, would not be able to deliver on this front, and worse, that by the 2018 elections the popular anger and desire for change that is driving the push for impeachment will have cooled, and further, painful, reforms will be shunned by the electorate.
The consequences for Brazilian growth potential in an environment of weak commodity prices are not to be underestimated.
Optimism for Argentina
Meanwhile, in Argentina, we find greater reason for optimism, with the country further along the reform path. The new government has an ambitious and wide ranging reform platform, and a popular mandate to back it.
Progress has already been made on the issue of the bond holdouts1, and importantly, the legislation received support across the spectrum.
Fiscal and inflation targets are next, and to us strike the right balance between bold and credible. Officials are frank, but confident about the challenges faced.
The year ahead will be an important one as the government seeks to make progress and build popular support ahead of the 2017 elections which could give it the majority it needs in the upper and lower houses.
This, to us, is the key risk; without a majority, it is uncertain whether the reform agenda can be implemented in full. With the holdout legislation, everyone stood to gain.
The same cannot be said of domestic economic reform. All the same, Argentina helps set an example for Brazil of what is needed to truly restore domestic and international confidence, although after twelve years of disastrous policies.
We hope that it does not take Brazil the same length of time to get there.
1. A holdout occurs when a bondholder does not give their consent to the restructuring of debt from an issuer that is defaulting, or nearing default. The bondholder “holds out” in order to reserve the legal right to demand repayment of the bond at face value.↩
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