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LGT Beacon: Big Challenges Ahead for Brazil's Hopefuls

October 15, 2014

Brazil’s presidential race is going into the second round. As the poll ratings for the incumbent president declined, the country’s stock market temporarily rallied, suggesting that market participants are anticipating a change of government in Latin America’s largest economy, and recent surveys support such hopes. But whoever prevails at the polls will face major challenges arising from Brazil’s weak economic situation and structural shortcomings

The presidential election campaign in Brazil brought some surprises. The death of presidential candidate Eduardo Campos gave the campaign a completely new direction. The entry of Marina Silva, who had taken Campos’ place in the race, vigorously upset the initial scenarios. Then, just shortly before the first round of the election, the situation shifted again, this time in favor of the other opposition candidate, Aécio Neves. In the end, Silva dropped out of the competition after receiving only 21.3% of the vote in the first round. Neves came in second, with 33.6%, while incumbent Dilma Rousseff took 41.6% of the vote.

Support of third-placed Silva makes Neves a credible challenger of President Rousseff

The latest electoral surveys show that Neves will emerge as the victor in the second and final round of the vote, even though the usual statistical margin of error, undecided voters and election-day abstentions limit the significance of such surveys. Rousseff’s effective campaign machine could also still make political life more difficult for Neves, a former governor of Minas Gerais, one of Brazil’s larger and wealthier states. Incumbent Rousseff had used smear-campaign tactics against her rivals in the first round, and this type of negative campaigning could further intensify before the second round on 26 October.

Rousseff's popularity is primarily based on socialist policies aimed at the poorer population strata of Brazil. She has also initially benefited from electoral rules that give the incumbent significantly more airtime on television and radio. However, in the run-up to the second round, airtime time is awarded equally to both candidates, reducing that advantage. Also, Neves is benefitting from the support of third-placed Silva, granted in exchange for agreeing to take over certain points of her policy program.

Neves’ more business-friendly views justify investors’ hope for change 

But what can be expected from the two candidates? Rousseff stands for distributive economic and social policies, which also re-serves a significant role for the state in the economy. This has already led to substantial market distortions in some cases. Neves, on the other hand, is considered to be a more pro-business candidate. Although he has promised to uphold existing social policies, he also envisions more restrictive fiscal outlook, and tackling high inflation is high on his agenda as well.

The structural challenges are still big 

The hopes for political change among market participants are therefore justified. However, the currently adverse economic environ-ment in Brazil represents a major problem for both candidates. Brazil had benefited from a credit-driven investment boom in the preceding cycle, but declining capital inflows and a reduction in state-subsidized lending have intensified the negative impact of falling commodity prices more recently. At the same time, inflation remains structurally high due to large infrastructure deficits, and the economy continues to suffer from a weak propensity to consume and invest.

With dwindling support from the economic cycle, it will also be increasingly difficult to cut the high fiscal deficit. Thus, whether Neves can succeed in such a stagflationary environment remains questionable, while the increasing fragmentation of Brazil’s parlia-ment is also likely to complicate policy in the years to come. Thus, it is better to keep expectations low.

Election-driven rally in the Brazilian stock market

Last but not least, with the country’s Ibovespa index already up 12.5% since the beginning of the year, Brazilian stocks are no longer "cheap". The presidential election seems to have been reduced to a binary event in stock market. And while we may yet see even higher stock prices in Brazil, the current rally lacks fundamental drivers. Developments should thus remain very volatile.

Read more in the LGT Beacon

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