2018 is an election year in Brazil. While the Brazilian market was dominated last year by political scandals and efforts to advance market friendly reforms, one of the main concerns for investors in Brazil for 2018 has been the re-emergence of the politician commonly known as “Lula”.
Former President Lula
Lula, whose full name is Luiz Inácio Lula da Silva, was President of Brazil from 2003 until 2011, and oversaw the greatest period of growth in the history of the country. While he undoubtedly raised living standards in Brazil during his tenure and helped reverse the historical inequalities in the country, many of the social programs that he introduced have left Brazil’s finance in tatters. The costs of the social programs have caused debt to GDP to increase at an alarming rate, and during the recent recession (2014-2017) the fiscal deficit dropped from -3% to -10%. The ratings agencies downgraded Brazil to junk-status in 2016, further deepening the country’s woes.
President Temer, who stepped in when former President Dilma (Lula’s successor) was impeached and removed from office in 2016, has spent most of his Presidency advocating market friendly reforms whilst fending off allegations of bribery. Despite the severity of the allegations, which caused the market to fall 10% when announced, he has been fairly successful in advancing reforms necessary for the revival of the Brazilian economy.
Regardless of the recent disappointments in passing the important pension reform, and despite the government facing historically low approval ratings (less than 10%), the pro-business agenda of Temer has resonated well with investors. The Brazilian stock index (Ibovespa) is up over 50% since his Presidency started.
Lula, on the other hand, having been vocal about running for office in the upcoming election, has pledged to reverse the reforms passed by the current administration and scrap the proposals currently in place. Although he is a polarized figure in Brazilian politics, Lula is still revered by many due to his efforts to reduce poverty. Proof of this comes from the polls: aside from being the most disliked candidate, he is also by far the most popular candidate. Consequently, it is no surprise that investors have been reluctant to go all-in on Brazil this year, however positive the short-term outlook is.
The market therefore breathed a sigh of relief on January the 24th when Lula’s conviction for accepting bribes whilst being President was upheld by a panel of judges, effectively sentencing the former President to more than 10 years in prison. He thus faces further challenges in resurrecting his bid to become President again. While the ruling does not keep Lula out of the race indefinitely (he has already promised to fight and appeal the sentence), it is proving less and less likely that he will be allowed to run.
“We believe the ruling has calmed the investment community as Lula’s resurgence is considered one of the main threats for the continued progress on important reforms”, says Erlend Fredriksen, analyst in DNB Global Emerging Markets. “We have confidence in the short- to medium-term prospects for Brazil, and with the election of a reformist candidate, it will renew our optimism for long-term progress as well.”
Currently, DNB Global Emerging Markets is overweight Brazil in the fund.
Investors’ sentiment improved considerably after the ruling, and the Ibovespa is up +6.4% afterwards. In comparison, MSCI EM and S&P500 is down -2.3% and -2.6%, respectively, in the same period. All returns are measured in USD as of the 13th of March.
The graph shows clear outperformance on the Brazilian stock exchange (green) since the ruling The race for President has been blown wide open by the conviction of Lula, and we expect the market to move with the polls going forward. The main concern, however, seems to have been removed – a weight has been lifted off Brazil’s shoulders.