Brazil: Renewed corruption scandal elevates political risks

04 July 2017

Corruption allegations against President Michel Temer have raised political risks in Brazil once again. The current political crisis will stall major economic reform bills in Congress, weighing on the economic recovery that was beginning to take hold under Temer’s pro-business agenda. However, reforms to the business environment are likely to continue, given broad congressional support, opening up a number of sectors to foreign investment.

Security Environment

In May 2017, a leaked recording of a conversation between President Michel Temer and the chairman of meatpacking firm JBS SA appeared to show the president authorising bribe payments. Allegations of corruption have significantly weakened Temer’s position. On 27 June 2017, Federal Prosecutor Rodrigo Janot charged Temer with taking bribes. The lower house of Congress will now vote on whether to allow Brazil’s top tribunal to try the President. If this occurs, Temer will be required to step down.

Corruption allegations will elevate the risk of anti-government protests in 2017. Whilst Temer has faced strikes and protests throughout his tenure, these have primarily been in opposition to his austerity agenda. Protests will increasingly focus on corruption allegations. In early 2016, rallies calling for the impeachment of former President Dilma Rousseff attracted as many as three million participants. If Temer refuses to step down protests may once gain attract such figures. Protests may become violent, posing property damage risks. For example, in April 2017, a general strike ended with several commuter buses being torched and police using tear gas and rubber bullets.

Trading Environment

Even if Temer is able to weather corruption allegations and remain in office, economic reform is likely to stall. Three small parties have already withdrawn from the congressional coalition which has allowed Temer to pass key legislation since 2016. In a sign of Temer’s weakened position, on 20 June 2017 the Senate’s Committee for Social Affairs rejected the government’s labour reform bill.

Wholesale pension reform, a centrepiece of Temer’s fiscal consolidation agenda, is now unlikely to occur. Any reform is likely to be limited, establishing a minimum retirement age but leaving costly benefits intact.

Uncertainty over the future of structural economic reforms will weigh on business confidence in 2017, hampering economic recovery. Prior to the recent corruption allegations, Temer’s probusiness reform agenda had begun to yield results. Real GDP growth in Q1 2017 reached 1.0% q-o-q, the first quarter of growth since Q4 2014. However, political instability may restrict levels of investment in the remainder of 2017, meaning that real GDP growth is unlikely to be above 0.5% this year.

Slowing reform momentum will also weigh on Brazil’s sovereign credentials, as fiscal consolidation measures, such as pension reform, are diluted or held up in Congress. Public debt is forecasted to reach 79.5% of GDP in 2019 from 69.9% in 2016 and if the political crisis continues to prevent economic reform, a credit rating downgrade is likely. This would increase borrowing costs for the government, further elevating sovereign credit risks.

Investment Environment

Whilst the political crisis will stall macroeconomic reforms, policies to improve the investment environment are still likely to be implemented. Policies aimed at opening up heavily regulated sectors to private investment, a central tenet of Temer’s agenda, have broad congressional support and so are less likely to be stalled. As a result, a number of reforms are still likely to be introduced in H2 2017 and H1 2018. Priorities include bills to simplify the authorisation regime for the telecommunications sector; to allow the purchasing of land by foreign nationals; and to improve regulations for bidding on government contracts.

There is a risk that pro-business policies will be abandoned, particularly if Temer steps down, new elections are called and the opposition Workers’ Party (PT) enters government. The PT has opposed many of Temer’s policies, including the privatisation of Minas Gerais state’s energy company Cemig. A change in government may also result in pullback from market driven policies in the power sector. This could include reduced government commitment to adjust energy prices in line with inflation.

Brazil: Renewed corruption scandal elevates political risks

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