Brazil: Election uncertainty to weigh on growth outlook

03 January 2018

The outcome of Brazil’s 2018 legislative and presidential elections remains unpredictable, given the discrediting of major parties and emergence of candidates from outside the political establishment. This uncertainty will weigh on Brazil’s growth outlook for 2018, as investors remain concerned over the possibility of a return to populist economic policies.

Security Environment

Politicians from Brazil’s major parties have been discredited in recent years by a series of corruption investigations. This will drive support for non-establishment figures in 2018’s legislative and presidential elections. For example, unorthodox former army officer Jair Bolsonaro has emerged as a presidential contender, with polls suggesting that he would reach a second round run-off. Bolsonaro’s campaign has benefitted from rising violent crime levels in urban centres, given his strong position on law and order. He has proposed relaxing gun laws to tackle crime and enhancing rewards for police who stop criminals. In Rio de Janeiro 71,146 robberies were reported in January-July 2017, a 2.2% increase on the same period in 2016.

Foreign nationals present in Brazil will also be exposed to these risks, as violent crime is increasingly occurring in tourist areas. For example, over the last two years there has been a 128% increase in the number of robberies in the Copacabana beach area. Robberies may occur in conjunction with opportunistic express kidnaps. Individuals are most likely to be targeted in express kidnappings when they are in affluent neighbourhoods, or close to ATMs and banks.

Trading Environment

Election-related uncertainty will weigh on Brazil’s economic performance in 2018. Investors will likely be deterred by any developments which suggest a victory for a non-centrist candidate. Current President Michel Temer has implemented fiscal consolidation measures to narrow the budget deficit and lower inflation rates. A return to populist economic measures would limit this broad trend, and weigh on Brazil’s emerging economic recovery. Brazil is expected to end its recession in 2017, with real GDP growth forecasted at 0.4%. This nascent recovery is being driven by the stabilising labour market and rebounding retail sales. Robust export performance will also be an economic bright spot. Real exports grew by 2.5% y-o-y in Q2 2017, a result of strong iron ore output and agricultural production.

Whilst investors are reassured by Temer’s pro-business agenda, his reduced political capital will also weigh on the sovereign credit position in the near term. Temer has proposed pension reforms to raise the retirement age and reduce pension payments. However, divisions within the ruling coalition have led to watered down proposals and significant delays in Congress. In December 2017, Temer agreed to delay a lower house vote on reform until 18 December 2017, to facilitate further negotiations with legislators.

If approved, reforms will then be voted on in the Senate in February2018. However, any further delays will make it unlikely that pension reform is passed before elections in October 2018. Along with policy uncertainty in the face of elections, this will elevate concerns over Brazil’s sovereign credentials. Gross general government debt is forecasted to reach 76.9% of GDP in 2018, from 69.9% in 2016.

Investment Environment

On 28 November 2017, the Brazilian Senate approved two presidential decrees, proposed by Temer, which outlined regulatory reform of the mining sector. The approved legislation will allow for the creation of a mining regulatory agency in order to speed up permit processes.

However, the second piece of legislation will increase royalties on mining activities. This includes an increase in iron ore royalties to 3.5% from 2.0% and gold royalties from 1.5% to 2.0%. Royalties will also be levied on revenue and not profit, weighing on the profitability of the sector for international mining firms. The world’s largest iron ore producer, Vale, stated that the move would weigh on its competitiveness and ability to operate high-cost mines.

Temer had hoped that increased mining royalties would be mitigated by a third proposal to amend and streamline the existing mining code. However, this decree was not approved, meaning that further reforms will not occur until the election of a new government in October 2018. This will generate significant uncertainty over the future regulatory status of the Brazilian mining sector, limiting investor confidence in the sector.

Election uncertainty to weigh on growth outlook

In this month's Risk Outlook, we also provide a detailed forward looking assessment of developments within the security, trading and investment environments for Colombia, Cuba, Mexico and Venezuela all of which have been the subject of recent enquiries from JLT's client base.

World Risk Review Jan 2018

The monthly Risk Outlook is supported by JLT’s proprietary country risk rating tool, World Risk Review (WRR) which provides risk ratings across nine insurable perils for 197 countries. The country risk ratings are generated by a proprietary, algorithm-based modelling system incorporating over 200 international sources of data.

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For further information, please contact Eleanor Smith, Political Risk Analyst on +44 (0)121 626 7837 or email eleanor_smith@jltgroup.com

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