Brazilian Elections: Markets will hinge on pension reform plans
Brazil’s elections come at a difficult moment, with the presidential candidates under heavy market pressure to come up with a credible plan to reduce the fiscal gap. If the next president, to be elected in October, has no credible plan to control social security spending, financial markets are likely to sell off sharply, pushing the real lower, interest rates higher and putting increased pressure on the new Brazilian leadership to act. Maarten-Jan Bakkum, Senior Emerging Markets Strategist at NN Investment Partners explains:
Brazil’s pension crisis
Too little of decisive action to control Brazil’s pension bill is one of the main reasons why the country’s fiscal deficit has remained above 7% of GDP for the past four years. With total social security expenditure approaching 45% of government spending and the number of beneficiaries rising by 3.5% annually, little room is available for productivity-enhancing investments in physical and social infrastructure.
This is the main reason why the growth potential of the Brazilian economy remains low (around 2%) and why public debt as a percentage of GDP continues to grow rapidly, by some five percentage points annually.
The current market environment across emerging markets is further exacerbating this situation, particularly as Brazil, with its structurally high fiscal deficit, negative public debt dynamics, poor growth performance and high level of political uncertainty, is always perceived as being more vulnerable than the average emerging economy.
The tighter domestic financial conditions, which are largely due to the deterioration of the global environment for emerging markets, have an immediate impact on Brazil’s fiscal accounts, as interest costs on the country’s public debt represent 6% of GDP. In other words, this year’s interest-rate rise makes the necessity of fiscal adjustment through pension reforms even more urgent than it already was.
Currently, it looks like two candidates have a decent chance in Brazil’s elections: right-wing nationalist Jair Bolsonaro and Fernando Haddad, the left-wing ex-mayor of São Paulo and likely replacement for Lula da Silva, who has been barred from running.
Bolsonaro is leading the polls. Although he presents himself as an anti-establishment candidate, his economic views are similar to those of the current government. His main issue is that his party (PSL) carries little weight in Brazilian politics and political analysts question his potential effectiveness as president and his commitment to reform.
Haddad is not well-known, although this is likely to change vastly once Lula endorses him as his replacement. The Lula/Haddad economic programme includes an end to the fiscal rule implemented by the current interim government, insignificant pension reforms, a suspension of the privatisation programme and capital controls to limit market volatility. All of this means that we can expect markets to react negatively in the case of a Haddad victory.
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