While politics was always likely to be noisy, the risk that social reforms could be substantially delayed, has likely not been priced into the bond market.
Brazil’s already-unpopular President Temer faces the rising risk of impeachment. This comes after a leading newspaper revealed he had condoned paying ‘hush’ money to a corrupt senior politician in the ongoing ‘car wash’ scandal, involving embezzlement at Petrobras. Temer has long faced allegations that he was directly involved in the scandal.
Could Temer be impeached?
Yes, but the legal process could turn lengthy. It may be difficult to prove that he directly received payments. Simply, condoning corruption may not be sufficient. Another route to impeachment is the ongoing investigation into electoral fraud relating to impeached-President Dilma’s 2014 election campaign. Impeachment aside, popular pressure may make his presidency untenable.
What happens to the reform agenda?
The likely outcome would be that all-important social security reforms needed to stabilise public finances will now drag on. Either because Temer is more focused on his impeachment than cajoling Congress to pass reforms or because the new leadership could be unwilling to push through unpopular reforms with the 2018 Presidential election getting closer.
What does this mean for the economy, ratings and the market?
Investors have been keenly watching the progress on fiscal reforms, to gain greater assurance of Brazil’s credible commitment to spending cuts. Government debt (71% of GDP) is high and rising. Political noise will dent confidence and do little to support Brazil’s economic recovery. A weaker real could once again spill over into inflation, complicating expected monetary easing. Policy drift, weak growth and failure to arrest the rise in government debt could see at least Fitch and S&P follow through on their negative outlooks.
Another political crisis not priced in
Brazil trades in line with its ‘BB’ peers. The Brazil complex has performed well, outperforming the EMBIG by 3.5% over the past year on expectations of reforms and a pickup in growth (JP Morgan, 18 May 2017). While renewed political noise was always a risk at current levels significant delays to the reform programme, which puts pressure on ratings, have in our view not been priced in. With opening indications on both corporates and sovereigns negative, until there is more clarity one can expect increased volatility in Brazilian assets.
Impact on corporate debt
Regarding the corporate names we like, spreads will widen in sympathy with the move in the sovereign curve but we do not see any fundamental changes in the companies that we are exposed to. Most of these names are export orientated companies and we believe will actually benefit from the weakening of the Brazilian currency.
With our investment philosophy of holding strong credits based on fundamentals for the long term and not being swayed by short term technicals or market volatility we do not see a need to alter our Brazilian exposure. We will obviously be monitoring the situation closely as it unfolds but currently we feel comfortable with our risk.
Sailesh Lad - Manager of AXA IM Emerging Markets Short Duration Bonds strategy - AXA IM