Brazil: Plus ça change…
“Those who do not remember the past are condemned to repeat it”, George Santayana
On Wednesday, August 31st, 2016, after a 3-day session, and with a clear majority of 61 votes to 20, Brazil’s Senate officially impeached Dilma Rousseff, making her the second President in Brazil’s history to be removed from office. Mrs Rousseff had been suspended from her presidential duties in May 2016.
The impeachment proceedings were based on allegations that Mrs. Rousseff committed fiscal crimes when she (i) amended certain decrees without Congressional approval, which sought to provide more budgetary flexibility and (ii) adopted certain accounting practices that concealed Brazil’s worsening fiscal deficit.
The impeachment process attracted widespread public support, particularly after Judge Sergio Moro unveiled the “Car- Wash” (Lava Jato) scheme, the largest corruption scandal to hit Brazil, involving state-owned companies, political parties, local conglomerates, pension funds and other related entities.
Temer’s three pillars
Following the President’s suspension in May, Vice-President Michel Temer took on the Presidency on an interim basis, and will now serve in that office until the expiry of Mrs Rousseff’s original mandate in 2019.
Mr Temer’s government program is anchored on 3 main objectives:
- Maintenance of social benefits for lower-income people
- Coordination of fiscal and monetary policies
- Recovery of market confidence.
On his first day as president, Mr Temer declared full support for continued investigation of the Car Wash scandal and appointed Henrique Meirelles (former president of Brazilian Central Bank) to head the Ministry of Finance. Mr. Meirelles promptly pulled together a respected technical team to execute the reform plans, which local markets took to calling the “Dream Team”.
In a first step towards reducing public expenditure, the number of Government ministries has been reduced by over 30%. Temer and his new finance minister have also sent to Congress a constitutional reform bill, which aims to limit the rate of annual public spending growth to the previous year’s inflation rate. Simultaneously, the finance team also started working on Social Security reform, the main goals being to increase the retirement age and decouple social benefits from the official minimum salary. All of this has helped forecasters to estimate a 20% decline in the annual budget deficit from 2016 to 2017.
The reaction to the Car Wash scandal has been seen in zero public tolerance for corruption, with new laws passed imposing tighter rules on procurement and bidding processes carried out by state-owned companies as well as prohibiting the appointment of politically connected persons as officers for such companies.
Positive Market Reaction
On the ground and in the response of the capital markets, the various initiatives we have seen to date have contributed to a return of some optimism to the country. Risk perception has decreased substantially, Brazil’s sovereign bond has seen a notable yield compression, the BRL has also seen a significant recovery, and so has the Bovespa index, which has returned to the 55,000+ level, representing an increase in USD in excess of 50% YTD. Inflation is expected to end the year at around 7.5%, which is a significant reduction from the 10.7% at end of 2015, providing room for interest rate cuts from 2H16 onwards.
Cleaning up the “Car‑wash”
As Eisenhower warned, “a people that values its privileges above its principles soon loses both”. The Federal Justice Department has certainly taken this maxim on board in the way it has sought to tackle the corruption exposed in the Car-Wash scandal. In March 2014, Federal prosecutors and Federal Judge Sergio Moro started investigating a chain of car service stations suspected of money laundering activities, but soon afterwards expanded their enquiry to become the largest corruption investigation in Brazil, looking at over BRL6bn in alleged bribes, money laundering and contractual fraud benefiting individuals, companies and certain political parties.
Over the past 2 years, the prosecutors have traced the sources and uses of funds, both in Brazil and abroad, which has led to the arrest of several CEOs, officers and directors of some of the largest Brazilian conglomerates, as well as former executives of state-owned companies and politicians. Other important public personalities, including former president Luis Ignacio “Lula” da Silva, have been taken in by police for questioning and remain under suspicion.
Altogether, 166 people have already been arrested, out of which 56 have agreed to plea bargains and 5 companies have agreed to leniency agreements after the payment. A total of BRL37.6bn have been applied in fines, out of which BRL 2.9bn have already returned to the Government.
The Olympic effect
The eyes of the world turned to Brazil in August, as the country hosted the Olympic Games, the first in South America to host the Games. Although surrounded by scepticism and doubt from the outset, Brazil delivered 2 weeks of thrilling competition and its trademark hospitality, While Rio may not have followed Beijing and London in attracting the traditional IOC send-off as the “best games ever”, there is no doubt that it significantly exceeded both domestic and international expectations. And for the local population, Brazil registered its best performance ever in the Olympics with 18 medals, 7 Gold, 3 Silver and 8 Bronze including winning the football gold to complete the picture.
What comes next?
Optimism remains high that after a very difficult period, Brazil will emerge from its current economic problems and return to strong growth. This is not going to be simple, and the next 12-18 months are likely to continue to be challenging, and pressures on the consumer are evident in the performance of many businesses in Brazil, including some of our own investee companies. However, the emergence of an educated and more affluent middle class continues, and we see this in increased enrolments in our education businesses and in growing demand for consumer credit and investment management services in our investments in the financial services sector. The change in leadership, together with the achievement of substantial progress in the program of fiscal and social security reforms, as well as the conclusion of the “car-wash” operation can put Brazil firmly back on track, but we know there will be plenty of bumps along the road to a full return to health and prosperity.