Date
15 October 2018
With the high court's decision, the electoral court is now very likely to disqualify Luiz Inacio "Lula" Da Silva from the presidential election in October. Photo: Reuters
With the high court's decision, the electoral court is now very likely to disqualify Luiz Inacio "Lula" Da Silva from the presidential election in October. Photo: Reuters

Brazil election moves on, but reform no guarantee

High drama engulfed Brazil recently after the supreme federal court ordered the country’s leading presidential candidate to prison until he exhausts all other avenues for appeal against a prior conviction.

Former President Luiz Inacio “Lula” Da Silva received in January a 12-year jail sentence from a regional appeals court for corruption. Flocked by supporters, he turned himself in to the authorities on April 7, effectively surrendering his bid to reclaim the presidency in October.

With the high court’s decision, the electoral court is now very likely to disqualify Lula when it names the official candidates in August. This would leave one-third of Brazilian voters – the polls show he has this much support, far more than his closest rival – looking to cast their ballot in favor of another candidate, including the one Lula may potentially endorse from his own party.

With Lula out of the race, the presidential election is wide open. Markets cheered the high court’s ruling, believing it paves the way for a reformist candidate’s victory – a view we share. Following Lula in the polls are aspirants who have vowed to embrace social and economic reform. This suggests that the momentum initiated by Michel Temer, the unpopular incumbent whose politicking skills have nevertheless won for him a strong base in Congress, could continue.

This is not a given, however. Despite advocating reforms on the podium, some of the other leading candidates lack a record of achievement, political will, or negotiating skills in advancing market-friendly policies.

The consulting firm Eurasia Group calls this group the “quasi-reformers” and gives it the same odds to the presidency as the “true reformers” or those who have a demonstrable record of commitment to structural reform, as well as the skills and affiliations to get their agenda approved in Congress.

We believe this poses a legitimate risk for Brazil. The election of a quasi-reformist president may result in reforms – but weaker versions of what we and the markets would like to see. Their lack of conviction – whether because of ideology, inexperience, or some other reason – could result in compromises with the Congress that dilute the original proposals, which would then be a dangerous path for Brazil.

The biggest structural reform that remains hanging in the balance – social security reform – is crucial to achieving long-term stability in government finances, and ultimately the country’s long-term economic growth. Failure to pass a comprehensive pension reform bill could therefore keep Brazil from reaching its growth potential.

It’s too early to predict a quasi-reformist candidate rising to the presidency, but we cannot rule this out given the amount of voter disillusionment in Brazil – due in part to the government’s inadequate provision of healthcare, education, jobs, and public safety, and in part to revelations of widespread corruption in government and politicians’ misuse of power.

So far, the quasi-reformers have been more successful at appealing to this anti-establishment sentiment than the “true reformers”, who are more associated with traditional politics or come from political dynasties. Lula’s camp of populists may also profit from this situation, but none of his prodigies are as popular as he.

Currently, the market is pricing in the victory of a true reformist – a stance that could use some caution. Should this group start to show weakness in their electoral performance, markets may strike a strong defensive mode and consolidate in the coming months. For now, in our emerging market strategy, we remain overweight Brazilian equities and long the real against the Mexican peso.

– Contact us at [email protected]

RT/CG

Regional Chief Investment Officer, Emerging Markets, UBS

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