Schroders: Brazilian revival hangs on election outcome

The first round of the Brazilian presidential election this Sunday resulted in a market-friendly outcome, but the second round in three weeks will continue to keep asset prices volatile.

Incumbent Dilma Rousseff won as expected with 41% of the vote—just 1% off the expected result for her—but Aecio Neves pulled a massive surprise by easily coming in second with 33.5% of the vote, ousting Marina Silva who faded badly with only 21% after polling nearly even with Rousseff as late as only a month ago.

Neves is clearly the market favourite and the best hope for a meaningful reform programme. His primary economic advisor is Arminio Fraga, former central bank head and a strong advocate for reforms. As long as it is perceived that Neves has a real shot at winning, the market is likely to rise. As Silva sank in the polls immediately leading up to the first round, markets fell sharply on the assumption that the incumbent was a shoo-in. Now at least a part of that pessimism will be unwound. However, pending the first polls after the first round due Thursday, Rousseff is likely to be perceived as the small favourite, with the advantages of a huge party apparatus and the incumbency in her favour. Weighing in Neves favour is his strong momentum, support in the business community, and a willingness to meet the negative campaigning of the president which Silva declined to match. 

In our view the upside from a Neves victory would be substantial. Souring market sentiment, and fundamental deterioration of the economy, has been steady for months as growth has slowed and fiscal deficits have ballooned.  Most recently reserves have declined and the currency has sold off sharply as hope for change began to vanish. Should Rousseff be re-elected we would expect an eventual credit downgrade to sub-investment grade would be a high probability over the course of the next two years. She has barely articulated any policy shifts for her second term, preferring to attack the plans of her rivals.

Neves on the other hand advocates a significant investment platform—perhaps the single key for a resumption of Brazilian growth—and an orthodox central bank that would re-gain credibility over time. The Brazilian byzantine political apparatus would likely water down some of those reforms, but any movement could begin a more virtuous cycle for a country that has been long out of favour. Prospects for a better course are likely to keep markets more buoyant as long as that hope remains alive.