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INFOCUSOCTOBER 2018

The search for order and progress: Brazil’s presidential election

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THE SEARCH FOR ORDER AND PROGRESS: BRAZIL’S PRESIDENTIAL ELECTION

On 7 October Brazil will hold the first round of its presidential elections. This will be the first election since former President Dilma Rousseff was impeached in 2015. With polls still too close to call, the country will choose between candidates with very different economic and political visions. Restoring political order in the country and boosting economic progress through growth are among the key challenges for the new administration.

As a democratic federal republic Brazil has a division of powers between the Executive, Legislative and Judicial branches. Therefore the President needs approval from Congress, formed by the Senate and the Chamber of Deputies, to pass any laws. On Sunday, together with the presidential election, Brazilians will elect two thirds of the Senate and the whole chamber of Deputies (513 seats). Each of Brazil’s 26 states and the Federal District have three seats in the Senate; with two out of those three seats up for election this weekend.

People will cast their votes for two senators from their respective states together with their vote for President. Although normally the winning party also controls the upper house in Congress, it could happen that no party reaches a majority in the Senate in which case a successful government will depend on the ability to form factional alliances. In the lower house, seats are allocated by proportional representation, according to each state’s population. This allows for the possibility of the opposition controlling the chamber of Deputies. At the moment, both houses are controlled by the current government.

If the polls are correct, none of the presidential candidates will take more than 50% of total first round votes. This means that the two most popular candidates will go into a second round vote, to be held on 28 October.

A mixed political sceneThe main candidates running for President are Jair Bolsonaro (PSL - Social Liberal Party), Fernando Haddad (PT - Workers Party), Marina Silva (REDE – Sustainability Network), Ciro Gomes (PDT – Democratic Labour Party) and Geraldo Alckmin (PSDB – Brazilian Social Democracy Party), with the first two being the leading contenders to go into the second round, as shown in Figure 1.

1 International Monetary Fund, World Economic Outlook.2 O que pensa Paulo Guedes, o cerebro economico de Jair Bolsonaro. http://exame.abril.com.br

The impending first round of presidential election provides stark choices for the people of Brazil. However, whatever the result, Joaquin Thul explains that the same challenges of new political order and economic progress will be paramount.

1. First round voting intention (%)

Bolsonaro and Haddad stand at polar opposites of the political spectrum which is something that could divide the electorate at a time when the country is in need of more political unity. Jair Bolsonaro, who has been leading the polls recently, is a former army captain. He is known in Brazil for his far-right and populist political views. During his terms in the local government of Rio de Janeiro, Bolsonaro was a firm supporter of the rights of citizens to carry guns and self-defence.

He has appointed Paulo Guedes as his leading economic advisor. Guedes, known for his liberal economic ideas, has proposed the privatisation of government-owned companies and the subsequent use of those resources to reduce the public debt. The current debt-to-GDP ratio in Brazil stands at 87%,1 the highest among Latin America’s main economies. This controversial privatisation plan would include companies such as Petrobras and Banco do Brasil and would generate strong opposition from other political parties. It is also unclear how this would fit with Bolsonaro’s nationalist tendencies.

According to the specialised Brazilian business and economics magazine Exame, estimates from Bolsonaro’s economics team show that these privatisations would yield the government BRL 800 billion (USD 200 billion) which would allow them to reduce the government’s debt by almost 20%.2 It is still difficult to know how much of Bolsonaro’s economic plan is politically feasible. His divisive and authoritarian rhetoric could be a barrier to the formation of alliances in

August 2018 | 2

Source: Ibope as at 2 October 2018.

20-Aug 04-Sep 11-Sep 18-Sep 24-Sep 26-Sep 01-Oct0

5

10

15

20

25

30

35

Votin

g in

tent

ion

(%)

Ciro Other

Bolsonaro Alckmin Blank / NullHaddad Marina N/A

2022

26 2831

2728

46

8

19212122

October 2018 | 3

THE SEARCH FOR ORDER AND PROGRESS: BRAZIL’S PRESIDENTIAL ELECTION

3 International Monetary Fund, World Economic Outlook.

Congress that are likely to be necessary to pass some of these economic reforms. This is because of the factional nature of Brazilian party politics, even within the same party.

The recent truck drivers’ strikes, motivated by the high cost of fuel and requesting a diesel subsidy, reflected Brazilian workers increasing dislike of the liberal policies implemented by the current government.

The main opposition to Bolsonaro currently comes from Fernando Haddad, the Worker’s Party (PT) candidate. Haddad was broadly unknown to the public outside the state of Sao Paulo before September 11th when he was confirmed by the PT as the party’s leading candidate following news that former President Lula de Silva has been legally barred from standing. As a former mayor of Sao Paulo, he is known within the capital; however, he did not even feature in the opinion polls in early August, when Lula was still expected to run.

A left-wing economist, Haddad was confirmed as a candidate less than a month before the elections. He has gathered the support of PT voters who embrace Lula’s leadership within the party and perceive him as the candidate who will continue Lula’s social policies. This is particularly important in the north-east region of Brazil, where many lower-income voters are located. With only a couple of days before the first round, Haddad currently has 21% of support, 10 percentage points behind Bolsonaro and 10 percentage points ahead of Ciro Gomes, the third placed candidate in the polls.

Financial markets seem to perceive Bolsonaro as the most market-friendly candidate of the top two contenders. Since candidates were confirmed on September 11th, Brazilian equities have rallied by 9% and the Brazilian real has strengthened by 5% against the US dollar. Markets have reacted positively following the publication of each new voting poll reflecting Bolsonaro’s lead, as seen in Figure 2.

2. Markets have reacted positively to polls showing Bolsonaro’s lead

3. Brazil central government major spending items (% )

Challenges to economic growthRegardless of the election outcome the winning candidate will inherit a tough economic situation. Growth in Brazil has slowly started to recover over the last year, with 1% GDP expansion in 2017 following two years of sharp contraction. According to IMF estimates, the Brazilian economy is expected to grow by 2.3% in 2018 and 2.5% in 2019. Inflation seems to be fairly benign at 4%, in contrast with higher historical norms in the country. However, the labour market remains weak with an unemployment rate of 12%. Boosting employment has historically been one of the flagship policies of previous PT governments. A challenge for the next government will be to create jobs without increasing government spending and this has been an important topic during the campaign.

On the fiscal front an immediate challenge for the new government concerns pension reform. At the moment social security represents 44% of total Brazilian central government spending, as shown in Figure 3. With the budget deficit expected to surpass 8% of GDP in 20183 and the debt-to-GDP ratio above 87%, the new government is expected to ask Congress to approve an extra BRL 258 billion (USD 65.5 billion) loan to help fund the social security deficit. It will be very hard for whichever party wins the elections to bring government finances under control and restore long term market confidence without a meaningful reduction in state pension commitments. This will be particularly challenging given that a reform of the pension bill requires a Constitutional amendment, needing a special majority in Congress.

Source: Thomson Reuters Datastream/Ibope as at 2 October 2018.

01Aug

08Aug

15Aug

22Aug

29Aug

05Sep

12Sep

19Sep

26Sep

03Oct

70000

72000

74000

76000

78000

80000

82000

84000

Bove

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0

5

10

15

20

25

30

35

Votin

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(%)

Bovespa Index Bolsonaro voting intention (rh axis, %)

Source: Thomson Reuters Datastream as at 2 October 2018.

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 180

10

20

30

40

50

% o

f tot

al s

pend

ing

Social security benefitsPayroll

Other compulsory servicesUnemployment allowance and benefit

43.8

22.1

13.9

4.1

ConclusionBrazil is facing a difficult political situation. Differences between the main candidates are likely to divide voters, in an election that might be decided by who has the lowest rejection rate rather than who is the most popular. With only a couple of days before the first round of the election, Bolsonaro and Haddad seem to be on course to enter the second round in late October.

October 2018 | 4

THE SEARCH FOR ORDER AND PROGRESS: BRAZIL’S PRESIDENTIAL ELECTION

In principle, a clear win for Bolsonaro in the first round would be a more market friendly outcome, which would prompt a short term rally in Brazilian stocks and a strengthening of the real. However, it is unclear how much these expectations are already priced in. In the week ahead of the first round, the Brazilian stock exchange has rallied by 5% and spreads from government-owned companies such as Petrobras and Banco do Brasil have tightened. If, in contrast, the first round results in a tighter race between the two candidates we could see a sudden sell-off in the stocks and a depreciation of the real.

Although the economic and financial outlook for Brazil could improve with a market-friendly outcome, the outlook also depends on the ability of whoever wins to form factional alliances in Congress. These will be the key to passing the necessary reforms required to restore economic growth and confidence in Latin America’s largest economy.

October 2018 | 5

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