The Daily Update - Brazil Election & PAINTBRUSH

Campaigning is underway for Brazil’s October Presidential election which is already proving eventful with Luiz Inácio Lula da Silva being barred from running by the Electoral Court due to his conviction for corruption. Plus, far-right candidate Jair Bolsonaro has ended up in hospital after being stabbed at a campaign rally which is likely to curtail his campaign appearances.

Lula has called on voters to back the former São Paulo Mayor Fernando Haddad who is now the Workers’ Party (PT) candidate and with Lula’s support Haddad should stand a good chance of reaching the run-off stages.  Monday’s Datafolha opinion poll showed Haddad at 9% vying for second position, Ciro Gomes (left-wing candidate) at 13% of the votes, Marina Silva (environmentalist) at 11%, the former São Paulo Governor Geraldo Alckmin at 10% (centre-right) and the far-right candidate Jair Bolsonaro leading at 24%.  The first round of the election will take place on October 7th.

The new President will face many challenges but a key area is to what extent they can reform contentious areas such as social security to help address Brazil’s fiscal deficit: Fitch estimate the general government deficit (including interest payments) at 8% of GDP in 2018.  Exacerbating this Brazil also has high government debt levels which Fitch estimate at 77.5% of GDP for 2018. Congress passed an amendment in 2016 limiting the public primary spending in real terms but as mandatory expenditure comprises ~90% of expenditure and social security costs have been growing reforms are needed.  An ageing demographic profile means pension reform is badly needed. Brazil also runs a current account deficit but this is smaller than the past at 0.5% of GDP in 2017.

Stratton Street’s investment approach uses net foreign assets as a screen and we seek to avoid countries with net foreign liabilities in excess of 50% of GDP, a threshold that IMF research indicates is associated with increasing risk of external crises.  Our analysis shows Brazil exceeds this threshold although we have avoided it even when below due to poor fundamentals reflected by its LT foreign currency rating trending down to sub-investment grade (Ba2/BB-/BB- by Moody’s/S&P/Fitch).  Brazil, is part of Stratton Street’s PAINTBRUSH list of countries, a list of 14 vulnerable countries we identified in February 2014.  As a guide, the Brazilian real is down 43.3% (spot basis) since the end of February 2014.

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