Asset markets across Brazil have continued to come under pressure this week as geopolitical concerns deepen; exacerbated by the country’s bar association’s majority vote, over the weekend, in favour of President Michel Temer's impeachment. With roughly one in three cabinet members under investigation for alleged corruption, it seems the previously touted ‘EM Gem’ is set to be plagued with an uncertain outlook as the political crisis ensues, and much needed economic reform is thus put on hold.
In between this year’s Olympic and Paralympic games Brazil is keeping itself in the headlines with yesterday’s awaited impeachment of President Dilma Rousseff. But as much as this news reflects the breadth of corruption (even amidst the once anti-corruption heralded Worker’s Party) it also demonstrates the forward momentum of reform that could eventually see Brazil through its recent months of political turmoil and years of subdued growth. Indeed its successes in beating expectations for hosting the 2016 Summer Olympics help affirm such optimism in its ability to also overcome the myriad of political and economic challenges, given time.
In the midst of a turbulent first quarter of 2016, emerging market currencies have had their best performing month in 18 years this March. The top performers are the Russian rouble and Brazilian real, up 11.2% and 10.4% respectively versus the dollar. The Argentine and Colombian pesos, Korean won, Malaysian ringgit, Polish zloty and South African rand were amongst other currencies that appreciated between 5% and 8% this month also. This of course is a retracement following the 50% rise in oil, back to end 2015 prices, and a more dovish tone from the US Fed. But should Brazil really be the one of the leading performers on the back of all these developments? Are markets assuming these factors have considerably more impact than the escalating internal strife? Of course Brazil stands to benefit from these latest developments and a settling of exaggerated Fed rate rise expectations. But the country is still in the middle of a major political upset at a time when it really needs to be addressing public spending and economic reform in the face of stagnating growth.
In what has been a pretty rough ride market-wide so far this year, we look to our favoured LatAm gem (or is it a gift? - apologies for the typo yesterday), Chile. Although the country remains highly dependent on commodities, ~50% of exports - with copper a large chunk of this, Chile has managed to maintain “strong fiscal and government metrics” according to rating agency, Moody’s.
Last week the International Monetary Fund (IMF) cut its forecast for global growth to 3.4% for 2016; from 3.6% it projected in October 2015. In the Fund’s quarterly World Economic Outlook, released on January 19, it also cut the forecast for growth in 2017 from 3.8% to 3.6%. Growth in 2015 was just 3.1%, the weakest since 2009, according to IMF data.
Moody’s yesterday placed Brazil’s Baa3 sovereign rating on review for downgrade to ‘junk’ citing, “Fiscal and economic activity indicators continue to sharply deteriorate with no clear sign of when they will bottom out”. Although the market was expecting the rating agencies to react to the country’s economic and political meltdown, the pace at which the agencies have reacted has taken the market by surprise. In our proprietary analysis of countries, Brazil was highlighted as a basket case way before any downgrades had occurred; in fact regular readers would have seen the daily on 9th September highlighting the risks of a downgrade, and within hours S&P announced their one notch downgrade to sub-investment BB+ rating. Fitch’s move to cut to one notch above junk, BBB-, (also on negative watch) soon followed in October.
Recent events could give one a sense of déjà vu that Malaysia is setting itself on a similar path to Brazil.
Najib Razak, the Malaysian Prime Minister, has seen his popularity plummet with a recent mass demonstration in Kuala Lumpur calling for his resignation. Just as Dilma Rousseff has been tainted by the Petrobras scandal, so Najib has found himself tainted by the scandal embroiling 1MDB (the sovereign wealth fund that has been his ‘brainchild’) where he is chairman of the advisory board. 1MDB got into difficulties by becoming overly leveraged with USD11bn in debt but it is also facing accusations of the misappropriation of its funds; close to USD700m is alleged to have found its way into a bank account associated with Najib Razak from an un-named Middle Eastern donor. To make matters worse, Najib has dismissed various officials, including the attorney general who was coordinating an investigation into 1MDB, prompting Dr Mahathir to comment in an interview “I think at some stage he has to go because today he has undermined the legal system.”
We wrote yesterday about the risk of Brazil being downgraded to junk, and a few hours later rating agency S&P took the market by surprise with the earlier-than-expected announcement, that it cut the country’s rating by one notch to sub-investment grade BB+. S&P have kept a negative outlook saying they believe there is “a greater than one–in–three likelihood of a further downgrade due to a further deterioration of Brazil's fiscal position, potential key policy reversals given the fluid political dynamics, including a further lack of cohesion within the president's cabinet, or due to greater economic turmoil than we currently expect.”