Investors haven’t been coy about their dissatisfaction with Brazilian President Dilma Rousseff. They weren’t happy when Latin America’s largest economy entered a recession in the first half of 2014, when the budget deficit widened to a record in August, or when inflation accelerated in September to the highest level in almost three years. That market sentiment was on clear display as the incumbent campaigned ahead of last month’s presidential elections. In the month leading up to the first round of elections on October 5, a period when Rousseff had a sizeable polling lead over her challengers, the MSCI Brazil index fell 18 percent and the real weakened 10 percent. The index then rose 6 percent the day after business-friendly candidate Aecio Neves unexpectedly won a spot in the run-off election. When Rousseff eked out a narrow victory on October 26—winning 51.6 percent of the vote to Neves’ 48.4 percent—it seemed likely the market would once again voice its displeasure.
Surprisingly, that has yet to happen. The Bovespa stock exchange has actually gained 6 percent since Rousseff’s victory, while the real has weakened less than 1 percent against the dollar, a decent showing given that most emerging market currencies have seen greater depreciation. “The market reaction was much more benign than most market players were expecting,” says Nilson Teixeira, who leads Credit Suisse’s emerging markets research team in Brazil.
So, have investors changed their views on Dilma? That depends largely on her policy going forward, but they at least seem more open to reevaluate. To understand this seeming about-face, first consider why markets were down on Rousseff in the first place. First, there’s ideology. Rousseff is a former Marxist guerrilla from a leftist Workers Party who tends to put social programs ahead of business, which would rub investors the wrong way in pretty much any country. In terms of the economy, she failed in her first term to pursue reforms that might have dampened the downturn, such as tackling the politically charged challenge of reducing public sector wages and pensions, or simplifying a complex tax system.
Instead, Rousseff has governed in ways that her opponents say have made the fiscal situation worse, including the dichotomous combination of heavy government spending and tax cuts. Investors also accuse her of interventionist policies such as keeping energy prices artificially low and influencing the central bank to keep do the same for borrowing costs.
That said, Rousseff is probably shouldering more blame than she deserves. True, GDP growth was much weaker during her first term than during her predecessor’s—the economy grew 2.5 percent last year compared with 7.5 percent in 2010, the final year Luiz Inacio Lula da Silva was in office. But Brazil was affected by the global financial crisis and more recently by waning global demand for commodities and Federal Reserve-induced capital markets outflows.
As for the possible about-face by investors, it could derive from a feeling that Rousseff might just use her new mandate to make some of the longer-term changes that the economy needs—consistently tighter monetary policy to lower the inflation rate and structural reforms to boost growth. The central bank delivered on the former when it unexpectedly raised its benchmark Selic rate to 11.25 percent last week, prompting a market rally. As for reform, Rousseff promised to start her second term with a blank slate by modifying her cabinet, which will include replacing outgoing Finance Minister Guido Mantega. The president has also said she will make changes to fiscal policy, potentially lowering government spending, and aims to push lawmakers to pass tax reform. She may loosen the government’s grip on energy prices as well. Ironically, these are policies that investors praised Neves for espousing, and Rousseff could be showing that she has heard the voice of that voting bloc loud and clear. “If these changes occur,” Teixeira says, “the market reaction could be positive over the next several months.”
Of course, it remains to be seen whether Rousseff can deliver meaningful changes to the economy in the medium-to-long term. Or even the short term: Brazil announced last week that its budget deficit unexpectedly widened to another record in September and Credit Suisse expects the economy to grow 0.3 percent this year.
Photo of Dilma Rousseff courtesy of Celso Pupo / Shutterstock.com