Rousseff gets four more years to win over financial markets

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The narrow re-election of President Dilma Rousseff was followed three days later by a surprise rate hike by the Brazilian central bank. Financial markets now await a clearer sense of policy direction which upcoming policy declarations and cabinet nominations should provide.

Political reform to make the country more governable is the priority now
President Dilma Rousseff was re-elected with 51.6% of the votes in Brazil’s general elections on October 26. This is the fourth consecutive election won by her Workers’ Party (PT). Her opponent, Aécio Neves, of the centre-right opposition, polled 48.4%. The margin of victory, the slimmest in Brazilian electoral history, leaves Ms Rousseff with a weak mandate to deal with the challenges facing Brazil. In her victory speech she announced that political reform to make the country more governable will be her first priority.

The challenges for the new administration
Ms Rousseff intended to hold a popular plebiscite about the political reform, but faced her first loss when the congress voted against the project. The scale of the challenge to establishing a consensus is underlined by the fact that from 2015 onwards, when the new administration takes office (at both state and federal levels), congress will host 28 parties (compared to 22 today).

Central bank resumes monetary tightening cycle.
In the wake of the election there was a minor sell-off (local equities dropped 2.8%, the Brazilian Real (BRL) fell 1.8% to 2.52), which was reversed after the Brazilian central bank resumed its monetary tightening cycle with a surprise 25bp rate hike on 29 October (click here for a history of official rates in Brazil). In our view, the central bank is concerned about the potential inflationary impact of the recent fall in the BRL (see exhibit 1 below). We now expect two further hikes of 25bp to take the Selic rate to 11.75% by the end of this year. In our view, rates at this level are potentially attractive for non-resident investors in a low yield environment. Dealing with high inflation (currently above 6.3%) and weak growth (we currently forecast GDP of -0.5% in 2015) is the big challenge for President Roussef. A historically low unemployment rate is the main bright spot.

The immediate focus for investors.
Some policy adjustments are likely in the short term. We do not expect any change to either Moody’s negative outlook on Brazil’s Baa2 rating or Standard & Poor’s BBB- (with a stable outlook) rating.
The focus for investors in the short term will be cabinet nominations and policy declarations. Prolonged uncertainty about policy direction would not go down well with financial markets.

Exhibit 1: Brazilian Real vs. US dollar

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Tiago Cesar

Investment Specialist, Brazilian and Latin American products

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