Brazil election result: initial takeaways for EM debt investors

What has happened?

Brazil’s left-leaning former President Luiz Inácio Lula da Silva (‘Lula’) has won the final round of Brazil’s presidential election, beating right-wing incumbent President Jair Bolsonaro by a small margin (securing 50.9% of total votes). For more background on the two candidates, please see an article we wrote earlier this year.

What does it mean for EM debt investors?

Investors’ immediate concerns relate to the implications for fiscal policy and social stability. We think risks associated with these are relatively contained:

• Lula is expected to be fairly moderate on his fiscal policy, at least in the short term – his choice to run alongside centrist candidate Alckmin (former Sao Paulo governor) was an important signal in this regard. Longer term, the make up of Congress (predominantly right of centre), should go some way to reducing the risk of radical policy proposals.
• As for social unrest in this politically divided country, this is likely to continue and Bolsonaro’s reaction to the results will be key in determining the near-term outlook in this regard. That said, Bolsonaro is unlikely to want to jeopardise his chance of running again in four years’ time by inciting violent protests. Furthermore, although Bolsonaro has yet to address the population, the presidents of the House, Senate and electoral court have all recognised the results, and political allies of Bolsonaro have indicated that they expect him to do the same.

Reflecting all of the above, the fixed income market reaction has been positive overall, especially in FX (the real gained around 2% against the US dollar). The key signposts to watch are Bolsonaro’s reaction to the result and Lula’s eventual economic appointments.

The bigger picture

Beyond the immediate political noise, there are other considerations for EM debt investors. Key among these is monetary policy. Brazil is among a number of Latin American economies that have led the way on policy orthodoxy this year, both within EM and on the global stage. Most Latin American central bankers report that their economies are functioning as normal and that rate hikes will be effective in bringing down inflation. There is no material change to neutral real rate assumptions relative to the pre-COVID/Ukraine war period, and consensus is that many markets – Brazil being a key example – are now close to the end of their rate-hiking cycles. This confirms our view that there are some attractive opportunities in the region for EM local bond market investors.

Longer-term, one area we will be watching closely is the new administration’s approach to climate policy. Under President Bolsonaro, we witnessed a backtracking on Brazil’s climate effort. For instance, Brazil was one of the few countries to have submitted less ambitious Nationally Determined Contributions (NDCs) at COP26. Bolsonaro also undermined environmental institutions, especially with respect to their battle against deforestation; deforestation reached its highest level in a decade under Bolsonaro’s administration and the government’s goal to reduce deforestation by 80% in 2020 relative to 2005 was missed. Future policy direction will be key to watch. You can read more about Brazil’s sustainability credentials in our recently published ESG report.