What does the reelection of Dilma Rousseff mean for multinational companies in Brazil?
In the most contested presidential election since Brazil restored democracy in 1985, incumbent Dilma Rousseff (PT) was reelected with 51.64% of valid votes in a runoff against her challenger from PSDB, candidate Aecio Neves.
Although the outcome of the elections resolves what was probably the biggest driver of uncertainty for multinationals in Brazil, executives will need to wait a few more months until they have all the information they need for long-term planning. This is because economic growth over the short and medium-term will be largely dictated by the degree of economic adjustment Brazil sees in 2015, as well as by whether Dilma can manage any structural reforms during her second term in office.
There is widespread consensus that Brazil will need to implement a painful economic adjustment package in 2015 in order to prevent further deterioration in the economy, which started to slow significantly in 2011 and will barely grow this year (FSG is forecasting GDP growth of only 0.3% in 2014). Brazil’s most urgent challenges to be addressed are: (i) a current account deficit that has risen to 3.5% of GDP, and that can no longer be covered by foreign direct investment; (ii) rising government debt and falling government primary surpluses that resulted in Brazil’s credit rating being downgraded by Standard & Poor’s in April this year; and (iii) stubbornly high inflation.
How painful will the economic adjustment be?
The degree of economic adjustment in 2015 will depend first and foremost on the willingness of Dilma to change course in her management of the economy, and secondly, on the degree of internal resistance that she faces within her party coalition, regardless of whether she commits to implementing painful adjustment measures.
At FSG we believe there are two plausible scenarios for economic adjustment in 2015: “Dilma Reboot”, and “Dilma Replay”.
In Dilma Replay, president Rousseff avoids implementing any sort of economic adjustment and instead, decides to double-down on government spending and credit expansion. In such a scenario, Brazil would artificially grow in 2015 but it would fall into recession in 2016 as Brazil’s credit rating would most likely be downgraded below investment grade. We believe that this scenario is very unlikely, although not impossible. Factors that could make this scenario a reality include the PT’s resistance to change based on economic and political ideology, as well as a desire to avoid painful reforms in order to facilitate the return of former president Lula as a presidential candidate in the 2018 presidential elections.
In Dilma Reboot, president Rousseff implements gradual adjustment in the economy, including: (i) a gradual decrease in government spending and provision of credit by public banks; (ii) a gradual phase-out of tax breaks and energy subsidies, (iii) interest rate hikes to control inflation; and (iv) a partial end to the BRL/USD swap program to allow currency depreciation beyond 2.4. In this scenario, the economy would grow at around 0.9% next year, with the potential for faster growth in 2016. FSG believes that this is the most likely scenario, as another credit rating downgrade below investment grade would seriously endanger Brazil’s growth and the government’s ability to invest heavily in healthcare, education and infrastructure.
Will Brazil be able to return to high growth after 2015?
While a “Dilma Reboot” scenario would avert further deterioration in the economy, a return to the growth rates that we saw during the Lula years will require more than just an economic adjustment. In the absence of the commodity supper cycle that Brazil benefited from during the last decade, and given a likely economic context of slower credit growth and cooling job market, Brazil will need to increase its current level of investment from 18% to at least 25% of GDP, as well increase productivity. Ultimately, encouraging investment and lifting productivity will require significant structural reforms.
Whether Dilma Rousseff is able and willing to implement an ambitious reform agenda is yet to be determined and it will be analyzed in Brazil’s presidential elections post-mortem report to be published by FSG early next week.