What multinational executives need to know about Lula, Temer, and labor reform

In the last week, Brazil has seen its fair share of ground shaking events. Not only was former President (and expected Worker’s Party candidate for the presidency in 2018) Luiz Inácio Lula da Silva convicted of corruption, but the current president, Michel Temer, won a preliminary vote in committee to block the continuation of corruption charges against his own person. Meanwhile, the Senate voted on and passed a bill to make significant changes to the country’s rigid labor law.

Yet, none of these events were necessarily what they appeared on the surface, and are in the very least non-determinate of a final outcome.

What happens now with Lula?

Lula’s conviction is not only important for symbolic reasons (Lula is seen by many in Brazil as responsible for pulling millions out of poverty during his two terms in the presidency between 2003 and 2010), but it is also significant for the outlook regarding the 2018 elections and the expectations for economic growth in 2018 and beyond.

  • Lula’s conviction was expected: Lula’s conviction and sentencing to 9.5 years in prison was widely anticipated, and does not affect FSG’s forecast for the Brazilian economy
  • Lula still retains his political rights and can run for office in October 2018: With only a conviction in the ‘first instance’ of the Brazilian judiciary system, Lula still retains his political rights. For Brazil’s ‘ficha limpa’ law to apply (clear record law that bars political officials from running for elected office), the former president will need to be convicted by a second level court by a group of judges. At this point, Lula would be determined ineligible to run for the presidency in 2018, and would be imprisoned (should the original sentencing be upheld)

While a decision could come at any time, the average length for such appeals tends to be 12 months (which would point to a decision by July 2018). However, if a judgement does not occur in this period it will be hard for the courts to convict the former president without appearing to be interfering in politics, as July 2018 is the point at which Brazil’s political parties can officially declare their candidates for the presidency

  • Lula’s conviction at the second-level court would likely create more certainty around the direction of economic policy beyond 2018 and help support short-term growth: The economic policies that Lula would pursue, if elected, are highly uncertain (he has indeed signaled strong disagreement with the policies of the current government), and his presence in the election process in 2018 alone would be enough to raise uncertainty in the period leading up to the election and depress economic activity. Without his presence in the elections (and without the emergence of a strong substitute), local and foreign investors alike would likely show greater confidence and thus aggressiveness when investing in Brazilian assets

Will Temer complete his term?

Michel Temer won a vote in the Constitution and Justice Committee on Thursday of last week (July 13th) to reject a request from the attorney general to try the president in the Supreme Court on charges of corruption. However, the vote was non-binding and the request will go to a vote in front of the full chamber of deputies where the outcome is still uncertain.

  • A delay until August to vote on Temer’s indictment in front of the full chamber raises the likelihood of a vote against Temer: The President and his allies preferred to move to a vote in the full Chamber of Deputies immediately, as they fear further evidence that could come out against the president in the form of a plea bargain deal from the former Chamber President Eduardo Cunha or his accomplice Lúcio Funaro. Without an immediate vote (for lack of a quorum), the vote will now be delayed until after the July congressional recess. The tentative schedule calls for a vote on August 2nd, but this could potentially be delayed further until the second week of August
  • Even if Temer survives a vote in front of the full Chamber of Deputies he still faces two likely additional indictments: At least one additional indictment is scheduled to be sent to the Supreme Court in August, while a third expected indictment is likely for either August or September. With Congressmen needing to vote on each indictment separately (voting one by one into a microphone), this string of cases raises the likelihood that Temer will be removed from office

Labor reform passed but will pension reform still pass before 2019?

Brazil needs to reform its pension system to correct its fiscal imbalance (or it risks prolonged stagnation). Meanwhile, it also needs to confront other structural challenges such as a very rigid labor market and a burdensome tax code. It indeed made progress on reforming its labor market with a passage of a reform bill on July 11th, as the government pushed this bill ahead of the more important pension reform bill to drive momentum in Congress.

  • Pension reform is stalled and won’t progress until after Congress votes on Temer’s indictments: The lower house will not take back up consideration of Temer’s pension reform bill until it decides on the current president’s fate, as the bill requires the investment of significant political capital from the government, which it will be leveraging to survive
  • With or without Temer, pension reform is more likely than not to proceed, but should be even more watered down than it currently stands: Even should the president be removed, his likely successor (Chamber President Rodrigo Maia) is well positioned to continue with measure. However, a risk exists that Maia is also implicated in an anticipated plea bargain from Eduardo Cunha, which would elevate the uncertainty around his ability to maintain the current political coalition in Brasilia

Multinationals will need to continue monitoring the resilience of the current soft economic recovery to recent events and continue reviewing scenario planning on a monthly basis

As FSG has emphasized since the outbreak of Brazil’s most recent political crisis, multinationals operating in the market should be reviewing their scenario and contingency plans monthly. While we have actually seen the market move closer to FSG’s base case scenario in recent weeks (of growth at 0.2% in 2018 and 2.8% in 2019), August and September will be critical months for the outlook on growth in 2018.

Outside of the votes on Temer’s indictment, and the eventual retaking of discussion regarding pension reform in Congress, multinational executives should be monitoring indicators of business and consumer sentiment from June (the first full month after the political crisis) that will be released in the next two weeks.

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