Now that Brazil president Dilma Rousseff’s removal from office has become much more likely, with both the congressional committee and the lower house voting to impeach, markets have been celebrating, with the Bovespa stock index up 45 % year to date (USD, as of April 14, 2016). In addition to the impeachment process, a parallel investigation into the campaign financing of Dilma’s re-election is also under way. Should evidence of wrongdoing be uncovered, then the 2014 election could be nullified and a new contest would take place.
Although her government will do anything to avoid it, one way or another, President Rousseff is likely on her way out. But the anti-Dilma rally may be premature. We feel that in the short term, the Brazilian stock market has gotten ahead of itself. Impeachment is a long, drawn-out process and the economy is likely to continue contracting as a considerable rate. Once investors are over the initial euphoria about the increasingly likely prospects of a Dilma departure, we would not be surprised to see some of the recent gains given back. The impeachment of a country’s president is destabilizing event, and it will remain a huge challenge for the successive leadership to create conditions supportive to a resumption of sustainable economic growth.
Impeachment is a long, drawn-out process and the economy is likely to continue contracting as a considerable rate.
Dilma’s departure would be important, however, because it will signal three key developments: it will show that Brazil’s institutions are working, especially the federal police, who are leading the corruption probe, and its judiciary, the top court of which will ultimately hear the impeachment trial. One of the charges against Rousseff is that she improperly used funds from state banks to cover budget shortfalls. The fact that Brazil’s police and supreme court would be taking her to task for violating fiscal laws shows a commitment to better financial governance.
Secondly, it would be a strong step towards cleaning up corruption. This is important because it will imply that investment money will be going to the right place, rather than lining the pockets of politicians. Corruption is an inefficiency that discourages investment and has been a real impediment to Brazilian economic growth. Finally, a new government increases the likelihood of reforms being introduced that are necessary for Brazil to continue to develop, such as tax reform and social security reform that will shore up the fiscal situation.
These three things are important, but so too are the basic economic drivers that make Brazil an attractive investment for the long term. Those drivers are: strong corporate fundamentals and positive consumption trends, supported by the burgeoning middle class. Brazil, as well as the larger Latin America region, has a diverse pool of well-managed companies in which to invest, in our opinion. If you put all these factors together, they create the story that is the basis for any emerging market investment—the opportunity for growth over the long-term, with the potential for geographic diversification. That story should continue to play out, regardless of how quickly Dilma Rousseff leaves government.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks may be enhanced in emerging markets countries.
This article was originally published on Business Insider on April 21, 2016.