Financial backers see Brazil’s polarization, monetary plans as key dangers after fights

After Jair Bolsonaro’s supporters took part in an anti-democratic riot at Planalto Palace in Brasilia, Brazil’s on January 9, 2023, the flag of Brazil is seen reflected in a broken window. Ueslei Marcelino for Reuters

NEW YORK/LONDON, Jan. 10 (Reuters) – Investors in Latin America’s biggest economy received a reality check when Jair Bolsonaro’s supporters stormed top government buildings in the nation’s capital.

Since the end of the military regime’s two-decade rule in 1985, elections have been followed by peaceful transfers of power; however, Brazil’s political polarisation is growing and will present a challenge for newly sworn president Luiz Inacio Lula Da Silva after his narrow victory in the October election.

Samy Muaddi, a portfolio manager at T. Rowe Price, called the events in Brasilia on Sunday, when Bolsonaro supporters broke into and vandalised the Congress, presidential mansion, and Supreme Court buildings, “disconcerting for investors.”

The direction of economic policy under Lula and general global financial circumstances will decide investment results, according to Muaddi. “Likely this is a transient shock,” Muaddi added.

Investors and experts stated that while Lula’s struggles to manage the dangers of this institutional shock are far from being overlooked, the focus is still on economic difficulties when evaluating the new administration in the long run.

According to Katrina Butt, a senior Latin America economist at AllianceBernstein LP in New York, “Lula will work to unify a working coalition in congress to pass legislation but will be careful not to impair his popularity with unpopular fiscal measures, potentially delaying the timeline for announcing fiscal adjustment measures.”

According to her, reduced inflation might enable the central bank to begin reducing rates in the second half of the year, which would help the economy grow even more “But the new fiscal framework is also related to this. The market may once again fear fiscal supremacy if the new criteria are deemed insufficient, which would preclude the BCB from relaxing.”

Discussions on the new fiscal framework are crucial under Lula’s government now that experts have drawn attention to the inflationary dangers posed by the leftist President-expenditure elect’s proposal of 168 billion reais ($32 billion) to fulfil campaign commitments.

The weekend violence “could reduce pressure on Lula to present an economic plan in coming weeks and could also slow the reform agenda,” wrote Elizabeth Johnson, managing director of Brazil research at TS Lombard, in a note, adding that “the market impact has been limited because of the swift government response.”

POLITICAL DIVISIONS

The immediate market impact appears to be limited. Stocks went positive after an initial slump, the real fell as much as 1.6% but recovered the most of the losses, and credit default swaps were largely unchanged.

Brazil’s has a history of political unrest, but last year it became a favourite among investors for emerging market asset managers because to its commodity-exposed economy and Roberto Campos Neto’s calm leadership of the central bank.

Alberto Ramos, the head economist for Latin America at Goldman Sachs Group Inc., predicts that creditors will be closely watching the political and social developments in the coming weeks.

Ramos told Reuters that the “violent demonstrations testified to the substantial socioeconomic and political divide pre- and post-election.” The political climate is uneasy and bitterly divided, and the resulting high social tension keeps risk premiums high and threatens to destabilise general governability.

On Monday, the difference between the price of Brazil’s hard currency debt and safe-haven U.S. Treasuries increased to 262 basis points, moving farther away from the pre-pandemic levels it briefly reached in early December. It is still moving downhill from the 2022 high of around 390 basis points. (.JPMEGDBRAR)

The political risk advisory Eurasia Group draws its major conclusions from Sunday’s rallies as a mobilised opposition with the “potential to turn violent.” According to a research led by Christopher Garman, managing director for the Americas at Eurasia, social unrest might increase if Lula’s government loses support from the public amid worsening economic conditions.

On Monday, police and Brazilian army demolished a camp of Bolsonaro supporters. After protesters damaged art and furniture, stole firearms and antiquities, and shattered windows and furniture, Lula vowed to bring those responsible for the violence to justice.

According to Jared Lou, portfolio manager at William Blair Investment Management, “slowing growth, restrictive monetary policy, stubbornly high unemployment, and a fragile budget balance all contribute to limit the range of policy options accessible to the government in coming quarters.”

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