Andressa Anholete/Getty Images News
By Fernando Castro
As expected, Luiz Inácio Lula da Silva won this past Sunday’s first-round Brazilian presidential election with 48.4% of the vote against incumbent Jair Bolsonaro’s 43.2%. As neither candidate captured more than 50% of the vote, there will be a runoff on October 30. While the weekend’s result confirmed Lula as the favorite, Bolsonaro’s performance was stronger than anticipated. With the wind at his back, and aided by improving economic conditions on the ground, Bolsonaro has improved his chances for a second term, although the odds remain strongly in favor of Lula.
Lula is well-known by investors, which makes him more digestible for the market than newer left-wing leaders in the region such as Petro in Colombia and Boric in Chile. During his presidency, Lula was relatively moderate and pragmatic. Further, following Sunday’s results the makeup of Congress shifted to the right, limiting the degree of freedom a potential Lula administration would have. Based on his previous time in office, we would not expect him to meddle much with the private sector, go after particular industries or renationalize private companies. The major risk of a Lula presidency comes from the fiscal side.
His supporters will point out that in every year of Lula’s presidency, Brazil printed a primary surplus. However, during his years in office, Lula benefitted from a time of strong global growth and a booming commodity environment (which benefits a commodity exporter like Brazil). This time around, Lula would be taking over the reins of Brazil under different circumstances: He could be facing a global economic slowdown, which would likely lead to lower commodity prices. Brazil’s budget also lacks flexibility: 80% of all spending is now mandatory. In addition, he has claimed that fiscal stabilization should be led by higher growth and not expenditure reduction, and advocates eliminating the existing fiscal rule, a constitutional amendment which helps contain spending. It is thus unlikely that a new Lula presidency would achieve fiscal surpluses, potentially increasing the risk to medium-term public debt sustainability in an environment of higher funding costs.
Political risks notwithstanding, in 2022 Brazilian spreads have meaningfully outperformed similarly rated credits. As such, we do not find much value in this segment. In local markets, however, the opposite is true: High positive real rates in an environment of falling inflation, coupled with the end of a monetary policy cycle that delivered 1,175 basis points of rate hikes, make for an attractive combination for long positions on rates.
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