As Brazil’s election heads to a runoff, the country’s fundamentals remain solid

The upcoming runoff election in Brazil could introduce some near-term volatility for Brazilian debt, but cooling inflation and strong economic growth could still paint a compelling picture for investors.

After President Jair Bolsonaro’s surprisingly strong showing in Brazil’s recent presidential election, the race will continue on to a runoff vote on October 30 against rival Luiz Inácio Lula da Silva. Given the vast differences between the candidates’ platforms when it comes to proposed socioeconomical policies, fiscal policy, and other related programs, the decision reached at the end of the month could have a significant impact on the trajectory of Brazilian assets.

In the near term, uncertainty in the next few weeks leading up to the election could cause some price volatility as investors digest new poll information. Despite these nearer-term bumps in the pavement, we feel that the road ahead for Brazil looks promising.

Brazil's central bank is ahead of the curve

Beginning last year, Banco Central do Brasil (BCB) embarked on a decisive tightening cycle, challenging the transitory inflation narrative ahead of many other central banks across both developed and emerging markets. Since early 2021, the Selic rate (BCB’s overnight lending rate) was increased by a staggering 11.75% before the central bank decided to maintain the rate of 13.75% at the September meeting.

In its communication, BCB highlighted its commitment to stay vigilant, ‘’assessing if the strategy of maintaining the Selic rate for a sufficiently long period will be enough to ensure the convergence of inflation.’’ For now, the effect of the central bank’s action on inflationary dynamics is evident, with month-over-month inflation cooling since July’s negative print of –0.68% followed by August’s –0.36%; the year-over-year measure has also fallen from recent double-digit highs.

Inflation has come off the boil in Brazil

Brazil CPI, September 2018–August 2022 (YoY %)

Inflation has come off the boil in Brazil. The chart illustrates changes in Brazil CPI on a year-over-year basis from September 2018 to August 2022. After rising from May 2020, inflation peaked in June 2022 and has been falling since.

Source: Bloomberg, September 2022.

This aggressive action by BCB has allowed the Brazilian real to be one of the few currencies to climb against the U.S. dollar (USD) year to date. The dollar’s surge relative to most currencies has pressured many pockets of the global economy, including emerging-market sovereigns’ ability to service USD-denominated debt. Here, Brazil stands apart from the rest as, so far, its currency strength relative to the dollar shields it from ballooning debt payments.

The BRL is one of the few global currencies that has held its own vs. the USD

USD/BRL exchange rate, January 2022–September 2022

The Brazilian real is one of the few global currencies that has held its own versus the U.S. dollar. The chart shows the U.S. dollar to Brazilian real exchange rate over the course of the year. At the beginning of the year, 5.6597 Brazilian real were equal to one dollar. At the end of September,  this had decreased to $5.4008 Brazilian real per one dollar.

Source: U.S. Federal Reserve, October 2022. BRL refers to the Brazilian real. USD refers to the U.S. dollar.

Whether or not this trend continues depends on the U.S. macroeconomic trajectory and the U.S. Federal Reserve’s monetary policy reaction function. However, BCB’s choice to commit to a tightening cycle ahead of its emerging-market peers has placed the country in a favorable position as central banks and governments around the world now battle to tame inflation.

Growth outlook is brightening

Brazil’s domestic growth outlook has proven to be resilient with Q2 GDP surpassing expectations and estimates for future growth being revised upward. The economic growth data suggests that the economy continues to expand, although at a more subdued pace. Data on the labor market remains compelling as well, showing continued expansion and suggesting that we may soon see the unemployment rate coming off of double-digit highs.

As home to several key global champion corporations—dynamic, high-growth companies that find their core business growing both domestically and abroad—the country also remains well positioned from a credit selection perspective. Countries such as Brazil with domestically driven economies tend to be better insulated against challenging macroeconomic backdrops such as the one we’re currently experiencing. Long-term demographic trends can also serve to provide a boost to sectors such as telecommunications, as mobile and data usage increases across the country. 

A sustainability shift

Given geopolitical rumblings and their effects on commodity prices this year, it’s no surprise that nations across the globe have expedited their transition to more sustainable energy policies. With the Latin America region heavily dependent on natural resources, countries such as Brazil that are plugged into the transition to next-generation policies could be well positioned for the future. In addition to being a large agricultural exporter, Brazil possesses valuable metals, such as lithium, used in decarbonization technologies. This further enhances the thesis for owning Brazilian debt.

Indeed, from a sustainability point of view, we believe Brazil has the potential to become a leader in the global carbon credit market, having recently established a framework for implementing a robust emissions trading system as well as a system for registering carbon credits; however, this path is dependent on whether supportive government policies are put in place. Mr. Lula’s agenda has embraced green measures, such as working toward net zero deforestation and increasing investment in renewable energy. In contrast, we think Mr. Bolsonaro’s presidency has shown him to be critical of climate science and willing to disregard environmental regulations.

Energy policy in particular is one area that we’re closely watching as the outcome of the election could have a significant impact going forward. Although the close nature of the election leaves room for some price volatility in the coming weeks, this uncertainty comes against a strong fundamental backdrop that affirms our favorable view of the country’s fixed-income markets.

Important disclosures

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Elina Theodorakopoulou

Elina Theodorakopoulou, 

Portfolio Manager, Emerging Markets Debt

Manulife Investment Management

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