As Jair Bolsonaro was elected on Sunday, October 28 with 55% against Fernando Haddad, the Workers Party’s candidate, one may examine the significant gap between some dismayed reactions in international public opinion and how financial markets welcomed the perspective of a Brazilian far-right presidency.
As in many countries, opponents had run out of energy to debate on the societal side, leaving the economic and genuine social parts mostly undebated. While international public opinion appears to be more focused on the shocking statements of the future president of Brazil, financial markets seem to have a positive view on Bolsonaro’s economic playbook, inspired by Paulo Guedes, a free-market economist from the University of Chicago. For instance, investors have sent the Brazilian stock market soaring since Bolsonaro prevailed in the first round of the election, while the yield on 2Y government bonds decreased abruptly (see chart below), as the economic program plans mass privatizations, a pension reform and lower taxes. Brazil’s new president will have to address two major concerns for the country: its continuously deteriorating public finances and the structural inequality in the country. Considering Bolsonaro’s roadmap for the economy, is it reasonable to believe that the country’s main issues will be tackled in the coming years? In other words, is the reaction of financial markets rational?
Financial Markets Perception
Sources: Beyond Ratings, Datastream
Public Finances Degradation
Brazil’s public finances have strongly deteriorated since 2015, with a jump in the debt-to-GDP ratio to 84% in 2017, while the budget deficit stood at a higher point of -10% of GDP in 2015, then stood at -7.8% in 2017 according to the IMF. As highlighted by the figure below, the sharp economic recession in 2015 (real GDP decrease stood at -3.5% both in 2015 and 2016) has greatly contributed to changes in public debt through the automatic debt dynamics and impacts on the primary deficit.
Contribution to Changes in Public Debt
Sources: Beyond Ratings, IMF Article IV
If the economic rebound last year (+1% in 2017) has somewhat reined in the increase in public debt, primary deficit and interest expenses still massively contribute to its growth. This will be a major challenge to address in the coming years for the new president. On the primary deficit side, as directly manageable public spending such as public investments and social transfers account for only 20% of government expenses, the main source of optimization should target the pension system, which accounted for 12% of GDP in 2018. According to the OECD, without any reform, pension payments could rise to 17% of GDP in 2060. If Bolsonaro’s economic program addresses this problem, with an ambitious pension reform, questions arise concerning his willingness and capacity to implement it, as civil servants (including military personnel) disproportionately benefit from the current system. As military forces are an important source of support for Bolsonaro, implementation of the pension reform could be rescheduled or emptied of its substance.
Otherwise, whereas mass privatization could bring additional cash to the government on a short-term perspective, lower taxes will necessarily impact the revenue side for public finances. Last but not least, 52 candidates of his party (Social-Liberal Party) were elected (against 56 for the Workers Party) to the House of Deputies, out of 513. In the Senate, only 4 out of 54 candidates. However, to vote on important reforms, like that of the pension system, it requires the support of 3 / 5ths. Bolsonaro will have to make agreements with the elected representatives of the other 29 parties of the Brazilian Congress. Thus, on the public finances side, outlook on Bolsonaro’s government actions is mixed, as the willingness and capacity to implement main pension reforms could be questioned.
Tackling Structural Inequality?
Despite the fact that around 25 million Brazilians have come out of poverty since 2003, the country is still the 10th most unequal country in the world, according to the GINI index published by the World Bank. Furthermore, last year’s economic recovery was accompanied by a jump in inequality, according to the Getulio Vargas Foundation. In fact, the monthly wages of the poorest 20% decreased by 5% in real terms in 2017, while the richest 20% increased by 10.8%. This inequality is mainly driven by an important share of informal labour -- leading to precarity for workers -- and a faulty educational system. These two points also explain the low productivity in Brazil, which notably undermines the future growth outlook of the country. Reducing inequalities through better education doesn’t appear in Bolsonaro’s program, nor does it seem to be a priority for the time being.
Hence, the financial markets and Bolsonaro romance is not particularly linked to the capacity of the future government to address the main economic and social issues of the country but seems mainly due to the appetite of the sector for keywords such as “mass privatizations” and “lower taxes”.
Ordem ou Progresso
Despite the economic takeoff of Brazil since the 2000s, inequality has not resorbed significantly. According to the 2018 World Inequality Report, the richest 10% accounted for 57.8% of output growth, compared to 16.1% for the poorest 10%. While some tax reforms and ambitious plans for public education could have led to social progress of the country, most of the electors have preferred to focus on the sidelining of a traditional political class involved in corruption scandals (following the operation Lava Jato) and the fight against violence that gangrenes the country (63,880 people were killed in 2017, a 3% increase from the previous year according to Brazilian Public Security). Hence, Brazilian electors seem to have put Ordem first, then let Progresso come later…
Thomas Lorans, Economist - Sources: Beyond Ratings, IMF, Datastream