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Defiant Dilma divides top managers on Brazil’s outlook

Defiant Dilma divides top managers on Brazil’s outlook

Brazilian President Dilma Rousseff has vowed not to resign despite public protests and continued corruption investigations.

While the country faces a turbulent time leading bond and equity managers are divided on how much of an impact a change in leadership would have for Brazil.

John Malloy, emerging markets co-head at RWC Partners, said corruption scandals and poor economic data has weakened the Dilma’s ruling PT party to a point where it should be almost impossible to govern or win the next election.

‘Lula, the “god” of the PT party is under serious accusations and could go to jail. In the next few months there are good chances that Dilma is impeached or that the courts start the process of annulling the last election,’ he told Citywire Selector.

He said the leaders of rival parties, such as PSDB or PMDB, have already expressed the need for deep economic reform, which would lift Brazil out of its economic crisis.

‘Our view is that if you have the correct policies in place Brazil could very well move from the bust part of the cycle to the boom in short period of time,’ said Malloy.   

However, Yerlan Syzdykov, head at emerging market debt at Pioneer Investments, said, while events appear to signal a rising probability of change, the market appears to be discounting a quicker policy adjustment timetable than is fully warranted.

‘In our view, the market’s apparent enthusiasm for Dilma’s impeachment is based on the consensus’ shift to a more positive view, one that appears to obfuscate the onerous nature of the subsequent process,’ said Syzdykov.

He added a change of government in Brazil is unlikely to be resolved quickly and the market’s expectations may have shifted too far, too soon.

Fiscal pressures

Malloy said from a pure macro view there is no more room to muddle through and, at this pace, the government debt ratio will be over 85% in two years. He said Brazil is on an explosive path and without fiscal change will be downgraded multiple times.

‘Bad fiscal pressure is causing an enormous premium on interest rates, taking monetary policy hostage and causing confidence to collapse because businesses and people know that Brazil can go back to very high or even hyperinflation.’

‘All this is leading to output collapse, real wages declining by close to 10% year on year and unemployment up to 9% from close to 6% a year ago. Change can't wait anymore,’ he added.

On the other hand, Syzdykov said there is an increasingly less pessimistic view of the Brazilian fiscal situation reflected in sovereign credit default swaps spreads.

‘While we agree that Brazil’s fiscal policy is in need of reform, we think it is possible that the market may be disappointed by the timing around these changes.’

‘Hence it is possible that the Brazilian fiscal remains a growth impediment for a longer period than the market expects. This would obviously cool some of the bullish enthusiasm we have seen in recent sessions,’ said Syzdykov.

Positioning for a change

Malloy was neutral on Brazil going into the year and went to overweight before the recent rally. One of his holdings is oil giant Petrobras, which, despite sitting at the heart of the controversy, Malloy still considers to be attractive.  

He said, as a result of the political scandal, the company has focused on restructuring its balance sheet with a new board, management and plans to sell non-core assets and pay down debt. 

‘At a cheap valuation of less than six times EBITDA, if the company were to trade at a reasonable valuation of seven time EBITDA the stock would be up over 60%. In addition, their very large offshore fields are economical at today’s oil prices,’ said Malloy.

He has also added CCR SA, one of the largest operators of highways throughout Brazil as infrastructure continues to be very poor and the government will need to invest heavily. 

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