Spotlight on Brazil: Policy Changes Needed to Deal With Macro Challenges

“These have combined to weaken domestic demand at a time when international demand for Brazil’s largest export items – oil, coal – has also fallen,” she said. “The country is beginning to work through these cyclical challenges. While the pain is now at its peak, we think things should begin to turn late this year or early in 2016.” The reforms implemented by Finance Minister Joaquim Levy are aimed at reversing the damage done by many of the policies enacted during President Dilma Rousseff’s first five years in office, and they should result in a reduced need for external financing to close the funding gap.  Already, there’s been an improvement in Brazil’s fiscal deficit, Wachnitz said, and though the capital account is still negative, it should gradually improve, too.

Even if the tide turns, it’s not likely that economic growth will take off substantially in Brazil. However, earnings growth should improve, Wachnitz said, and that, combined with declining interest rates and improving ROEs, should lead to falling equity risk premiums and higher multiples, which in turn could create some buying opportunities. “Given our more cautious longer-term views on commodities, we think the opportunities will surface in the more consumer-related sectors, which include some of the financials and the IT industries,” she said. Brazil also needs to make some headway on improving the allocation of capital, which was very poorly invested over the past five years, and make things easier for businesses to operate. Some of its labor laws, which increase employment costs and disincentivize hiring, must also be revised, Wachnitz said.

Brian Jacobsen, chief portfolio strategist at Wells Fargo

Brazil’s rising inflation rate and stagnant economy make for “a rather toxic combination,” Jacobsen said, “and ideally, you’d want tighter monetary policy to contend with that. However, that would be bad [for] growth, so Brazil is facing a real dilemma.”

Jacobsen said that the political will needed to turn things around, enact the right kind of reforms and back away from some of the spending policies that had been implemented during the first term of the Rousseff administration is sorely lacking in Brazil. In India, he said, “institutional competency is high, but on the policy front in Brazil, there is a bigger chance that they make a mistake.”

One of the key things Brazil needs is a better environment for businesses to operate in. The government needs to create this by cutting taxes and lowering the barriers to entry in some industries, Jacobsen said. The government also needs to loosen its hold on state-owned oil company Petrobras, currently embroiled in a huge corruption scandal to which Rousseff herself has been linked, “but I don’t see that happening,” Jacobsen said.

At the same time, though, Jacobsen said that macro challenges such as a rise in U.S. interest rates may not have a major impact on Brazil, “because a lot of damage has already been done.” Brazil has contended with the decline in commodity prices and the economy isn’t so vulnerable to a slight rate hike by the Fed. “I believe a lot of the economic weakness is due more to policy blunders that need to be corrected,” Jacobsen said.