Brazil: Political And Economic Implications Of Unrest

The past two weeks have seen what started off as an isolated incident of students protesting against bus tariff increases in the city of São Paolo turn into a nationwide protest movement that has affected at least a dozen cities and has seen some 250,000 people take to the streets earlier this week. In several cases, the protests have turned violent, with some smaller groups seeking to storm public offices, including São Paolo city hall. This prompted Brazil’s equivalent of the national guard to be dispatched across major cities. Latest media reports suggest that the demonstrations are now being directed against corruption in politics, and rising living costs at a time of large public infrastructure spending ahead of next year’s World Cup.

While there are reported cases of police using excessive force against demonstrators, it seems that the recent tensions are likely to die down in the coming weeks, given that several mayors have already expressed their willingness to meet the demonstrators’ demands of not raising transportation costs. Moreover, despite the presence of national security forces on the ground, President Dilma Rousseff has acted in a highly visible and supportive way, throwing her weight behind the protest movement and congratulating young Brazilian citizens on expressing their views on subjects they care about to make Brazil a better place.

At first glance, this may seem rich, given pictures of forceful crackdowns on some of the more confrontational elements of the protest movement. However, Rousseff’s position on the protest movements has several implications, which will all likely play in her favour ahead of next year’s presidential election. First, the Brazilian government is going out of its way to distance itself from the hard line stance adopted by Turkey’s Prime Minister Recep Tayyip Erdogan in response to violent clashes in Turkey earlier this month. This suggests that barring any further escalation of the standoff with security forces, the protest movement is likely to peter out.

Second, Rousseff is setting the bar high for next year’s presidential race and, ironically, is able to divert some of the negative attention away from rising living costs by playing up her own leftist credentials as a Marxist rebel during Brazil’s military dictatorship, who ended up being imprisoned. This will likely resonate with a young electorate, which overwhelmingly makes up the age group of the demonstrators. Furthermore, she is throwing her support behind a movement that is currently supported by a clear majority of Brazilians, according to latest opinion polls, particularly those with higher education. Crucially, this should further sap the more violent elements of the protest movement, which have resulted in vandalism and looting, a manifestation opposed by 78% of those who are otherwise in support of the demonstrations.

In this sense, there is reason to believe that Rousseff may indeed be turning a potentially dangerous situation in her favour, as it comes fresh on the heels of the first notable dip in her approval ratings since coming to office in 2011, and followed embarrassing boos during the opening ceremony of the Confederations Cup over the weekend.

Something Will Need To Change

Although higher transportation costs were the spark that lit the fire, the fuel for the latest protest movement was provided by a confluence of factors that – not unlike in Turkey’s case – have been building up over several years, if not more. First, a lot of attention has been focusing on the rise of Brazil’s middle class, which is now taking a more proactive role in political affairs and is less willing to tolerate deep-rooted political corruption, which the high-profile sporting events are likely to be associated with. Crucially, however, this is a question of living standards, and rising inflation, and perhaps more importantly, inflation expectations.

After investors finally started to catch up with our view that the central bank has not been doing enough to anchor inflation expectations, Brazilians appear to be the latest group to join the chorus. Expectations have ticked up sharply in June, with over 50% of respondents to a recent poll expecting inflation to rise. This is important, as a weaker exchange rate is already affecting perceptions of lower household purchasing power at current salaries.

The same survey by Datafolha shows that the share of respondents which expects their purchasing power to decrease is now at its highest level since early 2009. This is key, as it is the first direct indication, even before the protests, that inflation risks in Brazil are fast becoming a political issue. And this leads us to a key policy dilemma, namely that previous efforts to help stimulate the economy will need to be put on the backburner in favour of addressing high inflation in the country.

This will have several ramifications for the upcoming October 2014 presidential election cycle and ultimately makes Rousseff’s job a lot more difficult. A more aggressive tightening cycle by the central bank and the prospect of government subsidies or even outright public sector wage increases are likely to compound the country’s already large economic challenges, with the economy slowing to just 0.9% in 2012, with growth now forecast (by BMI) to accelerate to just 2.6% this year. Moreover, signs of increased public spending as the government is already committed to enormous social spending programmes under Bolsa Familia and the PAC II Growth Accelerate Plan, mean that our existing concerns about fiscal deterioration and a worsening credit profile could be exacerbated. Although we have yet to see how policy will be affected, we have modestly adjust our short-term political risk rating for Brazil to reflect an impact on specific government policy – the short-term rating has dropped from 70.8 to 69.6 out of 100.

There is a real crisis of confidence among investors, who have so far shunned Brazilian markets despite rapidly rising interest rate expectations, meaning that the Brazilian real, unlike most of its regional peers, has not bounced after its initial sharp sell-off in recent weeks. This means that there is already a great deal of inertia from the market for tighter monetary policy to attract capital back into the country.

Structural Reforms Will Become A Dominant Policy Agenda

The more immediate implications of the protests aside, however, we see several longer-term consequences from the rapid flare-up of social tensions. As much as the protests highlight a growing dissatisfaction with rising living costs, to an equal measure, they are aimed at high levels of corruption, referring back to often highly ineffective resource allocation by the government and lost funds along the way. The 2014 World Cup offers a very opportune scapegoat and the government will be very anxious about a return of public unrest this time next year, when the World Cup will be imminent or underway and the world’s attention will focus on Brazil. As a result, there is likely to be a growing political push to purge the ranks of state institutions of corrupt officials, offer greater transparency, and, given the very poor economic outlook as commodity prices head south, a way to lower barriers to business and investment in the country.

How successful this will be will depend on Rousseff’s resolve to campaign on a strong platform of change and transparency, although even in the best-case scenario, meaningful reforms would take years. Moreover, even if she possesses the necessary political will, Rousseff may simply not have the required political capital to deal with corruption on the local level and even dare to propose widespread tax and fiscal reforms across Brazil’s regions. As such, while we remain sceptical that a real improvement in Brazil’s business environment is around the corner, the political landscape may be changing as parties will increasingly vie for a younger, educated and politically disillusioned voter group over the coming years.

This blog is tagged to:
Sector: Country Risk
Geography: Brazil, Latin America

Related products in our Store...

Check out our most popular reports below or view more in our store