Public Unrest: Assessing The Policy Implications
The extent to which an isolated incident of student protests has spread into nationwide demonstrations, has brought several structural weakness es in Brazil to the fore, indicating that issues such as corruption, transparency of government institutions, high public spending, and rising living costs, will dominate the political landscape ahead of the 2014 presidential election . Below we outline our initial assessment of the likely implications from the rise in public unrest in Brazil:
President Dilma Rousseff's public backing of the protest movement will likely see demonstrations die down in the coming weeks.
However, concerns over higher living costs will increasingly impact the government's economic policy (we have moderately adjusted our short-term political risk rating).
Corruption and transparency will become dominant political themes, although progress will likely remain elusive for years to come.
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 spread across at least a dozen cities and has seen some 250,000 demonstrators 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, prompting Brazil's National Public Security Force (FNSP) to be dispatched across major cities, particularly in light of the ongoing Confederations Cup football tournament hosted by the country. Latest media reports suggest that the demonstrations are now directed against corruption in politics, and rising living costs at a time of elevated public infrastructure spending on next year's World Cup.
This Is Not Another Turkey
While there are reports of excessive force used by police against demonstrators, it seems that the recent tensions are likely to die down in the coming weeks, given that several mayors have already abandoned plans to increase bus tariffs. Moreover, despite the presence of the FNSP on the ground in several cities, President Dilma Rousseff has acted in a highly visible and supportive way towards the public, throwing her weight behind the protest movement and congratulating Brazilian citizens on expressing their views on subjects that they care about to make Brazil a better place.
At first glance, this may seem out of touch with on-the-ground developments, given media reports of alleged forceful crackdowns by security forces on some of the more confrontational elements of the protest movement. Moreover, the protest movement has evolved beyond the issue of transportation costs, and deliberately distanced itself from any political affiliations. However, Rousseff's position on the protest movement has several implications, which will 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 between police and demonstrators 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 to her own leftist credentials as a Marxist guerrilla fighter during Brazil's military dictatorship. This will likely resonate with a young electorate, which overwhelmingly makes up the age group of the demonstrations.
Furthermore, Rousseff is catering to widespread national sympathy for the protestors by 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 further cuts off the fuel to the more violent aspects of the protest movement, which has resulted in vandalism and looting, a characteristic 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 which led to embarrassing boos during the opening ceremony of the Confederations Cup over the weekend.
|Facing The Biggest Challenge Of Her Presidency Yet|
|Brazil - President Dilma Rousseff's Approval Ratings, %|
A Shift In Policy Lies Ahead
Although higher transportation fees 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. First, the rise of Brazil's middle class over the past decade has created a more politically proactive electorate, less willing to tolerate deep-rooted corruption, which the high-profile sporting events are likely to be associated with. Crucially, however, this is an issue of living standards, and rising inflation, and perhaps more importantly, inflation expectations.
|A Growing Concern|
|Brazil - Inflation Expectations Survey, %|
For some time now we have suggested that inflation expectations in Brazil are bound to adjust higher (see 'Regional FX And Fixed Income Strategy', January 25). This is already playing out in interest rate futures markets, and more recently, it appears that Brazilian households are beginning to worry about rising prices. Expectations have ticked up sharply in June, with over 50% of respondents to a recent poll expecting inflation to rise. This is an important development, as a weaker exchange rate is already affecting perceptions of lower household purchasing power at current salaries.
|Less Bangs For Your Bucks|
|Brazil - Survey On Household Purchasing Power Expectations, %|
The same survey by polling firm Datafolha shows that the share of respondents who expect their purchasing power to decrease is now at its highest level since early 2009. This is the first direct indication, even before the protests, that inflation risks in Brazil have become a political issue. This presents a key policy dilemma for the government and central bank alike, as we believe 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 (see 'Rate Hike A Strong Signal Of More Hawkish Monetary Policy', May 30).
|Brazil - IPCA Consumer Price Inflation, % chg y-o-y|
This will have several ramifications for the upcoming 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 and 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, and we are now forecasting growth to accelerate to just 2.6% this year (see 'Risks Of Stagflation On The Rise', June 12).
Moreover, the government is already committed to stepping up public spending programmes such as the Bolsa Familia and the PAC II growth accelerate plan, which is due to expire in 2014. We do not rule out a doubling of such efforts going forward, which means that our existing concerns about fiscal deterioration and a worsening credit profile could be further exacerbated (see 'Credit Risk To Remain Elevated', March 27). Although we have yet to see how policy will be affected, we are moderately adjusting our short-term political risk rating for Brazil to reflect an impact on specific government policy - the short-term rating drops from 70.8 to 69.6.
|A Worrying Divergence|
|Brazil - Exchange Rate & Interest Rate Swap, %|
There is currently a crisis of confidence among investors, not least due to the market realisation that quantitative easing in the US is going to be wound down by mid-2014. Investors have thus far shunned Brazilian markets despite rapidly rising interest rate expectations, meaning that the Brazilian real has continued to weaken against the US dollar, exacerbating rising inflation expectations. We therefore expect there to remain a great deal of resistance from investors to move capital back into Brazil despite tightening monetary policy. Monetary tightening in Brazil, therefore, may prove to be a lot more aggressive than we are currently expecting, starving the economy of liquidity and leading to a more abrupt slowdown in real GDP growth.
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, they are equally aimed at high levels of corruption, referring back to often highly ineffective resource allocation by the government. The World Cup offers an opportune scapegoat for protestors, and the government will likely be anxious about a return of public unrest this time next year, when the FIFA World Cup will be underway and the world's attention will focus on Brazil. As a result, there is likely to be a growing political push to be seen to address corruption at government institutions, provide greater transparency and, given the very poor economic outlook as commodity prices decline, 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 likely take years. Moreover, even if Rousseff possesses the necessary political will, the president may simply not have the required political capital to deal with corruption on the local level, making tax and fiscal reforms across Brazil's regions a very tall order. 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 political parties will increasingly vie for a younger, educated and politically disillusioned voter group over the coming years.