The United States isn’t the only democracy where alleged tape recordings are involved in some way shape or form in a governmental crisis. In Brazil the reverberations of the Petrobras scandal and bribery of top government officials just can’t be put in the rearview mirror. When the Brazilian newspaper O Globo reported late Wednesday that the nation’s President Michel Temer gave a blessing to attempts to pay a witness to remain silent in a corruption probe. Nomura’s Latin American research analyst Joao Pedro Ribeiro thinks the reverberations are going to be serious, noting “the likelihood of Temer finishing his term has fallen significantly.”

 

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Recorded conversations send Brazilian stocks reeling

A recorded conversation between Temer and local meat processing company executives negotiating to bribe former speaker of the House Eduardo Cunha, who is currently serving jail time, is likely to sink the current collation government which had been swept into office in part on a mandate to end rampant corruption in South America’s largest democracy.

When news of the bribery probe hit markets, it sent Brazilian stocks and its currency reeling. Brazilian Bovespa stock market was halted after opening 10% down after the overnight futures market on stocks was similarly closed after dropping limit down.

Just prior to the stock market being shuttered, many individual Brazilian names were down near 20%, with Cemig, the Brazilian state-owned power company losing 42% before the market was paused for 30 minutes.

Future in Brazil unclear as corruption probe proceeds

Much like the US, where the current scandal is placing in jeopardy the legislative agenda of the Trump administration, Nomura notes that Brazilian politics is increasingly uncertain.

If Temer is impeached or resigns it is unclear who Congress might appoint. Under such circumstances, the current speaker of the House, Rodrigo Maia, would take over until Congress selects a successor. But with shifting political alliances, who that might be remains unclear.

Nomura, for its part, thinks the former President of Brazil from 2003 to 2011, Luiz Inácio Lula da Silva, known in the region simply “Lula,” may return to office.  “Cries for open nationwide elections have already begun but would require congressional approval, which at this time seems unlikely given the very high level of uncertainty in open elections and the potential for a return of former president Lula,” Nomura noted.

The scandal is likely to impact pension reform, which was one of several underpinnings of hope regarding change in the government that had fueled a stock market rally. From Nomura’s standpoint, this could impact the market environment:

The increase in political risk and a worsening of the prospects for fiscal reform will likely exert upward pressure on USDBRL (including our 3.40 yearend forecast). In a scenario of a weaker currency and less certain environment for fiscal improvement, inflation expectations are likely to rise. This combination of factors would hamper the BCB’s ability to cut the policy rate from the current 11.25%, which suggests not only that the expected cutting pace (roughly 125 according to market prices) is optimistic, but that the terminal rate of the overall cycle (8.5% in our forecasts) could be raised meaningfully. Monetary policy here is clearly dependent upon the magnitude of the BRL selloff and the time it can take to contain political uncertainty. Naturally, a scenario marked by higher interest rates and risk measures bodes poorly for GDP growth (which we expect to be mediocre at 0.7% y-o-y in 2017 and 2.0% in 2018) both this year and next.