Brazil’s Deconstructed Scandal Sketch

Brazilian shares held on to MSCI-beating 70 percent and EMBI-leading 20 percent gains through November, as the arrested former chief executive of construction giant Odebrecht admitted to kickbacks in a plea deal set to implicate dozens of other members of the business and political elite. The bombshell verdict came as preparations mount for former President Lula’s corruption trial, and the interim Temer government handles new cabinet minister accusations of misconduct in a property transaction. The ceaseless scandal barrage has diverted attention from fiscal reform proposals on state finances, pensions, and long-term spending, as lawmakers in their shadow introduce legislation to place the judiciary on investigative notice and strip its immunity. GDP contracted 3.5 percent in Q3 and next year minimal growth forecasts have been further pared to the 1 percent and under range with industrial output down double-digits. Inflation with the output slack and stronger real toward 3.3/dollar has retreated to a likely 5 percent next year, which will enable several hundred basis points of central bank easing in principle. The primary fiscal deficit will remain constant around 2.5 percent of GDP as public debt creeps up toward 80 percent with residual commitments for provincial rescues. In the balance of payments, the current account hole should stay 1 percent of GDP on good commodity export and foreign direct and portfolio investment numbers, with the latter aided by reconsideration of Mexico’s prospects with President Trump in office. State banks are rationalizing operations and credit books with the headline NPL ratio at 4 percent, but the sector is grappling with a wave of major corporate bankruptcies including the Oi $20 billion telecoms default. Local and foreign creditors have appointed different advisers, and talks have been acrimonious with reference to a possible two-thirds haircut. According to S&P Ratings almost 30 borrowers have been unable to pay in 2016, and restructurings are lengthy and complicated despite recent liquidation procedure overhaul. The biggest debtor Petrobras has been promised domestic and international funds for working capital as it tries to sell assets, including select field rights. On the sovereign front the country as a net creditor became the first developing economy to join the Paris Club, as it may face Portuguese-speaking African exposure in Angola and Mozambique.

Argentina share and bond index advances are in high single-digits a year after President Macri’s election win, and ahead of mid-term legislative polls in 2017, which should keep the House and Senate party configurations intact, but act as a government early economic policy referendum. Growth should be 3 percent next year after 2016’s equal shrinkage on solid agricultural exports and consumption revival, with lower inflation estimated at 15 percent. Real interest rates remain at 5 percent, and bank stocks could take off with personal lending after a long absence during the Kirchner administrations. Social and infrastructure spending will sustain a 5 percent of GDP fiscal gap despite a tax amnesty that may collect $10 billion and staple subsidy rollbacks that dented the President’s popular approval. External debt appetite has surpassed original expectations with $40 billion raised this year in dollar issuance at home and abroad, with a heavy amortization and servicing schedule in the coming months. FDI in contrast has been paltry at $2 billion despite high energy sector interest with tariff adjustments, and critics note that reputation reconstruction still awaits long-term allocation.