Bolsonaro Petrobras Petro-bomb Scatters Debris

Brazilian President Jair Bolsonaro’s ousting of state oil giant Petrobras’ head a week ago will have longer-term repercussions despite his glancing efforts this week to win back the investor and business community.  The announcement resulted in a massive one-day sell-off of not only Petrobras shares, which sank 22% in one day wiping off some USD 13 billion in value, but also of other state-controlled companies and the already ailing BRL.  So far this year the real has lost more than 5% against the weak greenback after sinking 22.5% in 2020. 

While Petrobras shares have regained some ground with debt-cutting and asset sale recognition, investor confidence has not. The removal of widely respected Roberto Castello Branco handpicked by Economy Minister Guedes as CEO over rising fuel prices sparked worry that Bolsonaro will reimpose fuel subsidies and more generally increase government intervention in the economy in advance of the October 2022 presidential election.  The new Petrobras head is a former military general lacking any expertise in the oil and gas sector. Bolsonaro’s populist leanings instead of needed fiscal consolidation and promised reforms, including privatization, will worsen Brazil’s already soaring debt.  After 2020’s massive 8% of GDP coronavirus stimulus package, public debt is among EM’s highest at 90% of GDP while the general government deficit more than doubled to 14% of GDP from 6% a year earlier as the primary deficit hit a record 10% of GDP. Not long ago the country prided itself on opposite standout surpluses.

Despite USD 6.3 billion in foreign portfolio inflows in December, Brazil recorded net outflows of USD 8.5 billion in 2020, up from USD 6.7 billion in outflows the year before.  The pandemic-induced fall in imports, along with sharp currency depreciation, narrowed the current account deficit in the year to January to 0.65% of GDP, the lowest in 13 years. Terms of trade have turned favorable with booming commodity exports as foreign portfolio and direct investment covered the gap in January, but portfolio outflows from the Petrobras fiasco will widen it again.

While the government has enjoyed record low domestic borrowing costs throughout the pandemic, inflation is rising – with the annual rate running at 4.6% in January – and will be further pressured from BRL depreciation.  In January, the average rate of interest on local federal debt hit a low of 7.15% while debt issued the past 12 months averaged 4.65%, according to Treasury data.  Prior to the ousting of the Petrobras head, inflation was already rising on energy costs, and higher inflation combined with pressure on the currency from portfolio outflows and slowed foreign direct investment, will likely result in the central bank leading emerging market peers with a rate hike.

Local and overseas investors alike are increasingly concerned about the future of widely respected Finance Minister Paulo Guedes. Although the president this week called him “an anchor of our government,” it is clear that Guedes’ free-market influence has waned. Apart from the pension changes he pushed through congress, promised privatization and other structural reforms remain stalled.  While this week Bolsonaro signed the new law granting the central bank independence – which will protect the Governor from being sacked over government disagreements over monetary policy – and delivered to congress a plan to privatize state-run electricity provider Eletrobras, the moves paled against the Petrobras credibility loss.

After the economy contracted 4.5% in 2020, the IMF predicts 3.6% expansion, optimistic as the investment community now anticipates heightened government intervention in the economy while promised reforms remain stuck in Congress in the run-up to next year’s election.  The “provisional measures” for state development bank BNDES to begin work on the sale of Eletrobras, while welcome as a potential sign of a jump-start to divestitures, are merely a broad outline of which parts of the company will be offered.  In the meantime, as Covid cases continue to rise and vaccines slow to roll out, Congress is negotiating a scaled-down version of last year’s “corona voucher” program for the poorest. The Covid program cost some USD 9 billion/month and targeted the poorest third of the population, keeping Bolsonaro’s popularity rating high.  Continuation of the program would send debt toward the 100% of GDP level and again cause the government to breach the 2016 spending cap law, further denting investor confidence in the 20 months before next year’s election. Minister Guedes in the immediate aftermath of his colleague’s sacking reassured a US audience that the new heads of both legislative houses would honor the constitutional provision’s fiscal stability intent, also at risk from his boss’ repeated bouts of indiscipline.