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Brazil’s problems run too deep for Olympic boost

21-07-2016 | Insight | Daniela da Costa - Bulthuis, Léon Cornelissen, Paul Murray-John

Brazil’s economy is unlikely to win the gold medal for hosting the Olympics as its problems lie too deep, say Robeco’s experts on investing in the country.

Speed read:
  • Olympic bonus seen as too small to boost growth or job creation
  • Interim president’s reform plan should improve investor sentiment
  • Falling inflation and appreciating currency are positive factors

The Games in Rio de Janeiro from August 5-21 would normally be expected to provide an economic boost, thanks to new infrastructure, higher tourism and income from television and other sporting rights. Other countries have seen higher economic growth from hosting the quadrennial event, and Brazil uniquely could have enjoyed a double boost after hosting the soccer World Cup in 2014.

“Higher growth in the year of the Olympic Games was attributable to an acceleration in investments, but we don’t see that happening in Brazil,” says Daniela da Costa-Bulthuis, a portfolio manager in Robeco’s Emerging Market Equities team. Robeco manages around EUR 1.6 billion in Brazilian equities and bonds, including EUR 250 million in its emerging fundamental equity strategy.

“The expected positive impact of investments in infrastructure prior to both the World Cup and Olympic Games have disappointed on the back of poor execution of the government’s investment plan and an unfriendly investment environment, with excessive government interference, a high tax burden and low project returns.”

‘The country has been going through a political crisis and a recession since 2014’

She says a study by Olympic sponsors EY estimated that the Games would create 1.79 million permanent and temporary jobs in and around Rio. “If true, that won’t be enough to deal with the current 11 million unemployed Brazilians, which represents 11.2% of the working force,” she says.

“The country has been going through a political crisis and a recession since 2014, the year it hosted the World Cup. Since then, Brazil has faced protests on the streets, one of the biggest corruption probes ever involving state-owned companies and government politicians, and a presidential impeachment process.”

“All that is combined with low investment levels and low economic growth for three years in a row. Brazil has had its deepest GDP contraction in more than 20 years in 2015, shrinking by 3.8%. Expectations for 2016 are for a new contraction of 3.5%. The challenges the country is facing this year are much bigger than any positive effect the sports event could have.”

Some signs of progress

Da Costa-Bulthuis says it’s not all is gloom during the Olympics in Brazil though after the legal process was started to remove President Dilma Rousseff from office for illegal manipulation of fiscal accounts.

“Recent numbers show that business and consumer confidence have slightly improved after the Brazilian Congress approved a formal presidential impeachment process last April,” she says. “The interim government is pushing for liberal measures and a GDP recovery agenda. There are talks about possible structural reforms after the definitive impeachment trial – which is expected to begin in the first week after the Olympic Games.”

“So the Olympic Games could close the chapter of the political crisis in Brazil, and its success could contribute the most by helping to improve sentiment. After that, Brazil may enter in a moment of positive news flow coming from both political and economic fronts, that can mark the beginning of the country’s GDP recovery.”

Attractive bond valuations

Robeco’s Emerging Debt fund invests in Brazilian government bonds which have become more attractive in recent months due to falling inflation and an appreciating currency. “However, for fixed income investors the Olympics is a bit of a sideshow,” says portfolio manager Paul Murray-John.

“On the one hand, we are not insensitive to the benefits of the boost that the Olympics will give to growth. On the other hand, building trophy stadiums is unlikely to improve economic productivity.”

‘Addressing the fiscal incontinence of the Rousseff presidency’

“Brazil does offer attractive bond valuations at the moment - we are slightly overweight - but mainly for other reasons, namely high real yields, falling inflation and a government that has a plan to address the fiscal incontinence of the Rousseff presidency.”
“If the Olympics leaves a legacy of an improved transport infrastructure, then that will be more than enough to satisfy long-term bond holders.”

Drastic economic fixes

Much will depend on how the ramshackle Brazilian economy is reformed with or without the Olympics, says Chief Economist Léon Cornelissen. He says plans by Dilma’s temporary replacement as president are ambitious, but drastic measures are necessary.

“After 13 years of Workers Party Rule, the new interim President Michel Temer has made some interesting suggestions for market-friendly reform,” he says. “The most dramatic is a constitutional amendment to freeze public spending in real terms for up to 20 years. As the constitution and other legislation protects 90% of spending from cuts, such a move would force the government to change the laws.”

‘Privatization will be back on the agenda’

“Temer’s team is led by a former governor of the central bank, Henrique Meirelles, and it wants to break from earlier policies on a broad front: the unaffordable pension system has to be slashed, and burdensome regulations for corporations have to be lifted, beginning with the oil and gas sector. Antique labor laws and the overly complicated tax system has to be reformed.”

“Privatization will be back on the agenda. Next year’s budget will have to be submitted to Congress by 31 August, and local elections will be held in October. It will be interesting to see which reforms will be enacted in the coming weeks and months offering hope for investors that the world’s ninth-largest economy is being put onto a solid trajectory out of the current mess.”

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