Short Term Consequences of the Political Crisis

BRAZIL ECONOMICS - Report 22 May 2017 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

Last week started with an increase of optimism. The probability of approval of the social security reform looked better and asset prices began a new round of appreciation. These factors, together with the weak economic activity and falling inflation, led to stronger bets on a steeper decline of the interest rate. However, there has always existed a second scenario, with smaller probability, in which further political weakening of Temer would jeopardize approval of the pension reform, leading to higher risks of depreciation of the exchange rate, in turn darkening the prospects for monetary easing and resumption of economic growth. The audio recording of the conversation between Joesley Batista and Michel Temer has greatly increased the likelihood of this second scenario. Independently of the legal consequences of such dialogue – to be known in the next few days – the political damage has already been done.

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