The Chances of Impeachment Have Increased

BRAZIL ECONOMICS - Report 14 Mar 2016 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

Executive Summary
In recent days the real has appreciated, the CDS quotations have fallen, stock prices have risen and longer term interest rates have declined. These were not movements prompted by signs the Rousseff administration was “coming to its senses”, changing its economic policy bearings. Instead, they all resulted from the increased likelihood of impeachment, with consequent installation of a new government.
Changes in stock prices are very fast while changes on the real side of the economy are slow. If a new government is established with sufficient political support to enact an agenda of reforms, the country should recover its ability to grow. However, although an improvement is possible in 2017, we see no reason to change our projections for 2016, as presented in our most recent Quarterly Outlook.
The growing likelihood of a renewed government will maintain the tendency for asset prices to appreciate, and we discuss in more detail the perspectives for the real to get stronger. But due to the downward trend of the terms of trade, which is exogenous to the country and shows no signs of changing, the real exchange rate will continue being weak in relation to the historical average. The decline of risks and increase in demand for Brazilian assets might generate undershooting, but the Central Bank has a stock of more than US$ 100 billion in foreign exchange swaps and can (and should) use them. Further appreciation would reduce inflationary pressures and raise the probability of reductions of the interest rate, which would stimulate economic recovery.
We reiterate that the cause of the change in the outlook is the increased probability that the Rousseff administration will soon be no more. But what is that probability, 60%, or 70%? Whatever the response, the other side of the coin must still be considered, of a 40% or 30% chance that the government will survive. If impeachment comes to pass, as we think it will, asset prices will rise more, and later the economy will start to recover. But if the government manages to muddle through, the resulting letdown will have very negative consequences.

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