4 Reasons Why There’s Hope for a Turnaround in Brazil

As the country gears up to host the Olympics, there are signs that it is on track to break its recent streak of losing headlines.

2016-07-gmtl-ab-brazil-turnaround-economy-rio-large.jpg

In the months leading up to Summer Olympic Games, which open in Rio de Janeiro in early August, Brazil has had to contend with plenty of negative headlines: A corruption scandal that sidelined a president, a hollowed-out economy and a mosquito-borne disease with no known cure are but a few. But a look beyond the headlines hints at a country — and a region — quietly moving in the right direction.

That doesn’t mean the challenges Latin America’s biggest country faces aren’t serious. The economy shrank by nearly 4 percent in 2015 and will shrink again this year. That all but ensures that Brazil’s problems — from crime and corruption to mosquitos and public health — won’t be solved overnight.

Nonetheless, these clouds have silver linings. As the Olympics get under way, here are some of the positives that we at AllianceBernstein feel the press has missed:

New government, new market-friendly policies. The scale of the multibillion-dollar bribery and money-laundering scandal involving state-run oil company Petrobras is staggering. The resulting shakeup of government has brought about much-needed change in the form of a new government that appears committed to fixing the large fiscal imbalances that have crowded out investment and stunted growth. State-owned enterprises are also embracing a market-oriented approach, selling noncore assets, cutting capital spending and, in the case of state banks, limiting the role of subsidized lending that has distorted credit markets and driven up borrowing costs for businesses and consumers.

An independent judiciary and engaged citizenry have restored faith in democracy. Brazil’s constitutional process worked as it was designed. Judges were able to prosecute powerful politicians and businessmen without impediment.

Other institutions, such as the police and the media, did their jobs well too. And an informed emerging middle class, adept at using social media, took to the streets in overwhelming numbers to make their voices heard. These protests mark a fundamental shift in people’s ability to expose and confront corruption.

Domestic companies are cracking down on fraud. They’re hiring international accounting firms to improve compliance, engaging independent counsel to investigate allegations of employee wrongdoing and improving whistle-blower procedures. The result should be better corporate governance and better financial disclosure for investors.

Interestingly, Brazil’s not the only Latin American country under new management. Others are also trying to put the days of state-sanctioned corruption and interventionist government policies behind them and move toward a more practical brand of politics and economic orthodoxy.

In Argentina, President Mauricio Macri has made reforming the economy a top priority. After taking office last year, he helped end a dispute with holdout creditors dating back to the country’s 2001 sovereign debt default. The settlement gives Argentina access to global capital markets for the first time in a decade, which should help Macri as he tackles the economy’s large fiscal imbalances.

In Peru, center-right economist Pedro Pablo Kuczynski pulled off a come-from-behind election victory this year to succeed as president the more left-leaning Ollanta Humala. Since taking office, Kuczynski has appointed market-friendly cabinet ministers, and he plans to stimulate the economy with tax cuts and more infrastructure investment.

We think the trend will spread. The economic crisis in Venezuela, for instance, has grown so acute that the country is running out of food and medicine and has resorted to electricity rationing. The situation is simply not sustainable. That doesn’t necessarily mean a new government is imminent, but it does hint at the implementation of new policies.

The shift to the political and economic center across Latin America is closely tied to the end of the past decade’s unprecedented commodities boom. When prices were high, many resource-rich countries squandered the windfall by boosting spending on social programs, public sector wage hikes and other populist initiatives designed to gain political favor. As prices of key commodities fell, governments found themselves with gaping fiscal holes and undiversified economies. Meanwhile, popular anger over public officials’ malfeasance surged, forcing leadership changes and more macroeconomic discipline. Latin Americans are moving away from populism, just as voters in Europe and the U.S., wracked by economic insecurity, are leaning in the opposite direction.

Global investors are still heavily underexposed to emerging markets in general. In Brazil, for instance, foreign investment in local-currency bonds has been declining, even though these assets have been top performers.

There are still plenty of challenges ahead for Brazil and other countries in the region. The road back to economic health will be a long and winding one. Yet there is real change under way. Eventually, investors will return.

Shamaila Khan is portfolio manager of emerging-markets corporate debt, and Paul DeNoon is director of emerging-markets corporate debt; both at AB in New York.

See AB’s disclaimer.

Get more on emerging markets.

Related