With a far-right candidate leading in the presidential polls, potential for a fragmented Congress and a possible deterioration in economic data, investors worry about what’s next for Brazil following October’s election.
Much like other emerging-market currencies, Brazil’s real USDBRL, -0.0074% has already sold off this year, dropping more than 23% since January, according to FactSet. But the currency could come under additional pressure going forward, with the rest of the year rattled with uncertainties.
On Thursday, a poll by Datafolha for the Oct. 7 presidential and congressional election showed far-right candidate Jair Bolsonaro, who got stabbed two weeks ago, in the lead with 28%. Fernando Haddad, who is running in place of disgraced but nevertheless tremendously popular former President Luiz Inacio Lula da Silva, is in second place with 16%. Lula can’t run after being convicted of corruption charges.
Without a clear winner, there will be a possible run-off election on Oct.28.
The result of the vote will determine the scale and pace of fiscal and structural reforms that Brazil badly needs, as its public finances and need for pension reform have left previous leaders scrambling. “Without sustained reforms, fiscal deficits will remain high and government debt dynamics adverse, further weighing on broader investor confidence and economic activity,” according to a report from ratings agency Fitch.
“Large general government fiscal deficits and rising indebtedness amid a tepid economic recovery will seriously limit the policy flexibility of the new government. External risks linked to rising U.S. interest rates, potential global trade frictions and a slowdown in China could also add to vulnerabilities,” Fitch said.
Another problem could arise if Brazil’s Congress winds up being very fragmented, complicating the policy and reform process further.
On the monetary policy front, Brazil’s central bank left its benchmark interest rate unchanged at 6.5% late Wednesday, in line with expectations. But persistent weakness in the real and a possible turn for the worse in economic data could make central bankers rethink matters. They last cut rates in March.
“If inflation continues to trend higher, as we expect, we think the first hike will be seen in October,” said Fitch. “Much will depend on the real and how it trades around the elections.”
The last consumer price inflation reading was 4.4% for the 12 months leading up to mid-September.
“For all that the real has been dragged into the EM FX woes, in no small part due to electoral uncertainties, thus far the impact on inflation has been muted,” said Marc Ostwald, global strategist and chief economist at ADM Investor Services International. But it might not stay that way, as inflation reports lag behind real-time currency markets.