In Brazil, a Domestic Election Under Global Pressures

Latin America’s distance from the Russia-Ukraine war blunts some of the economic spillovers buffeting those closer to the conflict. But for Brazil, with the approach of national elections in October, there is no escaping the effects of rising energy and commodity prices, supply chain disruptions and associated geopolitical uncertainties.

The escalation of the crisis “could have a significant impact on Brazil’s economy,” said Atul Vashistha, chairman and CEO of risk intelligence company Supply Wisdom. “The country’s economy is majorly dependent on oil derivatives, natural gas” and agribusiness inputs including seed, fertilizer, machinery, fuel and other resources involved in farm production.

“Brazil is already suffering an inflationary wave as hydrocarbon prices increase, which would get even worse amid the ongoing Russia-Ukraine crisis,” Vashistha added in an interview.

Atul Vashistha, Supply Wisdom

International Monetary Fund economists, among others, have been sounding the alarm about the Russian invasion’s global economic consequences.

Regarding the interplay between global pressures and domestic Brazilian politics, Martin Castellano, head of Latin America research with the Institute of International Finance (IIF), said that reelection of President Jair Bolsonaro “could mean improved prospects for implementing some of the reforms on the current government’s agenda to lift medium-term growth that are still in the pipeline.”

Relations with Russia

Continued high inflation could hurt Bolsonaro at the polls. Although international affairs do not ordinarily influence voting patterns, Vashistha noted, Bolsonaro was criticized for meeting with Russian President Vladimir Putin early in the year. Brazil has voted for United Nations resolutions against Russia, while Bolsonaro has sought to remain neutral.

Brazil is not on a list of “unfriendly” countries that Putin plans to sanction, Vashistha said. “Although direct bilateral trade and financial ties are limited, Brazil could face a negative impact from the invasion.”

As election campaigning heats up, global investors can find some solace in the official independence of the central bank. A 2021 law “establishes that the president and directors of the central bank will have fixed terms of office of four years, not coinciding with that of the President of the Republic,” said Patricia Krause, a Brazil-based economist with credit risk and insurance specialist Coface. “This reduces uncertainty about continuity of monetary policy at a time of sticky high inflation.”

Modest Trade Flows

For all of Latin America, Coface data shows exports to Russia and Ukraine accounted for only 0.5% and 0.04%, respectively, of total foreign sales in 2019. The import percentages were 0.4% and 0.03%. 

Despite those low numbers, rising commodity prices could lift the region´s export revenues, somewhat mitigating the impact on GDP. Net oil importers – Chile, Peru, Mexico, and Argentina – are more vulnerable, because stronger agriculture and metals prices (favoring exports) may not fully offset the impact of higher energy prices. 

Patricia Krause, Coface

“Overall, risks to activity are tilted downwards, depending on the conflict’s length and, thus, the spillover effects on global supply chain disruption,” Krause said. “Currently, Coface forecasts Latin America´s GDP to grow by 2.2% in 2022, down from an estimated 6.7% expansion in 2021.” The situation also “clouds the outlook for the already overall high inflation in Latin America.”

Although raising interest rates would do little to tame inflation associated with surging commodity prices, Krause said this “will put pressure on central banks to calibrate their interest rates even more heavily, notably amid more aggressive monetary policy stance by the Fed.”

Decelerating Growth

Brazil’s GDP growth forecast for 2022 is 1.2%, down from 4.6% in 2021, owing to commodity prices, fiscal stimulus and an economic reopening favoring services.

Graham Stock, a London-based partner and senior sovereign strategist with Blue Bay Asset Management, said the conflict “on balance has had a positive consequence for Brazil through the trade channel. Prices for Brazil’s main commodity exports are up significantly year-to-date – soybeans 22%, iron ore 37% and pulp 23%. Import costs have also risen, particularly for fertilizer, which takes away some of the terms-of-trade benefit, but overall Brazil is a winner” on this front.

Graham Stock, Blue Bay Asset Management

However, those global price pressures have had domestic consequences. Food and fuel price increases had already pushed headline inflation into double digits in the second half of 2021. “The central bank started hiking early and aggressively and has now delivered 1075 bps of rate hikes since March 2021, but clearly this more restrictive stance represents a significant headwind to growth,” Stock said.

Brazilian inflation, at 12.1% in the 12 months through April 2022, is not likely to ease significantly and should probably average 10% for the year, according to Coface’s Krause. As a result, “the central bank has implemented one of the most aggressive monetary policies in the world, with the rate currently at 12.75% and expected to reach 13.75% by year-end.”

Attraction for Investors

Faster monetary adjustment and high commodity prices attracted $11.3 billion of equity and debt investment inflows in the first quarter, the IIF said. This contributed to a 15% currency appreciation in the 12 months through March 2022.

“Nonetheless, the exchange rate and capital inflow have been impacted since April by worries that the Federal Reserve could adopt a more aggressive monetary policy stance,” Krause said, and there has been a pullback in stock market gains.

Supply Wisdom’s Vashistha contends Brazil can be attractive for international investors. It has a population of more than 200 million, diversified economy and strategic advantages. But there are risk factors including “cumbersome and complex taxation, bureaucratic delays, and heavy and rigid labor legislation.” As part of ongoing efforts to improve the business climate, “Brazil introduced electronic certificates of origin, which reduced the time required for import documentary compliance, facilitating, and simplifying the whole process,” Vashistha said. “The country also made several infrastructure concessions which have helped foster investment.”

Risk aversion amid the Ukraine war has not resulted in massive capital outflows. Offsetting factors include improved prospects for commodity exports, elevated interest rates and attractive valuations in the wake of asset depreciation during the pandemic. “In Brazil, three factors are supporting activity this year,” said IIF’s Castellano: higher commodity prices, an overall more positive investor sentiment, and increasing fiscal stimulus.

Inflation is the main challenge. “So far, the central bank has anchored inflation expectations and managed to avoid second-round effects, which should help inflation converge to levels consistent with the target by late 2023 or 2024,” Castellano explained. “Another challenge comes from external conditions. The region could experience significant capital outflows if the world economy weakens significantly and global financial conditions worsen.”