Brazil: The positives of protests

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Bears thrive on accelerating inflation, weak growth and a falling real. But a positive, reforming response to protests might transform sentiment in Brazil.

It has been quite a month for the Brazil bears. Where to begin? Maybe with Standard & Poor’s downgrade of the country’s outlook to negative from stable. That means the chance of a downgrade is one in three in the next two years. But Barclays went further. It has published a report "Bracing for the downgrade" in which it says: "The combination of weak growth and fiscal deterioration is likely to lead the rating agencies to downgrade Brazil by one notch in early 2014."

Inflation continues to be above its 6.5% range ceiling and the central bank is – belatedly – trying to counter this pressure with orthodox monetary tightening. Sceptics question how effective this policy will be: inflationary expectations have jumped as the central bank has lost its credibility.

The rumour in São Paulo is that the dismayed bank finally realized that the government was not going to deliver on its side of a bargain: the central bank would lower Selic and keep it low – in order to achieve a long-sought-after goal of a lower base rate in Brazil’s financial system – if the government in turn asserted fiscal discipline to help in the fight with inflation. Realizing it would have to act alone, the central bank did so.

Meanwhile, growth expectations are being revised down. The consensus for 2013 is already down to around 2.5% this year, but that is still falling. At this rate a repeat of last year’s 1% growth would be a good result. Weakening fundamentals put pressure on the real and it began to fall. Finance minister Guido Mantega surprised the market with a sudden withdrawal of the 6% IOF tax on foreign investments in the local market – then, when that provided little support for the currency (removing a barrier created to stop short-term speculative capital was never going to have much impact if those flows had gone elsewhere months earlier), it removed the 1% tax on FX derivatives. The real continued to fall – going to $2.25 before finding some support – and was at $2.22 when Euromoney went to press.

Then there were the protests. On one night more than 1 million Brazilians marched on the streets in nearly 100 cities demanding – well, change. The disparate movement encompasses many demands – from the initial call for a recent 20 centavo (10 US cents) rise in transit fares in São Paulo city to be scrapped to protests against corruption and inflation.

Judging by emails and calls to Euromoney’s São Paulo office, the international coverage seems to have been largely unrepresentative. There was very little violence and vandalism given the truly impressive scale of the manifestações.

The picture of Brazil presented to the world – and international investors – was of a country in chaos. Maybe the news is not so bad. First of all, the protests had the desired effect. The increase in transport costs was scrapped – estimates say this will trim 0.1% off the inflation rate – prompting wags in the Brazilian press to speculate that Mantega was behind the wave of protests.

More important, the popular demonstrations seem to have shaken a complacent and indolent political class. On June 25 the Brazilian senate voted against PEC 37, which would have given immunity from prosecution to Brazil’s politicians and was a key gripe with the manifestantes. Politicians in general are falling over themselves to adopt the protestors’ agenda. President Dilma Rousseff promised a tribunal for political reform – although this policy might have been a bit rushed and there were immediately questions about its viability and legitimacy.

Whatever, the recent protest might just push Rousseff’s government to finally begin to undertake reforms, including to the country’s complex tax and business regulations and also to make serious attempts at fiscal adjustment. Either unwilling or unable to see the urgent need to reform previously – and strangely she seemed more stymied than liberated by the political capital she derived from her huge pre-protest popularity ratings – there has been sleep at the wheel of late. But if these protests wake up the dozing giant, the manifestações could be the biggest boost to Brazil bulls for years.