What’s the price tag on the brewing political crisis in Brazil? $150 billion. That’s how much value was wiped out on the nation’s Bovespa index on Thursday, as a leading newspaper found alleged testimony that President Michel Temer approved of payoffs to silence a potential political opponent.
Although Temer has declared his innocence, this is a crisis that is unlikely to be short-lived. And if you own shares of Brazil-related exchange-traded funds, it’s time to look under the hood and assess how the fund holdings may fare in the months ahead.
The Bovespa index had been on a tear, rising 78 percent from lows seen in January 2016 through this past Wednesday. Investors warmed to the prospects of key reforms in the nation’s retirement system, moves to enhance the interest of foreign investors, and an infrastructure modernization plan. “If these accusations prove to be true, Temer’s political support would decline significantly impairing progress on the reform agenda,” analysts at Merrill Lynch wrote in a research report.
The 9 percent plunge on Thursday seems stark enough, but a range of individual Brazilian blue chips fell from 18 percent to 26 percent, including utility firm Eletrobras, oil giant Petrobras, Banco Bradesco and discount airliner Azul.
The key question is whether the economic “green shoots” that had begun to emerge can be sustained and keep the country's economy moving forward. Or will the current crisis knock the economy back into a fresh slump?
James McKeigue, managing editor at LatAm Investor, a U.K.-based Latin America-focused finance magazine, thinks the fall-out may be limited. He notes that the economy is already climbing out of recession, and “the only significant blow in the short-term would be if there was a sustained bond and currency sell off, which would limit the central bank’s willingness to loosen monetary policy.”
If the fallout is contained, investors may re-focus on Brazil’s investment positives. “One bright area is the country’s powerhouse agro-export sector, which has overcome hits from a drought and beef scandal and looks likely to drive growth this year,” writes McKeigue in an emailed response.
An eight percent plunge in the real on Thursday may give a further boost to exports. A cheaper currency may also aid Brazilian factories. The nation’s Purchasing Managers’ Index is already back above 50 for the first time since 2015.
But it’s unwise to diminish the potential risks. This week’s events “clearly derails the controversial pension and labor reforms that Temer was trying to deliver,” says McKeigue.
Analysts from Merrill offer similar caution. “Given the higher risk for the reform agenda implementation, we expect Brazilian asset prices to suffer in the short term,” they noted.