Photographer: Dado Galdieri/Bloomberg

Brazil's Markets Aren't Fazed by Latest Corruption Scandal Headlines

  • Videos of Odebrecht plea deals hijack country’s attention
  • Real, stocks extend gains amid government’s reform push

Brazil’s newsstands and its markets have never seemed more disconnected.

As the nation obsesses over new details emerging from a sweeping corruption probe that’s implicated top business executives and politicians -- with pundits predicting who is likely to end up in jail and which government figures will resign in disgrace -- Brazilian assets are extending a rally that’s made them among the best performers in emerging markets. 

Investors, it seems, just don’t care about the scandal.

What makes that all the more surprising is that traders are counting on a government battered by revelations of cronyism and bribery to pass deeply unpopular reforms aimed at shoring up the budget by reducing benefits for retirees and cutting back on social spending. Brazil needs to fix its fiscal accounts to regain its investment-grade credit rating and justify the real’s surge to become the best performing major currency in the past year as stocks jumped more than 30 percent.

"This is not a political and economic environment conducive to the kind of structural reforms” Brazil needs, said Nicholas Spiro, a partner at London-based Lauressa Advisory Ltd. "But most investors do not see things this way."

Itau BBA suggested investors in Latin America increase their ownership of Brazilian stocks last week, while analysts from BTG Pactual Group and Citigroup Inc. are both sticking to buy recommendations for the country’s assets.

The latest revelations in the three-year-old Carwash corruption probe are coming from hours of videos released last week that show executives from the Odebrecht SA conglomerate explaining how they bribed officials to win lucrative contracts for the company. The tales go back decades and mention dozens of politicians, including all five of Brazil’s living presidents, detailing operations at Odebrecht’s so-called bribe department.

Newspaper front pages are filled with the most outrageous accusations and television news shows are devoting almost all of their air time to what they’re calling the “end of the world” plea bargains. In one video, former Chief Executive Officer Marcelo Odebrecht, who has been jailed for almost two years, tells prosecutors that no one is elected in Brazil without slush funds. If they claim to be, they’re lying, he says.

New investigations

The Supreme Court authorized dozens of investigations stemming from the Odebrecht executives’ testimony. The inquiries are looking into 7 percent of the lower house’s members, about a third of the senate, a third of President Michel Temer’s cabinet and almost half the country’s governors, according to consultancy MCM. All the targets have denied wrongdoing.

Still, markets are holding up. The real, which briefly fell when the first leaks on the plea deals broke on April 11, is still the world’s best major currency in the past 12 months. Stocks are down 1.3 percent since the leak, also pressured by a plunge in iron ore prices, compared with a drop of 0.2 percent for Mexican stocks.

Investors still have faith that Temer -- who took office last year after his predecessor was impeached -- will be able to push through his reform agenda.

Reforms, reforms

Political researchers Eurasia Group and Arko Advice said they expect the pension reform to pass, even though early surveys of lawmakers show the government lacks the votes it needs in the lower house. The slow pace of the investigations should help the government get through the ordeal, according to Eurasia.

"The larger repercussions of this development will be felt in the 2018 elections, not in Temer’s ability to approve his reform agenda," Eurasia said.

Itau analysts increased their overweight position in Brazil on April 10 based on expectations for the reform and higher growth estimates. BTG said in a separate report that there are several good reasons to like Brazil stocks, which remain undervalued and underowned by foreigners. Citigroup remains overweight in Brazilian corporate debt.

Still, in the past markets haven’t always been a good gauge of political fortunes in Brazil. The most striking example in recent memory is the plunge in the lead up to the election of Luiz Inacio Lula da Silva as president. After he took office in 2003 and reassured investors the country wouldn’t default on its debt, Lula went on to become a market darling, overseeing a surge in assets amid fast growth and a commodities boom.

Early disruptions

There are some early signs the plea-bargain revelations could disrupt Temer’s goals. The lower house suspended a vote Tuesday, and the Senate canceled an extraordinary session scheduled for Wednesday. The cancellation was "a clear sign the votes on the reforms will be delayed," said David Fleischer, professor emeritus at the University of Brasilia.

Temer, for his part, said he wouldn’t allow the probe to paralyze the government’s work, a statement echoed by several lawmakers and Finance Minister Henrique Meirelles in the past week.

"The seas will likely remain turbulent, but it doesn’t change the sense of urgency for the approval of the pension reform," said Rafael Cortez, a political analyst at consultancy Tendencias. "Paradoxically, it’s becoming even more key to approve the reform and minimize the damage to the political class."

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