Competitive Intelligence: Brazil Digs Itself a Deeper Hole, by Stratfor

President Michel Temer Photo: Evaristo SA/AFP/Getty Images

Summary

An end to Brazil’s plunge into political instability is not yet on the horizon, which means a sustained economic recovery may not be either. A new obstruction of justice scandal has engulfed Brazilian President Michel Temer and his close allies in Congress at a time when the Brazilian economy was just beginning to climb out of two years of deep recession.

On May 18, Brazilian Supreme Court judge Edson Fachin authorized an investigation into allegations that Temer sought to bribe a former lawmaker who has been threatening to implicate the president in various corruption scandals. The accusations stem from reports a day earlier, which claimed that the president had been caught on tape authorizing the chairman of Brazil’s JBS meat-packing company, Joesley Batista, to pay hush money to former lower house speaker Eduardo Cunha, who has been imprisoned for corruption since November 2016 and has tacitly threatened to help prosecutors build a case against Temer in exchange for a plea bargain.

The audio quality of the recording, which was released on May 18, is poor, and Temer does not appear to explicitly direct Batista to buy Cunha’s silence. But there were clearer parts in which Batista discussed other ways to interfere in the corruption probe with Temer. Though the president is defiantly shunning calls for his resignation, widespread suspicion of Temer’s wrongdoing, combined with the potential for a lengthy probe into the matter, is likely to weaken him. Culture Minister Roberto Freire has already resigned, and other Temer allies will have cause to leave the ruling coalition as well. Meanwhile, street protests against Temer are expected to grow, and at a minimum Temer will lose congressional backing for important economic reforms needed to sustain the country’s recovery.

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The Brazilian economy has shown more promise in 2017 than it has in years. Earlier this week, the Central Bank of Brazil’s economic activity index — a leading indicator released ahead of official gross domestic product figures — reported 1.12 percent growth in the first quarter. The news provided some relief for Temer, since it suggests that the economy posted quarterly growth for the first time in two years.

The recession, which began in 2015, has been Brazil’s deepest since the 1930s — a period of decline worse even than the era of hyperinflation in the 1980s and early 1990s. In both 2015 and 2016, the economy contracted more than 3 percent, while unemployment soared from around 5 percent to 13 percent. Inflation surpassed 10 percent in 2015, compelling the Central Bank to begin a monetary tightening cycle that saw interest rates rise to over 14 percent. The same year, Brazil’s currency depreciated more than 48 percent, while public debt jumped more than 21 percent.

At the time there was little cause for optimism. The intensity of the slump, combined with former President Dilma Rousseff’s inability to pass legislation to tame public spending, fueled concerns that Brazil was facing another interminable stretch of double-digit inflation. With the currency continuing to plummet, the government would have difficulties staving off its debts, forcing it to print money at faster rates. Politics only made matters worse. A corruption probe into state-owned oil giant Petroleo Brasileiro became one of the most far-reaching scandals in Brazilian history, implicating all of the country’s traditional political parties as well as its largest construction companies. Last August, it ousted Rousseff herself.

Temer’s Unfulfilled Promise

Temer inherited this storm as acting president in May 2016, and he assumed full responsibility for the crisis following the Senate’s conviction of Rousseff. So far, Temer’s biggest strength has been his substantial support in Congress. From the start, he has prioritized building the strong ruling coalition needed to pass unpopular but overdue economic reforms meant to check public spending and tame inflation and interest rates. Last year, he pushed through a constitutional amendment that will limit public spending growth for the next 20 years, with backing from more than two-thirds of the country’s lawmakers. His administration also eased requirements that Petrobras be the primary operator on every pre-salt oil project, making the Brazilian oil sector more attractive to foreign companies.

Other reforms, however, are still in limbo. This year, for instance, he’s guided contentious labor reforms through the lower house, but the measures have yet to pass the Senate. And in May, Temer was expected to send Congress a proposal to rein in the growing deficits of Brazil’s pension system by, among other things, increasing the retirement age.

The markets initially reacted well to Temer’s ability to move through unpopular reforms, as reflected in the improvement of some macroeconomic indicators. Brazil’s currency has appreciated around 20 percent over the past year, and inflation is expected to decline from over 7 percent last year to around 4 percent this year. This progress has allowed the Central Bank to lower interest rates from 14.25 percent to 11.25 percent, spurring economic activity.

But Temer’s presidency has never been on solid footing. The leader’s lack of charisma, his own corruption allegations, and the fact that he was never elected to office have plagued him from the start. And over the past year, his push for austerity measures has contributed to a steady decline in his approval ratings, which hit just 9 percent this month. Now under fire from new corruption allegations, Temer’s unpopularity is likely to erode his congressional support. At least eight impeachment requests have already been filed since the hush money scandal broke on May 18. (An impeachment process, however, could take more than six months to complete, and at this point the president of the lower house appears reluctant to move forward with it.)

Even without the scandal, popular dissatisfaction with the economy would present a major political challenge for Temer. Brazil’s nascent signs of economic recovery have been uneven, at best. The agricultural sector, for example, is expected to grow 3.6 percent this year, but the pharmaceuticals industry is expected to decline by 15.4 percent. Prolonged political uncertainty will only further undermine the country’s recovery — especially if it derails the push for much-needed economic reforms or cuts short Temer’s term altogether.

Brazil Beyond Temer

The Cunha affair isn’t the president’s only problem. Temer is also under scrutiny from the country’s Superior Electoral Court, which is hearing a case on allegations that the president accepted illegal donations on behalf of his vice president during the 2014 campaign season. His trial is supposed to resume June 6-8, and if just four of the court’s seven justices rule against him, it could lead to his downfall. Temer may be able to buy time by appealing the decision to the Supreme Court. In this scenario, the president of the lower house, Rodrigo Maia, would assume the presidency for 30 days until Congress votes on a successor. (Rumored candidates include Finance Minister Henrique Meirelles, former Supreme Court President and Defense Minister Nelson Jobim, and even former President Fernando Henrique Cardoso.) The new president would then hold the office until October 2018, when the country is supposed to have a presidential election. Nevertheless, this successor would be merely a caretaker and almost certainly struggle to push through contentious austerity measures. Attention would quickly move from reform to preparing for the 2018 vote.

It is possible that Congress will instead try to pass a constitutional amendment (requiring two-thirds support) to move up the election. Should it do so, several notable candidates will be gunning for Temer’s job, including former President Luiz Inacio Lula da Silva and Jair Bolsonaro, Marina Silva and Ciro Gomes. (A requirement that members of the executive or judiciary relinquish their posts six months prior to a presidential campaign would effectively remove all sitting mayors, governors, judges and prosecutors from the race, including popular Sao Paulo Mayor Joao Doria.) Early polls show da Silva leading the pack with support from around 25 percent of the voting public, followed by Bolsonaro at 21 percent and Marina Silva at 7 percent. The seemingly never-ending crisis of political scandal and economic woe in Brazil has fueled a surge in anti-establishment sentiment, creating an environment that favors candidates seen as outsiders such as Bolsonaro and Doria — both of whom have moved up in polls as support for traditional parties has waned.

Should the next president be an outsider from a small or medium-size party, he or she would face the tall order of forming the broad coalition needed to pass legislation in a multiparty system. So, regardless of how Temer’s fall plays out, congressional paralysis may remain a fact of life in Brazil. And amid persistent political uncertainty, the economic recovery that was supposed to be around the corner is likely to remain just that.

Source: Copyright ©2017 Stratfor Enterprises, LLC. All rights reserved. May 19, 2017 | 16:22 GMT

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