Goodbye, Dilma. Hello, Michel.

On August 31, Brazilian President Dilma Rousseff was impeached on charges of breaking budgetary laws, ending nine months of political infighting. The Brazilian Senate voted 61-20 to permanently remove her from her presidential post. Rousseff’s former vice president, Michel Temer, led the impeachment process and has assumed the presidential duties.

This week we will look at the current political landscape of Brazil under the new president. We will briefly describe the country’s recent political history and look at the specifics of Brazil’s economic development. We will discuss the conditions that led to the impeachment and the new president’s possible policy path. As usual, we will conclude with market ramifications.

Recent History
Brazil’s population of more than 200 million makes it the fifth largest country in the world in terms of population. Population growth has been rapid as the absolute number has doubled over the past 30 years. According to IMF data, Brazil was the ninth largest country in terms of nominal GDP in 2015.

Brazil is still very new to the international markets as well as to democracy. The country was ruled by the military from 1964 to 1985. During this time, civil rights were severely repressed while the military tried to implement economic reform. In 1985, the military peacefully ceded power to civilian rulers. The constitution was ratified in 1988 and the country held its first democratic election in 1989 with great enthusiasm. The new government was able to get inflation under control through extensive price freezes, and its new currency was introduced in 1994.

The Workers’ Party, which is moderately left-wing, first came to power in 2002 when Luiz Inacio Lula da Silva (known as Lula) won a resounding victory. Lula remains popular to this day, aided by the booming economy experienced during his two terms. Dilma Rousseff, also a member of the Workers’ Party, was elected president in 2010 largely on the back of Lula’s popularity. Rousseff’s second presidential term began in 2014.

Rousseff has been involved in left-wing politics for most of her political career. She fought against the military dictatorship alongside the Marxist movement and was jailed and tortured by the regime. She was one of the founders of the Democratic Labor Party, serving in several regional positions. In 2000, she left the party after an internal dispute and joined the Workers’ Party. She became Brazil’s energy minister before running for president in 2010.

Rousseff gained popularity during her presidency for lowering energy and food tax rates, populist measures which boosted support among the poorest constituents. In the beginning of her presidency, the country benefited from rising Chinese demand for Brazilian commodities which led to higher commodity prices. This allowed the government to increase public spending without addressing economic inefficiencies. These inefficiencies have been exposed in recent years as a result of slower global growth, leading to discontent among her constituents.

Brazil is rich in minerals and crude, and the country has benefited greatly over the past decade from the surge in commodity prices. The wealth effect was multiplied by capital inflows and credit expansion. Recently, discontent has grown as economic growth has slowed. The chart below shows the country’s annual change in economic growth, with the shaded areas indicating recessions. Brazil has been in a recession since Q2 2014, with nine consecutive quarters of negative annual GDP growth. The Olympics created a slight uptick in growth, but the year-over-year growth rate for the most recent quarter remained at -3.8%.

Historically, Brazil’s growth has relied on commodity exports, especially soy beans, iron ore and oil. With grain prices falling due to increasing supplies and industrial metals prices falling on soft demand, Brazil’s main exports have been hit hard on both price and quantity.

Industrial production has been weak, as the chart above shows.

Slow growth has caused the unemployment rate to surge from its low of 4.6%, reached in 2014, to 8.0% in the most recent data.

At the same time, consumer inflation remains high. CPI stands at 9.0% annually.

Inflation has been caused by supply side constraints. Infrastructure has remained inadequate as the railway system is in its infancy, rivers are not accessible enough for reliable transportation and roadways are in poor condition. The natural shortfalls of the river system are especially relevant since the country produces many low value-to-weight commodities, which are best suited for river transport.

Historically, Brazil has been one of the highest inflation and lowest growth countries among emerging economies. For example, inflation reached 2,000% per year in the 1980s. The solution to this high inflation was an arduous path of capital controls, heavy bank regulation and deep cuts to the government’s budget. In the early 2000s, investors dove into emerging markets; this, coupled with Brazil’s falling inflation following deep-seated reforms, resulted in large inflows of capital into the Brazilian markets. As a result, the Brazilian currency, the real, has appreciated and in turn made Brazilian manufacturing uncompetitive. It is important to remember that the Brazilian economy is mostly commodity-related and relies on low skilled workers, so exports need to compete on pricing rather than the value-added sphere.

At the same time, the country has been successful in poverty reduction, lifting about a quarter of its population into the middle class category in the past 10 years. This is no small feat. By comparison, China moved the same proportion of people out of poverty over the course of 30 years. With that being said, inequality remains a persistent problem for Brazil.