Water, Not Economic Reform, is Brazil’s Next Challenge

 

Brazil re-elected incumbent Dilma Rouseff of the Worker’s Party (PT) as its President for the next four years.  The mandate in this election was much smaller than her victory in 2010.  This time around she squeaked out a 3 percent margin of victory compared to 12 percent four years ago.  It was an extremely tough fought election, with the Brazilian Social Democracy Party (PSDB) and its candidate, Aecio Neves, making it a very close race.  The election also displayed the divided nature of the electorate, with the poorer regions voting heavily for Rouseff, while voters in the more prosperous urban areas, seeking economic reforms, went for Neves.  The closeness of the vote and the issues raised in the election were not lost on President Rouseff.  In claiming victory, she promised to be a much better President than she had been so far, and to focus on reforms and dialogue to bring the country together.

The immediate post-election reaction in the currency markets was skepticism over the likelihood of change and more business-friendly policies, as the Brazilian real showed some weakness against the U.S. dollar.  Despite initial weakness, over the longer-term the currency outlook is not so clear.

The scenario for a stronger Brazilian real rests on several factors.  First, markets typically extract discounts for risks, and the election removes the uncertainty hanging over the country.  We now know that the Worker’s Party and Rouseff will govern for another four years.  Second, Brazil’s economic problems over the last several years came as much from abroad, in the form of decelerating growth in China, a stagnant Europe, and falling commodity prices, as the home-grown challenges from spending on the World Cup and dealing with corruption.  With much of the blows from these external factors having been absorbed by the economy, there is a case for incremental improvement in the economy in 2015.  And, the case for a stronger Brazilian real is reinforced by the 11 percent short-term interest rates, providing a nice cushion of returns for those that can handle the risk.

The counterpoint scenario, however, comes not from the world of economics and politics.  The biggest economic risk facing Brazil in the near-term is the water shortage in Sao Paulo.  While Brazil has enormous fresh water resources and generates huge amounts of hydro-electricity, the reservoirs around Sao Paulo are drying up.  Neither of the Presidential candidates wanted to confront the obvious – yet water rationing is probably coming to Sao Paulo on an unprecedented scale, and it is not going to be popular.  Without increased rainfall over a sustained period of time in the reservoir region around Sao Paulo, Brazil could face serious economic repercussions from an extended period of water rationing that could hit the economy and the currency.  From our perspective, water risk trumps political risk over the next several months in Brazil.

Read More:

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Food Price Inflation and El Nino

Bluford (Blu) Putnam has served as Managing Director and Chief Economist of CME Group since May 2011. He is responsible for leading economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact. Prior to joining CME Group, Putnam gained more than 35 years of experience in the financial services industry with concentrations in central banking, investment research and portfolio management. He has authored five books on international finance.

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