Brazil: A Choice Between Two Polarizing Known Knowns

The presidential election outcome is unlikely to lead to a significant change in the expected near-term macro policy mix.

BY ALBERTO M. RAMOS
AND RENAN MUTA

Voters will go to the polls on Sunday, October 2, for a general election that as in 2018 has been characterized by deep political and social polarization. Investors' focus on the upcoming election is more muted than in the election four years ago. First, despite still significant anti-establishment sentiment the upcoming election is unlikely to change the political map and overall balance of political forces in a very significant way in Congress and at the local level. Second, the dominant perception is that the presidential election outcome is unlikely to lead to a significant change in the expected near-term macro policy mix and the outlook for reforms. While the outcome of the presidential election may not have a major impact on short-term macro policy direction and reforms, it may have deeper implications for broad macroeconomic performance and investor sentiment over the medium-term, given that the two most competitive candidates—incumbent Jair Bolsonaro and former president Lula da Silva—espouse different macro views on, among other things, the size of the State and its role in the economy, and of government spending and SOEs as engines of growth/investment.

Former President Lula Leads the Presidential Race

The set of polls for the 2022 election (significantly bigger than in previous elections) show higher than usual dispersion amidst a wide variety of polling methods and models. The poll-of-polls show former president Lula (PT) in the lead: polling consistently in the mid-40s and in some polls at striking distance from winning in the first-round. The incumbent, President Jair Bolsonaro, is tracking in second place with roughly 35% of voters' preferences. Bolsonaro's gap to former president Lula seems to have stabilized in recent weeks (with some polls showing it widening again) with the president struggling to gain electoral dividends from an improving economic and labor market backdrop, generous increase in fiscal transfers, and a message focused on the former president's political liabilities. The recent poll dynamics suggest that it is still likely that the election will only be settled in a second-round runoff, though a first-round victory by former president Lula is not impossible, particularly if strategic vote considerations come into play. Former president Lula is also leading in second-round simulations.

Congress Expected to Remain Fragmented and Leaning Center-Right

Key for governability and the outlook for reforms is the composition of Congress. While difficult to handicap local races, recent polls suggest that the composition of Congress is unlikely to change in a very significant way: left-of-center parties are expected to increase their representation, but congress is expected to remain fragmented, ideologically nebulous, and likely with still a majority of centrist and center-right political forces. Overall, a highly independent and autonomous legislature is expected to act as an effective check and balance on executive power and radical policy measures.

The Next President Will Face a Number of Political and Economic Challenges

On the economic front the next president will face a backdrop of still high inflation, a very restrictive monetary policy stance, decelerating domestic and global growth. In addition, growing fiscal spending pressures will very likely imply the suspension of the constitutional spending ceiling and the formulation and approval of another fiscal rule. On the political front, the main challenge is to guarantee governability which will require skill in co-opting broad segments of a likely still fragmented and ideologically diverse Congress to approve measures to deepen the fiscal adjustment and establish a credible medium-term fiscal anchor. Other reforms to overhaul a complex, porous, inefficient, and onerous tax system, to reform a bloated and inefficient public sector, and boost overall productivity growth, are also needed to elevate the still very modest growth potential of the economy. Overall, the key challenges for the next administration are to strengthen the structural fiscal accounts and support a capital/investment deepening drive needed to unleash a sustainable socially-inclusive growth cycle.

Under a Bolsonaro second term we would expect the continuation of unsettled governability conditions, but overall lower fiscal risk and a more private-sector friendly and reformist agenda. Furthermore, we would expect to see a renewed effort to reduce the size of the State (though privatizations and concessions), limited role for the SOEs including public banks, federal government spending restraint, and the pursuit of an investment friendly tax reform.

Under former president Lula, we would expect a tax-and-spend strategy given the deeply held belief that the public sector and SOEs should be key engines of growth and investment. Such strategy could lead to higher consumption growth in the short-term but also high inflation, and larger fiscal and current account deficits. Over the medium-term a more activist tax-and-spend strategy would entail higher fiscal risk premia (higher debt) and lower potential growth. Finally, a Lula administration is perceived to be comparatively more committed to an ESG agenda, which could eventually pay foreign policy dividends.

Overall, the two most competitive candidates in this election are two well Known Knowns: hence, the scope for a major post-election macro policy or political surprise is mostly perceived as limited. But they are also polarizing known knowns, to whom few are indifferent, as in highly stylized terms, they are loved by their core bases and loathed by others. Now it is the time for voters to decide.

Alberto Ramos is chief Latin American economist at Goldman Sachs Group. Renan Muta is Macroeconomic Research Analyst at Goldman Sachs.

This article is based on a client note by Goldman Sachs. Republished with permission.