On March 17th FSG hosted an executive event with regional and country managers in São Paulo. The event itself coincided with the occupation of the city’s most important avenue by anti-government protestors, which had been preceded only days before by the country’s largest anti-government protest ever. The pressing concerns of those executives in attendance were directly related to this popular movement, a movement that while generating growing hope for a political transition that could lead to faster economic recovery, continues to be marked with a high level of uncertainty regarding the ultimate outcome.
Elevated uncertainty regarding political scenario is making strategic planning difficult
The overwhelming concern at the São Paulo executive breakfast was how Brazil’s current uncertain political situation would be resolved, and what the outcome would mean for economic growth and business prospects. While 73% of the executives that attended the event believed that President Rousseff would not complete her current term, it was clear to most in the room that the methods used to remove president Rousseff would be critical for shaping the medium-term growth trajectory of the economy.
FSG provided clients with three scenarios, demonstrating our base case and both an extreme downside and extreme upside scenario. While FSG believes it is most likely that President Rousseff is removed (75% probability), we currently believe that there is a higher probability that she is removed via an impeachment (our base case), as opposed to removal by the country’s electoral court (our upside).
- Base case (45% probability): While an impeachment would allow for the rise of Michel Temer (PMDB), FSG believes that ongoing investigations into various members of the PMDB allegedly involved in the Lava-Jato scandal would weaken the new government’s ability to execute strong reform measures. As such, we expect only marginal growth in 2017 with a strong recovery delayed until 2018 elections bring in a government with the ability to construct a solid political coalition in Congress.
- Upside scenario (25% probability): If the president were removed by the electoral court (prior to January 2017), new elections would need to be held, allowing the new government to come to power with greater legitimacy and the political support necessary to return the country to more secure footing. The new government’s heightened legitimacy, and thus its ability to drive greater credibility around a lasting fiscal reform program, would likely allow it to expand spending in the near term and drive a quicker recovery in domestic consumption.
- Downside scenario (10% probability): Should Lula win the presidential elections in 2018, Brazil would face a significant risk of a rapid spiral toward insolvency as the government would likely double down on spending outlays and possibly interfere in Central Bank autonomy. FSG believes that in order for Lula to have a chance at winning, the governing PT party would need to find a way to drive economic growth in the short-term (and Lula would need to be cleared of corruption charges), which will prove incredibly challenging if not impossible under current conditions.
Unsurprisingly, because of the extraordinary high political uncertainty that Brazil is currently facing, the distinct probabilities of our three scenarios fail to add to 100%. This means that FSG is considering alternative scenarios that would also be economically impactful. Such examples would be the eventual resignation of the president, or the rise of an anti-system candidate in 2018 presidential elections, both of which FSG deems as possible but unlikely.
Regarding a potential impeachment, companies should closely monitor decisions by the PMDB and the PP parties on March 29th and 30th respectively, regarding their decision to remain in or leave the government. Following the official break of the PMDB in Rio de Janeiro from the government on March 24th, the likelihood that the PMDB as a whole will announce its official departure from the government has risen significantly, and with it the likelihood that impeachment will receive a positive vote in the full Chamber of Deputies in April. Ultimate defection by the PMDB and PP would nearly seal the fate of the government in Congress.
Additionally, a key signpost to watch that would suggest President Rousseff is at greater risk of being removed by the electoral court would be new information coming from eminent plea bargain deals from key construction company CEOs such as Odebrecht, which should occur in the coming weeks.
Companies are encouraged to increase the frequency with which they review their market assumptions until there is a more clear resolution to Brazil’s political crisis. At the moment only 16% of FSG clients are conducting monthly market assumption reviews, while 21% of our clients review the assumptions included in their strategic plans only on an ad-hoc basis and another 16% are reviewing only once per year.
Multinationals still see Brazil as a growth engine moving forward
Under this environment of high uncertainty, and despite a contraction of 3.8% of GDP in 2015 and an expected contraction of 3.7% for 2016, a surprising 33% of executives in attendance at our São Paulo event indicated that their companies were in fact increasing resource allocation to Brazil, while an additional 28% said that their companies had held resource allocation steady. Those companies that said they were increasing resource allocation to Brazil suggested that corporate still considered Brazil as a major growth driver moving forward, as the country still has significant gaps in areas such as infrastructure and healthcare provision.
When asked what strategies they were pursing to make the case for additional investment in Brazil, half of executives said their companies were focused on driving efficiency and productivity gains, in line with an environment of weaker demand and lower margins; 22% said that their companies were pursing new acquisitions, a more aggressive and market-oriented move in an environment of a sharply depreciated Brazilian real and cheap local asset valuations. Other executives expressed interest in investing in acquisitions now, but also suggested that promoting that idea to corporate amid high local tensions was a significant challenge.
Making the case for Brazil to corporate will remain difficult as long as international news flashes scenes of protestors
So long as scenes of agitated protestors gathering in front of the presidential palace in Brasilia are the main focus of international news coverage, country and regional managers will continue to struggle to demonstrate the true atmosphere in Brazil when taking new investment plans to corporate. While the government is reaching out to foreign governments, international organizations, and even the foreign press to push the view that the movement against the president essentially represents a coup, Brazilian democratic institutions and civil society have performed admirably despite significant strain.
When walking down Avenida Paulista during the anti-government protest or the subsequent pro-government rally, the atmosphere was not suggestive of a country on the verge of widespread unrest. Though isolated flair-ups might occur, it is clear that Brazil’s democracy has matured considerably and the risk of significant disruption is low.
In this sense, FSG believes that Brazil will find an institutional solution to its current crisis and that now is an ideal time to execute aggressive growth strategies in the country, including new acquisitions and movement into adjacent product or customer segments while also leveraging momentum to create leaner cost structures. While Brazil may never become a power exporter, companies should also be exploring opportunities in the external sector, taking advantage of the country’s increased competitiveness won through currency depreciation and economies of scale in local production.
Brazil will no longer provide the easy growth that it might have delivered before, but with more sophisticated strategic planning and internal alignment, companies can still leverage Latin America’s largest economy to drive significant revenue growth through the next decade.
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