Brazilian Pension Reform Could Bring Investors Returns for Years to Come

By Craig Mellow

Photograph by Carl De Souza/AFP/Getty Images

Things may be threatening to fall apart at global flash points from the Persian Gulf to Hong Kong.

But they are coming together in Brazil, at least from investors’ point of view. The No. 1 question for the fifth-largest emerging market has been whether insurgent president Jair Bolsonaro could shepherd fiscally critical pension reforms through an unwieldy Congress that includes some 30 political parties. It increasingly looks like he can.

A Brazilian lower house committee lately kicked off hearings on a bill that would produce 900 billion reals ($234 billion) in social security savings over a decade, clearing the way for passage by early autumn. A June 14 general strike called to protest the changes sputtered. The 900 billion figure is more than enough to catalyze a near-stagnant economy, fund managers say. “This would put Brazil’s fiscal situation on sustainable footing for the next 10 to 15 years,” says Graham Stock, head of emerging markets sovereign research at fixed-income specialist Blue Bay Asset Management.

A pension breakthrough could open the gates for reforms of Brazil’s dysfunctional tax system and sclerotic labor regulations, not to mention igniting private investment and leaving the central bank room to cut interest rates, Stock continues. “You could see 3% to 3.5% growth without crossing the frontier of what’s possible,” he enthuses. Brazil has not expanded that fast since 2010.

Bolsonaro was pegged early on as the “Trump of the Tropics.” But unlike the prototype, he has largely kept quiet on complex policy issues, leaving the pension sausage making to finance minister Paulo Guedes and Congressional speaker Rodrigo Maia.

Where investors divide is on whether Brazil’s good news is already priced into its assets. The iShares MSCI Brazil exchange-traded fund (ticker: EWZ) has climbed by 40% since Bolsonaro took a commanding lead in the polls last September, while global emerging markets are flat. The real has gained 9% against the dollar.

Jonas Krumplys, an emerging markets portfolio manager at Ivy Investments, sees further gains driven by reforms that are so-far below the radar, like positive management overhauls at state oil company Petroleo Brasileiroand banking giant Caixa Economica Federal, or a raft of privatizations that courts have green-lighted. “Brazil is our No. 1 overweight,” he says.

Verena Wachnitz, a portfolio manager for Latin American equities at T. Rowe Price, thinks the cream has been skimmed for now. “A lot of positive expectations are baked in,” she says. “Why not wait a few months to see if they turn out?” Stock, for all his future expectations, sides with Wachnitz from the bond market perspective. “We have an overweight, but not a big overweight,” he says.

The cautious outlook reflects memories of 2017, when pension reform seemed on the verge of passing until prosecutors charged then-president Michel Temer with corruption and racketeering. (He was arrested this March and awaits trial.) Similar shocks to the system are possible this time around, notably from embezzlement probes swirling around Bolsonaro’s son Flavio, a senator representing Rio de Janeiro.

Still, Brazil is enjoying a status it has not seen in a while: a bright spot on a hazy global horizon. Bolsonaro is using his charisma to good end, by market calculus, and the large, inward-looking economy is relatively insulated from turmoil elsewhere. Trade accounts for less than one-quarter of Brazil’s gross domestic product, compared to 38% for China. That looked like a disadvantage in globalization’s heyday, but now may be more of a comfort. The nation’s destiny is in its own hands, and the hands look surprisingly steady.

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