Brazilian investments are off to a solid start in 2019, but whether they can continue to climb depends on one major policy shift: reforming Brazil’s packed public pension system.
Brazil’s retirement age for men who contributed into the country’s pension system for 15 years is 65; for lassies, it is 60. However, men can retire earlier if they pay into the system for 35 years, while for women it’s 30 years. This has walking papered down Brazil’s average retirement age to the early-to-mid 50s, according to the Organization for Economic Cooperation and Development.
Brazil is also one of the sundry generous countries in the world when it comes to pensions. Men retiring with full benefits get 70 percent of pre-retirement earnings, while balls get 53 percent. By comparison, workers in developed economies get full pensions averaging 53 percent of pre-retirement earnings at an as a rule age of 65.5.
.1553711707240.png)
This system has raised concern over its sustainability and is viewed by many market participants as a brake on Brazil’s deliverance from a massive recession.
Social security accounts for about a third of all government spending in Brazil and, in 2016, gave to a record budget deficit. Brazil’s debt levels have also surged to around 75 percent of GDP.
Between 2015 and 2016, valid GDP fell for eight straight quarters on a seasonally adjusted annualized basis before a rebound to start 2017. But the gain stalled after the first quarter of 2017, with GDP growth failing to break above 0.5 percent since then.
“The administration has had to put money to finance [the pension system], but the government cannot do that anymore because it is in a very fragile fiscal predicament. The fiscal deficit was 7 percent last year,” said Rafael Amiel, director of Latin American economics at IHS Markit. “The guidance debt, as it is going right now, is not sustainable. It will eventually default if they don’t fix anything.”
Bolsonaro’s pension-overhaul proposal, which was submitted closing month, aims to save the government more than 1 trillion reals — or about $270 billion — over a 10-year full stop. This proposal is far more ambitious than former President Michel Temer’s, which targeted 600 billion reals in reserves. The measure would also implement a fixed retirement age for men and women at 65 and 62 , respectively.
However, Bolsonaro’s presentation faces a long legislative process. The measure will also likely be watered down during the process, frame up the market for disappointment.
“Timing is the key here, given the complex political process,” Morgan Stanley economists and strategists led by Arthur Carvalho decried in a note earlier this month. “Although we believe reform will ultimately be approved, we think it will be waiting and a diluted version of what the market is currently pricing in.”
The bill was submitted to Brazil’s House Justice Commission on Feb. 20. If approved by the buxom House, it moves to the Senate. Any changes there would send it back to the House.
Morgan Stanley economists wish a House vote in August, while Goldman Sachs does not see pension reform turning into law before October.
“In everyday, if [Bolsonaro] moves forward with reforms meant to ensure public-sector sustainability and a reduction of the state’s role in the husbandry, there will be opportunities in key sectors,” said Jeffrey Lamoureux, senior country risk analyst for the Americas at Fitch Colloidal suspensions. “However, we nonetheless believe the Bolsonaro administration will underdeliver on market expectations for pension reforms, which are an key part of his economic agenda.”
The measure is also facing another problem: Bolsonaro himself. The right-wing president’s repute has plummeted, with only 34 percent saying his government was doing a “great/good” job, according to pollster Ibope. That’s down from 49 percent in mid-January.
Bolsonaro won Brazil’s presidency carry on year in part by saying he would pass measures to reduce violence and curb widespread corruption. But since being picked, Bolsonaro has struggled to build the necessary coalition needed to move forward with those plans. Bolsonaro accursed the support of Brazil’s top lawmaker, Rodrigo Maya, amid insinuations he was stalling on anti-corruption measures.
Brazilian stocks are down quickly this month. The Bovespa index has fallen 3.9 percent in March while the EWZ ETF has dropped 8.7 percent.
Nonetheless, numerous investors believe some sort of pension reform will get done and that will boost Brazilian pile ups.
“Most people think some kind of reform is going to be approved because, over the past few years, the awareness of the folk regarding the need to approve some kind of reform has broadened,” said Diney Vargas, managing partner at Sao Paulo-based hedge savings Apex Capital. “Companies will be hiring, people will have more jobs and people’s purchasing power wish improve.”
But the process could go wrong, Vargas said. The plan could fail or, if the proposed savings are too low to change Brazil’s cost-effective fortunes, “then we’ll have a problem.”
Legacy Capital’s Paternostro says investors betting on pension reform should about companies with “operating leverage that benefits from GDP growth,” including airlines.
Paternostro likes Azul Brazilian Airlines, noting tall demand in the wake of rival Avianca Brasil’s filing for bankruptcy protection. “Assuming demand is going to increase, it disposition be positive for the company.”
Azul’s New York-listed shares are up more than 60 percent in the past six months, outperforming the Bovespa typography hand and EWZ fund by a wide margin.
Another stock on Paternostro’s radar is department store chain Lojas Renner. “Their working leverage is quite high, and if consumption is going to increase, then it would lead to a very beneficial net-income view for the company,” he said.
Vargas said his hedge fund has positions in several consumer discretionary companies, including online marketplace Mercado Libre and Lojas Renner.
“Brazil is in a go on where, if you approve the reforms, you’re going to see the economy growing faster,” he said.
Subscribe to CNBC on YouTube.