RaboResearch - Economic Research

Brazil: Lula’s interrogation, check mate for Dilma?

Economic Comment

  • On 4 March former president Lula was held for questioning by the Federal Police
  • Lava Jato investigations seem to intensify so a spate of arrests amongst politicians might follow
  • President Rousseff is now much more likely not to finish her term
  • Significant policy improvement is possible in the case of a newly elected government; such an improvement is less likely in the case of a caretaker government
  • Social and political polarization will pick up in the short term
Figure 1: Market sentiment improves on the back of Lula’s arrest
Figure 1: Market sentiment improves on the back of Lula’s arrestSource: Macrobond, BM&F BOVESPA, GFI Group

On 4 March the Federal Police held former president Lula for questioning in the Lava Jato corruption case. As markets translated this to higher odds of president Rousseff being impeached, this also led to a marked improvement in market sentiment. While we regard recent developments in the Lava Jato case as positive, we are more cautious on the implications for the political and economic outlook than the recent improvement in market sentiment suggests (figure 1). Namely, while it is now more likely that  president Rousseff will not finish her term than that she will, it’s uncertain in our view whether this unequivocally translates into significant policy improvement.

We see three possible scenario’s unfolding: 1) Rousseff finishes her term, 2) early elections lead to the formation of a new government with a strong mandate or 3) a caretaker government under the leadership of vice president Temer finishes the term. Only under the second scenario do we see a marked improvement in policy that allows Brazil to escape a muddle through scenario. Either way, political and social polarization are likely to pick up in the short term and 2016 remains another lost year in economic terms, as we noted on earlier occasions.

The good: Lava Jato investigations pick up …

Following months of  rumours and testimony leaks related to investigations in the Lava Jato corruption probe, former President Lula was held for questioning. Family members were also detained for questioning and the house and offices of the former leader were raided.  The arrest of Lula was no surprise as it had been anticipated since the summer of 2015. Against a backdrop of rumours that leniency agreements with key  business people and politicians are in a final phase of conclusion, the arrest signals that investigations in the corruption probe are intensifying. This is reinforced by the sentencing of several previously arrested business executives on 8 March, amongst which also the highly influential Marcelo Odebrecht. Thus, we could witness a long anticipated wave of arrests amongst politicians in coming months. Given the high degree of political polarization and related policy paralysis associated with Lava Jato, progress on the case is positive. The sooner Brazil puts the case behind it, the sooner political focus can return to economic policy.

… and Rousseff is increasingly unlikely to finish her term

Another positive consequence of recent developments, including Lula’s arrest, is that the odds of president Rousseff finishing her term have decreased significantly. Two ongoing processes could lead to Rousseff’s departure: 1) the impeachment procedure looking into any wrongdoing in fiscal management by the president in 2014 and 2) the Electoral Supreme Court (TSE) investigating any illegal financing of the ruling PT’s campaign during the 2014 elections. Rousseff is now more likely to leave than to stay in office, for two reasons. First, recent developments bring the corruption investigations closer to PT’s 2014 electoral campaign financing and thus increase the chance that the TSE investigation leads to an annulment of last year’s elections.  Second, while on the defensive Lula and the PT are radicalizing towards the left and that is likely to reduce essential political support the president enjoyed with more centrist parties in congress until recently. This loss could be exacerbated if planned pro-impeachment protests register a high turnout.   

The bad: a muddle through scenario is still highly likely

Brazil’s outlook depends on the type of government that takes over if Rousseff leaves : 1) a caretaker government under the leadership of vice president Temer or 2) a newly elected government following early elections. In the first case, the tight links between Temer’s party, the PMDB, and Lava Jato, are likely to keep the government on the defensive and lacking the political support to improve economic policy significantly. Thus, Brazil would still be likely to muddle through until the next elections in 2018. However, the second case would make room for a fresh start, a new coalition (and possibly less links to the corruption probe) and a stronger mandate for course correction on economic policy, allowing Brazil to escape the muddle through path. Unfortunately, early elections are only possible if the TSE investigation leads to an annulment of the 2014 election results and is concluded this year (early elections can only be called for in the first two years of an administration).  This outcome is likely to be constrained by the time pressure, making a muddle through scenario still highly likely. 

The ugly: political and social polarization intensifies

Either way, the processes are likely to be protracted and increase both political and social tensions. Lula’s radicalizing rhetoric is also likely to lead to more protests and social polarization. The former president mobilized his core supporters to the streets, by labelling the investigations a business elite attack on a party of the poor, accusing the prosecutors of an illegal attempt to unseat the president and inviting them to fight him in the streets. The economic outlook will thus remain clouded by fickle politics and 2016 will be another lost year in economic terms.


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