The future of Brazilian stocks hinges on two words: Pension reform

Bolsonaro’s pension-overhaul proposal, which was submitted last month, aims to save the government more than 1 trillion reals — or about $270 billion — over a 10-year period. This proposal is far more ambitious than former President Michel Temer’s, which targeted 600 billion reals in savings. The measure would also implement a fixed retirement age for men and women at 65 and 62 , respectively.

However, Bolsonaro’s proposal faces a long legislative process. The measure will also likely be watered down during the process, setting up the market for disappointment.

“Timing is the key here, given the complex political process,” Morgan Stanley economists and strategists led by Arthur Carvalho wrote in a note earlier this month. “Although we believe reform will ultimately be approved, we think it will be delayed 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 full House, it moves to the Senate. Any changes there would send it back to the House.

Morgan Stanley economists expect a House vote in August, while Goldman Sachs does not see pension reform turning into law before October.

“In general, if [Bolsonaro] moves forward with reforms meant to ensure public-sector sustainability and a reduction of the state’s role in the economy, there will be opportunities in key sectors,” said Jeffrey Lamoureux, senior country risk analyst for the Americas at Fitch Solutions. “However, we nonetheless believe the Bolsonaro administration will underdeliver on market expectations for pension reforms, which are an essential part of his economic agenda.”

The measure is also facing another problem: Bolsonaro himself. The right-wing president’s popularity 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 last year in part by saying he would pass measures to reduce violence and curb widespread corruption. But since being elected, Bolsonaro has struggled to build the necessary coalition needed to move forward with those plans. Bolsonaro lost the support of Brazil’s top lawmaker, Rodrigo Maya, amid insinuations he was stalling on anti-corruption measures.

Brazilian stocks are down sharply this month. The Bovespa index has fallen 3.9 percent in March while the EWZ ETF has dropped 8.7 percent.

Nonetheless, many investors believe some sort of pension reform will get done and that will boost Brazilian stocks.

“Most people think some kind of reform is going to be approved because, over the past few years, the awareness of the population regarding the need to approve some kind of reform has broadened,” said Diney Vargas, managing partner at Sao Paulo-based hedge fund Apex Capital. “Companies will be hiring, people will have more jobs and people’s purchasing power will 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 economic fortunes, “then we’ll have a problem.”

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