Join our community of smart investors

Brazilian economy in hands of World Cup flops

The beautiful game has returned to its spiritual home, but could the future direction both of Brazil’s economy and its stock-market hinge on the outcome of a simple football match?
June 19, 2014

When Brazil was awarded the football World Cup in 2007, its economy was growing at an annual rate of 6 per cent and the local stock market had scored a record high. Seven years on, and with the tournament now underway, things are very different. Growth has slowed to a trickle and Sao Paulo’s benchmark Ibovespa index has been on a downward trend for the past three years. Civil unrest, too, has been an overriding theme of the build up to this World Cup, and, according to analysts at Deutsche Bank, the outcome of a general election later this year could be "the most important for financial markets since 2002."

Whether unfortunate coincidence, or an inevitable consequence, this is not the first time Brazil has found itself facing disorder while hosting a World Cup. Losing to the unfancied Uruguayans in 1950 - the Maracanazo disaster - not only stunned the 200,000 expectant home fans packed into a still unfinished Maracanã stadium, but helped topple the incumbent administration amid allegations of fraud by government officials during the building process.

Twelve years ago, Luiz Inácio Lula da Silva became Brazil’s first left-wing leader in almost half-a-century. Expensive social reforms made him hugely popular, but the Workers' Party he helped establish has a less impressive record on the economy, particularly under Lula’s successor, Dilma Rousseff. GDP had reached 7.5 per cent and inflation was running at less than 5 per cent when she took office in 2010 - Goldman Sachs expects economic growth of just 1.1 per cent this year and inflation above 6 per cent for at least another 18 months.

Equity markets have, however, been in party mood. Since mid-March, the Ibovespa index has rallied 22 per cent to an eight-month high, outperforming every major market - the S&P 500 rose just 5 per cent and the FTSE All-Share an anaemic 3 per cent. True, an end to the panic around US tapering has revived most emerging economies, yet even the MSCI Emerging Markets index grew just 12 per cent in that time.

"Financial markets would like to see Dilma go," explains Craig Botham, emerging market economist at Schroders. "When her approval rating drops, the market goes up." And drop it has. A 28-point lead in the opinion polls in March has shrivelled to just 15. "All the noise surrounding the World Cup is certainly not helping her," points out Deutsche. A growing social divide, slum "pacification" programmes, political corruption and the astronomical cost of staging the tournament - at over $11bn (£6.7bn) it is the most expensive ever - have caused a wave of strikes and demonstrations.

Consumer and business confidence, meanwhile, sits near five-year lows, and severe drought has ruined Brazil's coffee harvest, affecting hydroelectric power supply and raising the spectre of water rationing. "The key impediments to growth in Brazil are structural and domestic rather than cyclical or external," says Goldman.

"Dilma has proven herself to have no credible reform credentials," adds Mr Botham, who reckons any further drop in her popularity could spark a 'hope rally' over the summer. Deutsche predicts a Rousseff victory, decided by "a second-round runoff by a narrow margin". Others are not so sure. "We are positioned for an opposition win,” Will Landers, who runs the BlackRock Latin American Investment Trust, tells us. "If she wins re-election, most likely the market would go back to levels of early March given the lack of success of current government policies."

A resurgent Real looks vulnerable, too. Up 10 per cent against the euro since March, central bank support in an effort to curb inflation is expensive and unlikely to last past October’s election. And, after a "tactical pause" last month with the benchmark rate at 11 per cent, Goldman Sachs calls "better-than-even odds" of a second round of fiscal tightening pushing rates up as high as 12.5 per cent. Taming inflation risks wiping out what little growth there is.