Petrobras fallout and poor growth add to pressure on Rousseff

Late last year, Sao Paulo's Museu da Casa Brasileira, a design museum, staged an exhibition, "Excelencia Italiana" (Italian excellence).

On the way in, guests could see the latest Maserati and Ferrari sports cars, while inside they could experience examples of Italian food and culture.

The evening was hosted by Azimut, an independent wealth manager based in Italy and an enthusiastic investor in Brazil. The group has made four acquisitions in the country since 2013, including April's purchase of 60 per cent of domestic wealth manager Quest Investimentos for R$70m ($24m).

"We are targeting Brazil as a key market in which to be present, and Azimut's strategy is long term," says Giuseppe Perrucci, president and co-chief executive officer of Azimut Brasil.

Such bullishness has become more the exception than the rule among investors, with the economy sinking into recession, inflation exceeding the central bank's targets and infighting in the ruling coalition of President Dilma Rousseff on the increase.

Add a corruption scandal at Petrobras, the state-controlled oil company, and an adverse external environment - the Chinese economy slowing and the US Federal Reserve expected to raise interest rates - and Latin America's largest economy is facing difficulties.

"Brazil in that context is one of the most vulnerable [emerging markets], because it is sensitive to Chinese demand for commodities and . . . to what the Fed [will] do," says Maarten-Jan Bakkum, a senior emerging markets strategist at NN Investment Partners.

This year was expected to be one of reckoning. Ms Rousseff and her former finance minister Guido Mantega ran a prolonged fiscal stimulus programme in her first term, which lasted from 2011 to 2014, to combat what they saw as offshore economic crises.

They suppressed fuel, energy and other prices and introduced temporary tax breaks to stimulate industry. This curbed inflation for a time and kept unemployment at bay, helping Ms Rousseff win a second term last year.

But then news of the Petrobras bribery scandal broke. Prosecutors allege that former executives conspired with contractors and politicians to earn kickbacks from the company, which dominates Brazil's fossil fuel industry.

Petrobras flirted with a technical default by delaying the release of its audited 2014 results - the figures are a requirement of some bond covenants - before releasing them late in April.

But the damage caused by the scandal is expected to continue, not only for the company but for its contractors, some of which have filed for bankruptcy protection after being accused of involvement in the bribery schemes.

This in turn is expected to hamper Petrobras's development of its vast offshore oilfields and, together with the lower oil price, make it harder to reduce its large net debt of $106bn.

"Petrobras may face challenges to deleverage its capital structure," said Fitch, the rating agency, which has kept the company on a negative outlook.

The Petrobras scandal has also brought protesters to the street calling for Ms Rousseff's impeachment and sent her popularity to a record low.

Sensing her weakness, a coalition partner, the PMDB, wrested more power. One of its most senior figures, vice-president Michel Temer, now leads the government's "political co-ordination" efforts with Congress instead of Ms Rousseff's own party, the PT.

On the plus side, the dealmaking has helped to stabilise the government, analysts say. The other positive, economists say, is that Ms Rousseff now seems determined to put public finances in order after the country in 2014 suffered its first primary budget deficit - before interest payments - in more than a decade.

Her new finance minister, Joaquim Levy, a University of Chicago-trained fiscal hawk, wants a primary budget surplus of 1.2 per cent this year and about 2 per cent in 2016.

Brazil's central bank too, after years of seeing inflation drift to the top of its target band of 4.5 per cent plus or minus 2 percentage points, now believes it can hit the centre of the range.

However, even if Mr Levy succeeds on fiscal tightening, what is next for Brazil? The PT is credited with raising millions out of absolute poverty. But with the country's twin commodities and consumer booms of the past decade fading, the country needs to invest in infrastructure, education and other areas to raise falling productivity.

"Growth is eventually going to have to come from infrastructure investments and that's not going to happen until we get new rules regarding concessions as well as bringing in infrastructure players which are able to invest and able to work," says Will Landers, portfolio manager of the BlackRock LatAm Investment Trust.

Some say green shoots are appearing with the weakening of the currency to about R$3 to the dollar, compared with about R$2.20 a year earlier.

Maersk Line, the world's largest container shipping group, says it is seeing some increase in exports. And Apex, a government investment agency, says more investors are setting up research and development centres in Brazil.

Markets, however, are likely to be less tolerant of a prolonged period of sliding growth than strategic investors. If there are no signs of recovery, analysts say, the country's credit rating, which has been under pressure from the budget deficit, could again be on the line.

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