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Once again, Brazil is gripped by crisis. Prosecutors accused president Michel Temer of running a criminal organisation last week. The voters want him out. His approval rating is just 5%. He is clinging to office by the skin of his teeth. And yet, Brazilian stocks are on a surge, up 22% in local currency terms this year, and another 4 and 1/2% in dollars.
It's not just that the economy is returning to growth after a recession that knocked nearly 8% of GDP in 2015 and 2016. Investors also believe Mr. Temer, despite the turmoil, is delivering on reform. And in many ways, they are right.
His government has put a cap on public spending. It has streamlined labour laws. It has brought in better governance at state companies, especially at Petrobras, the scandal-stricken oil company. This month, it brought in a landmark reform of subsidised public lending, which promises to end a system that costs taxpayers tens of billions of reales a year, and many argue has stymied investment and growth for decades. These are all big changes, and all to the good.
The problem is they do not address Brazil's fiscal deficit. Just to balance its books, the government needs to deliver a fiscal adjustment equal to about 6% of GDP. That is a massive task, and nothing that has been done comes close. The spending cap notwithstanding no spending has been cut, and very few, if any, cuts have been proposed.
Politicians say their hands are tied because about 85% of the national budget is pre-allocated by the constitution. Investment has already been cut to the bone. And even faster growth wouldn't help there because of the spending cap. The constitution, of course, can be changed. But nobody is proposing that, and there is no appetite for it. That puts a big question mark over future growth and over investors' optimism.
