On April 17th the lower house of Brazil’s Congress voted in favour of sending the case of impeachment charges against president Dilma Rousseff to the Senate for trial. The case for impeachment was passed by 71.7% of the votes, more than the two-thirds of votes needed. The 81-member Senate will vote by simple majority, probably by mid-May, on whether to hold a trial after a commission chaired by the Senate’s Speaker has analyzed the lower house motion. If the Senate accepts the case, Dilma will stand down as president for the duration of the trial, which must not last longer than 180 days. Her vice president, Michel Temer (of coalition partner PMDB), will assume the presidency during the trial. The Senate can remove Dilma permanently by voting in favour of impeachment by two-thirds majority. Mr. Temer then will govern for the remaining term until 2018. Ms. Rousseff can appeal to the Supreme Court to have the impeachment measure dismissed, but it is unlikely that the Court at this late stage will change its mind (given that it has rejected previous motions).

Partners in crime?

It is clear that Brazil is in dire straits and that the government should change track. The country is experiencing a severe economic recession and balance of payments crisis, partly due to mismanagement by Ms. Rousseff’s government. Furthermore, the country is rocked by an enormous corruption case (dubbed “Lava Jato”) at state oil company Petrobras. But the impeachment case is built on the charge that the president had manipulated government accounts to hide the true (larger) size of the budget deficit. Although the impeachment is not a “coup” (as Dilma’s fans want us to believe) as the law allows for this process to take place, the charges against Dilma are – in our view – not very substantial (we guess that most past Brazilian governments have used creative accounting in election years, although maybe not on this scale) and probably would hold against Mr. Temer as well (indeed, a Supreme Court judge ordered the lower house of Congress to create a commission to analyze whether Mr. Temer himself should be impeached). She has not been implicated in the Petrobras corruption case, like Mr. Temer’s PMDB buddies, Messrs. Calheiros and Cunha, Speakers of the Senate and the lower house respectively. Although we would like to see Ms. Rousseff to leave office so that more sensible and prudent macroeconomic policies can be implemented, we do think that impeaching her is stretching the constitution and is putting Brazil’s fragile political system at risk, i.e. impeachment could be used in the future to remove a president, just because he or she is unpopular.

The best step would be for Ms. Rousseff to step down and call for new elections. However, calling for new elections would require constitutional amendments, so we understand. This may be a big hurdle as many deputies and senators are afraid to lose their seat and, thereby, implied protection from prosecution, not least the highly unpopular Eduardo Cunha, who would have to put forward such constitutional amendment for a vote in Congress (requiring a two-thirds majority). The opposition party, PSDB, might also prefer to wait for elections in 2018 and hope that the PMDB would take the required harsh economic measures (firing civil servants, cut pensions, de-link wage increases from inflation, increase taxes, cutting subsidies, etc.) and take the brunt for that in the 2018 elections.

 BRL/USD Bovespa
(source: Bloomberg)

Investors are cheering the imminent impeachment of Dilma as they rightly expect more market-friendly policies if and when Dilma is gone. Indeed, Mr. Temer already set out reform proposals if and when he comes to power (he also accidentally sent an audiotape in which he discusses the outlines of a Temer administration via Whatsapp). The Bovespa stock index rose by 23% this year, whereas the real strengthened from 3.96 to 3.54 per dollar. However, we believe we are in for a rough ride. Mr. Temer needs to put a coalition together that can command 60% of the votes in both houses of Congress, no mean feat in a system that has 27 political parties with representatives that only act in self-interest (turkeys don’t vote for Christmas). As the reforms will be very painful, the PSDB might opt to stay out of a new government with PMDB, increasing its chances in elections to be held in 2018. Furthermore, it is unlikely that the best macroeconomic brains (for example, Arminio Fraga or Gustavo Franco) would risk their reputation by joining a government of the PMDB as many PMDB bigwigs are indicted in the Petrobras affair. Although we do have a very favourable outlook for Brazil in the long-term, we expect a lot of short-term volatility and believe the market optimism is overdone.