2022 Elections: Lula or Bolsonaro?

Dear investors,

As is customary in presidential elections, almost all public political discussions revolve around who will be the next president. Meanwhile, positions in the National Congress, which largely determine the future president's possible actions, take a distant back seat to popular concern.

This lack of attention to legislative positions appears to stem from two reasons: the first is the lower concentration of power in the hands of a single person (your candidate for deputy would be 1 in 513, and your candidate for senator 1 in 81); the second reason is the lack of understanding of how the legislative branch operates, especially the dynamics of its interaction with the executive branch.

Therefore, we will summarize the main aspects of the interaction between the president and the National Congress before sharing our vision of what awaits us in the scenarios of Bolsonaro or Lula winning the election.

What does the President of the Republic do?

We will focus on the duties of the Brazilian president that have the greatest impact on the country's economy.

The first is the role of head of state, in which the president leads the country's diplomatic agenda and represents it before other nations, directly influencing the political alliances Brazil will maintain with other countries during his term, which impacts international trade activities and the attraction of foreign capital for investment in our country. A recent example of the exercise of this role was Bolsonaro's negotiation with Putin to secure Russia's supply of fertilizers necessary for Brazil's agricultural activities.

The second part of the president's role as head of government is the right to appoint and dismiss ministers, without the need for approval by the National Congress. Thus, the president is the one who defines the team responsible for the day-to-day management of the federal government's matters and, directly or indirectly, decides how the approved budget will be used.

The president also has the power to directly interfere in companies controlled by the Union, as is the case with Petrobras, which underwent successive changes of CEO under direct interference from Bolsonaro throughout his term.

In other key roles, the president is now dependent on approvals from the legislative branch, which will make clear the importance of having a support base in the National Congress.

How does the president depend on the National Congress?

For better or for worse, public administration is obliged to follow a very broad set of laws.

Despite appointing his ministers, the president cannot create or eliminate ministries and other public administration bodies without the approval of Congress, so he is obliged to govern with a pre-established organizational structure if he does not have the support of the Legislature.

The executive branch also relies heavily on the National Congress to manage the federal government's finances. Government revenues derive primarily from tax collection, which is carried out in accordance with tax laws approved by Congress. The executive branch has some autonomy to change the rates of certain taxes (import and export taxes, IOF (Tax on Investment), IPI (Excise Tax), and fuel taxes), but any other significant fiscal action depends on the creation or amendment of laws and, therefore, requires Congressional support.

In turn, the use of federal revenues must comply with the Annual Budget Law (LOA), which considers an estimate of federal revenue for the following fiscal year, sets government expenditures, and is approved annually by Congress. The LOA, in turn, must be drafted in accordance with the Budget Guidelines Law (LDO), which determines government spending priorities and is also approved by Congress. The LDO, in turn, must comply with the Multi-Year Plan (PPA), which sets public administration goals for a four-year period and must also be approved by Congress.

In short, federal revenues and the allocation of collected resources are profoundly influenced by the actions of the National Congress. The LOA, in particular, severely limits the management decisions the Executive Branch could make, as it prevents the reallocation of resources between different areas of public interest. For example, the government cannot use funds earmarked for transportation in the LOA for education investments without Congressional approval, regardless of the context. Budgetary rigidity prevents the indiscriminate use of resources, but it can also lead to inconsistent situations. In a caricatured way, it's as if, faced with a sharp rise in food prices, you had to go hungry but still travel at the end of the year, as there can be no reallocation of resources from the tourism budget to the food budget.

Practical effect of our system of government

In general, the president can accomplish little without the support of a majority of federal representatives and senators throughout his term. Thus, the president is practically obliged to negotiate with Congress and compromise wherever necessary to secure their support, or his hands will be tied when it comes to implementing any changes with a significant impact on the country.

Under this dynamic, the composition of the National Congress greatly influences the direction each administration will take, as it determines which of the president's proposals will be accepted and implemented. This is why the election of our representatives and senators, so often overlooked by the general public, deserves more attention. Voters should even be careful to vote for a coherent ticket, in which their candidates for senator and representative are ideologically aligned with their candidates for president and governor. Otherwise, they are voting for a dysfunctional government, in which the executive and legislative branches will clash throughout the term.

Leaving aside the utopia of what should be done, the current (and historical) composition of Congress is quite fragmented. In the Chamber of Deputies, the party with the largest representation (PL) has 15% of the votes. In the Senate, the most representative (MDB) has 16% of the votes. The minimum number of parties that would need to align to achieve an absolute majority, assuming all members of these parties vote together, would be five parties in both the Chamber and the Senate.

Gravity pulls towards the center

Due to this fragmented structure of the Brazilian Legislative Branch, with the National Congress made up of representatives from 23 parties and senators from 17 different parties, the practice called coalition presidentialism emerged, in which the government creates a political alliance with a sufficient set of parties to achieve, in the Chamber of Deputies and the Senate, the majority necessary to approve its bills and budget proposals.

This way of governing always draws criticism, but it's a symptom of the political context in which the president relies on Congress to govern, and Congress is so fragmented. It's the pragmatic solution, supported by the concept that "politics is the art of the possible," and it fuels the so-called "centrão," a group of politicians who put idealism aside and focus on forging deals to secure congressional approvals, with sometimes questionable motivations.

In this political environment, the most purist agendas, whether from the right or the left, ultimately fail to survive Congressional proceedings. They are diluted by amendments, vetoes, and partial vetoes until they manage to garner enough votes to be approved. Thus, any future reforms will likely be slow, due to the time it takes to negotiate with various political leaders with different interests, and moderates, due to this dilution process linked to concessions to garner votes.

Bolsonaro vs. Lula

According to recent polls, the electorate is sharply divided between the right and left. Thus, the Congressional base is likely to remain fragmented and dependent on several centrist parties to aggregate the majority of the facts. Given this premise and the dynamics of the Brazilian political system, which favors the status quo, we understand that either president will have to govern through coalitions, with a low probability of being able to implement their campaign proposals in the way their voters expect. This significantly reduces the difference between the scenarios with one or the other president.

In any case, with Bolsonaro and Paulo Guedes as Minister of Economy, a more liberal government favorable to the market economy is expected, valuing the streamlining of the public sector and entrusting the private sector with the mission of promoting the country's economic development.

With Lula, who has not yet named who would occupy his Ministry of Economy, the expectation is for a government that seeks to strengthen the public sector and outline an economic development plan driven by government stimulus policies.

Regarding state-owned companies, the Bolsonaro administration would likely be less interventionist (despite its history with Petrobras) and would pursue new privatization initiatives, as we saw with Eletrobrás. The Lula administration, on the other hand, would likely continue its history of using state-owned companies as arms of the government to implement public interest policies, which could result in these companies being guided by motivations other than the pure interests of their private shareholders.

Our expectations

Regardless of the president's victory, we don't expect major advances in the Brazilian macroeconomy. Throughout our careers as investors, we've only had a very brief period of market enthusiasm for Brazil. Unfortunately, our normality is periods of timid growth or crises. Therefore, we seek to position ourselves in businesses capable of remaining healthy even in this difficult environment. Any better future would be a pleasant surprise.

Despite this skepticism, we believe that continuing the course of action adopted by Paulo Guedes, whom we see as a good Minister of Economy, would be positive. In this sense, Lula's victory raises the uncertainty of whether we will have a good minister or not. There is a nod to Henrique Meirelles, whom we see as a potential candidate for the position, but there is rejection of him by the Workers' Party base, which makes his nomination uncertain. However, it seems to us that Lula is concerned about not displeasing the market and should avoid highly controversial nominations.

If Lula wins, there's a greater risk of political intervention in state-owned companies, which could destroy value for their shareholders. Therefore, we're avoiding allocating significant capital to these types of companies. Currently, we hold only a small percentage of our portfolio in CELESC, an electricity distributor in Santa Catarina controlled by the state government, but with EDP as a significant minority shareholder, acting as a counterweight to the controlling shareholder and advocating for the company's technical management. Furthermore, we purchased these shares at a very attractive price, which considerably limits the risk of this investment.

Looking at the glass half full, Brazil is currently better positioned than several other developed economies. Furthermore, recent difficulties caused the stock market to plummet and allowed us to invest in new theses at lower prices. Opportunities always arise in the midst of crises.

Finally, we emphasize the importance of choosing your candidates for senator, federal deputy, and state deputy wisely. In these elections, we wish you all and our Brazil good luck!