Elections 2022: Lula or Bolsonaro?

Dear investors,

As is customary in presidential elections, almost all public discussions of politics revolve around who will be the next president. Meanwhile, the positions of the National Congress, which largely determine what the future president's possible actions will be, occupy a distant background in popular concern.

This lack of attention to legislative positions seems to derive 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 out of 513, and your candidate for senator 1 out of 81); the second reason is the lack of understanding of how the legislative branch operates, in particular the dynamics of its interaction with the executive branch.

Thus, 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 of these is the role of head of state, in which the president leads the country's diplomatic agenda and represents it before other nations, directly interfering in the political alliances that Brazil will maintain with other countries during his mandate, which reverberates in the activities of international trade and attracting foreign capital to invest in our country. A recent example of the exercise of this function was Bolsonaro's negotiation with Putin to guarantee the supply, by Russia, of fertilizers necessary for agricultural activities in Brazil.

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 subjects under the responsibility of the federal government and, directly or indirectly, decides how the budget approved for the federal government will be used.

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

In other key attributions, the president is now dependent on approvals from the legislative branch, which will make clear the importance of having a base of support 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 extinguish 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 Union's finances. Government revenues are mainly derived from tax collection, which is done in accordance with tax legislation passed by Congress. The Executive Branch has some autonomy to change certain tax rates (import and export taxes, IOF, IPI and fuel taxes), but any other relevant action in the fiscal sphere depends on the creation or amendment of laws and, therefore, needs support of Congress.

In turn, the use of Union revenues must comply with the Annual Budget Law (LOA), which considers an estimate of Union revenue for the following fiscal year, establishes what government expenses should be and is approved annually by Congress. The LOA, in turn, must be carried out in accordance with the Budgetary Guidelines Law (LDO), which determines government spending priorities and is also approved by Congress. The LDO, on the other hand, must respect the Pluriannual Plan (PPA), which determines the goals of the public administration for a period of 4 years and also needs to be approved by Congress.

In summary, the Union's revenues and the destination of the collected resources are profoundly influenced by the action of the National Congress. The LOA, in particular, greatly limits the management decisions that the Executive Branch could take, as it prevents the reallocation of resources between different topics of public interest. For example, the government cannot use transportation capital in the LOA for education investments without congressional approval, regardless of the context. Budget rigidity prevents the indiscriminate use of resources, but it can also cause incoherent situations. In a ridiculous way, it is as if, in the face of a huge 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

Overall, the president manages to do little if he does not have the support of the majority of federal deputies and senators throughout his term. In this way, the president is practically obliged to negotiate with Congress and give in whatever is necessary to guarantee its support, or he will have his hands tied to implement any change with relevant impact for the country.

Under this dynamic, the composition of the National Congress greatly influences the direction that each government will take, as it determines which proposals from the president will be accepted and can be executed. That is why the election of our deputies and senators, so ignored by the general public, deserves more attention. Voters should even be careful to vote for a coherent list, in which their candidates for senators and deputies are ideologically aligned with their candidates for president and governor. Otherwise, they are voting for a dysfunctional government, in which the executive and legislative powers will fight each other throughout the term.

Leaving the utopia of what should be done aside, the current (and historical) composition of Congress is quite fragmented. In the Chamber of Deputies, the most represented party (PL) has 15% of the votes. In the Senate, the most representative (MDB) has 16% of the votes. The minimum number of parties that should line up to achieve an absolute majority, assuming all members of those parties vote together, would be 5 parties in both the House and Senate.

Gravity pulls towards the center

Due to this fragmented structure of the Brazilian Legislative Power, with the National Congress made up of deputies 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 number of parties in order to reach, in the Chamber and in the Senate, the majority necessary to approve its bills and budget proposals.

This way of governing always provokes criticism, but it is a symptom of the political context in which the president depends on Congress to govern and Congress is so fragmented. It is the pragmatic solution supported by the concept that “politics is the art of the possible” and that feeds the so-called “centrão”, a group of politicians who leave idealism aside and focus on sewing agreements to get approvals in Congress, with motivations sometimes questionable.

In this political environment, the most purist agendas, whether from the right or the left, end up not surviving the proceedings in Congress. They are diluted by highlights, amendments and partial vetoes until they manage to add enough votes to be approved. Thus, any future reforms are likely to be slow, due to the time it takes to articulate with different political leaders with different interests, and moderate, because of this dilution process linked to concessions to raise votes.

Bolsonaro vs. Lula

According to recent polls, the electorate is sharply divided between right and left. Thus, the congressional base must remain fragmented and dependent on several centrist parties to aggregate most of the facts. With this premise and the dynamics of the Brazilian political system that privileges the status quo, we understand that either of the two presidents will have to govern through coalitions, with a low probability of being able to implement the campaign proposals in the way that their voters expect. This greatly 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 is expected, favorable to the market economy, valuing the downsizing of the public machine and entrusting the private sector with the mission of promoting the country's economic development.

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

In state-owned companies, the Bolsonaro government would probably be less interventionist (despite its history with Petrobras) and would seek new privatization moves, as we have seen happen with Eletrobrás. On the other hand, Lula's government would probably follow its history of using state-owned companies as arms of the government to carry out policies in the public interest, which could cause these companies to be guided by motivations other than the pure interest of their private shareholders.

our expectations

Regardless of the winning president, we do not expect major advances in the Brazilian macroeconomy. Throughout our career as investors, we had a very short period of market enthusiasm for Brazil. Our normality, unfortunately, are times of timid growth or crises. Thus, we seek to position ourselves in businesses that are able to remain healthy even in this difficult environment. Any better future would be a pleasant surprise.

Despite this skepticism, we understand that the continuity of the course of action adopted by Paulo Guedes, who we see as a good Minister of Economy, would be positive. In this sense, Lula's victory brings uncertainty as to whether we will have a good minister or not. There is a nod to Henrique Meirelles, who we understand as a potential good holder of the position, but there is a rejection of him by the PT base, which makes his nomination uncertain. However, it seems to us that Lula is concerned about not displeasing the market and should avoid very controversial appointments.

In the case of Lula's victory, there is more risk of political interventions in state-owned companies, which could destroy value for their shareholders. Thus, we are avoiding allocating too much capital to these types of companies. Today we have only a small percentage of the portfolio in CELESC, an electricity distributor in Santa Catarina controlled by the state government, but which has EDP as a relevant minority shareholder, acting as a counterweight to the controller and advocating for the company's technical management. In addition, we purchased these shares at a very attractive price, which considerably limits the risk of this investment.

Looking at the half-full side of the glass, Brazil is now better positioned than many other countries with a developed economy. Furthermore, the recent difficulties caused the stock market to crash and allowed us to invest in new theses at low prices. In the midst of crises, opportunities always arise.

Finally, we reinforce the importance of choosing well your candidates for senator, federal deputy and state deputy. In these elections, we wish good luck to all of us and to our Brazil!