The country which is "uninvestable" right now - no, it's not China

In our last wire, we discussed the impact of the changing Mexican political environment on our infrastructure investments. This time, we're going to broaden the conversation further by including Brazil and Argentina. We will also discuss the varied impacts of the US election on Latin America. 

Brazil

After Mexico, the political situation in Brazil looked remarkably calm and stable. Reigning president Lula da Silva is a decisive character, loved domestically but ‘feared’ internationally due to his leftist rhetoric. 

But a clear takeaway from this trip is that it is largely rhetoric – he is noisy with his populous stance but pragmatic in his execution. The biggest check to his response is the level of the Brazilian currency - if his policy weakens it too far, the masses suffer, which in turn means his popularity suffers. That is, the view on the ground is that while Lula will remain ‘noisy’ he listens to the FX and retracts when the BRL to USD weakens past R$5.50.

In terms of the political agenda, it’s very interlinked with the economic one. The key areas of discussion included:

• The upcoming appointment of a new chair of the Central Bank of Brazil and the transition thereto.
• Political adherence to fiscal constraints and how to cut spending/increase revenues to support spending.
• Inflation targets and policy commitment.
• Infrastructure and the ongoing privatisation of assets and projects to support national and state investment growth – this was an important discussion at a national level as well as on state-led panels.
• Next election and Lula’s potential competition.

Central bank replacement

In line with set terms of office, the current Chair of the Central Bank, Roberto Campos Neto, will be stepping aside later this year to be replaced by a Lula-appointed candidate. This caused some concern within markets, with Mr Campos Neto very highly regarded, having promoted monetary autonomy and independence of government directives. By contrast, Lula was very vocal in blaming the high borrowing costs, and in turn the Central Bank’s policy, for limiting faster domestic economic growth. 

Having heard Mr Campos Neto speak on global and domestic economic challenges, I can reiterate that he is a very impressive, market-centric Chair, leaving big shoes to fill.

Whilst in Brazil, the widely-anticipated Gabriel Galipolo was confirmed as the next Chair of Brazil’s Central Bank. He is a 42-year-old economist who was previously the second in command at the Finance Ministry. The markets were initially concerned that he lacked technical expertise and would bow to political pressure as opposed to maintaining true independent policy. 

However, economists are warming to him, and he is winning support as a strong successor to Campos Neto, particularly as he has the ear of Lula. Importantly, Campos Neto was very clear that he wanted to work with the incoming Chair to ensure a smooth transition of responsibilities.

Lula, who has been publicly vocal about his frustration with the high interest rates, has recently softened his stance, stating to policymakers earlier in August, “if they need to hike interest rates, then they need to hike interest rates”. Clearly, this removes any initial test of independence for the incoming Chair, and could even suggest Lula is willing to listen to the rationale of his appointed Chair before creating unnecessary noise - the change in tone coincided with statements by Galipolo that a rate hike was on the table for September's monetary policy meeting due to continued elevated inflation risk. 

This shift has appeased investors and commentators for the immediate future with one commentator stating that Galipolo had shown ‘persuasive ability’ with the administration.

Cynically, the message may have been conveyed to Lula that they should hike now so that they can get inflation in check quickly. This should enable the easing of rates towards the end of 2025 or as Lula kicks off his 2026 election campaign, with sentiment turning in his favour as he campaigns into a declining rate environment and economic stability. Any delay to rate hikes could see forced increases in the campaign, which would not support his narrative.

Fiscal constraints

The adoption of fiscal rules has increased in popularity over the past 40-50 years, particularly in the emerging world. By regulating expenditure, debt, and fiscal outcomes, rule-based fiscal policy looks to limit political freedom with public money. Fiscal constraints are the bane of populist or left governments, as they restrict the spending required to retain the popular vote.

In Brazil, fiscal constraints evolved over a more-than 30-year period, and ultimately became very restrictive and untenable, with a three-phase limitation in place. However, these limitations were contradictory and ultimately resulted in a significant cut in public investment to support social policy, particularly through periods of crisis such as COVID.

With Lula returned to power in 2024, he proposed, and Congress approved, a new fiscal arrangement called the Sustainable Fiscal Regime (SFR) based on standard fiscal rules used in other countries, namely a revenue rule, an expenditure rule and a primary result target arranged in a particular fashion. It’s this new regime that currently guides budgets and is creating near-term controversy. 

In summary, the new regime remains restrictive, promotes a surplus, is untested and subject to revision. Importantly it’s now causing Lula grief as he looks to adhere to his policies yet supports social policies driving his popularity.

In June/July, the market was concerned that Lula was looking to ignore the very rules he had just introduced, and the market, and more importantly, currency, reacted accordingly. To appease the finance minister pre-released elements of the 2025 budget and reiterated their commitment to the SFR regime. As such, the announcement of the 2025 budget in late August saw no big surprises. However, questions remain as to whether it’s achievable.

Inflation targets

Historically, Brazil always had inflation targets or bands, but adherence thereto has been quite loose – a ‘close enough strategy’. An important shift on this trip was a firmer commitment to get inflation back to recently revised targets. 

This created some tension between the government and central bank, but a renewed joint goal to slow the rate of inflation is a strong market message and has been very well received by domestic market participants. As one strategist said, “stable inflation is core to global acceptance and maturity of the Brazilian economy”.

Privatisations

The depth and breadth of needed infrastructure investment again dominated discussions at a national and state level. Several themes underpinned this investment trend, including:

• Core source of revenue for government budgets supporting social investment policies and the SFR.
• Investment as a driver of employment and ongoing economic growth.
• National decarbonisation goals – Brazil is hosting COP 30 in 2025 and is committed to showcasing the country’s resources and progress, with some interesting concessions coming to the market.
• Climate shifts – significant weather events across Brazil (as elsewhere) have further increased the need for infrastructure investment to strengthen networks.
• The potential of Brazil becoming a data centre hub and the energy/water needs to support this idea.
• Congestion issues and limitations caused by inefficiencies in the networks. As a personal example, my Uber trip from the centre of Sao Paulo to the international airport, a distance according to the app of 50kms, took 3hrs and 14min. There were no accidents or visible holdups - just normal afternoon congestion. Also of interest was that an Uber accepted this trip for a value of R$281 (A$74).

It should be noted that Lula remains noisy on the need for state-owned enterprises to remain in government hands and that their role goes beyond profitability to providing public services and contributing to national development. This ‘use for social good not shareholder value’ argument has been in play for decades, and has seen us rule out investment in certain assets whilst under government control – Eletrobras (BVMF: ELET3) being the obvious example. However, we would reiterate that a lot of this is noise as the Lula government has auctioned/privatised more assets during its terms in power than any other government in recent history, for the reasons discussed above.

Importantly, a key takeaway was that the opportunity to invest in attractive infrastructure assets in a growing and increasingly fiscally responsible market is enormous.

Next election

Although still two years away, there was a lot of discussion around the 2026 Brazilian presidential election, with market-centric commentary quite positive on the potential for a shift to the right. 

While Lula’s popularity remains strong and he is eligible for a second term, it’s thought that the 2026 election could offer some of the best political competition in many years, with some very viable right candidates potentially coming into play including:

• Tarcisio de Freitas – the current governor of Sao Paulo, was the Minister of Infrastructure under Bolsonaro.
• Eduardo Leite – current governor of Rio Grande do Sul. He is very young at just 39 years old, so probably more of a 2030 story.
• Romeu Zema – current governor of Minas Gerais. He’s a businessman by background and a champion of privatisation.

I would err on the side of a Lula re-election and am sure he will work tirelessly to retain the popular vote. However, a political shift would offer an unexpected country and market tailwind.

As an aside, among emerging markets investors, the LatAm region is currently overweight and with Mexico “dethroned” from the structural overweight, Brazil is gaining favour at a fundamental level and with the Federal Reserve's cycle perceived as a further tailwind for the country. As always, international investors are more positive than locals and driving flows into the market.

Argentina

While it was not a stop on this trip, Argentina certainly was a topic of conversation given the recent radical shift in government with far-right economist, Javier Milei, now in power and executing on election promises.

Milei was very vocal about the need for swift, sharp action with associated short-term national pain. He immediately started executing an extensive plan to overcome years of economic and political mismanagement. In a very short period of time, he managed to:

• devalue Argentina’s currency by 50%;
• slash state subsidies for fuel;
• significantly reduce government positions; and
• cut public spending.

This has seen a shift from a fiscal deficit in December 2023 to a surplus in April 2024 and has resulted in a sharp contraction of the Argentinean economy as consumer spending is drastically cut. However, his number one target remains inflation and while it has slowed MoM and is now below double digits (+4% in July and +4.2% in August), annualised measures still have a very long way to go. Importantly though, the discussion has shifted to the last mile as opposed to hyperinflation.

While there have been some near-term successes, Milei is handcuffed by a lack of majority in Congress and the need to strike deals to execute. This has seen much-needed asset privatisations and economic measures stall. Positively, he is looking to privatise over 20 state-owned enterprises including the national water utility, railways, airlines and the postal service. However, his omnibus bill, which includes these privatisations and several other economic measures, was defeated for a second time in February and the party is working to re-package these into smaller digestible pieces.

Milei is also facing a lot of backlash from the unions and workers as their spending power deteriorates, which is creating geopolitical noise and social unrest.

Argentina remains ‘red’ within the 4D country risk assessment and as such is uninvestable at the moment. 

However, time in the seat and ongoing execution by the current Milei-led government could certainly see an upgrade in the future. It feels like he is turning the ship but that it will be a very slow shift. It’s a country steeped in history and wealth and would like nothing more than to see political stability leading to economic recovery and the ability to participate in the huge scale of infrastructure investment needed to return it to the powerhouse it once was. 

For now, it’s a ‘watch and wait’, but we’re slightly hopeful that Argentina’s time could be coming.

USA

Given its importance to the region as a neighbour and key trading partner, it’s impossible to visit Latin America and understand the mood on the ground without a discussion on the USA. This was never more apparent than this trip given the proximity of a hotly contested US presidential election with some polarising policies in play.

In Mexico, the focus was on a potential Trump victory and policies that could cause global and domestic concern, namely:

• US protectionism with Chinese and global tariffs – not a significant concern for Mexico and, in fact, could be an opportunity as the near-shoring opportunity ramps up. However, Mexico recognised that this could have global consequences that must be navigated – economically it’s inflationary, supply chains would be disrupted etc.
• Immigration – Trump has been very vocal yet again on the crackdown on illegal immigration and borders. Domestically, they don’t have a problem with a stricter strategy, highlighting that they too are fighting the illegal immigration war.
• The war on drugs – surprisingly, this is the policy that caused most concern domestically. It was widely viewed that any attempts by Trump to involve himself in the Mexican drug war would not be welcomed at a political or local level.

By contrast, in Brazil, the outcome was far less directly relevant, with the focus more on the Fed move and how the outcome could change this trajectory. The head of the central bank commented that there are three recurring themes in the electoral debate with an inflationary basis:

• No sign of fiscal policy austerity.
• Immigration.
• US protectionism and increasing tariffs.

In the next instalment of this ongoing series, we explore the economics of LatAm and discuss the key infrastructure dynamics and the drivers of our portfolio positioning in the region. 

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