Political Risk Analysis - Favourable Electoral Court Decision Boosts Temer's Odds - AUG 2017

BMI View : Brazilian President Michel Temer is highly likely to survive the corruption scandal challenging his administration, following the dismissal of charges of illicit campaign financing. However, Temer will govern with diminished political capital that will lead to a weakening of his economic reforms.

Brazilian President Michel Temer is significantly more likely to remain in office through the end of his term in 2018 following the electoral court's decision to dismiss charges of illicit campaign financing against Temer's 2014 campaign with former President Dilma Rousseff. The decision removes the most significant challenge to Temer's tenure and supports our core view that he will most likely survive the corruption scandal currently challenging his administration ( see 'Odds Shift In Temer's Favour', June 6). We now believe that Temer holds an approximately 80% chance of finishing his term, up from 55% previously.

Temer Remains Is Most Probable
Brazil - Probability Breakdown Of Likely Outcomes
Source: BMI

That said, Temer will proceed with greatly diminished political capital and a still notable chance that his political coalition will crumble, which will likely result in weakened reforms. Prosecutors could seek to pursue charges against the president based on the testimony of convicted executives, and allegations of wrongdoing are likely to be staple in the media over the coming months as the 'Lava Jato' corruption investigations continue to play out. The Partido da Social Democracia Brasileira (PSDB), which is the second largest in Temer's coalition, is under internal pressure from some younger members to leave Temer's ruling coalition, as they see Temer as a political liability. The party is set to make a decision on its support for Temer over the coming days.

We expect the PSDB will remain behind Temer in order to retain its influence over the pension and labour reforms working their way through Congress. Moreover, we believe the downside risk of a split is relatively contained. PSDB leaders have publicly committed to supporting reforms even if they formally split from the ruling coalition. With few viable candidates to shepherd reforms through Congress in Temer's stead, the PSDB is thus highly unlikely to vote in favour of either investigations into Temer or impeachment. Either action would require a two-thirds majority in the lower house, which would be highly unlikely with Temer retaining the combined support of the PSDB, his own Partido do Movimento Democratico Brasileiro (PMDB) and Speaker of the House Rodrigo Maia.

We believe there is an approximately 20% chance that Temer is forced from office. The most substantial risks to Temer's presidency are now the potential for significant, credible evidence of wrongdoing by Temer while in office to emerge. For example, on June 10 local news media alleged that Temer ordered the country's intelligence services to spy on Supreme Court Justice Edson Fachin, who is overseeing the 'Lava Jato' corruption investigations. While unsubstantiated, the report is suggestive of the type of allegation that could lead to a splintering of Temer's coalition and an increase in legislative support for investigations or impeachment. Prosecutors are relying heavily on testimony collected during plea bargains with indicted executives and politicians, like the tape and testimony from JBS that implicated Temer, which could ensnare Temer again. We maintain our view that in such a scenario Temer is much more likely to resign rather than face impeachment.

BMI Brazil Scenarios Breakdown
Scenario Description Macro And Market Implications Probability
Source: BMI
Temer remains in office The PSDB remains behind Temer and no new evidence implicating Temer is forthcoming. Watered-down reforms could be enacted by end-2017, buoying investor sentiment and supporting a modest improvement in economic activity. 80%
Temer resigns after new evidence against him emerges and his coalition withdraws its support. Power passes to Maia, who holds indirect election in Congress within 30 days, or, in the face of public backlash, potentially pursues new legislation to hold early elections. Markets likely sell off as a lack of a consensus candidate to replace Temer undermines the reform outlook, and uncertainty undermines the economy's recovery. 17%
Temer is impeached Temer's coalition disintegrates after new evidence against him emerges and a months-long impeachment process overwhelms the political environment. Markets likely sell off and the economy dips back into recession in light of substantial uncertainty. 3%