Corruption allegations against Brazil’s president put reform agenda at risk

Brazil’s President Michel Temer has been accused of discussing bribery payoffs related to keeping silent the former president of the lower house, Eduardo Cunha, sending new shockwaves across the political establishment in South America’s largest economy. The country’s local currency and its Ibovespa stock market index both weakened by around 10% early Thursday before trading was halted.

According to O Globo newspaper, Temer asked the chairman of meatpacking giant JBS, Joesley Batista, to continue paying monthly bribes to Cunha, who was arrested in October for his role in the Petrobras scandal, in order to buy the silence of the former lawmaker.

In a statement issued by the government, Temer said he was never involved and has not authorized any action to stop leniency accords by people being investigated.

Batista allegedly recorded a conversation in March, in which he told Temer that he was regularly paying Cunha to remain silent from his jail cell. Temer is said to have replied: “You have to keep that going, alright?”

According to O Globo, the tapes were delivered to prosecutors as part of a plea bargain deal under negotiation between company executives and prosecutors.

The latest political scandal comes as the government is trying to advance unpopular reforms, including pension and labor overhauls, considered by many economists as key to restoring the country’s economy after two years of deep economic recession.

“It is very difficult at this moment to assess all impacts of this accusation, but for sure, at first glance the reform agenda is compromised,” Newton Rosa, chief economist at asset manager Sul América Investimentos, told BNamericas. “This will affect the prices of assets in today’s session and the next, and we will see the impacts of this on the exchange rate and stocks.”

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Cunha, a member ruling Brazilian Democratic Movement Party, or PMDB, was considered one of Brazil’s most powerful politicians and was responsible for opening the impeachment process against former president Dilma Rousseff last year, which resulted in her removal from office in August 2016, when her then-VP Temer took over the Planalto presidential palace.

In a note after O Globo’s report, Temer admitted the met with Batista but denied he asked or endorsed any payment for Cunha. After the allegation against Temer, some opposition politicians asked congress to open an impeachment process against Temer.

“What will decide if the impeachment calls will move ahead or not will be details of the recorded conversation. We need to check how bad and incriminating they are,” said Rosa.

The potential impeachment of Temer generates uncertainty about the line of succession. As the next general election is less than two years, in October 2018, the speaker of lower house, Rodriga Maia, would assume the presidency on an interim basis and would call for an indirect election – in which the lawmakers, and not the voters, would choose someone to finish out Temer’s term.

Amid the backdrop of repeated corruption scandals involving politicians, the challenge for the political establishment would be to bring the general population on board with having a very unpopular congress choose the successor, which would all but assure massive protests across the nation.

Temer was not the only politician denounced by Batista. The JBS executive also told authorities that he paid 2mn reais (US$595,000) to Aécio Neves, president of center-right Brazilian Social-Democracy Party, or PSDB,

On Thursday morning, Brazil’s federal police raided the house and office of Neves as part of the probe.

With the scandal and its impacts on capital markets, analysts are uncertain about the central bank‘s next key rate decision.

“The currency has already weakened in the non-deliverable forwards market, yields on Brazil’s euro-denominated bonds have risen and a Brazil ETF in London is down more than 12%. A drop in the real and a jump in bond yields, especially if sustained, would spook some members of the Copom [central bank rate committee] and could prevent another large 100bp rate cut at the next meeting” on May 31, wrote Edward Glossop, an economist of Capital Economics.

With the continued inflation slowdown, the central bank embarked on an aggressive campaign to cut its Selic base rate, which was reduced by 300bps since October 2016, to the current level of 11.25%. It is expected to reach single digits in the next months, according to economists.

“The central bank is monitoring the impact of the information recently released by the press and will act to maintain the full functionality of the markets,” central bank said in a press release.