Feb 18, 2016 | 09:15 GMT

5 mins read

As Brazil Stumbles, Argentina Finds Surer Footing

Forecast Highlights

  • Argentina and Brazil's geopolitical roles may soon reverse, with Argentina experiencing relative political stability while Brazil contends with economic and political upheaval in the next few years.
  • Argentine President Mauricio Macri will enjoy a relatively peaceful domestic political environment, but economic adjustment measures will spur inflation that could eventually incite unrest.
  • The main drive to impeach Brazilian President Dilma Rousseff has failed, but the threat of impeachment could be renewed if the Supreme Electoral Court rules that the president's 2014 re-election campaign was illegally funded.  

Argentina and Brazil are once again on diverging political and economic paths. But unlike in the past, this time their roles are reversed. Both countries have always had close historical, trade and political ties. As the two largest economies on the South American continent, the nations have enjoyed political influence and are at the heart of the Common Market of the South, one of Latin America's largest trading blocs. Both also share similar long-term economic problems. Relying on commodity exports for dollar-denominated income — but lacking the capital of more industrialized nations — has caused Buenos Aires and Brasilia to depend on direct foreign investment to finance major economic projects and growth.

Yet Argentina is now setting the stage to leave its lengthy period of economic stagnation and political populism behind, while Brazil is momentarily suffering from economic contraction, slow growth and political instability. Both countries are suffering the consequences of a slowing Chinese economy and each other's shaky economic growth. But political turmoil in Brazil, such as the impeachment drive against Brazilian President Dilma Rousseff as well as her unstable coalition, stands in contrast to relative political calm in Buenos Aires. Consequently, Argentina's next several years are poised to be far less politically eventful and less economically problematic than for Brazil.

Brazil Moves Toward Instability

Brazil's downturn began after 2011, amid slowing growth in Chinese demand for soybeans and iron ore, and was further hampered by falling commodity prices and a strong real. The 2014 corruption scandal at state-owned energy firm Petrobras exacerbated unemployment woes and helped precipitate downturns in construction sectors also. Now Brazil is expected to experience several years of contraction and stagnation, with the gross domestic product for 2016 expected to contract by more than 3 percent.

Worse for Rousseff and her party, the Petrobras scandal will continue to keep the threat of impeachment, congressional gridlock and political instability alive not just for the remainder of the year, but likely until general elections in 2018. Although the impeachment motion backed by lower house President Eduardo Cunha is all but dead, a separate court case could be used by opponents of the president to restart impeachment proceedings. Brazil's Supreme Electoral Court is still hearing a case concerning alleged illegal funding of Rousseff's 2014 re-election. If Rousseff is implicated, it could be used as a cause in the lower house to renew efforts to impeach her.

But even if Rousseff fends off the attempts, her party could suffer the consequences of the Petrobras scandal and economic recession by 2018. The ruling Workers' Party will likely lose influence in domestic politics and face a new challenger for the presidency — its former allies in the Democratic Movement Party of Brazil. With a three-way race for the presidency shaping up among the Workers' Party, the Democratic Movement Party of Brazil and the right-wing Social Democracy Party of Brazil, it is increasingly plausible that the ruling party could face a credible challenge to its power. 

Argentina's Steady Rise

Argentina, conversely, will experience greater political and economic stability in the near term, particularly as far as potential investors in the country are concerned. Central government currency controls, which were the main barrier to foreign investment, have been lifted, thanks in large part to Argentina's newly elected president, Mauricio Macri. Negotiations with holdout bondholders — firms and individuals holding foreign debt on which Argentina defaulted in 2001 — are progressing, and it seems a question of when, not whether, Argentina will successfully restructure its foreign debt and exit its state of default. And with Macri likely to abstain from expropriations, intent on stabilizing Argentina's tenuous public finances, the country appears more amenable to foreign investment than at any point in its recent history.

However, Macri's new administration will face many difficult tasks, such as preventing rampant inflation while undertaking inflationary measures to balance the country's budget. Argentina's estimated inflation year on year for 2015 was around 30 percent — the second highest in the Americas behind Venezuela. The fiscal and economic reforms being undertaken by the Macri administration are a logical transition away from the populist policies of former President Cristina Fernandez de Kirchner, who relied on extensive social spending to retain public approval and secure votes in two presidential elections. But with Argentina's budget deficit rising and the country's foreign reserves steadily declining, Macri has sought fiscal reform, steadily rolling back spending. The new government has raised the price of natural gas and some previously subsidized food, while reducing subsidies for electricity consumers. At this point, it will be the pace of reform that will determine whether there is meaningful protest in the streets or political resistance from the country's opposition.

Still, any unrest will likely be minimal, at least compared to that under previous administrations. By lifting export taxes and restrictions on agricultural products, Macri has won loyalty from organized agricultural groups, which in previous years had been major sources of social unrest. The Argentine Congress will also provide few threats to the president's legislative agenda, at least until legislative midterm elections in 2017. After the defection of 18 legislators from the opposition Front for Victory, Macri's Cambiemos coalition is the single largest political bloc in the lower house, markedly lowering the potential for political disruption.

Measured against Brazil's $2 trillion diversified economy, Argentina's is still a distant second on the South American continent. However, Buenos Aires is steadily moving away from the populist model established after its major economic upheaval, whereas Brazil faces political gridlock and temporary economic decline. Brazil will no doubt recover from its setback, eventually. But the next few years will be challenging for Brazil's leaders, and for the first time in nearly two decades, Argentina may soon be faring better, while its neighbor is in decline.

Lead Analyst - Reggie Thompson

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