Why Brazil is facing its political and economic nadir

CNBC's Katy Barnato and Jessica Hartogs, special to CNBC.

The controversial move by Brazil's president to appoint her predecessor and personal mentor as her chief of staff has been blocked by a federal judge, according to media reports.

It was announced on Wednesday that Luiz Inacio Lula da Silva would take a position in President Dilma Rousseff's government.

However, on Thursday, a judge issued an injunction saying this could impede the money-laundering investigation into the former premier, according to Brazilian newspapers including O Globo.

Brazilian President Dilma Rousseff with former president, Lula Da Silva.
Mario Tama | Getty Image

Both Lula and Rousseff are under scrutiny as part of an investigation — known as Operation Car Wash or Operacao Lava Jato — into the massive corruption scandal at Brazil's state-run oil company, Petrobras.

Lula's appointment sparked protests across the country after it was announced. At a time of economic crisis, the move provoked heavy ire in a country decreasingly tolerant of its frequent political scandals.

Many critics of the government saw Lula's appointment as an attempt to protect the former premier from prosecution for money laundering and make the impeachment of Rousseff less likely.

"The obvious issue is that Lula's presence could make impeachment less likely, as he used his influence in Congress to help Rousseff. With regards to Lula's own vulnerability, it appears that only the Supreme Court can authorize the investigation, imprisonment, and trial of Cabinet members," Win Thin, head of emerging market currency strategy at BBH, said in a note on Wednesday.


Rumors began circulating early this week that Rousseff, who was handpicked by Lula in 2010 to succeed him as president, would appoint him to her cabinet.

The Brazilian real depreciated by more than 4 percent against the U.S. dollar as a result of the speculation, but bounced on Thursday on the news of the judge blocking Lula's appointment.

"Giving Lula an appointment that gives immunity from prosecution gives the wrong signal to markets — the course of justice has been prevented," Blanco told CNBC by phone on Tuesday.

At a news conference on Wednesday following the announcement, Rousseff told journalists that she was "very happy," according to several reports.

"His joining my government strengthens my government," she said, "Many people don't want it to be strengthened. But he is coming and he's coming to help."

A transcript published by domestic media on Wednesday details a phone conversation between Lula and Rousseff that was allegedly taped by Brazilian Federal Police. In it, Rousseff says that her main goal in inviting Lula to join the cabinet is to try to avoid his detention.

Some sort of coup?

The Brazilian media is agog with speculation that Lula may seek to redirect economic policy. Reports suggest the head of the central bank has been asked to resign and that Lula has requested former central bank president, Henrique Meirelles, replace him.

Other reports suggest Meirelles is being considered for the post of finance minister and that Lula only agreed to rejoin the cabinet on condition that economic policies became more pro-growth.

"What does one call it when an unelected official basically takes over the reins of the government and installs his own policymaking team? At the risk of hyperbole, couldn't this be regarded as a coup of some sort?" BBH's Thin said on Wednesday.

Economy bottoming out?

The International Monetary Fund forecasts Brazil's economy will shrink by 3.5 percent this year, following a 3.8 percent contraction in 2015.

Brazil was recently handed a two-notch downgrade by U.S. ratings agency Moody's, the third agency to strip the country of its investment grade rating.

On Thursday, UBS economists led by Thiago Carlos, said Brazil's economy might have reached its nadir.

"Brazil is arguably facing its deepest recession since the 1930s. However, the recent improvement in investors' perception of the country, combined with data suggesting economic activity is stabilizing, raises the critical question of whether Brazil has reached an inflection point," they said in a report.

Clarification: This article has been updated since last published to include the full name of the former Brazilian president.

By CNBC's Katy Barnato and Jessica Hartogs.

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