World Economy

Brazil's politics, economy are huge messes as Olympics begin

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Thousands of people from around the world will be flocking the streets of Rio de Janeiro during the 2016 Olympic Games, but the country's political and economic state of affairs is anything but festive.

"What was supposed to be an event to [showcase] Brazil to the rest of the world has now become a nightmare," Carlos Caicedo, senior principal analyst for Latin America at IHS Markit, a London-based research firm, told CNBC in a phone interview. "The Olympics no longer matter to anyone in Brazil now."

What people care about is how the country's huge political and economic crises will be solved, Caicedo said.

For starters, Brazilian President Dilma Rousseff was suspended from her post May 12 amid corruption charges and is awaiting the final phase of her impeachment trial, which is expected to conclude Aug. 29.

"It is almost a foregone conclusion that she will be impeached by the Senate at the end of the month," said Andrea Murta, a Latin America analyst at the Atlantic Council.

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Rousseff is accused of altering official budget figures and using funds from state-run banks to cover up the actual condition of Brazil's faltering economy as she ran for re-election in 2014. Rousseff has denied breaking any laws.

Her impeachment would mark the end of 13 years of rule by the left-of-center Workers Party and leave Latin America's largest economy in the hands of the Michel Temer, Rousseff's conservative vice president and interim president.

Brazil's leadership troubles do not end with Rousseff.

Last week, Brazilian federal documents revealed that former President Luiz Inacio Lula da Silva, Rousseff's predecessor, will stand trial for obstruction of justice. Lula was previously under investigation in various jurisdictions in a massive corruption scandal centered around state-run oil giant Petrobras, but is now officially a defendant.

Petrobras is struggling to pay massive, multibillion-dollar debts, and it has been the target of a class-action lawsuit brought by shareholders in the United States. On Tuesday, an appeals court put the case on hold pending the resolution of an appeal filed by the company.

"There are very few countries with a company like Petrobras," IHS' Caicedo said, noting that Petrobras alone accounts for more than 5 percent of Brazil's GDP. The oil giant's U.S.-listed shares have fallen nearly 25 percent since November 2014, when the scandal broke.

"Petrobras will never be the same company it used to be, but I think that's a good thing," Atlantic Council's Murta said, noting that more foreign investment will be able to come into Brazil's energy industry with the decline of Petrobras.

Brazil's economy, the world's ninth largest, contracted by 0.3 percent in the first quarter, marking the fifth straight quarter it shrank. Last year, Brazil's gross domestic product fell to its lowest level since 2009.

Inflation has also shot higher recently, rising 9 percent in 2015, from 6.3 percent in 2014, according to data from the World Bank. Energy as a percentage of exports, meanwhile, fell to 7 percent in 2015, from 9 percent in the previous year.

"When Rio was chosen to host the Olympics in 2009, Brazil was at the top of the world," Caicedo said. "But since then, the situation in Brazil and globally has deteriorated."

"I think the turning point was in 2014, when something that seemed insignificant led to the biggest corruption scandal in the history of Brazil," he said, referring to Petrobras.

... but Brazil's stock market roars higher

That said, optimism in Latin America's largest economy has been brewing over the past three months since Temer took over.

"Businesses and consumers are feeling more positive and [2017 GDP] estimates are now slightly positive, but at least they're positive," said Ricardo Mendes, managing partner at Prospectiva Consulting, a Sao Paulo-based firm.

A key factor in the optimism surrounding Temer's administration is the prospect of economic and political reforms, including lower government expenditures, Murta said.

However, Mendes said "depending on who you talk to, sentiment is too positive," particularly within financial markets.

"Investors are looking at Brazil as sort of stable" amid Brexit and the U.S. election, he said. "There's a lot of money coming back into Brazil."

The iShares MSCI Brazil Capped ETF (EWZ) has risen nearly 17 percent since Temer took over, and it's up more than 60 percent year to date.

EWZ in 2016

Source: FactSet

But Mendes said investors need to be cautious, since Temer may face opposition in passing reforms.

Along those lines, Citi said in a Thursday note to clients:

Facing resistance in Congress, Temer administration backs down from insisting on certain spending controls in the original bill. Meirelles said state spending cap should be voted by state legislatures and may not become part of constitutional amendment (PEC). Raises concerns that resistance on reforms is higher and spending cuts more difficult than thought. Also growing displeasure from PSDB against government making concessions.

There is also the small possibility that the Brazilian Senate votes against impeaching Rousseff, which would lead only to further uncertainty.

"Brazil is in the middle of a perfect storm that hasn't ended," said Atlantic Council's Murta.

— Reuters contributed to this report.

Disclosure: CNBC parent NBCUniversal owns NBC Sports and NBC Olympics. NBC Olympics is the U.S. broadcast rights holder to all Summer and Winter Games through the year 2032.