A win for Brazilian president Dilma Rousseff will hit financial markets if she emerges victorious in national polls held on 5 October but whoever wins will face formidable economic challenges, argues Threadneedle Investments.

A win for Brazilian president Dilma Rousseff will hit financial markets if she emerges victorious in national polls held on 5 October but whoever wins will face formidable economic challenges, argues Threadneedle Investments.

The electorate in South America’s largest economy and one of the “BRICs” go to the polls at the weekend with polls showing Rousseff on course for a win against challenger Maina Silva, of the Brazilian Socialist Party (PSB). According to media reports on Friday, Rousseff extended her lead ahead of Sunday's election and would win re-election in a likely second-round runoff, while her main challengers are running neck-and-neck for second place.

The poll comes at a difficult time for Brazil, an economy that at one stage enjoyed a global boom for its commodities but has fallen into difficulty. The economy fell into recession in the first half of the year. In its quarterly inflation report released in September, the central bank lowered its 2014 economic growth forecast to 0.7 per cent from its previous estimate of 1.6 per cent. The central bank expects inflation to remain at 5.8 per cent and above the 4.5 per cent centre of the government’s target.

“We believe that the upcoming Brazilian election could go to the wire and that while a win for Marina Silva would be good for financial markets in the short term, Brazil faces considerable economic challenges that are likely to weigh on markets for some time thereafter. Given that markets have reacted badly to polls showing Rousseff ahead of Silva, a win for the incumbent would surely have a negative impact on financial markets,” Daniel Isidori, fund manager, Threadneedle Investments and Zara Kazaryan, fund manager, Threadneedle Investments, say in a note.

Brazil’s Ibovespa index was up 1.25 per cent on Friday. The MSCI Brazil index has fallen by more than 1.3 per cent since the start of the year; over the past three months it has dropped 12.3 per cent. Some Latin American countries have suffered worse, however. The MSCI Chile Index is down by almost 10 per cent since the start of January. On a brighter note, the MSCI Colombia Index is up 1.4 per cent although it has lost ground more recently. The MSCI BRIC is almost flat since the start of the year. Brazil represents 11.85 per cent of the MSCI Emerging Markets Index.

The Threadneedle managers said that “while the outcome of the election is difficult to predict, it is certain that the eventual winner will face daunting economic challenges”.

“A combination of unlikely events has contrived to deny President Dilma Rousseff of the easy electoral victory that once appeared likely. Her large lead in the opinion polls came under pressure after Brazilians took to the streets earlier this year to attack the government for the perceived high cost of preparations for the 2014 World Cup and the 2016 Olympics. The protests also reflected widespread dissatisfaction with public services and high levels of corruption,” the managers said.

“However, Rousseff remained comfortably ahead of her chief electoral rivals until the death of Eduardo Campos of the Brazilian Socialist Party (PSB) in an aeroplane crash in mid-August. Campos’s demise propelled his running-mate Marina Silva into the PSB’s candidate seat and she benefited from a surge in popularity, named the “Marina phenomenon. Thus, it now appears that neither Rousseff nor Silva will get more than 50 per cent of the vote on 5 October and that consequently there will be a runoff on 26 October,” they continued.

“Marina Silva has garnered support from both Rousseff and the other main candidate Aécio Neves of the centre-right Party of Brazilian Social Democracy (PSDB). An experienced politician, Silva helped Rousseff’s presidential predecessor Luiz Inácio Lula da Silva, to found the Workers’ Party (PT). She also served as an environment minister under Lula, who served two terms as president from 2003-2011 and remains Brazil's most popular and influential politician. Silva, born into poverty and unable to read until she was sixteen, has an understandable appeal for millions of poor Brazilians.

Meanwhile, her espousal of orthodox economic policies and her green credentials – she spearheaded Brazil’s environmental movement in the 1980s – has won her support from the better off,” they continued.

“Many Brazilians also believe that she would be a more pragmatic leader than Rousseff. She has promised to outsource management of the economy to trusted advisers. They say a Silva-led administration would return to the successful inflation-targeting regimes of the previous governments of Luiz Inácio Lula da Silva and Fernando Henrique Cardoso, would adopt fiscally-responsible policies and open the economy to competition and foreign investment. Indeed, Silva is often labelled `Lula in a skirt’, a favourable comparison given that Lula presided over a government that adopted market-friendly and successful economic policies along with ambitious social programmes,” they said.

Threadneedle said investors favour Silva over Rousseff, who has been criticised for excessive intervention in the economy. The firm adds that a Silva victory will boost the economy.

The year has seen a number of major elections in emerging market economies, notably India and Indonesia, with both of those countries being led by governments seen as relatively pro-reform and pro-market when compared with their predecessors.

Separately, Aviva Investors said in a note on Friday that if the outlook does not become clearer as a result of the first round results, "we can expect a further three weeks of volatility until 26th October, when a second, definitive, run-off between the top two candidates takes place. For investors it could be a roller coaster ride".