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Brazil's long road to recovery could begin where impeachment process ends

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Brazil's long road to recovery could begin where impeachment process ends

As athletes gather in Rio de Janeiro for the 2016 Summer OlympicGames next month, Brazilian politicians some 700 miles away, in the capital of Brasília,will be preparing for a very different kind of contest.

On Aug. 8, days after the Olympics' opening ceremony, Brazil'ssenate impeachment commission is scheduled to take its final vote on whether totake suspended President Dilma Rousseff to a full trial. If they vote in favor,Rousseff will likely be tried by the full senate between Aug. 25 and Aug. 27.

An end to the impeachment process, industry observers say, couldbring Brazil a big step closer to putting its government and its economy back ontrack.

"People are waiting for the impeachment final vote to startmaking decisions about the future," Luis Miguel Santacreu, a São Paulo-basedanalyst with Austin Rating, told S&P Global Market Intelligence.

In the interim, the economic situation in Brazil remains fragile.The country is facing a prolonged recession marked by high unemployment, a notableslowdown in credit, and persistent inflation.

That, in turn, is weighing on the country's banks. Accordingto a Fitch Ratings reportearlier this month, banks' nonperforming loans will rise to 4.2% of total loansby the end of the year, leading to a 21% increase in impairment charges. The ratingagency based the estimates on an expected 3.8% GDP contraction and a 12% unemploymentrate.

To be sure, Brazil has seen tepid signs of returning confidencesince Michel Temer was installed as Brazil's interim president May 12. The country'sconsumer confidence index jumped to 105.2 in May, marking the first time in overa year that the indicator signaled rising sentiment; the index remainedin positive territory in June, albeit at a weaker reading of 101. The country'sIBrX, an index of the 100-most-traded stocks on the BM&FBovespa, has jumpedabout 8% since Temer took over the presidency. The country's currency, the real,has also bounced back against the U.S. dollar and is now up around 28% from themultiyear lows seen six months earlier.

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Those signs of improvement come as Temer has put in place aneconomic team widely seen as more technical and pro-market compared to Rousseff'sadministration. Upon taking office, the interim president overhauled the entire cabinet, including tapping severalfinance executives for senior positions. Ilan Goldfajn, a former chief economistat Itaú Unibanco Holding SA,took the helm at , while ReinaldoLe Grazie, an executive at BradescoAsset Management SA, was put in charge of monetary policy.

The new administration also put forward a string of to reduce the fiscal deficitand ease the country's recession. The proposals include gradually eliminating thecountry's 2 billion Brazilian reais sovereign wealth fund, mainly by selling sharesin Banco do Brasil SA,and having state-run development bank BancoNacional de Desenvolvimento Econômico e Social prepay 100 billion reaisin federal government debt by 2018. Temer also wants to enact a constitutional amendmentthat would restrict government spending by pegging it to inflation, while bolstering2017 revenues by 8 billion reais through tax hikes and new duties.

But while Temer and his administration have articulated the wantfor greater fiscal discipline, the impeachment limbo has stifled a recovery in otherareas of Brazil's economy.

"Although Temer is more proactive in terms of fiscal issuesand public concessions, the economy is still dependent on investment and consumptiondecisions, which are very closely tied to whether Rousseff's impeachment will materialize,"Santacreu said.

Many believe the impeachment trial will ultimately lead to Rousseff'spermanent removal from office. The senate body that would ultimately decide is controlledby a more centrist coalition compared to Rousseff's opposition bloc Worker's Party;it already voted by a 2-to-1 margin to move the impeachment proceedings forwardin May.

Should Rousseff's impeachment end with her formal ouster, Santacreunoted, Temer would be able propose longer-sighted structural reforms for growthas he completes Rousseff's current presidential term, which ends in 2019.

Still, the clarity that the end of the impeachment process wouldprovide is just one of the numerous hurdles that Brazil's government will have toclear in their effort to bring back growth.

Marcos Piellusch, a finance professor at Brazil's Fundação Institutode Administração, noted that while Brazil's move toward financial discipline couldeventually "reflate the economy," as it should lower country risk andbolster investor confidence, the measures need the national congress' approval inorder to be put into effect.

Gaining that approval could be a major sticking point. Many ofthe fiscal programs that Rousseff's administration put forward in 2015 to combatBrazil's economic and fiscal problems died in congressional gridlock. "Withoutpolitical support, everything failed," as Austin Rating's Santacreu put it. 

Early signs suggest that Temer may have more success workingwith Brazil's legislature. On July 14, a congressional committee Temer's 2017 primary budget guidelines.

But even if Temer's administration succeeds in implementing meaningfulfiscal changes, industry experts stressed, Brazil will continue to struggle formonths, if not years, to lift its economy out of the doldrums.

"The country currently faces two crises: political and economic— in addition to a social crisis," Santacreu noted. "Even in solving thepolitical crisis, the economic one may still continue."

As of July 21, US$1 wasequivalent to 3.25 Brazilian reais.