As we know, financial markets dislike uncertainty. Last Thursday Brazil’s Supreme Court released a plea-bargain testimony accusing President Michel Temer of corruption and obstruction of justice. According to the tape recording, the President allegedly wanted to silence the former speaker of Brazil’s Lower House Eduardo Cuhna. Currently imprisoned, Eduardo Cuhna was giving testimony on the Car Wash Investigation. This has caused the biggest one day sell-off in Brazil risk assets since the US elections in November last year. To us, this news was an opportunity to carefully add risk in Brazil (please see last paragraph for more details). In our view, the news doesn’t change the fundamental and reform outlook for the country. Here is why.

A testimony from Joesley Batista, one of the owners of JBS, the largest meatpacker in the world, is detailed and impactful. Joesley and I have had regular meetings during my Brazil trips for the last ten years. I was somewhat surprised to see him as the cause of a major turmoil in the country.

Let’s move beyond the headlines. Financial markets can be short-sighted. There are many scenarios of Temer’s departure or non-departure at this stage. No doubt, it will be accompanied by volatility. Can this completely derail the reform agenda? I don’t think so. The reforms are needed and most likely whoever comes next will sustain the reform agenda. During my last trip to Brazil, we were surprised by the unanimous view on the need to approve the pension reform from the government and business circles.

In my view, a multi-year anticorruption campaign, while being painful in the short-term, has laid a stronger foundation for the country’s development over the medium-term. This, in my opinion, is what investors should be focused on.

To strike a contrast, I want to share with you what happens when corruption and the rule of law become synonymous. Have you heard of a country called Armenia? It’s one of the former CIS republics. Armenia is a beautiful country with three million people, rich cultural and architectural heritage. It has one of the highest literacy rates in the world. Two thirds of the Armenian population or 7 million people live outside the country. Most of the Armenian Diaspora communities came into being as a result of the Armenian genocide in 1915 in Western Armenia, which is now Turkey.

Thankfully the list of famous Armenians is not limited to the Kardashians. They range from a French singer Charles Aznavour to American former world tennis champion Andre Agassi. This includes an American singer Cher (Cherilyn Sarkisian), international chess champion Garry Kasparov, American entertainment billionaire Kirk Kerkorian …the list goes on.

Lessons from Armenia or Why Brazil’s Corruption Scandal is a Good Thing Polina Kurdyavko, Co-Head of Emerging Markets

Joesley Batista and Michel Temer

Armenia on the map

Yerevan, the capital of Armenia

Lessons from Armenia

Why are Armenian people successful everywhere except for Armenia?I am Russian, of Armenian descent. My husband and I just got back from a trip to Armenia. We are involved in various charitable activities with underprivileged children in the country. The contrast between Armenia’s macro picture and daily reality struck me.

The macroeconomic picture in Armenia looks healthy based on a research note published by Sberbank on 17 May. Strong remittances from Russia, a pick up in exports to Russia and EU, as well as dovish monetary policy should translate into a 3% GDP growth in 2017. The country has mineral resources (copper and precious metals) and fertile climate for agriculture. The government debt to GDP at 58% and the fiscal deficit at 3.5% are not in a worrying territory.

Yet human statistics are striking a different chord. Since 1991, Armenians have been abandoning the country. An average population has fallen by 500,000 citizens over this period to less than 3 million people today. The unemployment rate is over 17%. Over 30% of people live below the poverty line (same as in Venezuela!). 20% of children under five years old have health problems caused by undernourishment.

Armenia has been dealt a heavy hand with geopolitics. The frozen conflict between Armenia and Azerbaijan regarding Nagorno-Karabakh, as well as ongoing blockage of Armenia by Turkey made it difficult to develop trade links. Yet this is not the only reason for the harsh living conditions.

Foreign direct investment remains very low at below 1% percent of GDP. In my view, one of the key reasons is corruption. According to Transparency International, the country ranks 113 out of 176 based on the corruption perception index. Armenia is suffering under the thumb of local oligarchs and Russian monopolies. The government doesn’t have any real opposition and legal system is weakened. There are allegations of government officials taking regular cuts from businesses. A local journalist once commented, “It is difficult to find another country in the world, where the ruling party has so many members with mafia-style nicknames”.

Yet, there is hope. Events from an anticorruption scandal in Brazil to Ukraine’s shutdown of PrivatBank owned by one of the richest oligarchs in the country set a precedent and gave hope. Hope for a government that would allow a country to unlock its potential one day.

As we know, financial markets dislike uncertainty. While Armenia appears stable to investors, Brazil is in the midst of turmoil. The Brazilian composer Tom Jobim once said: “Brazil is not for beginners”. We are going through some interesting times. Times that I believe can structurally change the country for years to come. Investors should lengthen their time horizon.

At Bluebay, we are overweight Brazilian credit in Long Only EM credit portfolios. We are currently running a long exposure on our EM credit alternative potfolio. We used last week’s price drop to add to exposure in Brazil. In some portfolios, we have taken partial profits on more liquid names. Needless to say, Brazil requires close monitoring. The team will be visiting Brazil in June. Stay tuned. One of the children’s home that we visited on the trip in the center of Yerevan (entrance,

bathroom, kitchen)

TUMO center in Armenia - state of art digital media learning center

Lessons from Armenia

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