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Brazil's President Jair Bolsonaro looks on during a ceremony of delivering low-income residences at the Sao Sebastiao neighbourhood in Brasilia, Brazil April 5.

ADRIANO MACHADO/Reuters

When a left wing populist and a far-right lawmaker rose to power in Latin America’s two largest economies, investors thought they knew who was going to show them the money.

But more than two years and a costly pandemic later, disillusioned investors are now busy shifting from a Brazil that once promised compelling reforms and privatizations into a Mexico expected to benefit from a U.S. economic rebound.

Investor worries that Mexican President Andres Manuel Lopez Obrador would overspend to appease the base that handed him a landslide victory in 2018 have yet to materialize, and neither have President Jair Bolsonaro’s promises to streamline the Brazilian economy.

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Lopez Obrador “is ‘less bad’ than investors had expected, and the Bolsonaro administration has been ‘less good’ than investors had expected,” said Marshall Stocker, portfolio manager at Eaton Vance in Boston.

While their handling of the COVID-19 pandemic seemed in tune at times as they mixed denial with distrust of science, their financial responses have been sharply different.

Bolsonaro spent an extra 8.6% of gross domestic product on the response while Lopez Obrador barely spent an extra 0.6% of GDP, according to data from the International Monetary Fund.

“The glass-half-full read is that Mexico did not engage in any of the aggressive fiscal loosening policies that its neighbors did,” said Patrick Esteruelas, head of research at Emso Asset Management in New York.

This, alongside hopes that a $1.9 billion U.S. economic recovery package signed by President Joe Biden will fuel strong growth to the north, is spurring a change in investor sentiment.

While both countries suffered foreign investor outflows in February, Mexico stocks and bonds attracted $355 million in the first three weeks of March versus Brazil outflows of $465 million, data from the Institute of International Finance shows.

The IMF this week raised the outlook for Mexico’s 2021 GDP by 0.7% to 5.0%, while nudging Brazil up by 0.1% to 3.7%.

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The shift in favor of Mexico has been further supported by the COVID-19 situation in Brazil where deaths are expected to soon surpass the worst of a record wave in the United States in January.

Brazil has so far reported more than 13 million infections and over 336,000 deaths, while Mexico has reported more than 2.2 million cases and about 205,000 deaths, a Reuters tally shows.

Bolsonaro asked the armed forces this week if they had troops available to control possible social unrest stemming from the COVID-19 crisis.

“Bolsonaro has lost the support of much of the business community, the bulk of the population and part of the top brass of the military,” Elizabeth Johnson, managing director of Brazil research at TS Lombard, said in a note.

Infighting over the budget has soured relationships between the executive and Congress, she added.

BRAZIL VULNERABLE

Bolsonaro caught investors by surprise in February when he fired the head of the national oil company Petrobras after a battle over fuel price hikes.

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Last month, the CEO of Banco do Brasil, the largest state-controlled bank, resigned after a tussle with Bolsonaro over branch closings.

Brazil’s financial markets have not fully recovered from the sell-offs generated by these moves.

The real is down over 7% this year against the dollar, versus an around 1% drop for the peso. If the greenback were to firm further, the effect of a weaker currency would benefit more export-oriented Mexico over Brazil, where a weaker real would mostly add to inflation pressures.

Fiscal imbalances too are making Brazil more vulnerable to U.S. Treasury yield rises, with local benchmark bond yields flirting with highs last seen a year ago.

The possibility that leftist former president Luiz Inacio Lula da Silva could run against Bolsonaro next year is also piling up pressure on Bolsonaro to boost social spending and diminishing the chances of legislative reforms.

It is less likely that key administrative and tax reforms will soon be passed, but “even if they get any of these reforms done, they would be very much watered down with a very back-loaded fiscal adjustment,” said Gordon Bowers, an analyst at Columbia Threadneedle’s emerging markets debt team.

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An oversold Brazil could still offer opportunities for value hunters, some investors say.

“Brazil’s politics are messy and its communication is poor, but the rules still work and the government can maintain control of the path,” said Ricardo Adrogue, head of global sovereign debt and currencies at Barings. “There is budget to increase social protection, and the deficit won’t be explosive.”

“The rest is just noise,” he added, “and maybe a great investment opportunity.”

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