Reform hopes rise as Neves beats Silva in Brazil election

Markets rally on optimism for a shift toward economic orthodoxy after first round of presidential voting in Brazil

Brazilian President Dilma Rousseff is under increasing pressure to pursue a more liberal economic policy after Aécio Neves surprised by scoring a spot in the October 26 run-off vote, observers said on Monday.

Neves won 33.7% of votes in the first round of Brazil's presidential elections on Sunday, almost 8 points less than Rousseff. His rapid raise has enthused investors, driving a 4.9% rise in the Ibovespa stock index on Monday and fueling a rally in the currency markets. Yet some think that will be short lived.

	Aécio Neves at a campaign rally (Orlando Brito/ Coligação Muda Brasil)

"The possibility of a Rousseff re-election is still the most dominant outcome," James Lockhart Smith, head of Latin America at risk analysis firm Maplecroft told LatinFinance. Yet, by facing Neves, Rousseff is under greater pressure to compete on market and financial grounds in the run-off than she would have been if Marina Silva had entered the final two, he said.

"Given the strength of Neves' candidacy, Rousseff may have to work to ameliorate some of her economic policy positions and that may offer some hope of more market-friendly policymaking in her second term."

Rousseff has already shown signs of a shift toward more pragmatic policymaking in a second term - such as her promise to replace Guido Mantega as finance minister - market sources said. Similarly, slow growth could push her to implement more market-friendly reforms and tackle the country´s fiscal deficit.

Bolstering Brazil's lackluster economy will be a critical task for whoever wins the presidency.

"A sustained recovery in Brazil is unlikely until after the election and only if the government changes its economic team and begins to address the economy's cyclical and structural problems," Ashmore said in a research note.

Rally in doubt

Given Rousseff´s strong lead and the possibility that many of Silva's supporters will choose to vote for the incumbent make the sustainability of Monday's impressive rally look shaky.

While Neves is the market favorite, an electoral race that threw up several twists has made predicting the final outcome tough. The death of Eduardo Campos in a plane crash propelled support for running mate Marina Silva, yet that deflated last week, allowing Neves to reclaim his spot as the leading challenger to Rousseff.

"Our biggest concern remains that [investors] might get swept away by electoral hope, carrying Brazilian asset prices to huge gains only to be ultimately disappointed, as we witnessed in recent weeks in the case of Marina Silva's rapid rise and fall," Société Générale said in a research report.

Neves can boast of having staged a remarkable comeback and could benefit from strong momentum ahead of the run-off vote in October 26.

"If he can tap into rising discontent about cronyism and corruption within the current administration and transform himself into the "anyone but Dilma" candidate, then he could yet prevail," analysts at Capital Economics said. "It remains early days, but the likelihood that elections might prove to be the trigger for the much-needed shift in policy needed to revive Brazil's flagging economy is at least greater than a few weeks ago."