Brazilian President Michel Temer has said he will not resign after a political 'hush money' scandal caused Brazilian equities to fall 10% last night.
Temer became President last summer after the impeachment of Dilma Rousseff for manipulating the budget.
But according to Brazilian newspaper O Globo, he allegedly gave his support to an attempt to buy the silence of a former coalition ally, although he vehemently denies the allegations.
On the news, the Brazilian Bovespa index plunged 10% on opening yesterday and trading was halted for 30 minutes. The real also fell 7% against the US dollar.
There is now a possibility Temer will have to leave office, either through impeachment or resignation.
He has so far refused to resign, despite the Supreme Court authorising a criminal inquiry into the allegations.
According to the Guardian, he said: "I will not resign. I repeat: I will not resign. I know what I did," in a live TV intervew.
If he does leave office, the next in line for the presidency would be Rodrigo Maia but others are in favour of a new set of elections or the election of Chief Justice Carmém Lúcia rather than an existing politician.
Brazil was one of the best-performing markets of 2016 with the MSCI Brazil index returning 66% during the year on the back of ambitious reform plans and rising commodity prices. This was a significant turnaround from 2015 when the index lost 41%.
However, managers are now expecting a further sell-off for Brazilian markets, with Temer's future role and reform programmes in doubt.
Angel Ortiz, manager of the Fidelity Latin America fund, said: "This is a big shock to the market that will be negative for both the equity market and currency. After the Brazilian market's very strong run over the last 16 months, we can expect a sharp correction.
"However, such situations that lead to an indiscriminate sell-off typically result in opportunities to buy good companies at an attractive valuation."
Claudia Calich, manager of the M&G Emerging Market Debt fund, commented: "Any structural reforms, especially the pension reform, seem to be pretty much dead in the water now. The economy is stabilising after two years of recession, but this uncertainty - transmitted through a weaker currency, potentially less room for rate cuts and further decline in the already depressed levels of investment - could threaten this stabilisation.
"With regards to market implications - Brazil is clearly underperforming, but this will be an opportunity to buy other emerging market assets as short-term technicals are cleared - including USD shorts covered - or other credits that are uncorrelated to the Brazilian economy but are suffering in a similar fashion."
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