PBR Petroleo Brasileiro ADR

RIO DE JANEIRO—For the past two months, Brazilian financial markets have staged wild rallies over any sign that left-leaning President Dilma Rousseff might be ousted from office, even as the nation's economy spiraled further into the depths of its worst crisis in generations.

Now, with a crucial impeachment vote looming on Sunday, investors may soon get their wish for new leadership. If two-thirds of lawmakers in Brazil's lower house vote to try Ms. Rousseff on charges of doctoring the government's fiscal numbers, she will have to step aside, at least temporarily.

But while markets are cheering, the prospects for a growth rebound remain dim, even if Ms. Rousseff is succeeded by a more business-friendly head of state.

"The economy suffers from a variety of original sins," said Joã o Pedro Ribeiro, a Brazilian economist at Nomura in New York. He says Brazil's "potential growth"—how fast gross domestic product is capable of expanding in the long term—is now "very, very low" in comparison with other developing countries.

The president's critics say she has mismanaged her nation's once-flourishing economy and lacks the political skills to push badly needed overhauls through Congress. Brazil's GDP shrank 3.8% last year—the biggest contraction in a quarter-century, and a stark turnaround from the 7.5% growth notched in 2010, the year Ms. Rousseff was elected.

But the bleeding will likely continue regardless of who Brazil's president is because the government has virtually exhausted its firepower to fight the crisis. Years of economic stagnation, combined with constitutionally mandated spending on things like health care, education and pensions, have left Brazil's public sector with a deficit of nearly 11% of GDP.

"We talk about entitlement spending in the U.S., but I mean, that is what Brazil does—90% of the budget is entitlement spending. There is no discretionary spending," said Edwin Gutierrez, who manages $11 billion in emerging-market debt at Aberdeen Asset Management.

The fixes Brazil needs would require politically unpopular decisions, such as loosening labor laws and reducing automatic minimum-wage increases, as public opinion is stacked against elected officials of all stripes. Ms. Rousseff's likeliest successor, Vice President Michel Temer, has signaled a pro-market agenda but will likely have "a very narrow honeymoon" to implement it, said Christopher Garman, head of country analysis at risk consultancy Eurasia Group.

A Supreme Court judge recently ordered Brazil's Congress to charge Mr. Temer with the same offenses it lodged against Ms. Rousseff. While his chances of impeachment are considered slim given his strong backing in Congress, sSeveral high-ranking PMDB members have been implicated in a wide-reaching corruption scandal.

A newly energized leftist opposition, meanwhile, is likely to oppose any austerity measures he tries to impose.

"As a result, the binary manner by which markets are treating this weekend's vote is probably somewhat misplaced," Mr. Garman said in a research note on Tuesday.

On Monday, for instance, the Brazilian real soared 3% to a nearly seven-month high against the dollar, even as a survey of economists by the central bank showed GDP forecasts declining for the 12th week in a row. The economy is now projected to contract 3.8% in 2016, repeating last year's dismal performance.

Many challenges ahead are enshrined in Brazil's 1988 constitution, which makes it practically impossible for the government to lay off civil servants and allows workers to start collecting social security at an average age of 54. The constitution can be changed only with a two-thirds majority in Congress.

Another big contributor to the deficit, a law that links minimum wages and some pensions to inflation, would require a simple majority in Congress to overturn. But it reflects a practice, known as indexation, that permeates Brazil's economy, a legacy of the country's historically high inflation rates.

Such problems, along with other obstacles to growth like pervasive red tape and poor infrastructure, were masked from 2003 to 2011 by rising prices for Brazil's commodity exports. When commodity prices began to falter during Ms. Rousseff's first term, she intervened in the economy with populist policies that temporarily sustained consumer spending but ultimately left Brazil with a gaping budget deficit.

Ms. Rousseff attempted to right the fiscal ship after her 2014 re-election by naming a respected banker, Joaquim Levy, as finance minister with the task of implementing an austerity program. News of the appointment boosted Brazil's stocks and currency in a phenomenon that local media called the "Levy effect."

But his most important measures fell flat amid heavy opposition by interest groups in Congress, and he resigned in December.

Mr. Levy's struggles may bode poorly for Mr. Temer's hopes of swiftly delivering his party's promise to overhaul the pension system, cut wasteful government spending and stimulate private investment.

"We thought when Joaquim Levy came on board…that Brazil was moving in the right direction," said Michael Henderson, an analyst at Maplecroft. "But there is a lot of inertia there; a lot of these structural problems are hard to weed out. There are a lot of vested interests."

The cautious view of Mr. Henderson and other economists contrasts with the euphoria that has overtaken Brazil's financial markets in recent weeks as impeachment proceedings against Ms. Rousseff picked up speed in Congress.

Since mid-February, the benchmark Ibovespa equity index has soared nearly 30%, and the real has appreciated by about 15%. Stock-trading volume hit a near-record 8.27 billion reais a day in March, research firm Economatica said.

Perhaps the best bellwether for investors' sentiment about the political situation are shares of state oil company Petró leo Brasileiro SA, which is buried under a mountain of debt and embroiled in a multibillion-dollar corruption scandal that Ms. Rousseff's critics blame on her party's interventionist policies.

Though the company has made scant progress toward solvency and reported its biggest quarterly loss ever on March 22, Petrobras' local shares have roughly doubled in the past two months. Investors are betting that Ms. Rousseff's eventual successor will open up Brazil's oil sector and allow Petrobras to operate more like a private company.

Neil Shearing, chief emerging-markets economist at Capital Economics in New York, says it is possible that a market-friendly regime could emerge when the dust settles.

"But the groundswell of public discontent against the entire political class in Brazil may well prove to be a breeding ground for a more populist movement to come to the fore," Mr. Shearing said. "In the current environment, what comes after Dilma is highly uncertain."

Write to Paul Kiernan at paul.kiernan@wsj.com

(END) Dow Jones Newswires

April 13, 2016 13:45 ET (17:45 GMT)

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