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June 2 2008
I spoke at the Eurofinance Treasury and Cash Management Conference at Miami in April. The sessions featuring Brazil were the most well attended.
Headlines earlier in May all focussed on Brazil having achieved investment grade status. And the other day, CNBC was full of reports of Brazil having arrived. S&P's recent decision to elevate Brazil's bonds from junk status to BBB portends well for the country. It is time to take a closer look.
Brazil, along with Russia, India and China (the BRIC countries) has been touted as the future of global economic growth. However, its economic growth has stalled several times during the past 25 years, in stark contrast to the strong recent performance of the other three „BRIC‰ countries: Russia, India, and China. Brazil is the fifth most populous nation of the world. Brazil has a wealth of natural resources˜high-quality deposits of bauxite, iron ore, natural gas, nickel, oil˜and excellent conditions for forestry and agriculture. Several farmers from America's midwest have sold their holdings in USA (at high prices) and moved to Brazil in the recent past and have accumulated hundreds of thousands of hectares of agricultural land and with soaring prices of agricultural produce are poised to "rake it in". An American farmer who has moved to Brazil a few years ago told CNBC on Friday (May 9, 2008) night he is expecting an ROI of 25% pa - very healthy indeed considering agricultural investments generally have very long gestation periods. In the past five years, Brazil's government has successfully managed to chalk up budget surpluses. the surplus currently runs at 4.3% of GDP and is largely attributable to external factors ie. steep hike in prices of metals, agricultural commodities and oil. With relative political stability in the past several years, interest rates are down to low double digits (sub 15% area) compared to 40% at the height of the 1998 financial crisis. The Brazil risk premium has now fallen to below 200 basis points over US treasuries (the premium used to be over 1000 basis points). Local debt issuances has grown ten fold in the last five years.
So is everything well with Brazil. The answer in short is "no". No doubt, macroeconomic indicators have improved substantially but these alone will not tackle Brazil's problems. A collapse in commodity prices will push the budget balance back to the deficit area. What ails Brazil? To sum it up in one phrase borrowed from the McKinsey Quarterly Report - "low worker productivity". According to McKinsey, in 2004 Brazil‚s productivity per hour worked was only 18 percent of the US level. The beautifully written article analyses the key barriers to productivity growth in Brazil viz. a huge informal economy (and inappropriate regulations that make it costly for companies to enter the formal economy), macroeconomic instability, inefficient public services, and an inadequate infrastructure.
40% of the GDP is being spent on Government spending and much of it is on "social welfare spending" which has gone up dramatically in the last few years. Together with this, the burden imposed by debt servicing (most of the debt has relatively short maturities) leaves very little for investment in infrastructure. Investment in infrastucture is currently at 1% of GDP (compared to 3.6% in the eightees). By reducing the share of GDP that the Government consumes, it can reduce taxes, simplify taxes, improve tax collection and deal a death blow to the informal economy.
Public services are a mess - especially the judicial system. The McKinsey article cites a very interesting example which I quote verbatim "One electrical utility went to court in 1992 to question increased monthly sales taxes called Cofins. The lower court took more than three years to make its ruling, in the company‚s favor, but the story doesn‚t end there. In July 2003, after overcoming all process obstacles (including appeals by the federal government), the company received a letter from the authorities explaining that the amount the state owed to it would be paid back by 2014˜22 years after the case first went to court." This is no doubt an extreme example but it does eloquently drive home the point - public services need to be reformed urgently.
As an Indian who does business with China, I can relate to the "huge informal economy" drag argument!! The added problem in
Brazil is the lack of proper corporate governance standards. In 1999 the legislature resisted the changes proposed by the Government in this area. In 2000, the people came up with a market driven answer - the Novo Mercado, a special-listing segment of the existing São Paulo Stock Exchange (Bovespa). Novo Mercado‚s higher corporate-governance standards allow only a single class of share structures and require a higher level of disclosure. Reactions to the initiative were positive, prompting a wave of new issues. Entry into Novo Mercado is optional, but shareholders have clearly felt the benefits of the improved governance standards: new issues enjoy an average premium of 70 percent over shares in the broader market, which has stimulated interest from foreign investors.
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