Brazil’s new president Jair Bolsonaro promised major market reforms to re-energize the world’s eighth largest economy and attract more foreign investment. As he nears the 100-day mark, here’s where the country stands.
razil has been spellbound by the promise of economic recovery since its new president Jair Bolsonaro, was sworn into office on January 1. Bolsonaro, a member of the conservative Social Liberal Party, has promoted a market-oriented approach that focuses on reform, privatization, fiscal deficit reduction and cutting bureaucracy.
Though Bolsonaro’s party does not control the Brazilian Congress, the president is in the honeymoon phase of his four-year mandate and still has heavy support from the population, the market and other governors from several of Brazil’s states. Optimism is still high, and the financial markets, mainly based on local players, are already pricing in the improvements expected to be implemented by the new government. However, the majority of foreign investors remain on the sidelines waiting for concrete positive developments.
Key to Success
The main challenge to success is pushing social security reform through Congress. Currently, social security spending in Brazil amounts to about 44 percent of public spending and, when included with other federal obligations, it reaches an astronomical 92 percent. That figure constricts the possibility of reform in other areas of spending and will only become worse given Brazil’s aging population. Without reform, the social security deficit alone could reach about 11 percent of GDP by 2060.
In mid-March 2019, the new administration presented a social security reform package to Congress aimed at reducing the deficit and has been working diligently to gain approval. Passing the package is key to maintaining the momentum that the local financial markets have shown in the new government. Since inauguration, the Brazilian stock market has gone through a rally, reflecting a confidence that Bolsonaro will be successful in implementing the measures needed to stabilize the economy.
Despite this optimism, however, a few recent events could distract both the executive branch and Congress in the short term:
- The pension reform package includes a different proposal specifically for the armed forces. This will probably generate significant discussions in Congress.
- The arrest in late March of former President Michel Temer (on corruption charges) will likely add complexity to an already tenuous relationship between Congress and the executive branch.
- Polls showed that approval of the Bolsonaro government fell in March.
A trip to the United States by Bolsonaro in March to meet President Trump did little to move the needle back home. Among other topics, discussions revealed outstanding issues:
- U.S. support for the admission of Brazil to the Organisation for Economic Co-operation and Development (OECD) is solid but not likely to have much effect until Brazil can show that its economy is opening up to the world.
- Both the United States and Brazil need to work toward stabilizing the crisis in Venezuela. Brazil must halt the influx of refugees, and it will likely continue a dovish rhetoric and approach to Venezuela.
On the positive side, the two governments discussed eliminating visa requirements for US, Canadian, Australian and Japanese nationals. That concession by Brazil will certainly help tourism in Brazil and boost the fortunes of hotels, resorts and airlines.
The government’s hope is that foreign investors will climb aboard once they perceive the social security reform will be implemented and that fiscal deficit reduction will follow. It’s likely that the first sign of perceived success or failure in this regard will be reflected in the exchange rate. Failure (or a heavily diluted reform) will have a direct impact on the states and federal tax deficits.
The federal, states, and municipal governments of Brazil have a direct or indirect stake in 418 companies, of which about 130 are federally owned. Many of these are targeted to be sold by the current government. Selling such assets will generate proceeds to reduce public debt, increase economic efficiency, help halt corruption by reducing political influence in companies, and increase private investments in infrastructure. The maximum cash generation from sales of public entities is expected to be BRL$420 billion (USD$108 billion). Likely problems to be encountered include a strong adverse reaction from government employees.
2. Construction and Real Estate
Construction: Infrastructure investments have lagged for at least two decades, creating a gap in investment opportunities estimated at BRL$2 trillion (USD$513 billion). Estimates for 2019 and 2020 include a recovery of approximately 4.5 percent per year, which is largely insufficient to close the Brazilian infrastructure gap. Real estate: Previously, construction companies were required to reimburse the client virtually all monies paid during the construction of a building in case of a contract termination. A recent law has increased real estate companies’ protection by imposing higher termination penalties to clients. Now is a good time for entry into the market as it is still cold, with historically low housing prices (when expressed in USD terms) and significant pent-up demand.
3. Oil and Gas Exploration
One of Brazil’s strongest economic assets is undergoing significant reform following numerous corruption scandals. Opportunities abound: A continuous offer of blocks and mature fields with high potential is available; the divestment plan of 2016 continues, with dozens of teasers for the transfer of rights of a set of onshore fields and shallow water fields. More transparent bidding rounds now benefit investors and operators as Brazil’s National Agency of Petroleum Natural Gas and Biofuels sets schedules for a variety of productions and concessions.
4. State-Owned Banks
Bolsonaro’s new minister of the economy wants to lead Brazil towards a free market, including adjustments on the role of the country’s three federally -owned banks: Banco do Brasil, Caixa Econômica Federal, and BNDES. All three saw new CEOs appointed in January. Additionally, several banks owned by individual states are under consideration for sale. Overall, opportunities abound in loan portfolios (both performing and non-performing), foreclosed real estate assets, increased credit opportunities, the BNDES equity portfolio, and privatization of state-owned banks.
This sector remains a global powerhouse. Agribusiness GDP includes all services and processes directly or indirectly related to agriculture and farming activities, amounting to a record 23.5 percent of Brazil’s GDP in 2017. Additionally, the country ranks as number 1 in the world in the production of several commodities. Standout opportunities include beef exports, which are expected to increase due to China’s demand, and soybeans, which will benefit from trade wars between China and the U.S. However, certain barriers to foreign ownership of rural properties means that investors from abroad must consider alternative routes for return, such as convertible bonds, rural partnerships, and surface rights.
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6. Energy (Electricity)
Electricity consumption is showing signs of recovery following the economic downturn of 2014-16. Prices soared in the past five years following a combination of inflation, erroneous decisions by former President Dilma Rousseff, and greater generation by thermoelectric plants following severe droughts that negatively impacted hydro electric production. Overall, the electricity sector is highly indebted, with a portion of the operating power plants — and mainly those under construction or planned — facing financial distress and in need of capital in order to be able to face their financial obligations or Capex needs.
Although public education in Brazil is guaranteed by the constitution, the country has a historical deficit that the government has been unable to solve. Private universities have very successfully implemented online platforms, which now represent 19 percent of all higher education and is growing faster than on-site education. However, with the prospect of a stronger economy, unemployment is expected to drop, which will attract students back to the private classrooms. As a whole, education is still a sector with many individual small players, offering investors opportunities of all sizes.
8. Pension Funds
Pensions in Brazil are concentrated in funds from state-run companies; in fact, two-thirds of the assets are in the hands of three funds. A recent investigation identified corrupt practices around four of the largest pension funds in the country. However, a new ruling in 2018 strengthened the governance requirements of the funds, emphasizing the need for robust internal controls to avoid conflicts of interest in investment operations. Other reforms are intended to cut down on potential conflicts. Some pension funds are in the process of divesting PE investments, which creates investment opportunities in several sectors.
9. Pulp, Paper and Paper Products
China will continue to buy more pulp in 2019 as its moratorium on mixed paper imports is still valid, which increases virgin pulp demand. Brazil’s pulp producers are in a good position to take advantage of this situation due to their production capacity and low cost of production. With the change of government and improved investment climate, the amount of foreign capital injected into the forest sector in 2019 will potentially be the highest in recent years.