Investment Adventures in Emerging Markets

Real Challenges in Brazil

Brazil, the “B” in the emerging markets entities known as the “BRIC” countries (Brazil, Russia, India, China), has entered what I think can fairly be described as a rough patch of sluggish growth. Since my last update on Brazil, the country has experienced heightened economic challenges that threaten its competitive position to slip.

In 2011, Brazil’s growth eased to 2.7% after having reached 7.5% in 2010.1  The Eurozone crisis and the impact of a stronger Real on the competitiveness of Brazilian industry are partially to blame for this growth slowdown. A strong currency, lack of human resources in high-tech areas and unwillingness to allow imports of strategic materials may all be placing Brazil in danger of losing its competitive edge.

In spite of the slowing growth, Brazil has been enjoying an export boom, aided by China’s demand of Brazilian commodities and expansionary monetary policies in the U.S. and other developed nations. While the ideal combination of higher global prices and increased demand have helped drive exports of Brazilian commodities, exports of manufactured products have been impacted by a stronger Real and rising labor costs which make it more difficult to compete with other emerging market economies.

The good news is that Brazilian policymakers are paying attention to these challenges and appear to be steering the economy in the right direction.

In order to help stimulate the economy, in April Brazil’s central bank reduced its key short-term interest rate, the Selic, by 75 basis points to 9%. Since August 2011, the Selic rate has been slashed by 350 basis points.

In addition to the easing measures, the central bank has also stepped up intervention in the foreign exchange market to help push the Real lower, and has tightened capital inflow controls. Brazil’s government has also taken a number of actions to support export of manufactured goods. These include the introduction of a number of tax breaks, including eliminating the 20% payroll tax on labor-intensive export manufacturers such as auto parts, textiles, plastics and footwear. Financing for Brazil’s government-owned development bank, the BNDES (Banco Nacional de Desenvolvimento Econômico e Social), was strengthened to allow more credits at below-market rates or at concessional maturity terms. The BNDES is the main source of long-term funding inBrazil, and has been providing export companies with preferential export financing.

To help offset the loss of taxes from these pro-manufacturing measures, the government initiated a new sales tax on other specific sectors. Importers will be taxed at a higher rate than domestic producers. Generally Brazil’s tax revenue as a percentage of GDP is relatively high and has been rising. I believe this high rate coupled with a complex tax system creates a drag on productivity. In order to boost productivity I think Brazil will need to limit the increases in labor costs, improve infrastructure and education, reduce red tape and increase labor market flexibility.

Additionally, I believe there is a need for the government to cut spending and focus more on investments. Ideally, it should focus on reforms and concessions in order to step up the much-needed investments in the country. Although the cut in taxes is welcome, it should be done in a linear way and not just for select industries. Finally, I think that the government’s hands-on approach to the economy has brought more damage than benefits in the form of uncertainty of rules and exchange rate volatility.

On the positive side, I think the government realized it can’t undertake all investments by itself and broke a taboo of President Dilma Rousseff’s party by starting to privatize airports. At the same time, reforms were passed to curb the burden of civil servants’ generous pension schemes. Although the reigning in of pension schemes is for new civil servants, I believe this is a positive initiative.

Despite all these challenges, my research team and I continue to like the long-term investment potential in Brazil. It is by far the most populous country in South America, which means rising incomes and higher living standards of a young, working population have the potential to drive domestic consumption. In particular, we like the energy, financials and materials sectors. Should these trends continue, Brazil’s sluggish growth may turn into a growth spurt in the future.


1. CIA – The World Factbook, May 3, 2012.

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