Tue | Aug 22, 2017

Walter Molano | Brazil: Sowing the right seeds

Published:Friday | October 21, 2016 | 10:00 AM
In this April 24, 2012 file photo, Michel Temer speaks with Dilma Rouseff. Temer replaced Rousseff as president of Brazil after her impeachment in August 2016.

Brazilians can often be manic. Their unbridled optimism can wrongly be construed as arrogance, especially when they heap superlatives on everything Brazilian, such as, 'Brazil is the best in the world', or 'Brazil is the largest in the world'.

On other occasions, their demeanour can border on suicidal. Their famous quip, 'Brazil is a country of the future, and always will be', is a good case in point.

Often, their self-perception and reality are juxtaposed. They can be insufferable when things are not so great, and they can be bleak when the situation is actually improving.

Interestingly, the latter seems to prescribe the current situation. The mood in Brazil is very dark. After years of enduring an unending recession and a painful political crisis, it is understandable why pessimism reigns.

The country has seen its most powerful industrialists and bankers jailed. Its president has been impeached in a highly politicised fashion. Several of its most senior politicians have been indicted and fired. Some have even been imprisoned. The country was humiliated during the World Cup, and it was ridiculed during the Olympics - even though many of the accusations were false. Large Brazilian corporations, several of them titans on the international stage, were brought to their knees. The currency was savaged, and the economy lost its coveted investment-grade rating.

All of these incidents went a long way to deflate its Amazonian ego.

However, the country has made great strides in addressing its problems. It has become the unsung hero of Latin America and it is moving into the vanguard of the investment community.

For a long time, Brazil's Achilles heel was its public finances. Bloated public pensions, hobbled by indexation and hereditary privileges, heaped fortunes on a sliver of the population. As a result, the economy has been saddled with a nagging fiscal deficit that has allowed the country's debt-to-GDP ratio to balloon to almost 80 per cent.

Fixing the problem has been a political nightmare. Already burdened with the highest tax rates in Latin America, the Congress would not increase them further. Moreover, powerful lobbies impeded any attempts to modify benefits.

That is why Finance Minister Henrique Meirelles made fiscal reform his overarching objective as soon as he took office. His proposal was typical of Brazilian ingenuity. Instead of trying to dictate the exact modifications to the Congress, the government will nominally cap spending. It is then up to the legislature to decide how they will make the adjustments in health, education and social security.

Given that pension obligations are the elephant in the room, they will be the one that will suffer the greatest adjustments. Similar changes were recorded across the corporate landscape, as CFO's rushed to slash capex, improve debt profiles and unload assets.

Most companies stabilised their finances and averted ruin. The same occurred with the external accounts. The massive devaluation of the real slashed the current account deficit to less than one per cent of GDP, even though commodity prices remained in the doldrums.

What is even more remarkable was the deluge of foreign direct investment (FDI) that continued to flood the country, moving north of US$70 billion. This number will only rise as President Michel Temer launches his ambitious privatisation programme, selling off important assets in the electricity sector.

The additional FDI will generate jobs, spur growth and improve productivity. It will take some time to right the mighty ship. The Brazilian economy is not a nimble Ferrari that careens on two wheels. GDP growth will be close to flat this year, and it will barely move into positive territory next year. Nevertheless, these changes will sow the seeds for a much more sustainable economy.

Wearied by the endless crises, the public and local investment community have lost hope. Little do they realise that they have become a role model for the rest of the region, and even the world.

Where else do you see political and business leaders thrown into jail for infractions that are commonplace across the rest of the planet? The number one concern of any foreign direct investors is the protection of their property rights. This requires rule of law.

Brazil's actions have demonstrated that it will go to no ends to enforce the rule of law. Therefore, the actions of the judiciary will eventually result in greater capital inflows. Moreover, Brazil is taking concrete steps to stabilise its economy, instead of papering over its problems in an orgy of bond issuance as is being done by its erstwhile neighbour.

As the saying goes, 'No pain, no gain'. Well, Brazil is enduring the pain. That means that real gains are just around the corner.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com