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Examining Foreign Investment in Brazil

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Author: James D. Rosener

11/15/2012

This article was published in Venture Equity Latin America, November 15, 2012. It is reprinted here with permission.

The staggering 7.5 percent growth of the Brazilian economy in 2010 seems to be a relic of the past. In 2011, the figure was 2.7 percent,1 and the predictions for 2012 are not any better. A major reason for this downturn, no doubt, is the global economic crisis, but Brazil is also facing numerous domestic challenges in the form of a high rate of taxation, poor infrastructure facilities, high production costs, and lack of a qualified workforce, to name just a few. Despite all these factors, Brazil continues to be one of the top destinations for Foreign Direct Investment (FDI). Its projected FDI for 2012 was raised to $60 billion, about a 10 percent reduction from its FDI for 2011. The middle class of Brazil, which alone consists of approximately 40 million consumers, is a major cause for this trend. The efforts of President Dilma Rouseff to open Brazil to foreign investors and provide concessions in the field of public infrastructure and electricity should attract more foreign investors.

The Brazilian Bottleneck

Brazil has long been criticized for excessively focusing on the demand side of the economy, while at the same time, neglecting the supply side. As a result, Brazil is lumbered with bottlenecks in the production and infrastructure sectors. As a result, despite its strong middle-class, it does not have the capacity to produce sufficient supplies to meet the country’s demand for goods and services. As recently as 2009, the Brazilian government’s response to the economic crisis was to lower interest rates and cut taxes on consumption and imports. While this had the temporary effect of causing Brazil to post 7.5 percent growth in 2010, it is not a sustainable solution. Even during 2010, inflation levels were dangerously close to the Central Bank’s ceiling of 6.5 percent.2

Custo Brazil

Custo Brazil or Brazil Cost, refers to a plethora of factors such as high energy costs, poor infrastructure facilities, high labor costs, high rate of taxation, excessive bureaucratic delays and poor infrastructure facilities that have the effect of significantly increasing the cost of doing business in Brazil. In its annual Doing Business Survey 2013, The World Bank ranks Brazil 130 among 185 countries in terms of the ease of conducting business.

In 2011, the tax burden of Brazil was about 36 percent of its GDP.3 While on par with many countries, the average time (per year) taken by a business in filing its taxes is an astonishing 2,600 hours. This figure is even more shocking in light of the fact that the same study lists the world’s average to be 277 hours. While some of the blame for this gap can be attributed to bureaucratic delays (by no means a justification), the redundant and complex tax laws are said to be the main reason for such statistics.

Cost and taxes also burden the electricity and infrastructure sector. Even though Brazil relies on hydro-power for more than two-thirds of its electricity requirements, Brazilian consumers pay some of the world’s highest electricity bills, with taxes comprising around 45 percent of the average electricity bill. The 2012-2013 Global Competitiveness Report, published by the World Economic Forum, ranks Brazil as 107 out of 144 countries in quality of overall infrastructure. Its rank in each segment of infrastructure is no different—roads (123), railroads (100), ports (135) and air (134).4 Another major problem Brazil is facing is the lack of a qualified and capable workforce. This, in turn, this inflates the labor costs for prospective employers. Due to a dearth of trained personnel, employers have no option but to choose unskilled laborers and pay for their training. What’s more, employers also have to contend with protectionist labor laws, which obligate the employers to make several entitlement and employee benefit-related payments. Of course, high tax rates have the effect of further inflating labor costs.5

The excessive delays caused by red-tape and bureaucracy act as further deterrents for prospective investors. The 2013 Doing Business Survey also ranks Brazil as 130 and 139 in the number of days to start a business and the number of procedures to start a business respectively.

Reasons for Optimism

Despite the ubiquity of Cutso Brazil, there are many reasons to be optimistic about the future of Brazil’s economy. Brazil boasts a strong and growing middle class with an unemployment rate around 5 percent. Many multi-national companies, most notably auto-manufacturers, are capitalizing on this trend by investing in Brazil. UnitedHealth Group Inc. announced the acquisition of Brazil’s largest health care company, Amil, for an estimated $4.9 billion.6 Brazil’s oil and gas sector is expected to grow at a fast pace in the coming years and fuel Brazil’s recovery. Brazil is also set to host the 2014 FIFA World Cup and then the 2016 Olympics, both of which are expected to not only stimulate improvements in Brazil’s infrastructure but also act as important sources of revenue.

Most importantly, President Rousseff’s recent policy decisions should have a positive impact on investor confidence. Traditionally a left-leaning politician, she has adopted a pragmatic stance in her economic policy. On February 6, 2012, Brazil auctioned three (out of five) of its airports in a private auction.

In another much-needed and a much-welcome change, President Rousseff introduced major cuts in electricity taxes (effective January 2013). This reduces the tax burden for households and industries by up to 16 percent and 28 percent, respectively, by offering tax concessions to power utilities in exchange for cheap electricity. However, most power utilities threaten to reject this development due to an adverse impact on their profit margins.7 President Rousseff recently introduced a stimulus plan to encourage private construction of toll roads and investment in up to 6,200 miles of railroads.8 She is expected to announce similar packages for the privatization of port and air infrastructure and is also looking into ways to expedite the licensing process for these investments and avoid excessive bureaucratic delays.

Conclusion

Despite a bleak economic performance over the last two years, the 2014 World cup and the 2016 Olympics, coupled with a strong middle-class, are positive signs for Brazil’s economic recovery. President Rousseff has so far proven to be an able leader, who is not afraid of moving away from her party’s left-leaning base to introduce muchneeded economic reform. Brazil’s continued success will depend—to a large extent—on the further policy reforms undertaken by the president, most notably in her attempts to encourage privatization, and reduce bureaucratic delays and taxes.

Endnotes

1 More worryingly, the industrial sector recorded a growth rate of only 1.6 percent.

2 Fisch, Beni Broniscer, “The Brazilian Economy (Part I),” LLE, 9/9/12.

3 Brazil is ranked 156 in the World Bank Doing Business survey, 2013. The Global Competitiveness Survey, 2012-2013 (published by the World Economic forum) also ranks Brazil as 144 out of 144 in the “Extent and Effect of Taxation” criterion.

4 Brazil’s rating for its electronic infrastructure is 68 out of 144.

5 Recently, Brazil passed a law which stipulated employers to pay overtime rates to their employees for after-hour work calls and e-mails.

6 Humer, Caroline, “UnitedHealth to buy most of Brazil’s Amil for $4.9 billion,” Reuters, 10/8/12, http://uk.reuters.com/article/2012/10/08/uk-unitedhealth-takeover-amil-idUKBRE8970IE20121008?feedType=RSS&feedName=businessNews.

7 “Brazil utilities baulk at gov’t plan for cheaper electricity,” Reuters, 11/8/12, http://www.reuters.com/article/2012/11/08/brazil-economy-electricity-idUSL1E8M8CCO20121108.

8 http://www.reuters.com/article/2012/08/17/us-brazil-infrastructure-idUSBRE87G0KC20120817.

James D. Rosener

Mr. Rosener acknowledges the assistance of colleague Apoorv Tripathi in researching and drafting this article.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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