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Reform agenda in Brazil signals better investment conditions

Reform agenda in Brazil signals better investment conditions

17-12-2019 | Insight
The government commitment to reforms in Brazil is a source of cautious optimism for investors. Following the approval of social security reform, changes on credit, tax and administrative fronts are expected. Energy, infrastructure and financial services are key sectors that hold promise, says Robeco portfolio manager Daniela da Costa Bulthuis.
  • Daniela da Costa - Bulthuis
    Daniela
    da Costa - Bulthuis
    Portfolio Manager & Country Specialist

Speed read

  • Reform agenda is viewed by companies and investors in Brazil as a positive driver
  • Brazil stands out in the region as the most committed to pro-market reforms
  • Sustainability has grown to be one of the biggest risks for the country

Brazil’s economic position is strengthening as the country is coming out of a recession. In 2015 and 2016, its economy contracted by almost 7%, and now it is in the midst of a slow recovery with growth of around 1%. “Brazil has moderate growth ahead. Yet, it is a high-quality growth as it is driven by increasing competitiveness and higher productivity,” says Da Costa Bulthuis. The key contributing factor, she adds, is Brazil’s current political stability, which the country has managed to achieve following the period of turbulence related to the impeachment of President Dilma Rousseff in 2016, she adds.

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Pro-business reform agenda

Following the approval of social security reform this year, the government is implementing further steps. They include both tax and administrative reforms, further privatizations and a robust micro reform.

Tax reform aims to diminish the complexity of the tax system and reduce tax burden for companies, says Da Costa Bulthuis. It will simplify and rationalize the tax code by merging several taxes into a single VAT tax. The scope of taxes this reform will affect is yet to be defined – and it will depend on political agreements between federal, state and municipal instances, she says.

The country is also in the midst of administrative reforms that would reduce administrative costs by making public servants’ work contracts more flexible, and reducing special benefits and payroll indexation. “Administrative reform is aiming at reducing the size of the government, although there is a strong lobby against it,” explains Da Costa Bulthuis.

Another crucial step is the improvement of credit market conditions via several micro measures that are being implemented by the central bank. They include the creation of a centralized register for properties, an enhancement of the bankruptcy law to allow fast asset recovery, and introduction of home equity and mortgage securitization markets. “The goal of credit reform is to improve credit access and asset recovery, reducing credit risk and boosting long-term credit,” says Da Costa Bulthuis.

Adding to those measures, this year the Brazilian congress approved the creation of a positive credit bureau that will list information on good borrowers. This should enable large sections of the underbanked population in Brazil to build their credit score and lower the lending risk. It is expected this will boost opportunities for banks, financial service providers and fintech firms.

Privatization pipeline within the energy sector

Brazil’s energy and power sectors offer an attractive opportunity for investors at the moment due to the country’s sizeable resources and attractive consumer market, believes Da Costa Bulthuis. “Those are not just oil-related firms, but also those that rely on renewable resources for energy generation,” she explained. Companies in this sector are getting a boost from the ongoing privatization and oil auctions, which are expected to increase government revenue and bring new players to the market.

The ongoing privatization in Brazil is one of the economic drivers as it is expected to increase private sector investment in the economy. Several state-owned utilities including energy company Eletrobras are being considered for privatization. In addition, the economic team of President Jair Bolsonaro plans to sell 50% of the country’s fuels refining capacity, today fully controlled by the state-controlled oil company Petrobras.

Infrastructure and online services hold promise

The infrastructure sector is also potentially of interest for investors as it is undergoing privatization as well. Postal services, airports and ports are among the main assets to be sold. In addition, Brazil will intensify the auctions of new concessions in highways and railroads. The new regulatory framework is also being discussed by congress for sanitation services. It will also pave the way for state-owned water utilities to be privatized.

Growing demand for infrastructure and improved regulation will create investment opportunity potential in this area. First, Brazil is currently in the midst of adopting new project finance structures that reduce construction risk. Through the central and development banks, the government is fostering a local infrastructure bonds market in order to boost financing conditions to infrastructure projects. “This space needs to be watched as growth in infrastructure investments can accelerate and more companies might emerge,” says Da Costa Bulthuis.

The internet sector offers multiple opportunities

Online consumption-related services are yet another field with investment opportunity potential. “All internet services – payments, fintech, ecommerce – are booming in Brazil at the moment,” she says. Several startups are working together with large consumer and service companies to find ways to improve convenience and consumer experience. “Incumbent companies are adopting tech content that creates productivity gains,” says Da Costa Bulthuis.

In addition, the central bank agenda to support healthy competition in the financial sector has created space for the emergence of several fintechs providing innovative services to low-income customers and SMEs.

Sustainability risks demand attention

Although the country is going through a healthy economic recovery and is adopting an encouraging reform agenda, the recent environmental issues are a source of growing concern. Brazil has had one of the worst years in terms of environmental disasters in decades. In the beginning of the year, more than 270 people died in a rupture of a tailing dam in one of Brazil’s iron ore mines. In September, the fires in the Amazon region alarmed the whole world regarding the country’s poor ability to combat illegal deforestation. And since October, Brazil’s northeast coast has seen large blots of oil staining emerging across more than 130 beaches, with the origin of this oil not yet being detected.

Brazil must address its environmental problems urgently and commit to improved sustainability so that these issues do not jeopardize exports from its agribusiness sector and reduce the attractiveness of investing in its natural resources-related sectors.

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