Brazil avoids the cold chill of recession

 

Economic growth in Brazil is expected to top 4 per cent next year, writes DOMINIC COYLEin Rio de Janeiro

IT MAY be mid-winter in Brazil but no one here is feeling the chill wind of recession that has crippled economies in much of the developed world.

With the world’s largest untapped reserves of oil outside Saudi Arabia just off the southern coast and an ambitious construction programme in place ahead of the 2014 World Cup – and, it hopes, the 2016 Olympics – the mood is bright.

It’s not that the country is totally immune to events elsewhere. The economy did contract by 1.8 per cent year on year in the first quarter but even the OECD expects that the full year figure will be considerably lower than this, with growth falling to somewhere between -0.6 and -0.8 per cent for 2009 as a whole.

In recent years, Brazilian GDP has been growing at between 4 and 5.5 per cent per annum and the OECD in a report this week said it expected Brazil to bounce back for this year’s slowdown with growth of 4 per cent in 2010. Already the slowdown in job numbers has been stemmed.

“We are looking at the crisis in the rear-view mirror,” labour minister Carlos Lupi said this week. “I foresee a big turnaround in the second half of the year led by a recovery in the construction and manufacturing sectors.”

In part, this is a country recovering from decades of neglect when central and local government were unable to agree a joint approach to necessary investment and people descended increasingly into poverty. Local drug gangs and militias ruled many of the hundreds of favelas or shanty towns dotting the hillside of cities like Rio de Janeiro, once the capital of this, South America’s largest state.

The culture of violence within many favelas, the sharp divide between rich and poor and generations of corruption and patronage in politics have hampered the prospects of Brazil to assert its financial muscle in Latin America.

Visiting Rio de Janeiro this week, local officials acknowledged that whole industries, banking and pharmaceuticals in particular, fled the “Marvellous City” for the relative safety of São Paulo, about 350 kilometres down the coast.

São Paulo and Rio are the two largest cities in the country and, between them, account for close to half the Brazilian economic output. Overall, the country is the 10th largest economy worldwide. Sergio Cabral, governor of the state of Rio de Janeiro, says it expects to rank in the top five within the next decade.

At the moment, it is a market little tapped by Irish firms. Kerry group has a substantial presence but it is the exception.

While CSO data show the country is the second-largest trade partner for Ireland in Central and South America, the scale of that business is negligible compared to, say, the United States or other major western economies.

Representatives from more than 40 Irish companies are here this week to examine the challenges and opportunities involved in doing business with what is now one of the fastest growing developing economies. This is the largest group of Irish businessmen to visit the country and follows a trade mission led by former junior enterprise minister John McGuinness last year.

Brazil is not pretending that it is yet on a par with the developed economies of North America and Europe but it is moving quickly in the right direction.

One of the BRIC countries – alongside China, Russia and India – it is seen as a key player in future global economic growth. For now, in the words of Joaquim Levy, finance secretary for the state of Rio de Janeiro, Brazil is measuring itself against the countries of emerging Asia and emerging Europe.

On the financial front, a cautious approach to lending and reserves – ironically arising from the country’s failure to modernise its regulatory structures in line with the US and Europe during the late 1980s and 1990s – means Brazil avoided the perils of a bubble economy and has had plenty of cash to pump into the system over the past 18 months. Its banks have not seen the destruction in value that has now become all too familiar in the US and European markets.

Levy blames the market collapse on a failure by the US to make necessary adjustments to its economy. “Here, the worst has been avoided,” he says. “People were very scared in the aftermath of the collapse of Lehman [Brothers].”

But he worries that a rise of protectionist policies and tighter regulation – especially after financial markets stabilise and the US is forced to address its economic imbalances – could threaten Brazil’s recent success. A surge in inflation and an uncertain outlook on interest rates could also affect investment flows to Latin America, he concedes.

For now, though, the downturn has not halted investment. The government this week announced a €2 billion project to redevelop Rio de Janeiro’s port area and 30,000 workers are currently working on German steel giant Thyssen’s major new mill in the state, touted as the largest investment project currently underway in the western hemisphere.

Work is also ongoing on the country’s third nuclear power plant. In the year to April last, Brazil saw foreign direct investment of $41 billion.

Energy and steel are two of the core industries, along with agriculture. Other areas of strength include commodities, the automotive sector and, of course, tourism. The country is working hard to attract more investment in the services sector including from companies in the reinsurance, pharmaceutical and media/entertainment sectors.

Only 20 years after voting out a military government, Brazil is proud of the work it has done in recent years in keeping tabs on inflation and adopting a more responsible approach to fiscal policy.

This is particularly the case since the Asian crisis. Back in 2002, Brazil had to turn to the IMF for a loan to prop up its struggling economy. However, the money was paid back by 2005, ahead of schedule as Brazilian authorities adopted a tighter fiscal approach.

Still, this is a country with much to do before it can set itself alongside the developed world.

Third-level education remains the exception rather than the rule and policy is currently focused on trying to ensure that secondary school students complete their education cycle. Currently, there is a dramatic fall-off beyond the age of 15. English and Spanish are on the high school curriculum but Flavia Barros, an economist with the city government of Rio de Janeiro, acknowledges that “not much priority is given in schools to the instruction of modern languages”. This is despite the fact that the country is surrounded by Spanish-speaking states, many of which are important trading partners.

Just 8 per cent of the population speaks English.

Stelio Amarante, a former Brazilian ambassador in Ireland, says this is an area where the country needs to make more of an effort.

In Rio, too, for all the glamour, 20 per cent of the city’s six million inhabitants live in the favelas with little sanitation, infrastructure, education and employment prospects. Despite recent efforts to regularise matters, the black economy continues to thrive.

Crime, including violent crime, remains at far higher levels than most potential foreign investors would feel comfortable with. Across the country, the government is now investing heavily in sanitation but the situation remains poor following decades of neglect. Brazil’s physical infrastructure also requires heavy investment.

The head of Rio’s construction industry federation says around half of the country’s roads are in poor repair, although he says this still marks an improvement on the situation five years ago when the figure was closer to 80 per cent.

For foreign investors, Amaury Temporal, the director of the International Business Centre at the Federation of Industries of the State of Rio de Janeiro, says there are few dedicated financial incentives. “There is no distinction between foreign and domestic companies,” he says, adding that this position is set down in the constitution. “Our main goal is to protect all investors.”

He acknowledges that some “levers” to promote investment are in place but says these are very narrowly targeted. “We do not have a little kitty for foreign investors.”

What Levy does offer is a country that is fiscally prudent and secure relative to those around it. Its economy is more diversified, public sector debt has fallen from 52.4 per cent of GDP in 2003 to 38 per cent last year and foreign reserves have grown sharply over that same period.

And then there is simply the fact that this is Brazil. Local enterprise agencies in Rio make no secret of their view that the very culture of the city – the carnival, miles of fabled golden beaches and the Maracana football stadium – has a key part to play in persuading foreign executives to bring their business to the southern Brazilian city.

To be fair, this is not the sum total of what Brazil sees as its relative strengths in attracting foreign direct investment. Barros also points to a young skilled workforce, a strategic location and infrastructure and a cluster of the largest companies in Latin America.

Levy argues that Brazil, and especially its populous southern coast, makes a good entry point for businesses looking to establish a foothold in Latin America.

“Many countries have used Brazil as a stepping stone into the continent,” he says. “We are in a good position and are increasing ties with the rest of Latin America. We offer a stable environment, a strong regulatory structure and a friendly tax environment.

Investors might be somewhat sceptical on the last point. Taxes remain high by international standards – in part to fund an ambitious state pension scheme and the accelerated infrastructural and social investment programme. Interest rates are also substantially higher at 9.25 per cent, despite a 4.5 percentage point cut by the central bank in the current cycle. Local sources say rates are unlikely to go much lower.

The Irish business executives currently visiting the country as part of the Ernst Young Entrepreneur of the Year awards CEO retreat, have been surprised by some of the real business opportunities open to even small foreign companies. Many of the group had travelled with little or no expectation of doing business in Brazil but a number are now mulling potential deals.

However, their meetings with counterparts in Brazil have also confirmed that, for all its recent advances and the assurances of senior local officials, business practices here, at times, remain less than transparent.

Brazil may well be a future economic powerhouse but, for now, it is concentrating putting in place the structures needed to compete with those more developed economies.

“We have to keep working very hard to be more competitive in an increasingly globalised market,” Levy acknowledges, pointing particularly to the need for a better trained, more efficient workforce, “but people in Brazil are not complacent.”