Occupy Brazil

With European banks repatriating funds from their overseas investments, emerging economies such as Brazil have been left to their own devices to attract alternative sources of funding from elsewhere, hence a recent Brazil Summit in New York on April 23, 2012.  Just what Brazil was asking from the Big Apple’s investment community is not exactly clear and for the most part reminded me of the infamous Occupy Wall Street movements where the overall message lacked focus.  However, there was a striking difference.  

‘Occupying Brazil’ is not about a 1% wealth disparity but rather a living success story of wealth distribution where, in contrast, 55% of the Brazilian population today are considered part of the middle class. According to Brazilian experts, over 46 million consumers qualify as recent entrants and are ready and able to buy beyond the basics.  Companies selling furniture, electronics, autos, and more are lining up with good reason to earn a piece of this burgeoning market.  Unfortunately, the onslaught of companies has introduced a new set of problems, namely, where to accommodate everyone including their offices and how to transport them around efficiently throughout each city.

Brazil’s infrastructure, which includes its roads and highways is at the heart of both its greatest success and its most severe problems.  A 45 minute drive to Sao Paolo’s airport often becomes a 5 hour ride with only minutes to spare to catch an international flight.  Having too many cars circulating through poorly maintained roads is costing the Brazilian economy billions in lost productivity.  Fortunately the government is  aware and is aggressively seeking innovative solutions to address these and other pressing issues.

Even though Brazil is considered a developing country, Brazilian leadership is not to be underestimated.  Henrique de Campos Merirelles, a former Brazilian central banker and known for his poker-face style, won the highly coveted prize of hosting the 2016 Olympic summer games against a formidable slate of candidates, which included Madrid, Tokyo, and Chicago.  Equally as impressive, Brazil will host the 2014 World Cup Soccer games for a combined investment bonanza estimated at USD$53b.  Other milestone achievements include a $225b capital investment for extracting 95 billion barrels of pre-salt oil reserves located miles under the ocean.  These type of herculean investments have helped Brazil become the sixth largest global economy with a GDP of $2.5 trillion, surpassing the United Kingdom.  By comparison, the USA is the largest economy at $15.1T followed by a distant China (but growing rapidly) at $7.3T.

How will Brazil host two world class games, accommodate a vibrant and growing middle class, monetize its oil reserves, and maintain a sustainable economy for decades to come?

If you ask Guido Mantega, Brazil’s Finance Minister, he will undoubtedly point to lower interest rates and longer term debt.  But despite his assessment to solve his country’s problems, Mr. Mantega and other well-trained government officials are log jammed in a political quagmire among themselves, which in an uncanny way resembles the notorious traffic congestions on Brazilian streets.  Similar to vehicles sitting in traffic, the many ideas and suggestions from Brazilian officials are getting caught up in an antiquated political system that, like its roads, needs to be redesigned and overhauled.

Is there a Danger of Runaway Inflation?
Some experts fear that the increasing demand for goods and services in Brazil will overheat its economy and potentially trigger runaway inflation; however, a closer look at the numbers shows that nothing could be further from the truth.  Just recently Brazil reduced its interest rates to 9%, a level considered high by global standards but, when evaluated with other extenuating factors, falls in line with the norm.  First, not every loan in Brazil is treated equally.  For example, local industries can get access to subsidized rates that are closer to 1% through its national development bank, BNDES.  Banks loaning at 9% to consumers are borrowing at 1% and using a portion of their profits to support government-backed savings accounts that offer tax-free annual interest of 6.17% to consumers.  With an inflation rate of around 5%, Brazil is actually operating within the real interest rate range of other global economies.

Is there a Danger of a Real Estate Bubble?
According to the World Bank, Brazil would need an annual growth rate of 10% for the next 10 years, just to meet its growing demand.  Today Brazil’s GDP growth rate is fluctuating between 4 and 5%.  On its own, Brazil clearly cannot meet its soaring demand.  For example, Brazil’s annual growth of 4% for its roads and highway projects matches the 4 to 5% annual expenditures needed to maintain existing structures.  In essence, Brazil’s roads and highway infrastructure is experiencing zero growth on a net basis.  Another example is in real estate.  As long as developers continue building for current rather than future demand, a real estate bubble could never form.

However, not all is rosy for Brazil.  Without the efficient injection of long term affordable debt funding, the economy could stall.  Demand for goods and services from an onslaught of global consumers could force prices to rise causing havoc for the newly minted middle class who will demand more from their politicians and become adamant to vital social and economic changes.  Why then has Brazil not experienced economic collapse due to runaway inflation?  Part of the reason may be attributed to Brazil’s uncanny ability to foresee its own future in a manner that no global index has been able to capture.  I like to refer to this stealth trait as ‘Brazilian foresight’.

Brazilian Foresight
To appreciate the power behind ‘Brazil’s foresight’, one should ask two key questions:

Q1. Was it not Brazil who 40 years ago decided after the oil embargo during the Carter years to launch a biofuels industry that today provides the country with unprecedented energy independence?
Q2. Was it not Brazil that after pegging its currency to the dollar to control inflation, reverted back to its local currency, the Real, to regain its economic independence by shifting from local consumption to an export-led economy?

Truly, if an index for foresight were established, Brazil would be ranked among the top five!  A follow-up question might be, “Is the influence of ‘Brazilian foresight’ present today?”  Perhaps.

Traces of ‘Brazilian foresight’ emerged from the recent Brazilian Summit organized by the Brazilian Chamber of Commerce and held at the Harvard Club of New York.  Brazilian panelists who addressed the pressing need for cheap long-term loans, discussed an alternative financial arrangement known as public-private partnerships or PPP’s.  These complex arrangements between the public and private sectors combine strategic companies with a combination of government concessions and long term revenues.  A recent example is a soccer stadium that will be used for both the World Cup and the Olympics.  The 33-year deal involves the government and a group of strategic private companies whose expertise is expected to reduce investment risk and ensure a viable return over the long term.

Another trace of ‘Brazilian foresight’ was a recent bilateral agreement between Presidents Rousseff and Obama.  As part of a program called ‘Innovation in Sciences’, 100,000 Brazilian students will be sent abroad on full-paid scholarships to earn their Masters or Doctorate degrees at academic institutions worldwide.  Half are expected to attend US universities including Harvard and MIT.  This bold initiative will move Brazilian presence at prominent US universities along side 160k Chinese students, 100k Indian, and 70k South Koreans who are already present.  The Brazilian government hopes to entice their returning graduates to to fill the 900k engineering positions expected to open by 2020 in the IT industry alone.

Proposed Solutions
Clearly Brazil’s future will depend upon its ability to attract low interest, long-term debt.  But with political time horizons that seek short term victories, one might expect Brazil’s President Rousseff to decouple long-term debt financing initiatives with current politics.  For starters, floating a 3 billion Real 40-year sovereign bond at a low rate would not only send a strong message to the international investment community but also help investors set rates for their own projects.

Taking into consideration the potential foresight of Brazilians, one can only expect that both reason and smart solutions will eventually prevail.  Outside investors should take note, if indeed, they intend to some day ‘Occupy Brazil’.