Many events have taken place lately that even just a few years back would have been unthinkable. The US has had its public debt downgraded, public finances across western Europe have been drastically shaken, the Chinese government has reprimanded American politicians, Argentina has been offering advice to Greece on how best to handle its debt crisis, and Mexico's respected central bank governor Agustín Carstens's candidacy to head the International Monetary Fund was widely viewed as plausible and, as some had suggested, was also an attempt to raise the international standing of his country.
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But before the balance of the world’s economy tips completely, much still needs to change within many of the large emerging economies. Some of these changes are already happening, but the question is, how effective will they be?
Big country, big issues
Brazil now boasts the seventh largest economy in the world when measured by gross domestic product (GDP), beneath the UK and above Italy. Its economy has been fuelled by high commodities prices and new oil discoveries, but the country is still plagued by some serious and deep-rooted problems, such as its inadequate infrastructure, excessive bureaucracy and exorbitant corporate taxation.
The country has about 1.6 million kilometres of roads but less than 12% is paved. Brazil itself is of a similar size to the US but its train network is smaller than that of France, and São Paulo's Guarulhos International Airport has established a reputation of being heavily congested whenever its user numbers rise above the average. More pressing concerns, particularly among smaller businesses, are the country's high taxes and its bureaucratic maze of legislation. And small businesses' concerns should not be overlooked as an estimated 80% of jobs being created in Brazil are through small and medium sized companies (SMEs).
The World Bank’s 2011 Doing Business in Brazil report states that taxes, including profit tax, labour and other compulsory contributions, suck up 69% of Brazilian corporates’ profits. Preparing, filing and paying – or withholding – such taxes takes up a total of 2600 hours per year – far longer than in any other country surveyed.
Too much legislation
“We joke around here, saying that the tax code was made for the tax auditors because they can always catch you [breaking some rule],” says Reynaldo Figueiro, president of Connec, a small software company, and an investor in other ventures ranging from shrimp farming to financing university students.
Cesar Gon, founder of another Brazilian software company, Ci&T, agrees. He says: “It is impossible to keep up with legislation. In Brazil you can have a company and run it for 30 years and not comply with all the rules. But if you stay small you will not get noticed.” And this is something that many decide to do, says Mr Gon.
But purposely staying small to remain under the bureaucratic radar harms not only the overall economy – as businesses do not generate the high turnovers and employment rates that they potentially could – it also has a negative effect on the entrepreneurial spirit of the country.
Stark comparisons
Ci&T took a more ambitious view to expansion, making sure that the structure of the company met the necessary requirements to support its growth. It has now expanded its operations internationally, and has been surprised by the assistance it has received from governments in other countries.
“We were looking to expand into the town of Ningbo, China where there are 6000 computer engineer graduates per year,” says Mr Gon. “But we struggled to convince local senior managers to move from Shanghai or Beijing to Ningbo. We talked to the local authorities and they created tax breaks for people based in Ningbo. [The issue] was discussed and resolved in two months.”
This kind of resolute approach may not be found in many other countries, but its stark comparison with the situation in Brazil makes it all the more disheartening for businesses in the country. “Brazil has one of the best planning strategies for technology parks [in the world], but we can’t [materialise it],” says Mr Gon.
The same kind of inertia is preventing the Brazilian government from simplifying the country's copious fiscal rules and reducing the high levels of taxes corporates are subjected to. “The [government has] been talking about simplifying tax rules for 15 years but it doesn’t happen,” says Mr Figueiro. “It is politically very difficult to implement. Redistributing tax revenues between the three levels of government – city, state, federal – is a really tricky thing. If you redistribute the revenues you have to redistribute the functions and the service that is provided.”
Small steps
Change is happening, however, at least with regards to the level of taxes businesses pay. The government recently introduced tax breaks for local manufacturers in four labour-intensive sectors: clothing, footware, furniture and software. This was designed to help with the tough competition presented by cheaper imported goods – a problem that has been exacerbated by the real’s high exchange rate.
Another issue often cited by entrepreneurs is the length of time required to set up a business in Brazil. The World Bank’s data indicates that it takes about four months to open a company – more than twice the average in Latin America – and four years to shut it down, which is a fifth longer than the region’s average. This is a concern for the country's financial sector, which would service these small companies, as it delays the growth of their loan books. “[The process] has improved, but it still takes a very long time to set up a company – it is far from ideal,” says Carlos Maccariello, head of Itaú Unibanco’s SME business. “Various sectors' associations – including us through the banking association, Febraban – get together to try and rationalise the process.”
Slowly, however, there have been important improvements made to the financial structure supporting SMEs. Food company Delicake has tasted this first hand. The company’s founder, Elias Freire, opened his first store in 2009; he now owns a second one and has granted two franchises in São Paulo. His annual turnover is about 700,000 reais ($435,000).
In a scenario that would have been unthinkable only few years ago, Mr Freire was recently approached by a private investor, V2Finance. “One of the customers at the store was chatting to me and started asking how I finance the business,” he says. “I told him I hadn’t changed my car in years and never shoe shop. He said [V2Finance] would be interested in helping. Then, six months later, I called when I wanted to build a factory. [V2Finance wanted] 40% of the company. That was fine, as long as I remain in control of it.”
Attracting capital
There is a private investor community in the making in Brazil. JPMorgan’s Gavea Investimentos, Blackstone, Carlyle and KKR all raised Brazilian-focused funds in 2011, and investment vehicles have been set up by Brazil-based BTG Pactual and lenders such as Itaú Unibanco, Bradesco and Santander Brasil.
The Brazilian venture capital and private equity association, ABVCAP, estimates that from the industry's sleepy beginnings 15 years ago, a total $20bn has been raised – excluding the billions of dollars raised in 2011 – and between 60% and 70% of that capital has already been deployed.
“We now have lots of venture capital funds,” says Sidney Chameh, president of ABVCAP. “There is now money available for all of the growth phases and we think this will continue. If you add the Brazilian macroeconomic scenario to the new and better entrepreneurship culture and the availability of money to be invested, we believe that the growth of the sector is going to be tremendous.”
As more equity investors turn their attention to the Brazilian market, it is likely that areas of the country in need of modernisation will eventually generate business ventures. With Brazil set to host the 2014 football World Cup and 2016 Olympic Games, infrastructure is a sector where change is expected – although planned works for these events are severely delayed.
“Considering the long-term [economic] prospects of Brazil, we do need a lot of infrastructure, not only for sporting events,” says Mr Chameh. “And this infrastructure is going to catch the attention of other investments in other sectors that are going to serve this infrastructure – if you have [new] trains, someone is going to do a small piece [of equipment] for the train, and [someone else is] going to develop a service for the food served on the train.”
High interest rates
But despite the increased interest of early-stage investors, companies looking to grow are facing other issues. The exorbitant interest rates charged by lenders are, unsurprisingly, a key concern. As of May this year, the average annual interest rate on corporate loans in Brazil was more than 31%. “Financing from banks is suicidal,” says Mr Figueiro, a former banker himself. “If you go down that road it is the shortest way to death. [If you are a small company], they’ll charge you an arm and a leg and in six months you’re dead.”
Alexandre Costa e Silva, president of internet radio company Neovia, agrees. “Private sector loans are atrociously high,” he says. Neovia has a turnover of about $35m reais and is highly leveraged by its stockholders, who put in both equity and loans. “When [banks] look at our balance sheet, they think that our risk is high [because of the high level of leverage]. But it’s a chicken and egg situation: I’m in this shape because money is short,” says Mr Costa e Silva.
Help has come from Brazil’s development bank BNDES, which provides investments and financing to small companies that meet certain criteria, as well as from Sebrae, the association of SMEs, and Finep, the governmental agency for innovation, both of which provide advice and training.
Despite businesses’ complaints about high interest rates and the overly conservative approach to lending, banks have been looking closely at the small businesses segment and have increased their exposure to it, thanks in part to the better shape many of these companies are now in.
Clenio Severio Teribele, director of Banco do Brasil’s SME division, says that loans to its smaller clients have grown by more than 25% a year on average since 2003. Last year, the bank lent almost $50bn reais to the sector. Mr Maccariello at Itaú Unibanco presents a similar picture. His bank’s small companies loan book grew by 28% in 2010, while other client segments grew by an average of just 15%. He has also noticed a significant reduction in start-up businesses’ mortality rate, which stood at 75% a decade ago, and has now dropped to 45%.
Stuck in the middle
Banking products available to small businesses include loans originating from BNDES funds and disbursed through private banks. These are often issued with the condition that the funds will be used to purchase equipment manufactured in Brazil. An understandable policy, which, however, does not always suit all businesses. Mr Costa e Silva says that his company cannot really benefit from this BNDES financing programme because most of the equipment crucial to his business is manufactured abroad. He adds that other IT businesses find themselves in a similar situation.
Consolidation in recent years has reorganised Brazil's banking sector, focusing some medium-sized lenders onto smaller clients. Servicing this market, however, seems to pose challenges to second-tier banks, which have fewer resources and less coverage than the larger players.
“Some medium-sized banks are trying to move into corporate finance,” says Angela Martins, executive director of Banco Pine, a medium-sized bank itself. “But there are difficulties. Middle market companies have between $30m reais to $150m reais in turnover. Risks in this segment are difficult to evaluate, and you also have to compete with the large banks. It is difficult to decide how much credit to give to those companies; they usually tend to just discount receivables.”
Banco Indusval’s medium-sized clients represent 80% of its business. “After the consolidation of the banking system in Brazil, we became more and more important for those companies because [the] big banks pretty much concentrated on personal lending or big corporates,” says Kátia Moroni, executive vice-president of Banco Indusval.
“When I started here in 2003, it was very difficult for a small company to export its products,” says Ms Moroni. “We had to advise them on how to export, how to access the international market, how they could grow internationally – so we provided financing and effectively advisory services. Now the same type of companies are more sophisticated, they have internalised those [advisory services], they have excess of working capital. They have grown a lot.”
IFC involvement
As the needs of SMEs change, so does the positioning of second-tier banks, which find themselves squeezed between the competition posed by larger lenders and the growing demands of small companies. “Since the large financial institutions in Brazil are very competent, medium-sized banks [are most] successful in areas where they do not compete directly with large players or where they complement what large players do,” says Ms Martins.
The International Finance Corporation (IFC) spotted this shift in the market and a few years ago decided to modify its involvement in the Brazilian banking sector. “We had traditionally worked with the leading players but in 2005 we decided to focus on medium-sized banks,” says Antonio Alves, the IFC’s senior regional head of short-term finance for the Latin America and Caribbean region. “Top-tier banks don’t need us, and we don’t really help small businesses if we work with them.”
Since 2005, the IFC has increased the number of second-tier banks it partners with from three to nine, which has led to an increase in the total amount of financing provided to them, the figure jumping from $45m to $700m. The IFC is also developing a programme which finances small corporates directly, across all industries, for businesses which the corporation considers worthy of additional credit to what the company’s bank is prepared to offer.
The programme is due to begin operations in early 2012. The agribusiness sector is likely to gain the most out of this given the number and success of small producers and exporters, but small firms servicing the metals industries, the oil industry, as well as leather producers and manufacturers of agricultural machineries are also set to continue growing in the future, and therefore will require significantly higher financing.
Entrepreneurial spirit
If there is disagreement about how well small businesses are served by the local financial community, one thing that all parties agree on is that the most important and palpable change has already happened. Because there has been a change in the perception of what being an entrepreneur means, a genuine entrepreneurial culture has been created. While the large number of new companies that have entered the market over the years may suggest that Brazil has always had a strong entrepreneurial spirit, it was often the case in the past that setting up a small shop, restaurant or services activity was a result of high unemployment and a lack of other viable alternatives.
“Here in Brazil we have statistics showing that we are a very entrepreneurial country; I am not sure this [has always been] true,” says ABVCAP's Mr Chameh. “During the past 10 years we had one entrepreneur of quality, with a view and knowledge of the market, with a good product or service, [for every] three entrepreneurs that were there just to survive. Now this is changing to one entrepreneur who does it to survive to 1.7 of [entrepreneurs with good opportunities] so this is really changing the future of the country.”
The establishment of a genuine entrepreneurial culture may be the less obvious but more promising change that Brazil is experiencing.
