After nine months in office, many believe that Lula’s election promises are beginning to wear thin as growth falters and high interest rates hamper Brazil’s business sector.
During last year’s presidential election, Brazil’s corporate sector was split more evenly than many expected between José Serra, centrist candidate of the outgoing Party of the Brazilian Social Democracy (PSDC) of Fernando Henrique Cardoso, and the former firebrand leftwinger and eventual winner, Luiz Inácio Lula da Silva of the Workers’ Party (PT).
Many businesses liked Lula’s commitment to growth and hoped for a change of emphasis from the fiscal austerity and tight monetary policy of the previous eight years. With growth during those years having averaged barely more than 2% a year, many were prepared to give the other guy a chance.
Nine months into the new government’s tenure, fiscal and monetary policies remain virtually unchanged. Most business leaders applaud the government’s success in steering the country out of last year’s crisis and preparing the ground for growth. But many have become impatient with the low rate of growth, and with what they regard as the slow pace at which interest rates have fallen. There is also concern about a lack of definition to some aspects of industrial policy.
“What we want, above all, is clear polices, not this constant leaking of what might be about to happen,” says Joăo Batista Simăo, president of Abrac, the association of General Motors distributors in Brazil.
The auto industry is among those most affected by slow growth, high unemployment and high interest rates, as consumers facing an uncertain future are unwilling to commit to years of loan repayments. Auto makers have invested nearly $30bn in Brazil since 1997 expecting the market to grow quickly. Instead, with the economy reeling under the impact of a series of external and internal shocks, sales have slumped. Auto sales in the home market this year will be about 1.3 million vehicles, down from a peak of 2 million in 1997. However, the industry has capacity to produce 3.2 million vehicles.
Empty gestures
The government bowed to industry pressure in August and reduced the sales tax on cars temporarily until the end of November. There has been talk of longer-term cuts and the creation of a ‘sectoral chamber’ for the industry, bringing together manufacturers, trades unions and the government to discuss policy. But nothing more concrete has emerged.
There have been complaints, too, about a lack of clarity in policies covering privatised industries such as electricity and telecommunications. Power shortages in 2001, due to low rainfall (more than 90% of Brazil’s electricity comes from hydroelectric power stations) and poor planning, forced the government to introduce rationing. Further shortages are likely if the government cannot encourage the private sector to invest more in power generation. A new model for the industry was unveiled in July, but many aspects, some affecting profitability, remain unclear. Uncertainty has dogged the industry since many distributors were privatised in the late 1990s.
“It’s fair criticism to say that when we invested, we were investing in a regulatory system that was not fully developed,” says Steven Clancy, who stepped down in September as president of Eletropaulo, the Săo Paulo distributor controlled by AES of the US. “As the system has developed, there have been differences between regulators and investors.”
In telecommunications, a row erupted earlier this year when the telecommunications minister tried to overturn tariff increases stipulated in concession contracts. Telephone companies won the battle, but uncertainty has been fuelled by suggestions from within the government that three regulatory agencies set up by the previous government for the telecommunications, electricity and oil industries could face changes to their status.
Tightening regulation
When The Banker interviewed him in September, finance minister Antônio Palocci said the government was preparing a “definitive statement” on the agencies and on Brazil’s overlapping competitions watchdogs.
“There’s been a lot of debate over whether it was right to introduce the agency system,” he said, “but today our aim is to strengthen both the agencies and the ministries to carry out their roles. Policies and strategies will be the responsibility of the ministries, and regulation, contracts, inspection, oversight of competition, all this will be done by the agencies. At the same time we will strengthen our systems for defending competition. We want to guarantee to investors that contracts will be respected and that competition will be protected.”
The detail of what may or may not change at the agencies and competitions watchdogs will emerge only later. Yet reducing uncertainty will be crucial if the government is to encourage more badly needed private sector investment in infrastructure and in the productive economy in general. Foreign direct investment in Brazil fell from a peak of $32.8bn in 2000 to an estimated $8bn to $10bn this year, partly on concerns that a PT government would over-regulate the private sector.
Reducing uncertainty will also enable Brazilian companies to borrow overseas at lower interest rates. Companhia Vale do Rio Doce (CVRD), the world’s biggest exporter of iron ore, this year became the first Brazilian company to sell bonds on international markets at a lower rate than Brazilian sovereign bonds. It sold a $300m 10-year bond with a yield of 9.25% a year, compared with an annual yield of 12.582% for the comparable Brazilian sovereign.
“If our cost of capital falls, everything changes for us,” says Roger Agnelli, CVRD’s president. “We get more attractive returns, and it increases the potential of our business. Any investment we make has to take into account the return over and above the cost of capital, and our cost of capital is affected by the sovereign risk.”
Lower borrowing costs are helping CVRD to pursue an investment and restructuring plan to concentrate on its core activities in mining, energy and logistics. With 85% of its earnings from overseas markets, it is one of a group of big Brazilian exporters to have benefited from the devaluation of the real last year.
Export benefit
Embraer, the manufacturer of regional and military aircraft, exports 97% of its output and has also done well from devaluation. But the company, which used to be Brazil’s biggest export earner, has suffered from the downturn in the global aviation industry exacerbated by the 9/11 terrorist attacks. The company saw its aircraft deliveries fall from 171 in 2001 to 132 in 2002 and to 110 this year. But Maurício Botelho, president, says Embraer is well placed to take advantage of changes in air travel.
“The crisis is so strong that it’s forcing airlines to reconsider their mission,” he says. “The big airlines are in a crisis of shrinking traffic, but if you look at the low-cost, regional airlines, you see an increase in profits.”
Mr Botelho says this has been good for Embraer’s recently-launched family of Embraer 170/190 jets which fill a gap in the market between 90-seat and 120-seat aircraft. Embraer has signed contracts this year to supply 234 of the new jets to airlines including JetBlue of the US and Lot of Poland, with another 289 units under option. Total deliveries will rise to 160 aircraft next year.
Embraer’s dependency on the export market means its performance is largely immune to volatility in Brazil’s economy. Mr Botelho even discounts the positive effect of last year’s devaluation on the company’s local currency earnings, seeing results in dollars and US GAAP as a better reflection of performance. Nevertheless its value base, as he puts it, is in Brazil and, like CVRD, its borrowing costs are linked to sovereign risk. He is positive about the Lula administration’s performance so far: “They’re showing themselves to be highly competent. They have secured the country’s credibility overseas, and overcome the twin threats of inflation and devaluation.”
Nevertheless, the outlook faced by those selling to the domestic market remains less encouraging. Marcel Telles, co-chairman of the brewing and soft drinks group Ambev, says the fall in consumer earnings this year has held market growth in check.
“The most relevant relationship for us is not with GDP but with disposable income,” he said during a recent conference call. “Even if GDP grows this year, people have less disposable income, or at best their income has remained stable. We are managing to keep price increases below inflation, but disposable income hasn’t grown at the same rate, it’s declined.”
Mr Telles expects Ambev’s sales to grow by 2% in volume terms this year, provided the economy picks up in the second half. “Our market is very much affected by consumer confidence,” he says. “When you go through a period like the last 12 or 18 months, when people are very unsure about the health of the economy, everyone holds back a little.”
Overcoming that insecurity is one of the biggest challenges facing the government over the next 12 months.
