All Eyes on Rio: Navigating the Changing Geo-Economic Landscape in Brazil
All eyes are on Brazil. With interim President Michel Temer at the helm, foreign companies are doing deals within the country across sectors, taking advantage of the window to inject capital into a newly invigorated and pragmatic Brazil.
When we look at Brazil, we see three key emerging themes:
- At the macroeconomic level, the government is taking pragmatic measures to restore fiscal equilibrium, including placing a ceiling on real government spending. The market is pricing in these confidence-building measures, with a steady rebound in the Bovespa and a rally in the Brazilian Real. This strengthening indicates that the moment to scout for bargains is swiftly receding and the window to invest and allocate capital in Brazil is now.
- At the geopolitical level, we may see violence or street demonstrations in Rio. While this may jolt some investors, it is wise to hold one’s hat, as this unrest has preceded major sporting events in Brazil in the past.
- At the sector level, we are seeing a high volume of deals in the financial services, insurance, and technology areas, as Temer’s government is focused on luring in more foreign business. With Brazil’s diversified economy, youthful population of 200mn, and bountiful industrial capacity, companies may want to take advantage of the moment to allocate capital in the country as the Temer cabinet’s confidence-building actions take effect.
Improving macroeconomic conditions: seize the moment
Contrary to the waves of populism undulating within the transatlantic community, Latin America is experiencing a surge in pragmatism. While Peruvians have elected a self-proclaimed ‘technocrat’[1]as their president, Argentina welcomed its first non-Peronist leader in 14 years.[2] This countervailing wind to populism swept Brazil, where the interim president has appointed a cabinet of seasoned — officials who are in alignment with his chief prerogatives of reducing government indebtedness and combating inflation. An adroit politician, interim president Temer is ‘cut from…nonideological [sic] cloth’, personifying the wave of pragmatism currently sweeping across the region.[3]
Since taking office in mid-May amidst impeachment proceedings of his predecessor, the president has taken deliberate actions to restore confidence in the economy by placing a ceiling on government expenditure. The market has priced in this confidence, as the Bovespa (Brazil’s stock exchange) rallied, and the Brazilian Real jumped 19% (to about 3.27 against the dollar)[4] — making it the currency which gained the most ground against the US dollar this year.[5]
The government is also making concessions to lure in foreign direct investment.With the appointment of Moreira Franco as Secretary of Investment, Temer seeks to implement reforms in order to ease existing restrictions on foreign ownership across sectors.[6] With the new Speaker of the House appointed by the interim president (the first centre-right head of Congress in 21 years),[8] such pro-business motions have greater potential to pass.
The government also sits atop approximately $350bn of foreign currency reserveswhich, following a variety of intervention methods and reverse swap mechanisms[9], the central bank has avoided having to draw upon. This is in contrast to other commodity exporting countries who have had to redeem part of their foreign currency reserves amidst the sustained downturn in oil prices since mid-2014.
Geopolitical and social conditions: Hold onto your hats.
Despite improving macroeconomic conditions, some foreign companies considering investing in Brazil may be deterred by potential violence that accompanies international sporting events in the country. We may see protests taking to the streets. In both the Pan-American Games in 2007 and the World Cup in 2014[10], Brazil witnessed clashes between gangs and police ahead of major sporting events. Potential investors should not be alarmed by such demonstrations.
Although the Zika virus has caused health concerns, the US Center for Disease Control (CDC) recently announced the risk of contracting the virus this summer to be lower over the Southern Hemisphere winter period [11] and the World Health Organization (WHO) has asserted that the risk of the virus spreading from Brazil this month to be ‘very low’[12]. Concerns, though, have caused some tourists to cancel their plans.
Looking beyond this summer, as the government induces fiscal austerity — and as an emerging middle class continues to demand greater accountability and transparency (a call not unique to Brazil) — we are likely to witness more street protests. As we know, belt tightening measures are never popular. However, if the interim president is successful in trimming government indebtedness, this is likely to strengthen his hand allowing for deeper reforms, leading up to the next presidential election in 2018.
Beyond the Black Gold: allocating capital across sectors
Brazil is blessed with an abundance of resources, and an economy diversified well beyond oil and gas. Undoubtedly, mining and O&G exploration and production (E&P) have been hard-hit in Brazil, due to the compounded adverse effects of the plunge in commodity prices since mid-2014 and repercussions from the anti-corruption ‘Lava Jato’ operation. However, in 2016, the diversified sectors of technology, financial services (FS), and insurance are leading the charge in M&A activities and interest from private equity and venture capital groups.[13] From 1Q16 and leading up to June 2016, venture capital money has poured into Brazil to fund startup accelerators, telecoms, and app developers.[14] The government has responded in kind to this foreign investor interest by indicating a new stream of privatizations, which may extend across sectors and into infrastructure projects. This activity is on top of the promotion of the well-established software and technology development ecosystems.
Beyond FS and technology/IT sectors, many foreign companies keep a close eye on the prize that is Brazil’s consumer economy. Per capita income grew tenfold from 1970–2011,[15] enabling an emerging middle class to buy goods on credit and providing a boon for retail and consumer companies. The end-consumer, though, may be the last to recover. Although the central bank is focused on holding inflation below 4.7% p.a. by the end of 2017, stabilizing the currency, and getting interest rates to 11%,[16], these efforts will take time to unfold. Consequently, even though deals in the consumer sector currently trail the financial/insurance and technology sectors, the current dislocation [17] may yield an opening for retail companies to consider a strategy to allocate capital in Brazil.
In this age of digital innovation, Brazil also presents an opportunity to develop local solutions to local problems, and export them to other countries. São Paulo is the 5th largest urban area in the world,[18] and its sprawling city landscape presents a ripe testbed to develop digital solutions to infrastructural challenges. For example, one start-up company in São Paulo enjoying significant success provides green/ecological laundry service via online ordering– a creative solution addressing acute water shortages, which may work in other countries facing the same issues. With a skilled workforce (Brazil has a median age of 31), and a marked culture of youthful entrepreneurship, the country yields a patent opportunity to incubate and export innovation to solve complex problems in markets beyond its borders.
Prospects
Going forward, investors and companies with their eyes on Brazil stand to benefit from the interim (and potentially permanent) government’s emphasis on easing regulations across sectors — potentially extending from agricultural land and airports into telecommunications. The democratic institutions and the freedom of press are robust. This is evidenced by efforts to curb perceived illicit acts which have, at times, caused the Brazilian judiciary to concede injunctions to limit internet messaging apps . These interruptions were quickly overturned by higher courts.
Such interventionist risks will need to be balanced by the sheer opportunity of having access to Brazil’s demographically abundant urban centres — populated with a young educated workforce — as a locus for innovation, and as a jumping-off pad to service the wider region, and to apply lessons learned to other global markets. After all, as a wave of pragmatism extends across the Latin American continent, investing in a slowly but steadily recovering Brazil might present a preferable alternative to allocating capital in advanced economies, marked by expensive equities, negative interest rates, and the choppy waters of populism.
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For additional information about this topic and how PwC can help, please contact:
Dr Alexis Crow, Advisory, Lead, Geopolitical Opportunity Team
(212) 203–8609, alexis.a.crow@pwc.com
David Sapin, Advisory, Risk & Regulatory Leader
(202) 756–1737, david.sapin@pwc.com
Brian Dunch, Advisory, Risk & Regulatory Principal
(703) 835–5994, brian.s.dunch@pwc.com
Cornering the Globe is a publication of PwC’s Advisory Risk and Regulatory practice, and is intended to highlight key issues our clients should be considering as they think about expanding into global markets. At the Macro level, long-term economic and demographic trends indicate an abundance of opportunities to profit and expand in emerging markets. However, the risks of doing business in these regions — such as exchange rate volatility, political uncertainty, meeting the skills gap, and shifts in tax and regulation — often hamper decision-making, forcing companies to react to events, rather than prepare for change, and capitalize on potential dislocations. By critically assessing key geopolitical issues that impact our clients, we provide insight into the ways in which companies can build capabilities to weather political and economic change in their foreign operations. Our Geopolitical Opportunity team combines rigorous insight into the key macroeconomic and geopolitical issues facing business leaders today, with deep industry and sector expertise, helping companies to strategically allocate capital to grow specific business units or assets in markets around the world.
