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Volume XXXIII No. 3 (July-September 1998)
The Privatization Process and Foreign Direct Investments in Brazil: Results and Perspectives
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By Gilson Schwartz
There has been a growing perception of political risk in the Asian emerging markets, which was heightened with the highly contagious financial crises that has spread throughout the region and even spilled-over to other emerging markets since mid-1997. From Thailand to Hong Kong, not to mention Indonesia and the Koreas, but also in Russia, Venezuela and Mexico, political as well as economic tensions are visible. At the same time, although Latin America has also become a target of speculative attacks against its currencies, Mexico showed enormous resilience to the 1994 crisis and Brazil stands as some sort of Latin American China: a key geopolitical player as well as the major recipient of foreign direct investments.
The most important question now is whether Latin America will be able to remain a relatively safe haven during the Asian bail-out, as the Asians gradually became during the 80s (to the point of forging a new “economic miracle”), when the Latins were subject to a “lost decade” of foreign debt restructuring, hyper-inflation and fiscal meltdown. However, given the severity of the present crisis, it might also be the case that no emerging market will be spared the costs of an enduring sacrifice.
Latin America is not immune to criticism and doubts. The key geopolitical issue in this respect is the uncertainty of US-Latin American relations, especially after the defeat of President Clinton’s fast track proposal in the US Congress. This openly contrasts with the pragmatic US approach to relations with China or Russia, for instance. However, this might be a window of opportunity for the expansion of the Common Market of the Southern Cone (Mercosul), not only in its relations with other Latin American economies but also with the European Union and even Asia. This has been, as a matter of fact, the perspective of the Brazilian government in its open resistance to a faster integration of Mercosul into the Free Trade Area of the Americas (FTAA).
Brazilian diplomacy is working within the framework of the so-called “global trader” hypothesis and, as a consequence, the country aspires to being a global player. However, as available data suggest, the importance of US multinationals is still astounding and there is a growing perception that the higher level of financial dependency leads to a necessary compromise with US interests and financial institutions.
In the Southern Cone, Mercosul is advancing towards a South American Free Trade Area (SAFTA). The Chilean government has implemented a package of incentives, especially for the agricultural sector, intended to create the necessary support for the Mercosul agreement. The Andean Pact is also pursuing a similar approach. But the region is still subject to political skepticism. This time the obstacles to structural reform are not the key issue, but the movements in countries like Argentina, Peru and Brazil for re-election of their presidents, with possible political concessions to gain popular support (in other words, there is again the risk of populist policies).
The Brazilian government focuses its policies on reconstruction of the development model as a second stage after the price stabilization plan (Plano Real), centered on the definition of a new import substitution process linked to a far-reaching privatization process. The degree of foreign trade and financial liberalization is now seen as excessive by important business and political leaders in Brazil.
In 1998, Brazil will have the lowest inflation ever in the past half century (about 2 percent annually). Unlike during former stabilization plans, this time the government has not pushed inflation down through price freezes, but rather used an exchange rate anchor and trade opening. The exchange rate depends on the credibility of current policies in international capital markets, while the trade opening is gradually being reversed to safer levels (from the viewpoint of domestic producers). The key to a successful transition is in the shift from consumer-led to investment-led growth, based on privatizations and foreign direct investment in booming sectors. At the same time, the government is pushing through special industrial policies in labor-intensive sectors such as toys, amusement parks and, to some extent, the automobile sector (privileged also because it could become an export platform and a crucial import substitution sector).
In short, it can be said that the tripod upon which the new Brazilian development model rests (privatization, new import substitution model and foreign funding) is still subject to economic and political uncertainties, due to the frailties of the stabilization plan itself, especially under external financial instability, even though it must be acknowledged that private investment and privatization are proceeding at a relatively fast pace. As more than one observer has pointed out, when price stability depends on capital inflows that are wary of trade and current account deficits, and given the fact that higher growth would entail higher balance of payments imbalances, it is absolutely necessary to repress growth in order to manage the exchange rate. This is one of the fundamental frailties of the new model, so far, because it is a fact that the expansion of the Brazilian consumer market has become a key factor for the attraction of foreign investors.
On the other hand, the Real Plan has shed new light on the Brazilian tax crisis and made it clear that the government has basic problems in this area. In order to attracted foreign funds, especially short term capitals, a high interest rate must be imposed by the Central Bank. This results in the Treasury spending more than it earns, as it services a mounting domestic debt.
The period immediately after the introduction of the Real Plan (July 1994) was marked by a consumption boom. If the income of active workers alone, as measured by the Brazilian Institute of Geography and Statistics (IBGE), is considered, the actual income gain resulting from the fall in inflation rates amounted to 20.6 percent between June and December 1994. 1 A new element was brought in by stabilization: credit (to buy in installments) again became an attractive and possible funding for consumption.
There was a strong deferred demand for durable goods, particularly for less sophisticated models. The sale of stoves, for example, grew by 65 percent in the first semester of 1994, as compared to the 62 percent growth presented by home appliances and electro-electronics as a whole. Car sector sales grew 10.3 percent in the same semester, particularly popular models (44.2 percent increase). Financing terms for consumers increased and interest rates practiced by retailers went down, although they remain at high levels to date. Availability and consumption of imported items grew as never before, according to figures released by the various business associations. 2
The rising consumption resulting from the economic stabilization process occurred in parallel with a series of changes already observed since 1988, the most outstanding being the opening of the economy and the restructuring going on in the manufacturing sector in search of enhanced competitiveness. This combination soon reflected on foreign exchange data. The main cause for the deterioration of the trade balance reported in the second semester of 1994 was the increase in imports, particularly cars and other durable goods.
Trade deficits became a source of concern as of December 1994, with the Mexican economic crisis and the possibility of the so-called “tequila effect” (contagious capital flight out of Latin American emerging markets). This gave way to a different regime characterized by a stop-and-go policy.
>From December 1994 to April 1995, the government adopted a number of measures to curb consumption by attacking the main driving force behind it: the increase in the supply of credit. Leasing operations for individuals were prohibited; the term extent for purchase in groups ( consórcios) was curtailed, operations with credit cards and consumer loans reduced; the rate of IOF (Tax on Financial Operations) levied on consumer loans increased; and restrictions imposed on factoring. The results of the consumption constraints were, however, greater than expected by the government: manufacturing production and trade sales dropped sharply and default became rampant. Flexibility was called for as of the second semester of 1995, as the banking system was under unprecedented distress.
Economic activity recovered throughout 1996, fueled again by rising credit supply, and was concentrated on the segment of durable goods, while other sectors improved more slowly. The result was a significant disparity in the performance of segments. The production of capital goods, for example, continued to drop. By early 1997 economic activity indicators were again showing a more impressive recovery, but then the Asian crisis initiated a new wave of financial instability. From “go”, economic policy once more had to emphasize “stop”. In October, 1997, annual interest rates were doubled to 40 percent, leading to a severe deterioration of public finance and an almost complete halt in economic activity.
This fiscal imbalances are also rooted in the so-called primary accounts (that is, financial expenditures excluded). The federal government is unable to meet payroll expenses in its entirety (inclusive of retirees and pensioners) with funds of a tax nature. This is a consequence of the fact that, in the post-1988 fiscal regime, the total non-finance revenue share that can be allocated to such purposes has fallen significantly below expenses in view of the numerous commitments of that revenue to other purposes. In 1995, for example, the government had to issue R$ 7 billion ( reais) in fresh security notes to bridge this gap alone; something obviously incompatible with the implementation of any sort of stabilization plan. Secondly, non-finance expenses tend to grow at a higher rate than tax collection. Basically, this concerns open accounts (retirees and pensioners, social security benefits, health, unemployment insurance and social care), where different mechanisms cause a substantial increase in expenses that is substantially unrelated to what happens on the revenue side.
From Stabilization to a New Development Model
Despite these macroeconomic quandaries, it is important to emphasize that qualitative changes of such magnitude are taking place in the Brazilian economy today that it is almost impossible to make forecasts based on historical data. One example is the behavior of the trade balance and its relation to new capital-intensive investments.
One common hypothesis is that there are limits to growth because imports grow faster than exports. If there is, however, a significant upswing in investment in the medium- and long-term, the results of the trade balance and other macro-economic indicators could show significant improvement when, for example, there is an upgrade of exports or even an exhaustion of the initial rise in imports motivated by the investment cycle.
Moreover, investments are supposed to bring about reductions in costs and an improved infrastructure. But if the economy is undergoing a qualitative transformation, trade balance forecasts, for example, can no longer be based on the historical elasticity between the level of activity and imports.
At the same time, it is crucial to realize that the stabilization process itself produces both inter- and intra-sectoral differentiation. However, qualitative changes and productive differentiation makes the process of creating credit and evaluating credit risks in the banking system extremely difficult. Add to this the fact that in some countries, like Brazil, a model of credit analysis has yet to be created, or is only now being created, after the implosion of the consumption bubble. As long as the credit system is immature, the difficulties in creating long-term or sector-specific funding are naturally greater, which makes the take-off investment much harder and slower.
Political obstacles must of course be added to these difficulties, especially with respect to the public credit system and the flexibility of government spending. The confidence factor becomes crucial for private investors’ decisions, especially expectations of long-lasting fiscal adjustment.
Financing for investment is therefore determined by both sectoral dynamics and political factors. While the foundations of the economic system are changing, percent-1 the financial system works with states of confidence in rapid mutation. Given the low level of domestic savings and the fact that stabilization depends on the exchange anchor, there is also a growth constraint set by macroeconomic percent 0 factors.
The crisis/creation of a credit system, the problem of confidence in a phase of sectoral and institutional transformation and the limits to growth imposed by the exchange anchor are, therefore, the three fundamental factors which now condition the success of a new development process.
Intra- and Inter-Sectoral Differentiation
Many innovations in terms of institutional design are taking place in Brazil, in an attempt both to handle the crisis and to create conditions to start a new phase of development with renewed investments. One of the main innovations is the resuscitation of a planning system, which never ceased to exist and produce diagnostics, including agencies such as the Instituto de Pesquisa Econômica Aplicada, under the Ministry of Planning (IPEA), and development banks such as the Banco Nacional de Desenvolvimento Econômico e Social (BNDES).
There is a clear movement to create this institutional context which is associated with a strong developmentist tradition. Curiously, at this very moment, the so-called “new consensus in Washington” underlines the importance of “institution building”, that is, creation of a business-friendly environment as part of the economic adjustment process, beyond the strict macroeconomic policy rules. 3
Moreover, the government is increasingly resorting to “policy-oriented credits”. The BNDES budget for 1998 reaches the record figure of R$ 20 billion, larger than the Inter-American Development Bank (IDB) budget, for instance. This state bank is one of the main levers being used by the government, both for differentiated credit support for businesses and exports in various industrial sectors and in the clean-up of state finances through programs that anticipate privatization revenues, besides its subsidiary role as a funding instrument in the privatization process itself.
The Ministry of Industry and Trade is also implementing a system of selective trade liberalization, which does not reverse trade opening, but allows for some compensation in selected sectors—frequently crucial to the survival of domestic companies. It also creates institutions to supervise non-tariff barriers and unfair commercial practices, while a new Foreign Trade Chamber was created under the Presidency.
These examples manifest a commitment to avoid de-industrialization, while trying to launch new bases for a long-term credit system. In other words, the macro-stabilization model sets the foundation for a more ample institutional and economic reform. In several industrial sectors, heterogeneity and transformation have been tremendous and the government is re-creating instruments of selective intervention. The privatization process is one of the crucial aspects of this structural transformation. The potential for privatization in Brazil is enormous. It could be a source of dynamism, but this depends on the inclination of those in power and the political system.
Thus, while exchange and interest rates seem immobilized in a routine of stability, the industrial sectors will be witnessing transformation which, for the optimists, will lead to the definition of a new growth cycle. For the pessimists, the major obstacle is the difficulty (essentially political) in enacting more profound and rapid reform of the state. Without the necessary fiscal adjustment, not even the BNDES will be able to compensate for the effects of high interest rates over the aggregate rate of investment. Moreover, while there is a substitution of national goods for imported ones, various sectors will be denationalized and some disinvestment will occur, an antithesis to the traditional import substitution model.
Towards a New Import Substitution Model
Higher imports, spurred by demand for machinery and technology, will sooner or later create a new, more competitive industrial structure, so that in the end exports will also increase and grow. This is the basic logic behind the new Import Substitution Model, implemented with the support of higher tariffs in some sectors (especially the automobile sector), new export promotion funds and the usual bureaucratic, non-tariff barriers to imports.
The Brazilian automobile industry has always received attention from researchers in industrial organization and policy-makers, due to its weight in the country’s industrial structure, its effects on the production chain and its capacity to, directly or indirectly, generate employment. The “automotive regime” continues to be one of the key aspects of Brazilian industrial policy.
After twelve consecutive years of unstable but stagnant behaviour (around 700,000 units per year), the Brazilian vehicle market started to grow again in 1993. The average annual growth rate of 20 percent in internal vehicle sales (in units) over the 1993-96 period is comparable only to the most expansive phase in demand at the beginning of the seventies. In the long term, periods of growth in demand are well defined: from 1971 to 1979 and from 1993 to 1996, separated by a long period of stagnation. Sales of 1.5 million units in 1996 set a new record in the commercialization of vehicles produced in Brazil. Including imports, sales exceeded 1.7 million units. However, it is important to point out that sales of heavy commercial vehicles (trucks and buses) showed a divergent tendency to automobile and light commercial sales and have oscillated around 60,000 units per year, even in recent years, showing that demand is still stagnating in this market segment. 4
Assessment of the domestic market must be extended to include the building of Mercosul as a unified regional market. Adding up the registrations of new vehicles in Brazil and Argentina reveals that, in 1995, the “domestic” market actually exceeded 2 million units, after starting the decade with less than one million units. A qualitative change has resulted from this recent growth. The vehicle market, if we consider Mercosul, reached a volume comparable to that of important markets in industrialized European countries, such as England and France, even surpassing the Italian market in 1994. In the ranking published by Anfavea (the national automakers association), Brazil is in seventh place among the world’s biggest markets in 1995, and in sixth place if Mercosul is considered. This volume opened new perspectives for achieving economic scales in production and for the participation of new producers. 5
Indeed, the markets of newly industrialized countries are extraordinarily dynamic with respect to those of industrialized countries, which are relatively stabile or in decline. This point must be emphasized in order to understand the reasons that have given rise to a new cycle of investment in the Brazilian car industry. With regard to Latin America, renewed growth in this decade represents the fulfillment of a promise long expected by market specialists. Various statements by executives, analysts and consultants suggest consensus that, in terms of growth, the Brazilian market seems to be one of the most promising in the world. If present macroeconomic and external conditions can be maintained, the projections point to a market of 2.5 million vehicles in the year 2000.
This tendency was reinforced after the government made it clear, through the adoption of the “Automotive Regime” (higher import tariffs on cars, creating a special protectionist regime), that it would not absorb growing and significant trade deficits in this sector. The expansion in capacity which took place in the first half of this decade was primarily a result of investment in the modernization of existing plants. Since 1994, however, and especially after the announcement of the new “Automotive Regime”, a growing number of foreign companies have entered the Brazilian market, announcing new capacity plans.
The government, however, expects new investment to be increasingly export-oriented, a very risky bet, even if the overall performance of foreign companies in Brazil is taken into account. Multinationals in Brazil exported less in 1996 and now account for 48.34 percent of Brazil’s exports of manufactured products.
Brazil’s total exports of manufactured products, which account for 75.76 percent of the country’s exports, remained stable in 1996 compared to 1995, showing growth of only 0.09 percent. Exports of manufactured products by foreign-owned or partly-owned companies (defined as those with over 25 percent of their total capital of foreign origin) were down 1.78 percent on 1995. Data from the Secretariat of Foreign Trade (SECEX) of the Ministry of Industry, Trade and Tourism show that among the 16,000 exporting firms in Brazil, 412 industrial firms (producing manufactured and semi-manufactured products) were owned or part-owned by foreign capital. The total exported by these firms was US$ 16.8 billion, or 48.34 percent of the US$ 34.7 billion total for exports of manufactured products. Moreover, exports by American-owned firms were the only ones showing high growth, up 12.53 percent on 1995. It should be stressed, however, that even the increase in exports by American-owned firms are mainly due to the exceptional figures for two auto makers, GM and Ford. This is precisely the outcome expected by the government with the protectionist automotive regime. 6
In short, it has yet to be seen whether the new foreign direct investment trends will support the government’s new import substitution model, either through higher exports or relying on the assumption that after a certain point, imports needed for the modernization and expansion of plants will stabilize.
Privatization and Infra-structure: Strategy and Risks
The privatization process in Brazil was late in starting. Some believe that this delay has a negative effect on the quality of the fiscal adjustment needed for a lasting stabilization. However more optimistic observers think the delay has in fact turned out for the better, since the sale of the key state-owned productive enterprises in Brazil began just when the other emerging markets had already completed their programs. In this second view, with fewer assets on offer in the context of pronounced financial diversification by institutional investors globally, the scenario for privatization in Brazil was not only favorable but very opportune in its timing. With this inflow of funds, the current account deficits associated with the Real Plan were assured a reliable source of long-term financing.
Nevertheless, in the current context of international financial crisis, neither of the two views appears to be wholly correct. Given the magnitude of the crisis and the scenario of growing difficulties in assuring external financing for emerging markets that is unfolding for the years ahead, stabilization itself could indeed have been more efficient if it had been accompanied by a more vigorous privatization process right from the beginning. However, it’s easy to speak with hindsight. Moreover, the privatization of the Telebrás phone system could not have taken place at a better time. If it had been delayed any longer, Brazil’s current account would be looking much worse now. Yet, given the extent of the crisis—which is affecting not just the emerging markets but even the world’s leading economies—putting only state assets up for privatization is not enough.
In the current circumstances, two issues have become crucial:
Although privatization is relatively recent, particularly in strategic sectors such as transport and telecommunications, there have already been some positive effects on the country’s industrial structure. The key point, in this respect, has been the role of privatization in inducing a recovery in the level of investment, especially in infrastructure industries. At a time when there is a need for overall restraints on consumer demand (particularly for consumer durables), privatization—and the effects it has triggered—is really starting to function as a factor in buoying up aggregate demand.
In this context, it is important to underline the government’s recent decision (August 1998) reducing tariffs on certain imports, including machinery and equipment items, from 20 percent to 5 percent. There are now about 900 items on this low-tariff list after the Ministry of Industry carried out a round of consultation with leading companies. The government is still providing facilities for imports in priority industries that are committed to investment programs, such as paper and cellulose, telecommunications and tourism.
However, the role of privatization in inducing direct investments (including foreign ones) is meant not only to offset the fall in consumer spending, but also to compensate for the tendency in recent years for private investment to concentrate largely on consumer durables rather than the non-durable goods industries. Against a backdrop of the squeeze on consumer spending and the reduction in growth, the tendency was for these investments to be put on hold. Beyond this limitation, these investments in general mature more rapidly, as far as expanding productive capacity is concerned.
By opening up investment opportunities in infrastructure industries, the government is creating direct and indirect incentives to the capital goods and services industries, although the latter have to undergo a bracing program of modernization as they become more exposed to global competition.
In short, privatization is having at least two beneficial effects on Brazil’s industrial structure and for sustained industrial policy:
However, these favorable impacts are conditioned by quite differing situations in each industry and also by the fact that the main infrastructure sectors not yet privatized are subject to restrictions of a fiscal nature. This is the case, for example, of Petrobrás. 7
Each sector faces its own specific difficulties. In the mineral extraction industry, in spite of liberalization, prospects are affected by limited geological knowledge of Brazilian territory and by saturation on the world market. Investments in port facilities on the other hand have been very successful, and have involved considerable amounts of money. The rail system is still unsatisfactory and the government has recently seen fit to make requirements for privatization contracts in the industry more flexible. There have been promising examples of highway contracts, such as the Dutra, but there are glaring defects in highway maintenance nationally, with most still under state control.
There have been active privatization programs and investments taking place in some state government-controlled utilities, such as sanitation. Among the big infrastructure industries, electrical energy poses more uncertainty since there are regulation problems yet to be solved. Eletropaulo Metropolitano, however, which took over the São Paulo energy company, has just announced an ambitious investment program through to the year 2003. In order to avoid accidental black-outs alone (now a serious problem for Light, in Rio de Janeiro), the company is to invest R$ 230 million this year, and has plans to invest R$ 250 million every year through to 2003, to increase capacity. 8
Privatizations so far have had beneficial effects on the country’s industrial structure, meshing with modernization of infrastructure, and this will have an effect on macroeconomic performance—although this will only become visible over a period of some years. In addition, we should also look at how the sales so far have impacted public debt and the current account.
Again, BNDES has played a particular role in this field. One aspect of this role has been to help arrange financing for the consortiums bidding in privatization sales. Furthermore, BNDES, as a state-owned bank, has been backing state government privatizations, both technically and financially. As the main financial agent in the infrastructure sector and responsible for industrial modernization, BNDES can undertake spending on industry in a way that is much freer from restrictions of a fiscal nature. This means its investment policy can contribute both on the fiscal side and to the industrial adjustment needed to make the Brazilian economy more competitive (thus helping to balance the trading account).
This role as the main agent in privatization policy while encouraging the recovery of the level of infrastructure investments and aiding in the modernization of industry has meant that BNDES has seen an increase of 1,058 percent in its spending on infrastructure in projects over the last three years, from US$ 478 million in 1994 to US$ 5.5 billion in 1997, and an outlay of R$ 4.2 billion in the first half of 1998 alone—plus demand now amounting to US$ 7.3 billion. Infrastructure projects took 9 percent of total funding in 1994, going up to 34 percent in 1997. 9
This record has also had effects on the pattern of international financing coming into the Brazilian economy. BNDES has been giving priority to the partnerships with multilateral organizations such as the International Bank for Reconstruction and Development (IBRD), the IDB, the International Financial Corporation (IFC) and the Corporacion Andina de Fomento (CAF), and also with some foreign banks that have taken part in privatization sales. In the first half of 1998, BNDES spending has already reached R$ 8.78 billion, up 48 percent on the same period of the previous year. 10
The major funding in the first half of 1998 was for infrastructure (R$ 4.2 billion), which is up 101 percent on the first half of last year. For industry the total grew 73 percent to reach R$ 3.2 billion, while funds channeled to the commerce and services sectors totaled R$ 699 million, up by 11 percent. In the 12 months ending June 1998, funding reached R$ 20.7 billion, which means that there has been a growth of 87 percent in relation to the R$ 11.1 billion spent in the 12 previous months (July 1996 to June 1997). Of this total, R$ 10.2 billion went on infrastructure, an increase of 154 percent in relation to the 12 previous months. Finally, BNDES recently launched its biggest-ever issue of US$ 1 billion bonds, with a ten-year maturation period, on the US (90 percent) and European (10 percent) markets.
In addition to backing BNDES’s role as the catalyzing agent for thorough industrial restructuring, the government has been resisting pressure to use privatization sale proceeds for current expenditure and social welfare programs. At the time of the Telebrás privatization, for example, the debate on channeling money from the sale towards social welfare expenditure cropped up again, but President Cardoso reaffirmed guidelines on keeping down the burden of interest-rate charges by using this money to pay off public debt (saving about R$ 500 million with the privatization proceeds from Telebrás alone). In other words, it is only in an indirect way that money raised from the Telebrás privatization will eventually be used for social welfare programs.
The government has also been holding this line in relation to privatizations being carried out by state governments for which BNDES has provided support and proceeds have been paid over in advance. In the case of the privatization of Celpe (the electrical energy company in the state of Pernambuco), for example, the government stated that the money would only be paid in advance on condition that it be used to pay off public debt. The National Monetary Council issued a resolution stating that money advanced by BNDES could only be used to pay off debts registered with the federal government. However, political pressures are constantly recurring on this terrain. In the case of the privatization of Companhia Vale do Rio Doce, only half the money was used to reduce debt. Last July, however, the government ordered cuts in the estimated cap on indebtedness for this year for state and municipal governments and federal state-owned companies, amounting to R$ 2.5 billion of funds from BNDES and the Caixa Economica Federal (savings bank). The Ministry of Finance estimates that the privatization of Telebrás ought to cut R$ 2.6 billion per year from government spending for the servicing of the public debt.
Conclusion
The privatization process has had a beneficial impact on the restructuring of industry and in overcoming the limits on external financing, especially at a time of international crisis. From the point of view of the adjustment in public accounts, the effect depends on the government’s ability to withstand political pressures seeking to use the funds for political ends. Over the last two years, the federal government has been showing firm commitment to guaranteeing that these proceeds, including proceeds from privatizations carried out by state governments, are used to reduce public debt.
BNDES has played a decisive role, creating a portfolio of long-term projects that are less dependent on short-term market appraisals. It is also encouraging a policy to facilitate certain strategic imports that aid modernization and have a knock-on effect on the efficiency and logistics of the whole of productive industry, while helping to raise long-term funding and structure project finance deals in partnership with private financial institutions and multilateral bodies.
In other words, although there are a series of troubling macroeconomic factors that hardly differentiate the Brazilian economy from other emerging markets, the way privatization has been pursued in Brazil makes the country less vulnerable in the long run, to the extent that long-term direct investment opportunities continue to arise.
In this setting, looking far beyond the short-term restrictions on growth, the Brazilian government has been outstanding in its maintenance of an investment “portfolio” anchored in the privatization program and linked to a new import substitution model that provides a basic guarantee of sustainable growth, without inflationary pressures and, crucially, compatible with carrying through adjustment in public sector spending and in the external accounts.
Finally, it is clear that the sectors which up to now have shown themselves to be more dynamic are those that, besides being very rationalized in terms of work force, are intensive importers of industrial inputs (such as the petrochemical complexes, large car manufacturers and even the industrialized food sector and electrical/electronic industries). It is therefore quite natural that, despite the modest aggregate growth rate, a much higher rise in imports than in exports has been registered to the present. However, there is no reason to believe that the intra- and inter-sector linkages will not reach other sectors, especially if privatization in infrastructure and telecommunications progresses. And improvement in infrastructure, progressively privatized, would be a determining factor in reducing the “Brazilian cost”, especially in transportation and communications, thus enhancing the country’s competitiveness.
Foreign investment is present, directly or in association, in both the privatization of the public sector and the formation of strategic alliances with private groups in various sectors. This is a radical difference from the model of the forties and fifties which continued, in some way, up to the eighties, and in which state companies and protection of the domestic industry were dominant. Today, the state is retiring from production of goods and even services, while at the same time establishing partnerships with foreign capital and continuing to stimulate national industry.
However, instead of stimulation by linear and generic tariff protection and non-tariff barriers, planning and long-term credit mechanisms are gradually being recovered. Another fundamental difference from the past role of foreign capital in investments is its direct or indirect participation in terms of new capital flows, which have been advancing under the auspices of a stable exchange rate and a reasonably low interest rate abroad. Its two main features are the multiplication of foreign “creditors” through the development of financial innovations and the opening of the capital market and, at the same time, the liberalization of foreign credit to sectors like real estate and even durable consumer goods (like automobiles). The international crisis may cause an interruption, but maybe not a definitive paralysis of these new financial linkages.
There are also frontiers yet to be explored or still in the preliminary phases, such as the opening of the banking system and reform of the social security system. The prospects for expansion of the Brazilian pension funds are positive, as in other countries that have at least partially privatized their social security systems.
Three factors will be fundamental for foreign investment decisions in Brazil: First, stability of rules (which include exchange and interest rates, but also the acceptance of multilateral fora, like the World Trade Organisation, for negotiation); second, the consolidation of processes of regional long-term institution building through the Mercosul; third, the perception that in an environment of stable inflation, consumer markets grow steadily and the privatization process is not reversed.
The upturn in investments is associated to complex timing depending on sectoral dynamics and the definition of new patterns of relationships between the state, and domestic and foreign private capitals. In addition, recent experience—even before the “tequila effect”—has shown that the passage from economic stability to growth and development is not automatic, and that price stability is a necessary, but not sufficient pre-condition to stimulate an investment “take off”, especially under contracting global markets.
The use of exchange anchor models for stabilisation and the political difficulties in accelerating both the reforms with fiscal impact and the privatization process mean that Brazil faces additional obstacles before it can start to sustain a process of growth. Imbalances, which may be temporary, as in the foreign trade accounts or even the growth of public debt, could be perceived as indicators of fundamental fragility, provoking a lack of confidence and deferring investment decisions.
The Brazilian government is pledged to a vigorous process of “institution building” and the gradual overcoming of the credit crisis both in the public and private sectors. At the same time, it is mobilizing planning mechanisms, stimulating the private sector and allowing for a progressive internationalization of the capital markets and the credit and savings circuits.
In short, although the international financial crisis is one of the worst possible scenarios for emerging markets, Brazil may well be seen as a land of sound investment opportunities—the China of Latin America.
Gilson Schwartz is Visiting Professor at the Research Center on International Relations of the University of São Paulo, Brazil, Editorial Supervisor to the Brazil Investment Link and Editorial Advisor to the newspaper Folha de S. Paulo.
Endnotes
*: This article is an updated version of a paper prepared for the IAI’s International Affairs Laboratory. The opinions expressed do not necessarily correspond to those of the firms participating in the Laboratory. Back.
Note 1: IBGE; website: www.ibge.gov.br Back.
Note 2: See, among others, Anfavea; website: www.anfavea.com.br Back.
Note 3: See, for instance, S. J. Burki and G. E. Perry, Institutions Matter, Beyond the Washington Consensus (Washington, DC: World Bank, 1998). Back.
Note 4: Associaçao Nacional de Fabricantes de Veiculos Automotores (Anfavea); website: www.anfavea.com.br Back.
Note 6: SECEX; website: www.mict.gov.br Back.
Note 7: According to a Cepal-UN study, R. Bielhowsky, Investimentos na Indústria Brasileira depois da Abertura e do Real (Santiago, Chile: Cepal, 1998) mimeo. Back.
Note 8: Eletropaulo Metropolitano; website: www.eletropaulo.com.br Back.
Note 9: BNDES; website: www.bndes.gov.br Back.