With a population of 210 million people, a wealth of natural resources and the world's ninth largest economy in nominal GDP terms, Brazil has always been a land of great potential. But years of political turmoil and stagnant productivity have held the country back. As Brazil enters a period of economic reforms, Paulo Miguel, Chief Investment Officer at Julius Baer Family Office Brasil, explains why there is room for optimism.
Some of Brazil’s key economic strengths include a huge market, a diversified economy with a historically solid industrial base – perhaps less so in recent years – a strong agricultural sector, and a robust domestic market. Brazil is an interesting country for those who like to innovate and who wish to bring something new to the table. It’s characterised by its flexibility and its openness to contributions and new ideas.
Brazil’s greatest challenges today are education and productivity.
Something that people may not be aware of is that is that between 1930 and 1980, Brazil recorded more growth than any other country. More than Japan, more than Europe during its reconstruction period and even more than China at the beginning of the 1980s. But in the last 30 to 40 years, although we have a large economy, we’ve experienced a period of very weak growth and stagnant productivity.
So Brazil’s greatest challenges today are education and productivity. Therefore, it’s a very interesting time for us because we’re entering a period of reforms that could transform the dynamics that have dominated the economy over the past 30 years.
Pension reform is in fact the most important reform because it will play a key role in stabilising public accounts. The Brazilian government’s spending on pensions and wages accounts for the majority of the federal budget.
This reform contributes to reining in state spending, thus containing the credit risk of the public sector, which has historically been one of the main factors contributing to high interest rates in Brazil. By reducing fiscal risk, the pension reform will contribute to the continuation of this recent period of lower interest rates.
But pension reform isn’t the only aspect we need to consider; Brazil has a few other fundamental reforms on the agenda. One of these is the issue of taxation. For a number of reasons, economic decisions are marred by the Brazil’s tax structure, especially when it comes to the taxation of goods and services, which can result in decisions that are uneconomical. As a result, Brazil’s taxation system really hinders productivity growth. The tax reform currently under discussion is attempting align Brazil with international taxation standards. And an improvement to Brazil’s tax structure could have a great impact on fostering productivity.
Infrastructure investments foster job creation
One of Brazil’s main challenges today is that we have 13 million unemployed people, and worse, many more in a situation of underemployment and job insecurity. If you look at the broader metrics that include part-time employment, people who’d like to work full-time but aren’t able to, we get to a figure of almost 27 million people, which is about 25% of the economically active population. So it’s an extremely dramatic situation from a social perspective.
But we have an added challenge in that it’s not easy for Brazil to embark on a policy of fiscal stimulus in the current climate because we have a large budgetary imbalance; we still have a significant deficit.
We expect investment in infrastructure to accelerate significantly over the next 2 to 4 years.
The good news, however, is that we have ample room for monetary loosening. So the path of least resistance for stimulating the economy is an extremely loose monetary policy, more so than we’ve ever had in Brazil. Previously, the cost of capital was too high but today we’re seeing that, in view of interest rates converging at historically low levels, the capital market and the private sector have a great interest in investing in infrastructure, which has the potential to generate a significant number of jobs.
The stock of Brazilian infrastructure today is 50-60% of what it should be for its income level, but offers an interesting rate of return in light of what we see today in terms of cost of capital. So we expect investment in infrastructure to accelerate significantly over the next 2, 3, 4 years.
Opening up to trade
The trade agreement between Mercosul and the European Union, pending its ratification and execution, is extremely important for Brazil because the Brazilian economy is perhaps one of the most closed economies in the world. It’s a symbolic agreement because it is the first one in a long time and it may pave the way for more trade agreements in the future.
In fact, now that everyone is talking about the Amazon, the implementation of this trade agreement is important because it comes with environmental clauses. So finalising the trade agreement and putting it into effect is equivalent to protecting the environment.
Transformation and growth
Although Brazil is known for its extremely competitive agricultural sector, today we’re also seeing a certain exuberance in more innovative sectors. There is a vibrant ecosystem of venture capital, of FinTechs, of investments in start-ups in various dynamic segments. This creates an attractive environment for investing in emerging companies that focus on technology, disruption, and the modernisation of business models. This relates to the Brazilian nature of embracing innovation. We’ve observed that virtually all venture capital funds with an international presence are present in Brazil – and the size of these investments is growing.
There is a real desire to transform the way things are.
The country is currently undergoing a process of transformation and growth. So, if you combine this period of reforms and of changes to the way the Brazilian economy operates with this global reality of digital transformation and processes, Brazil is combining these two things right now, and this makes the country very attractive for investments. There is a real desire to transform the way things are, and I think we’re at a point in time in which this transformation has a chance of happening.