Brazil - A Shifting Growth Model


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Our new report ‘Brazil – A Shifting Growth Model’ finds that a large population, growing middle class and considerable natural resource endowments should keep Brazil on international investor’s radar.

However, a rise in protectionism and state interventionism has contributed to an economic slowdown and diminished prospects, leading investors to look elsewhere in Latin America for new opportunities.

The medium-term outlook is now 3-3.25% annual GDP growth, below the average of 4.5% seen in 2004-2010.

Will policymakers’ tolerance of higher inflation rates, declining domestic savings rates and increasing wage expectations threaten Brazil’s investment environment in the future?

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Brazil - A Shifting Growth Model

  1. 1. Foreign direct investment drive Investors join the rush to Brazil A visitor to Santa Cruz, on the outskirts of Rio de Janeiro, can see the promise of a new wave of investment in Brazil. The neighbourhood is minutes from the port of Itaguai, which is being expanded and modernised. Work began in 2008 on a transportation corridor that will cup greater Rio de Janeiro within a half-circle of express lanes, connecting highways that radiate from the centre and easing traffic. Tax breaks defray the costs of those willing to invest. This helped Rolls Royce to pick Santa Cruz in 2011 as the location for a US$100m high-tech facility, its fourth in Brazil. It will assemble and test industrial gas turbines to power offshore oil and gas platforms. Petroleo Brasileiro (Petrobras, the state-controlled oil company), soon bid US$650m for 32 engines. Rolls Royce was “coming at a good time”, the state’s vice-governor said. “I’m sure we’ll be here again soon, announcing more investments for the region and the state.” As Brazil taps into deep offshore oil reserves discovered off its south-east coast, the business of building turbines for platforms could be worth as much as US$2.5bn to Rolls Royce in the next five years. That comes on top of a spending splurge driven by a growing middle class. Foreign direct investment (FDI) in Brazil rose to a record US$66.7bn in 2011, according to the UN Economic Commission for Latin America and the Caribbean (ECLAC), and stayed buoyant in 2012, in spite of a global FDI downturn of 18%. This was part of a larger shift. In 2012 FDI to developing nations exceeded flows to developed countries for the first time. Among the “up-and-comers” Brazil stood out, capturing 28% of South America’s FDI in 2012. Investors included a US technology firm, IBM, which in April 2012 launched a partnership with a subsidiary of a Brazilian conglomerate, EBX Group, focusing on oil and gas to research natural resources; a French consumer products company, L’Oreal, which is building a US$39m research centre in Rio de Janeiro, and a Spanish bank, Grupo Santander, which is continuing its plan to open to 120 branches per year throughout 2013. Still, there are some signs of trouble. Inflation, Brazil’s persistent spectre through the 1980s and 1990s, rose to 5.84% in 2012, close to the 6.5% ceiling of the Banco Central do Brasil (BCB, the Central Bank). Then there are the tougher structural challenges: high tax and labour costs, crumbling infrastructure, corruption and a shortage of well-trained workers. The World Bank ranks Brazil 156 out of 180 countries with respect to ease of paying taxes. Construction of the highway, proposed in order to alleviate bottlenecks around Santa Cruz, was abandoned when the company building it, Delta Construções, became the epicentre of a congressional corruption investigation. Refurbishing of the nearby port is facing delays. Even hiring a skilled workforce is difficult, with lax education and unemployment of just 4.9% in Brazil’s biggest cities. This pushed Rolls Royce to announce in July 2012 that it would build a training centre to produce the workers it needs. So far, the investment is paying off. By December of last year, Rolls Royce had received another US$153m order to equip seven offshore drilling vessels. Investors are still betting on the promise of what is to come. But there is hard work ahead if Brazil, perennially the country of the future, wants to prove that it has come of age. Sponsored by: BRazil In 2012 FDIto developing nations exceeded flowsto developed countriesforthe firsttime.Amongthe “up- and-comers” Brazilstood out, capturing 28% ofSouth America’s FDIin 2012.
  2. 2. After a slowdown in 2011-12, Brazil has lost some of its luster and the medium-term outlook for economic growth is now just 3-3.5%, below the annual average of 4.5% seen in 2004-10. For a middle-income country—income per capita is US$12,000—with catch-up potential, these rates of growth are disappointing. Of course, size still matters—Brazil should overtake the UK by 2015 as the sixth-largest economy in the world. And the country’s considerable market opportunities— thanks to a large population, a growing middle class and considerable natural resource endowments—will keep it on international investors’ radar screens. But Brazil’s slowdown and diminished prospects have already been leading some portfolio investors to look elsewhere in the region, notably Mexico, where reform prospects have brightened considerably, economic policies are less interventionist and GDP growth is set to be higher. Not only are external conditions less favourable for Brazil over the medium term than in the previous decade, but so too are its labour market dynamics. China’s growth is decelerating from the double-digit rates it experienced in the past, dampening growth in demand for Brazil’s exports. Income policies in recent years—the government has lifted the minimum wage by the equivalent of nominal GDP growth, well above productivity gains—have lifted the already high cost of doing business, stemming from infrastructure deficiencies, a high tax burden (36% of GDP last year) and complex tax system, red tape and labour market rigidities—among other structural factors. Several of Brazil’s manufacturing segments suffer from a lack of international competitiveness, and despite efforts to address some of the reasons behind this (including cuts in electricity tariffs and non-payroll costs for over 40 manufacturing segments), the process of de-industrialisation—with manufacturing as a share of GDP falling from an average of 18% in the 1990s to 14.3% last year—is likely to continue. Policy hyper-activism The outlook for the policy environment has become more of a concern for investors, as the government responded to the 2011-12 slowdown with a battery of measures, which, on the whole, have seen a rise in protectionism and state interventionism. Brazil’s 2004-10 growth spurt was partly explained by a “stabilisation dividend” brought about by a strong policy framework, anchored by fiscal discipline, inflation-targeting and a flexible exchange-rate regime. With an improvement in its credit rating (Brazil has been investment grade since 2008, indicating a relatively low risk of default), there is room for the government to move towards a less restrictive fiscal stance. But the government has chipped away too heavily at the “tripod” that served it well and the policy framework has morphed into a less coherent model with multiple, potentially conflicting targets—growth, inflation and the exchange rate (a weaker Brazilian Real to alleviate the manufacturing industry’s competitiveness woes). Inflation is creeping up towards the ceiling of the accepted range (2.5%-6.5%, with a target of 4.5%), pulled up by services inflation, which is running at over 8% (lifted by minimum wage rises and a tight labour market). Policymakers’ tolerance of higher inflation threatens to undermine the investment environment. That said, efforts to reduce payroll costs for struggling manufacturing segments are welcome, and an ambitious infrastructure logistics plan to upgrade Brazil’s roads, ports, airports and railways through concessions to the private sector over 2013-15, is a bold move. © The Economist Intelligence Unit Limited 2013 Population 193.9m GDP US$ 2,252.4 bn Real GDP growth 0.9% Consumer price inflation 5.4% Budget balance -2.5% Current-account balance -2.4% Median household income US$14,146 Mobile phone subscriptions (per 1,000 population) 1,345 Transport & communications US$406.5bn Food, beverages and tobacco US$298.4bn Housing & household fuels US$187.2bn Health services US$150.4bn Leisure & education US$88bn Clothing & footwear US$74.5bn BRAZIL Origin of GDP (% real change pa in each sector) Source: Economist Intelligence Unit 5 3 4 2 0 1 -1 -2 -3 Agriculture 2012 2013 Industry Services Current-account balance (% of GDP) Source: Economist Intelligence Unit 2003 3 2 1 0 -1 -2 -3 -4 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Macroeconomic overview 2 0 1 2 A s h i f t i n g g r o w t h m o d e l
  3. 3. © The Economist Intelligence Unit Limited 2013 Labour market dynamics: from a demographic bonus to onus Brazil’s 2004-10 growth spurt was facilitated by rapid labour force growth, thanks to a previous baby boom that saw a surge of new entrants to the labour market. The unemployment rate has fallen below 6%, close to the level of unemployment below which inflation rises. But labour force growth is now slowing and Brazil’s demographics in the 2020s will begin to weigh more heavily on growth and cause policy challenges, as the ratio of workers to dependents declines. Income policy has been set in stone at least until 2015 and it would prove politically very difficult for the next government (which takes office on January 1st 2015) to introduce changes—such as aligning the rise in the minimum wage more closely to productivity gains that would bolster competitiveness—because of increasing wage expectations among the population. Less consumption, more investment? Brazil’s growth model has been mostly consumption-driven up until recently, fuelled by a cocktail of jobs, income and credit growth, as well as the windfall from high prices for its commodity exports, thanks to voracious demand from China. However, since the peak of the consumer credit splurge in 2010, households have been strengthening their balance sheets, dampening private consumption growth to close to 3% in 2012. Lower interest rates should help households to work through their debt overhang and contribute to a rise in private consumption growth, but rates will be weaker than in the past. Investment levels have fallen below 18% of GDP (compared with the mid-20s in other Latin American countries and over 30% in faster growing Asian economies), because of a declining domestic savings rate. Weaker domestic and overseas demand will impair investment growth, although government stimulus measures and directed credit from the state-owned Banco Nacional do Desenvolvimento Econômico e Social (BNDES, Brazil’s development bank) will lead to a small improvement on last year’s 4% fall in investment in 2013. In 2014 and beyond, investment growth rates of 4-5% are feasible, buoyed by investments in infrastructure concessions and development of huge oil reserves in Brazil’s pre-salt fields. After five years of delays, caused by political bickering over the distribution of royalties and a change in the regime from profit-sharing to a production-sharing regime, Brazil’s authorities are set to restart the auction of blocs on the remaining 70% of the fields yet to be auctioned. The 2014 World Cup and 2016 Summer Olympics in Rio de Janeiro will keep Brazil in the international limelight, but the economic outlook hinges on factors other than the In 2014 and beyond, investment growth rates of 4-5% are feasible, buoyed by investments in infrastructure concessions and development of huge oil reserves in Brazil’s pre-salt fields. holding of these prestigious events. Structural reforms that strengthen the policy and investment environment would lift economic growth prospects considerably and boost foreign direct and portfolio investment. However, economic growth is likely to fluctuate mostly between 3% and 3.5% in the medium term. This will still provide considerable opportunities for investors in Brazil’s large and (albeit now more slowly) growing market. Gross public debt (% of GDP) Source: Economist Intelligence Unit 2003 20 30 40 50 60 70 80 10 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 EIU sovereign risk score (0-100) December of each year Source: Economist Intelligence Unit 2003 20 30 40 50 60 10 0 2004 2005 2006 2007 2008 2009 2010 2011 2012
  4. 4. About Aberdeen Asset Management Aberdeen Asset Management PLC is a global investment group, managing assets for both retail and institutional clients from offices around the world. The group’s headquarters are in Aberdeen but we prefer to locate our fund managers near the companies and markets in which they invest. Aberdeen Latin American Income Fund is a specialised trust which aims to provide ordinary shareholders with a total return, with an above average yield, primarily through investing in Latin America through a diversified portfolio of equities and fixed income investments. Please remember, the value of shares and the income from them can go down as well as up and you may get back less than the amount invested. Details about Aberdeen Latin American Income Fund are available at the trust specific website: The majority of Aberdeen’s managed trusts are on offer through the Aberdeen Investment Trust ISA or Share Plan, available at the award winning Aberdeen Investment Trust Centre: Issued by Aberdeen Asset Managers Limited, 10 Queens Terrace, Aberdeen, AB10 1YG, which is authorised and regulated by the Financial Conduct Authority in the UK. The information in this report is accurate as of May 2013. About the Economist Intelligence Unit The Economist Intelligence Unit (EIU) is the world's leading resource for economic and business research, forecasting and analysis. It provides accurate and impartial intelligence for companies, government agencies, financial institutions and academic organisations around the globe, inspiring business leaders to act with confidence since 1946. EIU products include its flagship Country Reports service, providing political and economic analysis for 195 countries, and a portfolio of subscription-based data and forecasting services. The company also undertakes bespoke research and analysis projects on individual markets and business sectors. More information is available at or follow us on Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in the report.