By Thierry Ogier and Taimur Ahmad
Brazilian president Dilma Rousseff has called it a “transport revolution.”
The government’s latest plan to rid Brazil of its infamous transport bottlenecks calls for $65 billion of investment in the country’s notoriously decrepit infrastructure.
These, after all, are the same bottlenecks that experts say are holding the economy back – and which also mean that an oversized Brazil is becoming too constricted for its aspirations to become an economic superpower.
The latest initiative calls for a vast modernization of roads and railways over 25 years, including a big push to invest some $40 billion within five years. The first contracts to build or upgrade 7,500km of roads and public-private partnerships to set up 10,000km of railway lines are due to be signed next year.
The thinking isn’t new: Every government for the past 20 years has launched its own plan to reduce what is commonly known as the ‘Custo Brasil’ – the additional cost one has to bear to operate in Brazil. Progress, however, has been limited.
But this time is different, say Brazilian officials and private investors.
Critically, the slashing of Brazil’s benchmark Selic interest rate to a record low has now paved the way for long-term investment for infrastructure – with the aid of the capital markets. Luciano Coutinho, president of the BNDES, Brazil’s development bank and one of the top policymakers Rousseff’s team of tells LatinFinance in an exclusive interview that the central bank’s move will lead to a “big wave” in investment (see Parting Shot, page 72).
Under the presidency of Alexandre Tombini, the central bank has cut the benchmark rate by 525 basis points to 7.25% since August 2011. At the same time, the government has tried to encourage the private sector to boost long-term investment and focused on policies to address supply-side bottlenecks, rather than simply boost consumption.
The strategy, says Coutinho, is now “to attract the private financial system to help share the burden with the BNDES,” the state-owned development bank that extends loans at below market rates and is often accused of crowding out the market. Now, “we have the chance to crowd in the market to new private assets,” he says.
But if inflation pressures persist or become worse, a new round of monetary policy tightening could limit the impact of such a revolution. The consumer price index registered a 5.6% increase in the 12 month-period to mid-October, and the market average inflation forecast for 2013 now stands at 5.4% – meaning that real interest rates are at their lowest level ever in Brazil.
If prices don’t go any higher forcing a change in policy, the low rates might help the government goals, as big investors will be forced to find returns somewhere.
“Institutional investors, pension funds, insurance firms and the like are now below their targets, so they need to diversify their sources of fixed income,” says Coutinho. “I am very confident that the share of financing for infrastructure based on financial instruments will grow very fast in the coming years such as to grab at least 20%-30% of the long-term financing market.”
“There is no better alternative than sound infrastructure projects bhigh rates of return as a base for the issuance of new fixed-income securities or bonds,” he says.
Many domestic investors, who have never seen such a low level of interest rates in their lifetime, seem ready to seize on the opportunities.
“We have a long road ahead of us but we are on track to reduce the cost of borrowing,” said Pedro Daltro, CFO of BR Properties, a real estate developer, at a recent LatinFinance conference in São Paulo.
“My generation has not seen interest rates as low as this… but it will take maybe 10 years before we are close to international levels,” he said. Such convergence to international levels was indeed one of Rousseff’s presidential pledges.
Meanwhile, doubts have already been raised regarding the sustainability of interest rate cuts. True, the inflation targeting regime, which was introduced in 1999, has remained in place. But the central inflation target is 4.5%, and the central bank has kept loosening monetary policy even when headline inflation was above the 5.0% mark.
The central bank has argued that the external environment and benign inflationary pressures (excluding food inflation) were supportive of the government strategy. Luiz Fernando Figueiredo, a former central bank director between 1999 and 2003, agrees: “We are not abandoning the inflation targeting model. We are using a more flexible version of it,” he tells LatinFinance.
In addition to a more flexible inflation targeting regime, the central bank has also stepped up its interventions on the foreign exchange rate market in order to prevent the appreciation of the real, which for all intents and purposes is not free-floating any longer. (Indeed, the naturally volatile Brazilian currency has hovered around two reais to the dollar for the past three months.).
“They drew a line in the sand,” says Marcelo Carvalho, chief economist at BNP Paribas in São Paulo, who points to the risks of such a strategy. “If commodity prices rise, there will be no buffers – the exchange rate will not be able to absorb the shock – and there will be some impact.”
Carvalho says a number of factors could increase price pressures, following another year of sluggish growth in Brazil (around 1.5%). “Economic recovery is accelerating, and the labor market will become even tighter,” he says. It’s not just that market expectations are no longer anchored on the central inflation target: he argues that inflation will blow the top range of the target next year (at 6.7% instead of 6.5%).
Brazilian policymakers may have gotten themselves in a bit of a bind.
“You can’t target inflation and the currency at the same time, without having free capital flows,” Carvalho says. “Sooner or later, the authorities will need to start tightening policies again next year, if they care about inflation.”
But the BNDES’ Coutinho says that pragmatism will prevail, and the central bank will tighten if need be. Coutinho, who obtained his PhD in economics from Cornell University, is often referred to as “professor” by his colleagues, but he does not mince his words at the suggestion that the new strategy might be implemented at the expense of macroeconomic stability and the fight against inflation.
“That would be such a stupid idea. There is no way we will shoot ourselves in the foot by doing so,” he says.
If needed, the central bank will choose to tighten monetary policy again, but the interest rate hikes will not be as drastic as on previous occasions. “Brazil has become a more predictable country, which means less interest rate volatility,” says Pablo Fonseca Pereira dos Santos, deputy secretary of economic policy at the Brazilian ministry of finance.
Although the government has pledged to pursue investor-friendly policies, not everybody is convinced that this will be the case.
An immediate example of this is the privatization of the airports. Three of them were auctioned this year, including São Paulo’s international terminals, but the winners were not the ones that the government had expected – which has led to delays in the privatization of other airports.
“The government is not willing to play the game for what it takes. They want to tell investors what the return rate should be. They don’t believe in market forces. They understand the economy as a club,” Paulo Bilyk, a founding partner at Rio Bravo, an investment firm, tells LatinFinance. “They are weary of private enterprise. They don’t have a performance-improving agenda. They do have an agenda for a stable economy, but not for productivity.”
Brazil fell two places to rank 130th out of 185 economies in the World Bank’s report on the ease of doing business compared with last year, with areas such as obtaining credit, registering property, resolving insolvencies and protecting investors falling in the rankings.
The BNDES, which Coutinho has headed for the past five years, was instrumental in helping the Latin American giant implement a counter-cyclical strategy and support investment in the wake of the global financial crisis, thanks to massive capital injections – over $100 billion – from the Treasury.
Since last year and until the end of 2012, an additional 100 billion reais ($49 billion) will be added. While minimizing the fiscal cost of such measures in the longer term, Coutinho insists that the BNDES has taken on a new role in the Brazilian economy by promoting the importance of the private sector in financing and the reforms of capital markets.
“This idea that the BNDES is ‘crowding out’ usually comes from economists who do not know how the market works,” he says.
“In fact, we were the main propellers of this new agenda in suggesting the legislation – for private involvement in long term financing/capital market reform – and adjustments in stimulating the creation of new funds and new instruments, and providing liquidity in the secondary market.
“The main hindrance for the big participation of private forces in long-term finance was the very high short-term interest rates in Brazil. Turning this page was the big novelty in Brazil,” he says.
The market response at home has been positive, although foreign investors have been more circumspect. Some veteran executives say they never had it so good, after decades of turmoil in Brazil, and that the outlook is promising. “I hope we are now in the decade of infrastructure,” says Roberto Mendes, chief financial officer of Localiza, a local car rental company and the largest in Latin America.
There is a broad consensus that Brazil needs to advance on the reform path – not least to offset inflationary pressures resulting from the supply side bottlenecks – by tackling structural issues such as infrastructure, but also education and the lack of skilled labor. Indeed, addressing old bottlenecks and boosting productivity would do the Brazilian economy a lot of good.
The Rousseff government has already lowered the payroll tax in several industries and pledged to do more in the coming weeks. More elements of tax reform may follow, however piecemeal they may come.
The road, no doubt, will be rocky. But as long as the central bank can be firm against inflation, the Brazilian economy may well emerge stronger. “Of course we do have challenges, but I’m confident that there is no way the Brazilian macro policy could think of abandoning price stability,” says Coutinho. LF