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Is it safe to invest in Brazil?

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With a population of over 214 million people, Brazil is the most populous country in Latin America, providing a large market for goods and services. Combined with abundant resources, a robust financial system, and sound regulatory frameworks, Brazil offers significant investment opportunities.

Brazil is already playing a key role in world decarbonisation given that its energy matrix is 60% hydro, 11% wind, 8% biomass, 3% solar and only 18% thermal. Brazil’s plentiful natural resources enable it to generate electricity primarily from clean and cheap renewable energy sources, and it is expected future capacity growth will be concentrated primarily in wind and solar, furthering this trend.

Material investment in renewable energy provides significant opportunities for infrastructure investors, not only in generation but also in transmission assets.

Brazil is also a major player in the commodities sector and one of the world’s largest producers and exporters of agricultural products, such as soybeans, corn, coffee, sugar, and beef. It has significant reserves of minerals, including iron ore, gold, and bauxite, making it a leading exporter of raw materials.

Brazil’s vast natural resources, abundant land area, and favourable climate provide it with a key natural advantage in producing these commodities. To support the increased production and exports of these commodities there is a need for considerable investment in infrastructure such as roads, rail and ports. These can offer compelling investment opportunities for infrastructure investors and investment trusts (e.g. the Utilico Emerging Markets Trust plc [LON:UEM]).


A decade of ups and downs

Over the past decade, Brazil has undergone significant economic and political changes. After weathering the Global Financial Crisis in 2008 better than many other countries, Brazil was hailed as a poster child for economic growth and expected to become a rising global power. The country boasted a growing middle class, successful social welfare programs, and an expanding economy. However, Brazil struggled to maintain its momentum and, from 2013 onwards, faced a growing fiscal deficit, rising inflation, and a shrinking economy.

However, the 2016 impeachment of President Dilma Rousseff marked yet another turning point for Brazil. Her removal from office followed a long-standing economic and political crisis and widespread public protests over corruption and mismanagement. Her successor, Michel Temer, implemented market-friendly policies and reforms, including a labour reform and a constitutional amendment capping public spending. The latter aimed to stabilise the economy and restore investor confidence, after seeing the country’s debt-to-GDP ratio increase from 51.5% in 2013 to 73.7% in 2017.

In 2018, Jair Bolsonaro, a right-wing politician, was elected and continued the market-friendly reforms initiated by Temer, pursuing a range of economic policies to promote growth and reduce government intervention. These policies included a major pension reform, the independence of the Central Bank, a privatisation program, and a series of measures to reduce bureaucratic red tape and promote investment in infrastructure.

In October 2022, Brazil held its presidential, congressional, and gubernatorial elections, revealing a deeply divided and polarised country, particularly in the presidential race. Ultimately, former President Lula won the election with 50.9% of the votes, while centrist and centre-right parties secured a majority in Congress, crucial for maintaining checks-and-balances.

Within weeks of the election, market sentiment was roiled by Lula and the new government as it made negative statements on the previous reforms, in particular attacking the spending cap framework. The appointment of politically-aligned individuals to technical positions and the approval of fiscal packages to expand social programs raised concerns about the country’s fiscal accounts, causing the local market to fall by over 10% in Q1 2023.

Expectations of interest rate cuts were pushed back, leaving the country with one of the highest real interest rates in the world. However, this is having a noticeable effect on inflation, and with rates at 13.75% there is significant scope for interest rate cuts which could lead to the equity market rerating.

Tax reform – the one to watch

The most significant reform under discussion this year is on taxation. The Brazilian tax system is an extremely complicated, costly and inefficient mess. Brazilian companies spend 1,501 hours per year preparing and paying taxes, much more than the average in Latin America (317 hours) or OECD (159 hours).[3] This is highly inefficient and directly impacts private investment and ease of doing business.

Number of hours per year preparing and paying taxes

Is It Safe To Invest In Brazil

The objective of the Consumption Tax Reform, which is expected to be voted on this year in the Brazilian Congress, is to simplify and rationalise taxation on the production and sale of goods and services. Currently, the Brazilian tax burden is at 32.4% of GDP, with industrial and commerce sectors the most affected. The proposal aims to consolidate taxable bases into two new taxes: (i) a tax on goods and services (IBS), similar to the value-added tax (VAT) in most developed countries; and (ii) a Selective Tax, which is a specific tax on some goods and services.

It is estimated that the proposed changes could boost GDP by 12-20% over the next 15 years. It is also expected that there will be an Income Tax Reform, which may see the creation of a tax on dividends, offset by a reduction in the corporate tax rate, incentivizing companies to invest more in the local economy.

Outlook for Brazilian equities

The Utilico Emerging Markets Trust has an overweight position in Brazil compared to MSCI EM, with exposure at the end of March 2023 at 20.9% versus the index at 4.9%. Despite Brazil’s political and economic volatility, UEM’s Brazilian holdings have consistently delivered strong results.

“We see promising opportunities for bottom-up, long-term investors in Brazil’s infrastructure space, with over 80% of UEM’s Brazilian exposure in comparatively defensive sectors or those tied to export-oriented infrastructure assets that have demonstrated solid operational results and robust growth potential,” the trust’s managers said this month.

The Utilico team believes that Brazilian equities are trading at extremely attractive valuations, which will likely return to historical averages when investors become more confident in government policies towards the fiscal accounts, and the Brazilian Central Bank initiates an easing cycle.

Currently, local interest rates are at 13.75%, implying an interest rate in real terms of over 7.5%, which is among the highest in the world. These rates are detrimental to economic activity, which should help to control inflationary pressures and allow the Brazilian Central Bank to signal a change in monetary policy in the coming quarters.

While Utilico says it recognises that there is significant political and economic uncertainty in the short term, the Brazilian market offers substantial upside in the long term due to a combination of attractive valuations and strong company growth dynamics. “If there is an improvement in the macroeconomic scenario, these holdings should see further upside that is not factored into our base case,” the firm said.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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