Doing Business In Brazil: Key Considerations
Brazil: samba, bossa nova and beaches – these are some of the icons the tourism industry trades on. But like many of its South American neighbors, Brazil has also been known for poverty and enormous government debt. It is a place of extremes, boasting tremendously wealthy citizens, a lasting and exotic cultural brand and a high crime rate. The country is also the fifth largest in the world in area and borders all but two nations on its continent. Brazil is a force to be reckoned with.
While the appeal of Brazilian exoticism still helps to sustain its tourist industry, the danger of Brazil’s debt seems to be diminishing. Since 1998, when the IMF granted the country a $41.5bn loan, the currency and economy have been relatively stable. Despite ongoing concerns about inflation, interest rate pressures, and unemployment, Brazil has succeeded in attracting substantial foreign investment that continues to grow as the government maintains its tight monetary policy and the local economy shows convincing signs of recovery.
In this article, Carlos Asciutti at PricewaterhouseCoopers’ Brazilian practice discusses the key considerations to bear in mind when doing business in Brazil.
Carlos Asciutti: There is no doubt that the biggest development has been the election of President Luiz Inacio Lula da Silva in January 2003. A related development is the business community’s sense of relief about his macroeconomic policies. Because the president came from a leftist party, business people were concerned that social programs (i.e. greater government spending) would win attention over continuing to stabilize the economy. On the contrary, the president has taken some important steps towards more firmly establishing Brazil as an attractive global business partner. One important thing is that Lula closely adheres to international contracts, and secondly, he is paying full attention to stabilizing monetary policies and keeping fiscal budgets under control. The issues are closely connected.
We have many social problems in Brazil, and the president has spent as much money on them as is feasible given our current economic situation. However, we also need the money to go towards paying off the large public debt. Rather than opening up the government’s pockets to social programs with no regard for Brazil’s other economic demands, he has stuck to tight monetary policies better than anyone before him. This was unexpected from a leftist candidate who had for many years preached that he would do things differently. It has created a great deal of confidence within the business community.
In fact, the president has actually increased the target for budget surplus. The surplus serves as a guarantee to bondholders that the debt will continue to be paid and will not increase. Our target is a surplus of about 4-5 per cent of GDP and that is enough both to ensure the debt won’t grow and to cover interest.
CA: The first important issue is to understand the market, the second is to understand the regulatory environment, and third would be to understand the culture. Again, they are all closely connected.
By ‘the market’ I mean the investors’ specific target market or the number of people who are likely to buy a particular product in Brazil, regardless of the expectations of markets elsewhere. There are 170 million people in Brazil. For most products and industries, however, the target market is much smaller. For example, the local automotive market is about 2 million vehicles per year; in the US it’s close to 20 million vehicles. The US has a population of about 280 million people. When you do the maths, you can see that the US buys 10 times the number of vehicles in Brazil with a market that has less than twice the number of people.
When you look at the Brazilian ratio of vehicles to people, you might be tempted to say that there is a great potential for growth in automotive production if you base your estimates on the US market per capita ratios. The same is true in the ratio of pharmaceutical production and most of the other industrial sectors.
One of the main characteristics of a developing country is that the gap between the rich and poor is much larger than in developed countries, and reducing this income disparity is one of Brazil’s biggest challenges. We have areas where the GDP per capita is equal to that of the most developed areas in the world and others where a GDP per capita does not exist at all. The disparity of purchasing power must be taken into account by investors when developing expectations for target markets in Brazil across the board.
In addition, Brazil is a very large country and there are differences in markets geographically. For instance, São Paulo and Rio account for about 60 per cent of the GDP but only 30 per cent of the population.
Q: What should visiting business people be aware of regarding the regulatory environment?
CA: One of the major differences between Brazil and the US or the UK, for instance, is the fact that the legal system is based on a ‘civil code’, rather than on a common law basis. In general terms, in a civil code environment, most of the principles and norms are established in the constitution and other supporting regulations and the judicial courts have to interpret the law on a case-by-case basis. In countries with a common law practice, the decisions are usually based on precedents and similarities with other legal cases.
Because of Brazil’s civil code system, the courts do not necessarily have to follow the same decision taken on previous similar cases and the judges have the freedom to take decisions based on their interpretation of the codes regarding the specific case being tried, even if the decision is contrary to previous decisions on similar cases.
You can imagine the amount of time and uncertainty that this system brings to overall society, especially to businesses and corporate contracts, transactions, etc. Judicial claims in Brazil sometimes take more than 10 years to be resolved in courts and the outcomes are normally unpredictable. This regulatory environment also has important impacts on tax and labor rules, which in turn have a tremendous effect on businesses and corporate relationships.
CA: Yes. Our government and our legislation are certainly part of what can be seen as the Brazilian culture and its impact on businesses. Both government and the regulatory environment are very much involved in business here and newcomers need to understand this interrelation well in order to be successful.
CA: Like most markets in the world, Brazil experienced a significant reduction in the number of deals in 2001 and 2002 as a result of 9/11, the Internet bubble and the weak situation of capital markets around the globe. In the case of Brazil, as mentioned earlier, we also had a new leftist government taking office in 2003, which made things even more difficult for M&A transactions. However, as from the second half of 2004, we have seen a tremendous come back in the market.
For instance, with 170 transactions in the first half of 2005, we have seen an increase of almost 40 per cent when compared to the same period in 2004. This number is similar to the volume experienced in the first six months of 2001 when the market was still very hot.
This is a result of a greater level of confidence on the part of the investors that the economic and political environment in Brazil is positive for new investments, despite the fact that the economy in 2005 is not expected to show the 5 per cent growth of 2004. However, the prospects for continued growth in the medium and long term play an important role on the decision to make new acquisitions.
The areas where Brazil has seen more M&A transactions are in the banking, pharmaceutical, food, IT and retail industries. In addition, the number of transactions involving foreign investors buying local operations has also represented an increase of almost 30 per cent as compared to the first half of 2004, which shows the appetite for continued growth.
CA: Brazil is doing very well in this area. The country is opening itself up to new ways of doing business. Cash flow in, out, and across the country is getting easier, and many sectors have already been or are being privatized by the government.
Privatization has had a huge impact in certain industries and segments, such as telecommunications, power and banking in particular. This all happened in the 1990s. If you look at the level of foreign direct investment prior to the 1990s, it was around $1bn a year. In 2000 it was about $33bn. It has been a huge attraction for foreign investors.
After 9/11, there was a dip in foreign investment worldwide, and that obviously affected Brazil. In the past few years, however, we have seen it coming back. Foreign direct investment in 2004 amounted to $13bn and is expected to grow to $17bn in 2005.
The greatest asset for foreign investors, I would say, is the potential for market growth combined with the already existing industrial base of most areas of Brazil. The potential for growth for investors is tremendous. If you look at the ratio of automobiles to people, from our prior example, regardless of the income gap between rich and poor, there is enormous room for growth. Of course we now compete with other developing countries for investment, especially China, Russia and India, and this competition was almost non-existent in the 1990s.
Most likely, investors can expect their investments to grow in Brazil at a faster pace than they would grow in most developed countries. That’s from the investors’ perspective. From the Brazilian consumer’s perspective, the more producers and suppliers we have, the more competitive market and prices for local consumers. In summary, foreign investment is good for everyone.
This article was originally published in PwC’s monthly global online business publication, Executive Perspectives.
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