If you are a planning to travel to the FIFA World Cup in Brazil you probably have sun soaked beaches, costumed parades and a carnival atmosphere in mind. Unfortunately, you are more likely to be greeted by street protests, civil unrest and a growing opposition to the World Cup from the most football-obsessed nation on earth. As shocking as it sounds, this would like Canadians turning their backs on ice hockey and Indians falling out of love with cricket. Brazil won the bid to host the World Cup in 2007 during the days of President Lula Da Silva and it was meant to be a coming out party for the nation. But the glory days from 2002-2010 when Brazil grew over 5 percent seem like a distant memory. How did Brazil end up scoring an own goal when most investors thought its time had finally come?
In spite of all the progress made so far, the reality is that Brazil’s stifling bureaucracy has managed to grow and keep a lid on its potential. According to the World Bank, it still takes 13 bureaucratic procedures and 107.5 working days to open a business in Brazil. If you want to build a factory, it takes 400 days to get construction permits and 58 days to having running electricity. This same bureaucracy has failed to deliver essential public services promised to ordinary Brazilians while sparing no expense to deliver infrastructure for the World Cup, which has largely benefited the rich and corrupt in terms of government contracts. As a result, most of the protestors are urban, educated, middle class Brazilians who would normally be enthusiastic supporters of their much vaunted football team.
You know its time for reforms when pizza costs over $30 in your country. In the “Emerging Market Handbook” we noted how there was a Brazil cost or _“Custo Brazil”_ to doing business in Brazil. Add inflation and currency overvaluation to the mix and you have a recipe for the kind of unrest that has plagued Brazil the last few weeks. As noted in the previous column “Made in China? Think Twice”, it costs more to manufacture in Brazil than in some developed countries thanks to inflexible labor laws, high taxes and high interest rates.
Boom and Bust
Before discussing how Brazil can get out of this mess it is important to understand how it got here in the first place. In many ways it is easy to conclude that the Brazilian leadership got complacent but there is more to it than meets the eye. The benefits of a solid foundation of reforms instituted by the much underrated President Cardoso created a wave ridden by the much loved President Lula Da Silva. While President Dilma Rouseff got to partially ride the wave in her first term, the benefits quickly evaporated as her government failed to take some of the harder measures needed to sustain the pace of reforms. The commodity boom driven by China and rapid urbanization masked most of the problems afflicting the economy today.
Now with the commodity boom having come to an end and with little room for the workforce to grow, Brazil’s problems are there for all to see. Ordinary Brazilians could afford their expensive cars, TV’s and washing machine’s thanks to a liberal lending policy by banks which was encouraged by the government. Now most consumers are stretched to the limit in terms of debt which has resulted in a slow down in domestic consumption which was one of the key drivers of the Brazilian economy.
The Big Fix
There are three key area’s that we believe needs the urgent focus of the government and any signs of change in these area’s could be a positive signal for investors. Firstly, investment in infrastructure would reduce the cost of goods and raw materials coming from the Brazilian hinterland to its cities. Secondly, simplification of its notoriously complex tax code would reduce compliance costs and the size of the informal cash economy while raising government revenues. Thirdly, investment in higher education to boost the productivity of its workers as the easy gains that come with adding new workers have been exhausted.
While there is overriding pessimism when it comes to Brazil these days, investors only need to look at some of the multinationals that are still thriving in Brazil. They continue to invest in underdeveloped area’s of the economy and sell their products to the rapidly rising lower middle class of Brazil. Unemployment remains near record lows and wages are rising. Perhaps a World Cup win will lift spirits and a change of guard after the October elections will get the country back on the road to prosperity.
By Pran Tiku CFP & Vikram Kondur CFA
Our comments, opinions and analysis are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Markets and economic conditions are subject to rapid change, comments, opinions and analysis are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.