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Brazil: Why Executives Should Care Who Wins

Why Wall Street doesn’t care who wins Brazil’s watershed elections, but executives should.


Executives building businesses in Brazil should take note of this Sunday’s presidential election runoff. This election will have a major impact on the ability of multinationals operating in the country to turn GDP growth into profit for their companies.


Brazil is about to elect a former communist guerilla, Dilma Rousseff of the Workers Party (PT), to the highest office in the land. There could be no greater demonstration of Brazil’s new status as the country-that-can-do-no-wrong in the eyes of the investment community than the corresponding indifference of capital markets and financial institutions to this political development.

That Dilma will win the presidential runoff is a near certainty, as questions over her view on abortion and new allegations of abuse of power against her are again failing to elicit much more than shrugs and channel surfing from the electorate.

Likewise, investors believe Dilma poses no threat to the growth of the Brazilian economy. The conventional wisdom driving this insouciance holds that Dilma Rousseff and her challenger, José Serra of the PSDB, will follow a similar set of orthodox macroeconomic policies, much as current president Lula da Silva of the PT continued most of the policies established by his predecessor, Fernando Henrique Cardoso of the PSDB.  Serra would, of course, also follow the policy blueprint designed by Cardoso. This framework will ensure relatively low inflation, moderate to high interest rates (though low by historical standards), a stable currency, and capital inflows needed to invest in long term growth. These conditions, in turn, will guarantee macroeconomic stability and growth, and concurrent strong returns from investments in Brazilian debt and equity.


Sustained GDP growth, however, is no guarantee of corporate profitability. Brazil’s worst kept secret is that the cost of doing business in the country is sky-high, and the barriers to profitable growth are intense. The expression Custo Brasil refers to the swamp of regulations, tariffs, labor laws, and taxation that erodes margins and the willpower of all but the most resolute executives.  Regarding taxation, which is just one facet of the Custo Brasil, Latin Business Chronicle recently rated Brazil dead last in Latin America in its Latin Tax Index. 

So would a victory by either Serra or Dilma greatly alter the Custo Brasil? In the short run, no. Neither candidate, if elected, would be likely to push through major improvements in key areas such as labor law, pension reform, tax reform, or import tariffs. Serra, as the more business friendly center-left candidate, is more committed to reducing the Custo Brasil and tackling hard reforms, but would be unlikely to muster sufficient political capital to progress any meaningful reforms, at least for the first few years of his administration. Dilma, in contrast, would be in a more powerful position to push through reform, but is more broadly supportive of the status quo and less likely to expend energy and resources on reforms she does not totally support.

Nevertheless, labor costs are one area in which the next government will influence business costs in the short run, though indirectly. Executives in the industrials and manufacturing sectors are nervously monitoring strikes and negotiations in the auto industry, where unions are demanding raises far above inflation estimates, and growing increasingly assertive. Companies fear a Dilma win would further embolden organized labor to push for still more aggressive wage hikes, further adding to costs. A Serra victory, on the other hand, could guarantee a more neutral government role.

Concerning reducing the Custo Brasil, the major difference in outcome will be small in the next few years, but could be more significant over the next government’s full term in office, as a Dilma government will be less concerned with improving the ease of doing business as long as overall macroeconomic growth remains moderate to high. Serra, in contrast, sees the Custo Brasil as a longer term structural threat to competiveness and considers reform to be unfinished business from the PSDB’s previous tenure and is thus more likely to pursue reform for the duration of his time in office.


Should she win, expect Dilma to accelerate the involvement of the state in the private sector. For multinational companies (MNCs), this could mean a playing field tilted in favor of Brazilian firms in strategic industries and an increased necessity to partner with Brazilian or state-controlled firms in order to gain favorable investment terms.

While the business environment may not change significantly following the elections, the relationship between the state and the private sector has already begun to shift over the last few years, as Lula began to move away from the more passive approach to the private sector he adopted in his first term to calm international markets spooked by his victory.

In a sign of increased state direction of the economy, the latter years of Lula’s administration saw the government push for consolidation in key industries to form “national champion” firms, as well as expanded government ownership of strategic assets in certain sectors. The government’s aggressive moves to guide growth and steer the economy are sometimes referred to as the “Smart State” model.

Lula’s “Smart State” model is increasingly involved in dictating the outcome of business competition, and creating an increasingly complicated environment for foreign companies. Through BNDES, Brazil’s national development bank, the government grants access to cheap credit to help consolidate selected industries and attract companies to social projects.

Additionally, the government is exploring taking a direct or indirect stake in key industries such as infrastructure, telecommunications and energy resources. Telebrás, the state-owned telecommunications company that was essentially disbanded in 1998, may be revived to implement the National Plan for Broadband. The controversial proposal to reform Telebrás is raising concerns that the government wishes to reverse privatizations made under the previous administration and revive inefficient state industries. Dilma herself has been quite vocal in her denunciations of the privatizations that occurred under the Cardoso administration.

With recent legislation such as the “Buy Brazil Act” (Provisional Measure (PM) Nr. 495), the government is mandating preference for Brazilian firms or goods produced in Brazil in government procurement. According to Marcus Freitas, Frontier Strategy Group Expert Advisor and Professor of Law and International Relations at Fundação Armando Alvares Penteado in São Paulo, “According to the new law, preference shall always be given to products: a) made in Brazil; b) made or provided by Brazilian corporations, and c) made or provided by corporations that have invested in research and technology development in Brazil… The Federal Administration expects foreign companies interested in the Brazilian public procurement market to establish a presence and invest directly in the country.”


A Dilma government will intensify the challenge many executives operating in Brazil already face: Huge expectations for growth from corporate headquarters on the back of strong GDP numbers, yet massive obstacles to profitability and an increasingly tilted playing field for foreign firms.

In response, executives at foreign companies are increasingly looking to partner with domestic firms to gain access to government loans, projects, and contracts. Companies without access to these partnerships face entrenched competition from Brazilian firms. The hot M&A and JV environments in Brazil mean those who wait will be left with few desirable partners in the future.

Additionally, savvy executives are aggressively communicating the impact to profitability of the cost and difficulties of doing business in Brazil back to corporate, and working to set goals and manage expectations accordingly. Certainly that job will be easier if corporate headquarters understand that while a Dilma win may be just fine for Wall Street, it comes with plenty of headaches for executives tasked with growing businesses in Brazil.

This column is drawn from research for quarterly and monthly market intelligence reports from Frontier Strategy Group. Frontier Strategy Group runs the Council on Emerging Markets. Republished with permission.


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