INTERNATIONAL ENTERPRISE SINGAPORE IE Insights Vol. 12/ Oct 2013 Brazil: Beyond the World Cup and Olympics Despite emerging market instabilities in the interim, there are important investment opportunities in Brazil over the long term. Pre-salt oil discoveries have prompted Petrobras’ capital expenditure in the oil & gas sector to reach nearly S$300 billion over the next four years. The government is also planning to resolve infrastructure bottlenecks with estimated spending expected to exceed S$100 billion over the medium to long term. Meanwhile, an expanding middle class will drive growth in consumer markets. These positive long term trends indicate that Singapore companies can capitalise on public and private spending in Brazil’s key industries – oil & gas, infrastructure and consumer goods. By Anchit SOOD, WOO Wei-Li Americas Group [email protected] Contents 03 10 Summary Long-term Business Opportunities for 05 Singapore Companies Emerging Market Challenges - Singapore’s investments in Brazil - Systemic issues - Where to invest - Much-needed public sector - What to invest in reforms - Oil & gas support services - Infrastructure 08 - Consumer products Longer Term Positives - Natural resource endowments 25 and technological spin-offs Conclusion - Strong domestic consumption - Vibrant private sector Disclaimer While every effort is made to ensure that the information in this document is accurate, the information is provided by IE Singapore to you without any representation or warranty. Any reliance on the information in this document is at your own risk. IE Singapore does not accept any liability for any errors, omissions or misleading information. IE Singapore and its employees shall not be held responsible for any consequence arising from your reliance on any information provided by us. You are advised to consult your own professional advisors. 2 Summary • Recent socio-economic and political events have exposed Brazil’s emerging market risks. These, together with the high cost of doing business as a result of high taxes and hefty social security obligations have decreased the competitiveness of companies doing business in Brazil. • Recent public outcry and upcoming elections in 2014 may serve as catalysts for the government to re-focus on key issues such as the infrastructure gap, poor education and the high cost of doing business. • Nonetheless, International Enterprise (IE) Singapore remains positive about Brazil’s long-term potential. Rich natural resource endowments and related technological spin-offs, a growing middle class with a young population, and a vibrant private sector will underpin the nation’s growth going forward. • For the next three to five years, the focus of investments will be on Brazil’s three pillar industries - oil & gas, infrastructure and consumer goods - thanks to a combination of private and public sector spending. • In the oil & gas sector, Petrobras is expected to spend S$293.9 billion between 2013 and 2017 to exploit its pre-salt oil discoveries. In addition to opportunities for Singapore’s large-scale shipyards which are well-known specialists in the construction of rigs, floating production storage and offloading vessels (FPSOs) and conversion projects, other sub-sectors along the value chain - offshore supply vessels as well as equipment and engineering services suppliers - will also benefit. • To plug the infrastructure gap, the Brazilian government has announced a slew of projects covering sea, land and air transport worth more than S$100 billion over the next five to 25 years, which will lay a firm foundation for the country’s longer term development. Singapore companies involved in the investment and management of airports and ports will benefit. Companies engaged in the provision of electronic systems and solutions for urban transit, logistics and urban planning also stand to gain. 3 Summary • Unique characteristics of the Brazilian consumer market suggest that the best way to capture the consumer dollar would be through supplying manufacturers of consumer goods rather than those in consumer services. IE sees opportunities for Tier 2 suppliers in the automotive sector especially those in tooling, plastic moulding and electronic systems. • IE recommends focusing on South and Southeast Brazil. The states in these two regions account for more than 70% of Brazil’s GDP and have more established business practices and governance systems. Other than the states of São Paulo and Rio de Janeiro, Singapore companies can consider emerging states in these two regions, such as Minas Gerais, Espírito Santo, Rio Grande do Sul and Santa Catarina as investment destinations. Investment costs are lower due to less competition and pressure on infrastructure. Local governments are also more proactive in offering incentives to attract investment. 4 Emerging Market Challenges Systemic issues have emerged as the economy cools. Brazil’s robust GDP growth in the previous decade, averaging about 4.5% per annum, has slowed dramatically. In 2012, the economy grew just 0.9% as commodity prices slumped and external demand weakened. Ilan Goldfein, the chief economist of Brazil’s largest private bank, Banco Itaú, predicts growth rates as low as 2.0-3.0% going forward1. Systemic issues The slower growth has exposed systemic emerging market issues in the Brazilian economy such as inadequate infrastructure, bureaucracy, over-regulation and a lack of skilled labour. The country also faces challenges more commonly associated with developed economies – a low savings rate, high taxes and hefty social security obligations. These factors have markedly increased the country’s cost structure and stifled its labour market, making companies less competitive. Figure 1 provides perspective on the cost of doing business for companies in Brazil, labelled “Custo Brasil” (or “Brazil Cost”) and its implications. Meanwhile, increasing costs of living, with the Consumer Price Index (CPI) forecast at 6.0-5.3% between 2013 and 20152, was one of the triggers of recent widespread protests and dissatisfaction with the current administration. 1 “Brazil economy needs rebalancing”, BBC, 17 July 2013 2 “Brazilian Automotive Market Analysis”, PricewaterhouseCoopers, July 2012 5 Emerging Market Challenges Figure 1: Illustrating “Custo Brasil” Business Environment • Ranked 130 out of 185 countries by The World Bank, in terms of ease of doing business. • Placed between Bangladesh and Nigeria • Below China (91), Russia (112) and Indonesia (128) • Above India (132) Tax Burden • The World Bank estimates that 67% of corporate profits end up with the government • Compliance is burdensome • Takes 2,600 man hours for an average company to file and pay taxes, versus 84 hours in Singapore and 347 hours in Mexico Cost of Production • National Association of Machinery estimates “Brazil Cost” to contribute 36% to cost of goods sold • A Brazilian-made Volkswagen Fox costs 32,000 reais (S$20,480) to make but sells at 21,317 reais (S$13,642.90) overseas Logistics • Transporting soya costs US$170 (S$212.50) per tonne from the main soya growing regions to the port of Santos, 43% more than transportation costs over the same distance in the US Labour Cost • Wages can be higher than other emerging markets especially for skilled and semi-skilled labour such as engineers, welders and marine crew • Social security contributions can often double the wage bill • Lawsuits against employers, while small, are common and often favour the employee Figure 2: Consumer price index (2005 - 2015 forecast)3 % 7 6.5 6.2 5.9 5.9 6.0 6 5.7 5.3 5.1 5 4.5 4.3 4 3.1 3 2 1 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3 “Brazilian Automotive Market Analysis”, PricewaterhouseCoopers, July 2012 6 Emerging Market Challenges Consumer credit has expanded rapidly in recent years resulting in debt accounting for 43% of average individual incomes4. Credit growth is forecasted to continue, albeit at a slower rate, hence delinquency ratios need to be monitored given the near term domestic and international economic uncertainties. Much-needed public sector reforms Ironically, slower growth may serve as a catalyst for the government to re-focus on key issues, such as the infrastructure gap, education, “Custo Brasil” and fighting corruption, some of which were part of the policy agenda of the current administration. The upcoming Presidential, Congressional and State-level elections in October 2014 may also help spur government action over the country’s public sector inadequacies. President Dilma Rouseff has earned much-deserved credit since her election in 2011 for her tough stance on corruption, macroeconomic management and determination to initiate reforms. However, much more needs to be done, particularly against the backdrop of weak macroeconomic conditions. For instance, the government may need to cede more control and equity stakes in some state enterprises through the privatisation of state assets. This will attract more private participation, which will generate much needed investments, create competition, and ultimately, lower overall costs. 4 “Fitch: Brazilian consumer credit expected to expand”, Reuters, 20 May 2013 7 Longer Term Positives Despite emerging market woes and slower growth, Brazil has long term potential. Natural resources aside, the country has a relatively young population and rising middle class which will underpin domestic consumption, as well as a vibrant private sector. Natural resource endowments and technological spin-offs Brazil is endowed with many