Brazil: Pillars Supporting a Re-rating

Brazil: Pillars Supporting a Re-rating

Factors Supporting Brazil’s Structural Growth

Pension Reform: On July 10th, the lower house showed strong support in approving the main text of the government’s pension reform proposal. In early August, representatives approved the second round without alteration. This text approves the saving of BRL 933 billion over 10 years, which is approximately 30% above the market’s initial estimates.¹ The bill now lies in the hands of the Senate, and could be approved in the fall of 2019. Pension reform is vital for public sector debt sustainability.2 This improves credibility, opens financing, and brings investment back into the country. In the process, foreign direct investment should strengthen the currency, lower inflation, and allow the central bank to continue cutting interest rates, and spur growth.

Tax Reform: Brazil’s tax system is incredibly complex and expensive. According to the World Bank, Brazil’s tax system ranks 184 out of 190 countries surveyed. It takes more time for a mid-sized company to file taxes in Brazil than in any other emerging market country. Economy Minister Guedes aims to simplify the system by using a uniform VAT rate to replace other taxes. He has also proposed to lower the corporate tax rate from 34% to 15%, which should drive positive earnings revisions. Additionally, he plans to hike the tax on dividends from 0% to 20%, which may lead to more re-investment and capex-led growth.

Privatizations: Brazil has the largest number of state-owned enterprises of any country in Latin America.3 Historically, the market has perceived these companies as inefficient, inflated, and as an impediment for open markets. The new government plans to change this and has even created a role for a secretary of privatizations. The government plans to sell at least BRL 75 billion in assets of state owned companies this year. Not only will this likely improve market efficiency, but it should also increase market liquidity, improve corporate governance, and help adjust Brazil’s fiscal balance.

Trade Liberalization: Brazil has a long history of running an Import Substitution Industrialization (ISI) based economy. Essentially, the government has historically implemented high tariffs in order to boost its domestic industries. The current government is taking a new approach to the economy and now intends to focus on free-trade agreements with Latin America, Europe, and the United States.