This article has been written by Hetal Panjari, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution and edited by Shashwat Kaushik.

It has been published by Rachit Garg.

Introduction

Brazil’s economy is currently facing an inflection point where purchasing power is comparatively slow and growth is stagnant. The current challenge for the economy is to prevent a recession. Also, Brazil’s economic conditions are challenging for corporations too, as due to the policy uncertainty prevailing in Brazil, it discourages corporate firms from making long term investments, further making it difficult to create stable investment relationships between the investor and the corporate entities. Economic uncertainty, however,  spread due to sudden changes in input output, employment, interest rates, oil prices, and exchange rates in the country. Further Government decisions have a huge impact on economic uncertainty if there is mismanagement and the wrong economic decisions are taken. Further, elections also impact market conditions, which affect stock prices and corporate decisions.

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Economic history of Brazil

The economic history of Brazil involves many different economic changes throughout the country’s history. Initially, during the colonial rule of the Portuguese from the 1500s to the 1930s, the Brazilian economy primarily relied on domestic products and exports. This had stopped the country’s development. After 1930, the Brazilian economy had become stable, and the textile industry was primarily booming. Fast economic growth took place during World War II in the 1940s. Major industrial development took place from 1940 to 1970, along with the steel and automobile industries; the service industry of the country also took off due to industrialization and new industrial policies. Until 1974, Brazil’s GDP was the highest in the world. However, an economic crisis hit in 1980,  during which the country experienced inflation and slow economic growth. During the economic crisis, the Brazilian government came up with many economic plans; however, they didn’t turn out to be fruitful. The country also faced economic debt during this period.

However, the Brazilian economy started facing a slow economic boom in 2004. In the later half of 2008, the world economy hit a rise to a decrease in exports, a credit squeeze, and many companies cut their operations due to losses, which led to the declaration of such companies as bankrupt. To tackle this situation, new economic policies were implemented, wherein various fiscal policies were implemented and subsidised credit was given to the productive sectors.

This situation was hit due to low levels of investment, inflated and inefficient public spending, high social security costs, low labour productivity, and poor infrastructure. These issues are still prevalent in Brazil. To resolve the issues, the Nova Matriz Econômica (new economic matrix) was implemented, which includes expanded state intervention in the economy, currency devaluation, and interest rate reduction. However, this matrix was a failure, which  downgraded the country’s sovereign debt rating in March 2014.  Between 2014 and 2016, the Brazilian economy faced one of its worst recessions in history. Further, in 2020, when the COVID pandemic hit, it posed a threat to the country’s growth potential.

Realm of corporate governance in Brazil

Corporate governance is the system whereby organisations are run, overseen, and encouraged. It  involves relationships between the shareholders, the Board of Directors, the officers, and regulatory bodies. The principles and practices of good corporate governance apply to any kind of organisation, regardless of size, legal nature, or type of ownership. Corporate governance is based on four pillars–transparency, fairness, accountability, and corporate responsibility. 

The Brazilian Institute of Corporate Governance (IBGC)  defines corporate governance as the practices and relationships among shareholders, the board, the CEO, independent audit members, etc. that seek to optimise a company’s performance and facilitate access to capital. Brazil’s economy has gone through major changes, which include economic growth, macroeconomic stability, and changes in investment patterns. Since the 2000s, Brazil has seen relatively weak corporate governance.

The corporate governance structure in Brazil applicable to listed companies is established on the basis of Brazilian Corporation Law, regulations issued by the Securities and Exchange Commission of Brazil (CVM) , and listing rules issued by the Brazilian Stock Exchange to each of its listing segments. Moreover, Brazilian corporations are controlled by the majority of shareholders, who own the majority of voting shares.

Implementing corporate governance practices has become an important task and mandatory for Brazilian companies, be they state-owned entities, listed, private, or family-owned. However, companies that have access to capital markets attract local and foreign investors who invest in their stocks.

Economic uncertainty affects the capital markets and also affects the investor selection portfolio. Government policies shape the business environment, and the uncertainty of economic policies has a direct impact on the market and its liquidity. Changes in government policies have a direct impact on economic conditions, giving rise to risky investment decisions. Investors are also cautious during such uncertain conditions, which has a negative impact on stock prices.

Finance plays an important role and is linked to corporate governance and economic development. Good corporate governance structures assist in capital market development and thus provide the private sector with greater access to long term funding. Currently, the major concern for Brazil’s economy is the availability of long term finance at competitive rates for private sector development. Thus, lack of finance has become a concern for the expansion of corporations, especially for locally owned enterprises that face difficulties in accessing foreign capital markets. Brazil’s private sector faced financial problems during the 1980s, wherein there arose funding issues in the country and the state could no longer provide enough funding.

The crisis of public finance is still prevalent in the economy even today.  Local capital markets are also underdeveloped, particularly in the area of equity finance. Since the early 1980s, local business groups have been relying practically entirely on retained earnings and on foreign capital markets to finance growth.

To sum up, Brazil’s corporate structure is fragile and faces the following problems that need to be resolved –

  • Financial vulnerability results in high capital costs.
  • Long term domestic financing results in a delay in the centralization of capital, as in Brazil there are many corporations that are family owned.
  • Weak competitive performance in all sectors.
  • Loss of national ownership in many sectors.

Coping up with policy uncertainty in investment patterns

Financial development plays an important role in economic growth and stability. If we check in terms of investment, liquid capital markets increase the supply of differentiated assets, facilitating investment choices. Capital market development in Brazil is a key policy issue going forward to foster savings and investment. Brazil’s savings and investment levels as a share of GDP are still low by international standards. Local investors in Brazil have been less active in the equity market when it comes to investment in pension funds and mutual funds.

Brazil’s financial sector is dependent on natural capital to support economic growth and ensure future returns for investors. Nature’s assets are abundant in Brazil, from its farmland, forests, and energy reserves to its ecosystem services, such as the rainforest, which helps regulate weather patterns. Brazilian financial systems are at capital risk because the sectors that banks and pension funds finance are heavily reliant on Brazil’s natural capital. Growing business demand for natural capital and falling supply due to environmental degradation are contributing to changes in investment patterns.

Thus, it is important for investors to consider the future potential risks that a company may face, depending on the current valuation of the investment. Thus, if there is a rise in the cost of natural capital, it will have a direct impact on the repayment of credit or shareholder return on investment. Brazil’s complex regulations and bureaucratic systems make it difficult for businesses to venture into the Brazilian market. As of 2023, Brazil’s economy is experiencing a period of moderate growth following several years of economic uncertainty. The country rebounded strongly during the global financial crisis, but the financial challenges are leading to a decline in GDP. The Brazilian government has implemented several measures to reduce the deficit; however, the country is still facing major challenges. Investment in the Brazilian market is severely impacted due to stringent government norms, tax complexity, corruption, unemployment, hindrance in the local labour force, inflation, infrastructure shortage, import barriers, sensitive fiscal position, Volatility of the local currency and its significant depreciation, Volatility in foreign direct investment (FDI),  etc.

With the resources available, the challenge in Brazil is no longer how to increase production but how to export what is being produced, thus reviving the economic condition and changing investment patterns. Brazil also has severe domestic problems that are affecting the currency’s valuation. The volatility is disturbing for businesses as it raises debts, creates uncertainty, and also affects investment decisions, such as how much a company should export or import.

On the other hand, investment patterns that are predominantly seen are-

  • Brazilian investors  prefer to invest in something tangible, like real estate. 
  • Brazilians are still afraid of inflation. Hence, they tend to spend their wages as soon as they receive them.
  • High taxes and expensive prices reduce the purchasing power and investment capacity of Brazilians. Energy, food, clothes, and electronic goods are more expensive than in many other countries.
  • Several companies left the public market and are no longer listed.

Conclusion

Doing business in Brazil can be complex and challenging, as companies must navigate  various obstacles to succeed in this market, which include Brazil’s complex tax system, high labour and slow process of judicial review. Brazil’s complex regulatory system hampers foreign investment, which is hampering the economic growth of the country. Brazil is in the early stages of the development of small and medium- size businesses. It is necessary to view foreign investment as a broader way to review economic difficulties. Further, Brazil’s capital markets are still facing a number of challenges, which include prevalent short-term indexation, investors’ risk aversion to long-term fixed rate bonds, and low liquidity in the secondary market.

Thus, Brazil must reduce its fiscal complexity and the costs of public administration and invest in efficient education and income distribution projects in order to increase productivity and competitiveness on a global scale.

References

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