As 2021 rolls on, we have already seen some major changes in the global economy. International business leaders and governments worldwide are now calling for a return to multilateralism and urging for cooperation to reboot the global economy.
This global speech illustrates that, for the first time in several years, the global economy is getting into sync, where both developed and emerging market economies are recovering at the same time.
Brazil, being one of the most developed Latin American countries, was thriving before the pandemic as investors sought higher yields from developing nations. However, the last year of turmoil plunged the Brazilian economy into crisis, ballooning the public debt to unprecedented levels, putting the labor market into a state of vulnerability, as well as battering the Brazilian real down.
Although experiencing the most severe global economic crisis in more than several decades, Brazil has proved to be a resilient economy and has been pointed to as one of the largest consumer markets in the world, as well as a potential center of opportunities for foreign investors.
With a few caveats beforehand, it’s crucial for any foreign investor to understand the macroeconomic dynamics, the new corporate stance towards environmental issues, the digital trend opportunities, as well as how the government will encourage before they enter into a country rife with volatility.
Macro Perspective
Like most developing countries, Covid-19 hit Brazil hard. The country became an epicenter of the coronavirus pandemic in Latin America last May, which led the local governments to impose strict measures to combat the spread of the virus. As a result, the domestic economic activity suffered a negative shock, due to a temporary shutdown of non-essential economic activities. At the same time, the pandemic had big effects on the international trade, where Brazilian export industry was more affected by the cooling of international demand.
Both situations caused unemployment to reach historic highs, as some firms were not able to avoid temporary lay-off or even survive. However, the economic impacts have been softened through comparatively permissive pandemic restrictions and one of the strongest stimulus packages in Latin Americana that supported the incomes of more than 67 million lower income Brazilians, spending more than 8% of GDP. As a result of the basic income package both income inequality and extreme poverty declined through 2020.
Nevertheless, 2020 GDP is expected to drop by 6.0% (Table 1). This can be considered a great performance considering its major peers in the region are expected to perform an even deeper contraction. Looking ahead, the recovery path is likely to prove uneven and varied across industries, however, Brazil should experience a rapid recovery in 2021 and 2022, which will be based on government stimulus and recovery of international trade.
This suggests that there may be opportunities to invest across the country tracking this potential economic growth.
Table 1. Real GDP Growth projections
Source: OECD Economic Outlook
Digital Perspective
Many corporations in Brazil responded to the pandemic crisis by speeding up their digital transformation projects and accelerating their go-to-market strategies, which helped companies to roll out new ranges of products and services, and expand their portfolios. That was made possible through the dramatic development of the digital environment in Brazil.
For companies looking to go digital or with digital products, there is a huge opportunity in Brazil. Internet access alone represented 27% growth[1] in the last 5 years vs 10% globally[2]. Outpacing the rest of the globe in terms of internet adaptation. There are 215.2 million mobile connections in Brazil, which represents a penetration of 102%[3], meaning that 66% of all Brazilians are mobile internet users (Fig 1).
Figure 1. Mobile phone internet user penetration in Brazil from 2015 to 2025
Source: Internet World Stats
Moreover, social media penetration is also 66% and Brazil ranks second in terms of hours spent on social media platforms each day: 3h 34 min. In general, Brazilians spend more than 9 hours[4] a day online, one of the highest globally.
It is without question that this behavior, along with the massive Venture Capital funding observed in the last three years, are important elements that have been favoring innovation and the growth of companies in Brazil. As a result of this focus on digital investment, there has been a boom of startups (most of them engaged in digital innovation) that have managed to break the US$ 1 billion mark, the so-called UNICORNS (Fig 2), in 2020.
Brazil has been growing as an important axis for the entrepreneurship ecosystem. Nonetheless, what is required for the tech industry to keep growing at a faster pace is regulation, transparency, government stimulus and, undoubtedly, foreign investor’s interest.
Figure 2. Latin American Unicorns
Source: https://contxto.com/en/market-map/the-21-latin-american-unicorns-galloping-to-success/
IPOs Perspective
In 2020, the Brazil IPO market picked up, as low-interest rates led investors to the stock market. This influx of public capital was put to work in 27 IPOs throughout 2020, compared with 5 during 2019 (Fig 3). When compared with the last boom of IPOs in 2007, the initial stock offering grew even more, going from R$ 10.2 billion to R$ 45.3 billion, corresponding to an increase of 342% in that period[5]. Thus, last year was the most active year since 2007.
As the outlook for 2021 as of now is for low-interest rates to continue, local companies are still planning to go public to raise money and fuel a surging demand from domestic retail investors seeking alternatives to historically low-interest rates. On that note, the list of companies studying access to the capital market suggests this year could be even busier.
Figure 3. Brazil IPO market – Volumes
Source: Anbima
Go green, ESG Perspective
The country approved a passage of a landmark social security bill, which opened the door to a wave of privatizations and tax cuts by making it more attractive for foreign companies to invest in Brazil. At the same time, Brazil is deregulating the investment landscape, such as mining, gas, oil, electricity, logistics and infrastructure (i.e water and sewage), as the federal government understands that private sources of capital are the better way to finance infrastructure long-term in Brazil.
“Despite positive policy changes and an impressive track record on renewable energy, Brazil’s reputation from an ESG perspective remains tainted by deforestation in the Amazon – something the current administration has been slow to counter.” according to Nick Smale, partner at Brunel Partners.
It means, the current government must reinforce its image abroad to indicate that they understand the current Environment, Social & Governance (ESG) friendly trend and that it is a reality all over the world.
Under the 2015 Paris Agreement, Brazil committed to cutting 37 percent of its carbon emissions by 2025, and 43 percent by 2030. To achieve that, it will need to make stronger commitments, for instance adopting strong carbon-neutral metrics and creating tax incentives for investments to come in the form of ESG friendly companies.
Foreign Exchange Perspective
Among the many questions that can arise when foreign investors talk about investing in Brazil, one always present and that is largely responsible for many deals not being reached is Foreign Exchange.
The Brazilian Real weakened 30% against the U.S dollar in 2020 (Fig 4), making it one of the worst-performing currencies in the world. The current rate is seen by many as cheap, potentially offering an attractive entry point for international capital allocators. To complicate matters, the Real has an annual volatility of around 16% vs. the USD, which is extremely high when compared among other emerging currencies.
“Whilst a strong case can be made for the BRL strengthening in the longer term, further BRL weakness and volatility remain a distinct possibility and will continue to deter international investors, particularly those that look to make longer-term investments” highlights Mr. Smale.
Unfortunately, Brazil will continue to face economic challenges that will last for decades and which will have a continuous impact on the exchange rate. An outlook that underscores the need for currency hedging strategies in this uncertain market environment.
Fig 4. Historical USD/BRL spot rate
Source: Bloomberg
The need to mitigate FX volatility, coupled with historic low-interest rates (Fig 5), creates an ideal environment for investors and firms to implement FX hedging strategies to protect their capital and cash flow.
Figure 5. Selic interest rate
Source: Brazil’s Central Bank
Conclusion
“Brazil is a market with a highly developed investment landscape, frequently overlooked by international investors, that continues to offer uncorrelated alpha opportunities that have not suffered the return compressions seen in overcrowded developed markets.” Explains Smale.
In addition to a post-pandemic rebound, Brazil should have tailwinds in the form of a government that remains committed to pushing through market friendly reforms, a burgeoning tech ecosystem and (hopefully) a more positive story to tell on ESG. A perennial issue for investors in Brazil historically has been the volatility implicit in Latin America, particularly with regards to the currency. Better options to mitigate some of the currency risk and volatility could help Brazil reemerge as an attractive place for high return seeking investors.
-------------------------------------------------------------- [1] https://www.statista.com/statistics/255208/number-of-internet-users-in-brazil/ [2] https://www.itu.int/en/ITU-D/Statistics/Documents/facts/FactsFigures2019.pdf [3] https://www.pagbrasil.com/insights/digital-in-2019-brazil/ [4] We Are Social – Digital in 2019 [5] Anbima – Capital Markets Report – December, 2020