Brazil climbs three positions, ranks 6th in FDI

UNCTAD shows optimism about Brazil’s rise, unlike the rest of the world

06/10/2022

FDI flow to Brazil in 2021 reached $50.3 billion, up 77.9% from 2020 — Foto: Scott Eells/Bloomberg

FDI flow to Brazil in 2021 reached $50.3 billion, up 77.9% from 2020 — Foto: Scott Eells/Bloomberg

Brazil was the sixth country that attracted the most Foreign Direct Investment (FDI) in 2021, climbing three positions in relation to the previous year, the World Investment Report released Thursday by the United Nations Agency for Trade and Development (UNCTAD) points out.

The expectation is that the country can continue to attract a good volume of productive foreign investment, although the global trend now is slowing down because of the war in Ukraine.

The FDI flow to Brazil in 2021 reached $50.3 billion, up 77.9% from 2020, when the country received $28.3 billion, according to Unctad’s consolidated figures.

In January, the UN agency had estimated that the flow to Brazil could have increased by more than 100% and the country would be the seventh-largest destination for real foreign investment.

“Brazil is an interesting case,” James Zhan, head of Unctad’s investment division, told Valor. “It is typically one of the largest recipients of FDI in the region and even among the most advanced developing countries.”

He notes that there was a strong recovery of investment in Brazil in 2021, but it has not yet resumed the level of 2019, before the pandemic, when the flow reached $65 billion. Last year, the flow was driven by the reinvestment of profits that multinationals had accumulated in recent years.

For Mr. Zhan, commodity prices may encourage multinationals to increase their investments in Brazil, expand existing operations and perhaps some new investments in the extractive industries and in the production of other commodities, such as in agriculture this year.

“That could be a kind of continued increase in investments for a full recovery of FDI in the country,” he said.

In 2021, Brazil was behind only the U.S., China, Hong Kong, Singapore and Canada as a recipient of FDI. And it attracted more productive resources than India, an economy that grows about 8% annually and is pointed out as one of the drivers of global expansion.

The FDI flow of $50.3 billion last year represented 18% of the gross fixed capital formation (GFCF), a measure of the productive capacity of an economy, compared to 11.8% in 2020.

The stock of FDI in Brazil totaled $592.7 billion at the end of 2021 (or -0.4% compared to the previous year) and represented 36.9% of the GDP compared to 41.1% in 2020.

The announcement of greenfield projects in Brazil reached $23.2 billion, or 35.1% more than in 2020. Mergers and acquisitions by foreigners in the country fell 45.7% between 2020 and 2021. The volume declined to $2.7 billion last year from $14.3 billion in 2018.

Overall, global foreign direct investment flows reached $1.6 trillion last year. Reinvested profits by subsidiaries of multinationals accounted for the bulk of this amount, reflecting a record high in profits for these companies in the wake of rising demand, low financing costs, and significant government support. Multinationals’ profitability doubled to 8.2% last year on average.

As for this year, UNCTAD sees “a significant risk” of the momentum for international investment recovery stopping untimely.

The global environment for international investment has changed dramatically with the war in Ukraine. New project activity already reflects increased risk aversion among investors.

Preliminary data for the first quarter show a 21% drop in greenfield projects. And international project financing fell by 4%.

Most of the top 5,000 multinationals have revised downward their earnings estimates for 2022 — but with differences that point to risks of setbacks in the energy transition.

The oil and gas industry forecasts an additional 22% gain and the coal industry another 32%, while the renewable power industries project a 22% drop in profits.

Other factors will negatively affect FDI in 2022. The spread of Covid-19 in China (with new lockdown measures) impacts global value chains.

Rising interest rates in several countries are also expected to slow down M&A activity and dampen growth in international project financing.

Negative financial market sentiment and signs of a looming recession could accelerate a fall in FDI. But UNCTAD also points to stabilizing factors. For example, large public support packages for infrastructure investment, with implementation over several years.

*By Assis Moreira — Geneva

Source: Valor International

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Airport auction seen as drawing interest from major players

Challenging scenario, with strong inflation of construction costs, is unlikely to hinder competition

06/10/2022

Brazil’s new auction of airport concessions, scheduled for August 18, is expected to draw strong interest from the private sector. The challenging scenario in the infrastructure market, with strong inflation of construction costs, high interest rates and economic uncertainties, is unlikely to hinder competition, analysts told Valor.

The highlight of this 7th round is the block of Congonhas airport, in São Paulo. Any operator interested in the asset, considered one of the federal government’s “crown jewels,” will have to take some regional airports as well – 10 of them, located in Minas Gerais, Mato Grosso do Sul and Pará. This block of airports will receive R$5.9 billion in investments. The winner will be the one who offers the highest fixed concession payment – the minimum amount is R$740.1 million.

“It is hard to imagine that there will be no competition for a block that includes Congonhas. All the large groups that participated in the last rounds are analyzing it,” said Ricardo Fenelon, with law firm Fenelon Advogados.

This is an eagerly anticipated auction, said Fabio Falkenburger, a partner at law firm Machado Meyer. “Since this cycle of concessions began, all operators have been studying Congonhas. This asset has guaranteed air passenger traffic and great potential for commercial exploration,” he said.

The resilience of domestic flights after the peak of the pandemic also makes players more confident, said Daniel O’Czerny, head of global infrastructure finance for Latin America at Citi.

The participation of some groups is seen as certain, including CCR, France’s Vinci Airports and Spain’s Aena. Other large international operators already present in the country are strong candidates, including Switzerland’s Zurich Airport and Germany’s Fraport. The investment fund manager Pátria, which has been trying for some time to enter the airport industry, is not showing much interest, but is also considered a strong candidate.

The arrival of new players is not seen as likely, but considering the importance of the airpot in São Paulo, it is not ruled out either. Groups such as France’s ADP, Australia’s Macquarie and U.S.’s Houston Airport may take part.

The other two airport blocks included in the seventh round play second fiddle, but are also seen as good opportunities. The North block, which includes the airports of Belém and Macapá, will receive investment of R$875 million. The executive aviation block, formed by Campo de Marte (São Paulo) and Jacarepaguá (Rio de Janeiro), will draw R$560 million in construction works.

The North block is expected to draw medium-sized operators, such as Socicam. Vinci and Aena are also seen as natural candidates due to possible synergies with the airports they already operate. The French group has already won a first regional block in the North region last year, which includes airports in Manaus, Porto Velho, Boa Vista and Rio Branco. The Spanish company, on the other hand, has been operating six airports in the Northeast region since 2020.

Ronei Glanzmann — Foto: Geraldo Magela/Agência Senado

Ronei Glanzmann — Foto: Geraldo Magela/Agência Senado

Some analysts see the business aviation block as a question mark. But the government expects a successful auction, said Ronei Glanzmann, federal secretary of Civil Aviation.

“We have seen companies totally different from those that typically participate in auctions. It is a segment that involves three businesses: general aviation, real estate exploration and, especially in Jacarepaguá, fuel supply. The perception is that there may be multidisciplinary consortiums,” he said.

The scenario of economic instability, high interest rates and fast inflation of construction inputs have hindered infrastructure auctions this year, especially those of highways. In the case of the airport auction, market players say that these factors are unlikely to make it unfeasible.

For Elias de Souza, partner at Deloitte, the crisis scenario is likely to impact mainly the attraction of new operators. “I don’t think new groups will come for this auction. The current macroeconomic scenario requires more security. But those that already operate in the country know the local risks and are likely to bid,” he said.

According to a source that follows the auction closely, the advantage of airport projects is that the impact of cost inflation is somewhat lower and, in addition, operators have a greater variety of ancillary revenues. Mr. O’Czerny also notes that the range of airport operators already present in the country is much larger than in the road sector, which favors competition in the auctions.

Vinci and Zurich declined to comment. CCR said it is “attentive to opportunities.” Aena, Fraport and Pátria did not immediately reply to Valor’s requests for comment. Socicam said it is analyzing the projects.

Source: Valor International

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Petrobras stalls fuel price hikes

Meanwhile, changes in management team of oil behemoth are also in standstill

06/10/2022

Fuel prices prompted change in the command of Petrobras — Foto: Leo Pinheiro/Valor

Fuel prices prompted change in the command of Petrobras — Foto: Leo Pinheiro/Valor

The double-digit gap between diesel prices in Brazil and abroad means that Petrobras could immediately raise costs to refineries, sources told Valor. The company, however, continues to analyze the market situation before deciding.

Consultants’ calculations indicate that the price of diesel that Petrobras charges from distributors is between 15% and 17.5% below international parity. In the case of gasoline, there are estimates that the price the state-owned charges from distributors in Brazil is 45% below the price negotiated in the Gulf of Mexico, one of the world’s main refining centers.

Meanwhile, the management changes intended by the government in the state-owned company, as part of President Jair Bolsonaro’s strategy to try and control fuel prices, continue to face difficulties.

On Wednesday, there was a meeting of the board of Petrobras. The company’s strategic planning was on the agenda, but the discussion turned to the state-owned company’s Eligibility Committee (Celeg), linked to the Personnel Committee (COPE). Celeg/COPE verifies if candidates for the board meet the necessary requirements and have no restrictions to run for the position, according to the internal rules of the company and the State-Owned Companies Law.

In a statement released on Thursday, Petrobras confirmed that the collegiate debated the day before a request made by the federal government, the company’s controlling shareholder, to replace the current CEO, José Mauro Coelho, by Caio Paes de Andrade, who is associated with Economy Minister Paulo Guedes. But there was no decision concerning this issue. A person familiar with the company said that “the analysis [of Mr. Paes de Andrade by Celeg] has not been made yet because the information is not ready.”

Mr. Paes de Andrade was nominated on May 23, through a letter from the Ministry of Mines and Energy (MME), which requested a shareholders’ meeting to elect him as a board member — the first step for him to become the company’s CEO to replace José Mauro Coelho. On May 25, the Petrobras collegiate met and concluded that it needed to wait until the federal government sent the list of eight candidates (including Mr. Paes de Andrade) to the Petrobras board, which has not yet happened.

Mr. Coelho, the current CEO of Petrobras, was elected in the shareholders’ meeting in April by an unbundled vote, and once he is removed all other members of the collegiate elected by the same system must go through a new election. Eight of the 11 members of the Petrobras board were elected by this method, which allows votes to be concentrated on certain candidates. These are the eight positions expected to be disputed once again in the meeting, which has not set a date so far.

This list seems to have become a point of conflict between independent advisors and the government. Celeg/COPE, after having received Mr. Paes de Andrade’s documents, is still waiting for the list of the other government candidates. The government, in turn, is trying to bring forward the result of the Eligibility Committee’s analysis to know if Mr. Paes de Andrade will be approved by the company’s governance bodies. The situation has become a kind of chess game, in which each party waits for the opponent’s move to define its own move. Meanwhile, almost nothing is happening.

*Gabriela Ruddy, Francisco Góes — Rio de Janeiro

Source: Valor International

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Eletrobras raises R$33.7bn in mega stock offering

After privatization by capital increase, government will hold about 40% of votes

06/10/2022

Investors say changes will help company gain efficiency — Foto: Domingos Peixoto/Agência O Globo

Investors say changes will help company gain efficiency — Foto: Domingos Peixoto/Agência O Globo

Eletrobras managed to price at R$42 each share in the mega stock offering that will privatize the company. Eletrobras sold 802.1 million shares, raising R$33.7 billion.

According to a Valor Data survey, in dollar terms, the amount represents a little more than twice the volume of Vale’s privatization, and 78% more than Banespa’s privatization. It was the second-largest privatization ever in the country, second only to that of telecoms company Telebras.

With the sale of part of shares held by the Brazilian Development Bank (BNDES) and especially the dilution of the federal government’s stake with the issuance of new shares, the government is no longer the controlling shareholder of Eletrobras — although it holds a golden share. The federal government and the BNDES go to 40.3% from 68.6% of the common shares (there is still a small participation of other government funds, not detailed in the prospectus), going to 36.9% of the total capital.

By early evening, the tug-of-war between banks and investors was concentrated on a R$0.5 difference, with the official range between R$42 and R$42.5. Relevant international investors, such as GIC and CPPIB, had tried to reduce the price (in the morning, the groups were pushing for shares between R$38.5 and R$39.5). With the high interest in the operation, around R$60 billion, the banks managed to raise the price. The Brazilian institutional group includes funds such as SPX and Truxt, already existing shareholders 3G Radar and Banco Clássico, and firms such as RWC and GQG.

Workers who invested using funds from the Workers’ Severance Fund (FGTS) will keep R$6 billion in shares, which was the maximum value for this type of reserve. According to Valor Investe, around 370,000 workers used the FGTS to make reserves for the shares — a demand higher than the 248,000 workers who joined, with the same fund, Petrobras’s offering in 2000, but lower than Vale’s offering, in 2002.

In the privatization process, the company wants to migrate to Novo Mercado — the strictest governance segment of B3. To keep the status of a corporation, the golden share gives the federal government veto power on changes in the bylaws, such as trying to change to 10% the limit of voting power for each shareholder or group. The company also defends the new composition, which prevents the controlling shareholder from creating a poison pill.

Privatization via capital increase also implies the payment of fixed concessions, concerning the renewal of concessions and the adoption of the operation regime — changing from the quota model to the independent production model, in which the plants can sell power at market price.

Although it is different from the classic privatization by auction, with the sale of government participation, the process has the same outcome. “Internally, the structure changes a lot. There is no longer need for a public hiring test, it is no longer under the control of the public spending watchdog TCU, it no longer fits into the law of state-owned companies, it is no longer a semi-public company,” said Vitor Rhein Schirato, founding partner of Daemon Investimentos.

These changes alone can already help the company gain efficiency, in the view of investors. “Historically, privatizations have been accompanied by higher productivity and competitiveness. The companies became more efficient and this in itself should boost competition in the sector, benefiting the consumer,” said Sergio Zanini, a partner at Galapagos.

With different projects and supporters in recent years, the privatization of Eletrobras was fraught with disbelief even after the public offering was filed (you never know when an injunction might come along). At the beginning of last year, Wilson Ferreira Jr. left the command of the company – to which he had agreed to return precisely to conduct the privatization – annoyed with actions in different wings of government to block the process.

Mr. Ferreira Jr., who currently heads Vibra, estimates that Eletrobras will be able to more than triple its investments, becoming a more efficient and competitive company. The management of a state-owned company “is a living hell,” the executive told newspaper O Estado de S. Paulo last week, describing complex and rigid decision-making. The company, on the other hand, will now assume risks that used to be shouldered by the controlling shareholder, such as hydrological risks.

Some people link Eletrobras’s privatization to the beginning of the electoral race – but the fact is that it materialized. “It was one of the government’s promises since the election and, for good or for bad, being able to deliver this offering, at this size, with this demand, is relevant for the government,” Mr. Zanini said.

In the base offer, Eletrobras issued 627.7 million new shares, and BNDES sold 69.8 million shares. An additional allotment added more 104.6 million to the offering.

*Maria Luíza Filgueiras, Manuela Tecchio — São Paulo

Source: Valor International

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Farmers seek to avoid barriers to Brazilian meat in Europe

Mato Grosso-based institute proposes technical, financial cooperation to foster sustainable production

06/09/2022

The Mato Grosso Meat Institute (Imac) has started a movement to try and avoid the approval of new rules by the European Union that would impose trade barriers to livestock products from the state and the country because of deforestation.

In meetings with authorities in Belgium and Germany this week, members of Imac will present a proposal for technical and financial cooperation with Europe to foster sustainable production in Brazil, to remunerate the environmental services rendered, and improve the monitoring of the herds.

“We will suggest that the European Union participate with more influence and economic capacity in the Brazilian meat market, defining obligations for monitoring and inspection of the production chain, with the integrated cooperation of its links, to give support and structure an action plan that will allow the recovery of deforested areas without marginalizing cattle farmers, mostly small and medium-sized ones,” said Caio Penido, head of Imac.

The intention is to open a “channel of dialogue” with the Europeans. Imac wants to put together a more “proactive, constructive and inclusive” joint trade policy, capable of sharing costs and problems. The current assessment is that new European rules under discussion may exclude several producers that act legally, without reaching the objectives of environmental protection.

Among the points presented by Imac to the Europeans is the fact that the proposed regulation for the bloc does not consider the implementation costs and the economic impact borne by farmers for its regularization, nor does it treat companies that already apply compliance systems differently.

The institute suggests the “creation of incentives through remuneration for environmental services rendered, including in an integrated manner to the global carbon market” and the increase of import quotas with premium prices for properties that conserve biodiversity.

The institute also warns that the legal deforestation supported by the Brazilian Forest Code, of up to 20% of forest areas in the Amazon rainforest, for example, must be respected. According to Imac, the cattle farmers will not give up a certain gain with the production in a regular and productive area because of “generalist economic arguments.”

In the document presented to the Europeans, Imac highlights the control programs already implemented in the country. “The main problem of deforestation in Brazil, in the meat chain, is technological unavailability and lack of professional assistance,” it said.

The European proposal for “regulation of deforestation-free products” determines that imports will not be able to enter the European market if the production area is identified as being in a deforestation zone, which Brazilian cattle farmers consider a “boycott.”

The project may be analyzed by the Council of Ministers at the end of the month, and the final draft is expected to reach the European Parliament in July. Besides meat, the rules may affect other production chains, such as soy and coffee.

*By Rafael Walendorff — Brasília

Source: Valor International

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Pressure on long-term interest rates may remain high

Analysts say fiscal risk, approaching end of the tightening cycle will stir interest rate curve

06/09/2022

Luiz Armando Sedrani — Foto: Divulgação

Luiz Armando Sedrani — Foto: Divulgação

Even though they are at the highest level this year, long-term interest rates may not find so much support ahead for a stronger withdrawal of risk premiums. The market is already starting to see the end of the monetary tightening cycle over the coming months and, even though some agents see this event as important to unburden the market, the scenario for long-term rates is not very favorable, because fiscal and political risks continue to rise, at the same time as the Treasuries continue to go up.

The bets of the agents, therefore, have been concentrated on the steepening of the yield curve, that is, on a wider spread between long-term and short-term interest rates. At the moment, the spread between long and short rates is negative — in market jargon, the yield curve is inverted. On Wednesday, the difference between five- and ten-year interest rates was -0.635 points. In the view of market analysts, this difference tends to widen after the end of the monetary tightening cycle. This bet indicates the possibility of short interest rates falling significantly, or even the chance of long rates rising further.

“All the paths lead to a greater slope of the yield curve,” said Mauricio Oreng, head of macroeconomic research at Santander. He listed the factors that point to this scenario: the monetary tightening process in advanced economies, which has generated doubts about the natural level of interest rates; the inflation peak; the nearby end of Brazil’s benchmark interest rates Selic hike cycle; and the fiscal risks, which remain on the radar.

As for the international scenario, Mr. Oreng notes that international interest rates usually have an influence, especially on long-term rates. “We have this tightening scenario that may be faster than in other cycles for several central banks in developed countries and there is doubt whether in the future, when the cycle is over, interest rates will be at higher levels,” he said.

“The doubt is what the natural level of global interest rates will be in the future. Did we have an increase after all those inflationary impacts in the post-Covid, worsening of production chains, geopolitical tensions? It is a question mark that can bring the view that the natural interest rate in Brazil may have risen additionally,” Mr. Oreng said. He notes that, with the increase in fiscal risk during the pandemic, Brazil’s neutral interest rate rose to around 4% in real terms, in Santander’s calculations, and adds that it may be that the neutral interest rate will rise even more, depending on the global neutral interest rate.

As for domestic factors, fiscal risk is one of the issues that have often put pressure on long-term interest rates. In the last few days, the discussions about the sales ICMS tax and other tax cuts proposed by the federal government to contain fuel prices generated a strong rise in long-term rates, which reached their highest levels since October 2021. On Wednesday, the DI rate for January 2027 rose to 12.605% from 12.57%.

Besides the fiscal issues, one main factor cited by market analysts for betting on the steepening of the yield curve is the proximity of the end of the monetary tightening cycle. As soon as the Central Bank indicates that it has ended the process of raising interest rates, the market will start to include in the price of assets when the inverse movement will happen, which can generate a predisposition of the market to bet on the fall of shorter-term interest rates.

The CIO of BV Asset, Luiz Armando Sedrani, highlights the fact that Brazil is one of the few countries, among the world’s main economies, whose interest rate is already above current inflation levels, which can be translated into an advanced stage of the monetary tightening cycle.

According to him, global inflation caused by commodities may start to lose traction from now on. Moreover, when inflationary pressures more linked to economic activity in Brazil begin to give way, the disinflation movement may be faster than expected by financial agents. “This way, we have a preference for bets that benefit from the steepness of the yield curve. On the one hand, we believe that the Central Bank may cut rates sooner than expected. And, on the other hand, the increase in political risk also benefits the strategy,” states Mr. Sedrani.

In the context of better-than-expected fiscal results, the executive believes that it seems to be difficult to contain the government’s impetus to expand spending, especially in an election year. “We believe there will be pressure for more spending and the government will try to stimulate the economy. This concerns us, it has an impact on the yield curve, and so our bets are on steepening,” he argues.

Legacy Capital is another asset management company likely to increase positions that benefit from a greater spread between long and short interest rates, in view of the proximity of the end of Selic peak. “Whenever the cycle of interest rate hikes has been interrupted, the curve has steepened. For different reasons, but the slope always increases,” said Gustavo Pessoa, partner and manager of Legacy.

Legacy follows this process in Brazil and other countries, and it “has never failed,” Mr. Pessoa said. Thus, the firm maintains this position in the portfolio. “The difficulty is to understand when the cycle will be over. When the movement [of increasing the slope of the yield curve] happens, it tends to be abrupt and powerful,” he said.

Fernando Fenolio, the chief economist at WHG, evaluates that the bets on a wider spread between long and short interest rates are based on the view that the actions of the Central Bank are likely to influence short rates, while the fiscal risk can keep the long-term interest rate under pressure.

“If the Central Bank stops raising interest rates at the next meeting, in a scenario of high inflation and deteriorating expectations, the yield curve could steepen considerably with an inflation premium. It would mean a market reading that it [the monetary authority] would be interrupting the cycle at a moment when the work is not yet finished,” Mr. Fenolio said.

On the other hand, if the monetary authority ends the tightening cycle at a moment of cooling of current inflation and expectations, the inclination of the curve could occur at a lower magnitude. “In this case, the market would begin to project the interest rate cut cycle,” the economist said.

“But the premium for the fiscal situation could well dominate the steepening. In a more extreme scenario, if the fiscal risk rises too much, we could even see a need for the Central Bank to raise interest rates again and the curve to flatten again,” Mr. Fenolio said. He, however, stressed that this is not WHG’s baseline scenario.

By Victor Rezende, Gabriel Roca — São Paulo

Source: Valor International

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Eletrobras sees strong demand from investors

Demand could reach R$53.5bn; stock price of Brazil’s main power utility will be defined Thursday in privatization process

By Maria Luíza Filgueiras, Talita Moreira — São Paulo

06/09/2022

Eletrobras’s power transmission towers — Foto: Custódio Coimbra/Agência O Globo

Eletrobras’s power transmission towers — Foto: Custódio Coimbra/Agência O Globo

Brazil’s main power utility Eletrobras prices Thursday its great stock offering and, on the way to privatization, reaches the final stretch of the bookbuilding with plenty of volume to launch the operation. According to sources close to the operation, the company had already secured about R$53.5 billion by early Wednesday afternoon.

The demand via the Workers’ Severance Fund (FGTS) is around R$7.5 billion, but allocations will be limited to R$6 billion – which already signals sharing among investors. Workers could invest up to 50% of their resources in the fund, and applications closed on Wednesday at noon.

As it has already been launched with strong anchoring, the institutional investors that are not in these groups or that exceed the ceiling reserved for each profile will dispute what remains of the bookbuilding. There are about R$26 billion in reserves for a number of shares of around R$6.5 billion – that is, the demand is four times higher than the offer.

When the secondary offering was launched, Eletrobras shares were at R$44. On Wednesday, ELET3 closed at R$42.14 and ELET6 at R$41.63, which adjusts market expectations for a funding of around R$34 billion, with the allocation of the supplementary lot.

The banks BTG Pactual, Bank of America, Goldman Sachs, Itaú BBA, XP Investimentos, Bradesco BBI, Caixa Econômica Federal, Citi, Credit Suisse, J.P. Morgan, Morgan Stanley and Safra are coordinating the operation.

Source: Valor International

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Fuel tax breaks offer short-term gain but slow down growth in 2023

Economists say positive impact is temporary and that inflation will follow

*Alex Ribeiro — São Paulo

06/09/2022

Affonso Celso Pastore — Foto: Leo Pinheiro/Valor

Affonso Celso Pastore — Foto: Leo Pinheiro/Valor

The government’s measures to reduce fuel prices may lower inflation and stimulate the economy in the short term, during the election period, but they will lose a good part of these gains next year, making the scenario of the new presidential term more challenging.

“The best definition for this set of measures is fiscal populism,” said former Central Bank President Affonso Celso Pastore. “First, it brings down inflation in the election year, with the goal of boosting the approval rating of the president. It transfers inflation to next year since the measures cannot be extended if they have a minimum of responsibility. This is not economic policy. There are no economic or social objectives.”

The time-honored definition among economists for populism is precisely policies that bring gains in the short term, helping the approval ratings of the rulers, but that does not prove sustainable in the medium and long term.

Financial market economists are calculating the effect that the package of measures may have. Considering that the measures achieve all the goals expected by the government, inflation this year could be about 3 percentage points lower than forecast, according to calculations by Itaú Unibanco, which is in line with the estimates of other lenders.

The problem is that at least part of the measures is temporary. The Bolsonaro administration announced its intention to reimburse the states that cut the sales tax ICMS on diesel and cooking gas to 0% from 17%. It also intends to reduce to zero the federal tax rate by the end of the year.

This measure, according to Itaú, would have a downward impact of about 0.9 percentage points on inflation in 2022. But, as they are only valid for this year, they would also cause a 0.9 percentage point increase in inflation in 2023, which today is the main target of monetary policy.

Considering both effects, inflation this year would fall to 6% from around 9% estimated by the market, easing the pressure over President Bolsonaro during the election campaign. However, inflation could rise to 5.4% next year from 4.39% forecast by the market. Thus, it will be moving away from the inflation target of 3.25%.

A former head of the Central Bank, who asked not to be named, says that the inflationary impact in 2023 and beyond could be even more severe. States and municipalities are giving up non-permanent revenue gains and would have to replenish revenues with tax increases once the boom in commodity prices has passed.

The increased fiscal risk caused by the measure could also cloud the inflationary scenario, said Solange Srour, the chief economist at Credit Suisse. “The fiscal risk is increasing and creates a new problem for the new administration, whoever the president will be,” she said.

According to her, the states’ tax cuts, based on a revenue gain that does not tend to be permanent, could weaken their fiscal situation further down the road. “When states are in difficulties, the federal government is always called upon to bail them out.”

Short-term measures, on the other hand, give only short-term relief on some prices, but in essence do not change the dynamics of inflation. “The Central Bank should not feel more comfortable to end the cycle of interest rate hikes,” she said.

Itaú estimates that the entire tax reduction package would have a fiscal impact of 1.7% of the GDP, also considering the bill that limits the ICMS tax rate on electricity, telecommunications and fuels to 17%.

From the point of view of economic activity, the package would have an initial stimulus impact. Tax cuts expand the population’s disposable income and tend to make room for more spending in household budgets.

But, in a further moment, the economy will tend to feel the impacts of the worsening in financial conditions. As a result, the prospects for GDP expansion in 2022 may improve in relation to the 1.2% forecast by the market in Focus, the Central Bank’s weekly survey with economists. But for next year, it may fall below the estimate of 0.76%.

For now, Ms. Srour said, the market’s reaction has been relatively moderate, in interest rates, exchange rates and stock markets. But there may be an intensification of risks as the proposal of constitutional amendment (PEC) is discussed in Congress and it becomes clearer that the first year of the next federal and state governments will be more difficult.

“In the debates about the PEC, the pressure to offer a larger and longer compensation to the states, besides other demands, may increase,” she said.

Igor Barenboim, partner and director at Reach Capital, has a different view. For him, one cannot rule out the possibility of the measures having a more lasting positive effect. “It can be good for inflation, it can be good for economic activity,” he said.

He argues that Brazil is being impacted by a commodity price shock, with both positive and negative unfolding. On the negative side is inflation, particularly severe in fuel prices. But there is also a positive impact on the economy that favors tax collection.

For Mr. Berenboim, it is acceptable that political forces use some of those gains to mitigate the negative impacts of the shock. Another economist with a large bank says that even with the program launched by the government, the primary result will be much better than expected.

A few months ago, this economist’s estimate was for a primary deficit of R$100 billion. With the surprise in the tax collection and the auction of power utility Eletrobras, the outlook has changed to a positive result of R$80 billion. The new expenditure with the fuel package may lead to balance or a primary deficit, but not as high as previously predicted.

Mr. Barenboim says that the impacts of an eventual worsening of fiscal risks on inflation and activity are not guaranteed. At this first moment, the markets’ reaction was moderate, and the real economy would have already readjusted prices considering a weakened real.

Source: Valor International

https://valorinternational.globo.com/
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Analysis: Should Central Bank reassess fiscal risks?

Questions emerged after federal government’s decision to undermine fiscal anchor to hold fuel prices down

06/08/2022

Central Bank’s building in Brasília — Foto: Divulgação/Rodrigo Oliveira/Caixa Econômica Federal

Central Bank’s building in Brasília — Foto: Divulgação/Rodrigo Oliveira/Caixa Econômica Federal

Market analysts have begun to discuss whether the Central Bank’s Monetary Policy Committee (Copom) should reassess its balance of risks to inflation after the government unveiled the intention to go over the spending cap to reduce fuel prices in this election year.

In its last two meetings, the Copom became less downbeat about the fiscal situation. As a result, the danger that the lack of control of public accounts could lead to higher inflation than projected for next year took a back seat in its monetary policy decisions.

In March, the policymakers concluded that the balance of risks to inflation was less tilted to the negative side, arguing that current fiscal data were better than expected and that the foreign exchange rate and inflation expectations already reflect most risks. In May, for similar reasons, they saw risks balanced.

The rebalancing of risks was at odds with the view of most of the market. The pre-Copom survey made on the eve of the meeting in March showed that 50% of economic analysts evaluated that the fiscal situation had worsened at that moment, compared with 22% who said it had improved. The remaining 28% thought there had been no change.

Due to the strike by Central Bank employees, the results of the May pre-Copom survey were not released. The Central Bank has sent a new survey to the market to gauge opinions for its meeting next week.

In its official documents, the Central Bank has asked the financial market for “serenity” in assessing fiscal risks in an environment it considers to be one of great uncertainty. Many, however, say that the improvement in short-term data is undermined by the destruction of the fiscal anchor.

The exchange rate is again under pressure as the deterioration of the fiscal situation became clear after a new attempt by the federal government to go over the spending cap, the rule that limits public spending to the previous year’s inflation. Above all, such deterioration caused long-term interest rates to rise, which means that investors require a higher premium to buy National Treasury bonds.

A potential revision of the balance of risks would have implications for monetary policy. Currently, the Copom is managing interest rates with a view to meeting the 2023 inflation target. According to the most recent projection of the monetary authority, released in the May meeting, inflation is seen at 3.4% in 2023, above the 3.25% target for the year.

The market, however, already estimates inflation of 4.39% in 2023, after faster rates in April and May. The projections by the Central Bank may be revised upward as well.

If the Central Bank acknowledges the worsening of the balance of risks, making it asymmetric again, it would mean that the inflation expected by the policymakers would be even higher, since the chances of a higher-than-expected reading would be greater than of a lower-than-expected rate.

In theory, this would require even higher interest rates to bring inflation to the target within the relevant monetary policy horizon.

But many analysts are skeptical that the Central Bank will revise its balance of risks to inflation. The monetary authority has sent several messages that it is near the end of the monetary tightening cycle. In addition, considering that current inflation is rising more than expected, the Central Bank is unlikely to look for new reasons to raise interest rates even more.

* Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Reduction in fuel taxes may harm ethanol

Cheaper gasoline can make biofuel unviable because of loss of competitiveness

06/08/2022

Analysts say measure may lead owners of bi-fuel cars to fill tank with gasoline instead of ethanol — Foto: Hermes de Paula/Agência O Globo

Analysts say measure may lead owners of bi-fuel cars to fill tank with gasoline instead of ethanol — Foto: Hermes de Paula/Agência O Globo

Eager to reduce fuel prices by any means, the Bolsonaro administration may end up hurting sales of a renewable fuel like hydrous ethanol, which has an average carbon footprint 70% smaller than the gasoline currently sold in Brazil’s gas stations.

Analysts say the creation of a 17% ceiling on sales tax ICMS levied on fuels in a general way, as proposed in the complementary bill 18, both for fossil and renewable fuel, may lead owners of bi-fuel cars to fill their tanks with gasoline instead of ethanol.

This may happen because the ICMS tax on ethanol is already lower than the rate charged on gasoline in several states, which guarantees the biofuel competitiveness for a good part of the year in important consumption centers, such as São Paulo, Minas Gerais, Paraná and Goiás.

Together, the four states represent 80% of the Brazilian consumption of hydrous ethanol. In these states, the ICMS on gasoline is between 25% and 31%, while the tax on ethanol is 5 to 12 percentage points lower, between 13% and 25%.

If ICMS is limited to 17% across the board, the reduction in the gasoline tax burden will be much greater than the reduction in the ethanol tax burden.

In São Paulo, only gasoline would be favored, since the load on fossil fuels is currently 25%, while the ICMS tax rate on ethanol is 13.3%. According to simulations by ItaúBBA, gasoline would become cheaper, and ethanol would be worth 74.6% of its price, up from 69.4% today. For the average Brazilian bi-fuel fleet, hydrous ethanol becomes uncompetitive when its price exceeds 70% of the price of gasoline, because of efficiency.

The same is true for Minas Gerais, the second-largest biofuel consumption center in the country, where gasoline is taxed at 31% of ICMS and ethanol at 16%. With the reduction of the gasoline tax rate to 17%, the ratio between the price of biofuel and gasoline would rise from the current level of 70.1% — where the two fuels are equivalent in terms of efficiency — to 80.1%, making ethanol less competitive.

The discussion has reached the Senate. On Tuesday, Senator Fernando Bezerra Coelho (Brazilian Democratic Movement, MDB, of Pernambuco) said he is likely to present a constitutional amendment proposal of ethanol this Wednesday to ensure a 30% lower ICMS tax rate for biofuel compared to gasoline.

The PIS/Cofins tax exemption that the Bolsonaro administration intends to grant both on gasoline and ethanol would not change this scenario, since both fuels would be treated equally. According to BTG Pactual, gasoline would be 17% cheaper at the pumps in São Paulo, or R$1.14 a liter.

If ethanol producers want to prevent the destruction of demand for the product, they will have to accept receiving lower prices, analysts say. BTG Pactual calculates that the prices charged by São Paulo’s mills to distributors would have to drop 17%, or R$0.38 a liter, to R$2.87 a liter.

In the scenarios outlined by ItaúBBA, the São Paulo plants that supply the state would have to reduce the amount they receive by R$0.2806 per liter, while those in Minas Gerais would have to accept a reduction of R$0.6556 per liter.

Felipe Maia, a tax lawyer with Santos Neto Advogados, says that if there is no different treatment in the debate about tax reduction on consumption, “there will be a migration and there will be a lack of demand for ethanol, which will have an environmental impact.” In many states, biofuels already have tax incentives at the production stage, but Mr. Maia says this is not enough to encourage this market.

This dynamic would also impact the sugar market, since the reduction in the price of hydrous ethanol tends to discourage mills from producing more biofuel and stimulate the production of the sweetener – even if the additional remuneration from the Decarbonization Credits (CBios), linked to ethanol, is taken into account, BTG Pactual said.

Currently, the total remuneration offered by ethanol, already considering the gains with CBios, is 3% below the remuneration offered by sugar. With a drop in ethanol gains, the difference would reach 13%, according to the bank. As a result, the mills can produce more sugar than expected.

In a scenario with prices from last week, consultancy hEDGEpoint had already signaled a tendency of pressure on sugar prices if the ICMS bill is approved. According to the firm, the price of ethanol, converted to the value of sugar on the international market, which was the equivalent of 20.14 cents a pound last week, would fall to 18.46 cents a pound.

* Camila Souza Ramos — São Paulo

Source: Valor International

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