Brazil's Infrastructure in Perspective - Defiance EIRA

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Defiance Holdings All rights reserved. Copyright 2009-2010.Defiance Capital Management Investment Research and Analysis

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Brazils Infrastructure in Perspective:Yesterday, Today and Tomorrow

February 27, 2010 - 10 pages

Defiance Capital Management

Leonardo Cardoso Senior [email protected]

Economic and Investment Research & Analysis


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Brazil: Yesterday, Today and Tomorrow

By Leonardo Cardoso

Yesterday

For a little more than 300 years since its discovery on April 22, 1500, Brazil was a colony ofPortugal. In an effort to force Brazilians to consume products manufactured in Portugal, thecrown prohibited the establishment of factories in the country. As a result, that was a period ofeconomic exploitation of natural resources, most notably brazilwood, sugar and gold, and little tono industrial development.

On September 7, 1822, independence from Portugal was declared and the country became aconstitutional monarchy, the Empire of Brazil. In the beginning, the Imperial State investedheavily in infrastructure improving roads, building railroads and retaining an excellent systemof ports. The liberal monarchy, free of the socioeconomic and political pressures from Portugal,

favored private initiatives and centered the economy on the export of agricultural products andraw materials. By mid 1800s, coffee had become the number one export of Brazil and amovement to abolish slavery and free labor had begun. With profits from the export of coffee,sugar and cotton, new factories that didnt require specialized labor were built and immigrantsfrom Portugal, Italy and Germany, lured by the demand for paid labor in the agricultural fieldsand factories, flocked to Brazil.

Although extremely diversified in the period after Independence, the Brazilian economy requireda great effort to carry through the change from a pure colonial economic system based on slaveryinto a modern capitalist system. Towards 1880s, the combination of religious issues between theEmperor and the Catholic Pope; growing discontent by military leaders towards freedom of

speech and corruption in the Imperial Court; desire by the middle class to participate in politicalmatters; lack of support by the barons of coffee who resented the abolition of slavery and wishedmore political power; and financial problems generated by the Triple Alliance War, forced theBrazilian Empire into crisis. On November 15, 1889, republicans who favored changes byrevolution rather than evolution, drew military officers led by Field Marshal Deodoro da Fonsecainto a conspiracy to replace the cabinet; the first coup dtat of Brazil deposed Emperor DomPedro II and created the First Republic of Brazil (aka: Old Republic) and its First ProvisionalGovernment.

Generally, federalism is the movement of the people towards centralization and transfer of powerfrom the States to the Federal Union. The unusual development of federalism in Brazil

decentralization of power and politics into States formed under a new Federal Union, gave birthto a political and socioeconomic system of oligarchies1 that are still present today. The OldRepublic lasted until the Revolution of 1930, and despite some political turmoil, it was a periodof economic prosperity due to strong coffee and rubber exports.

1 Oligarchy in Brazil can be exemplified by strong military influence in the government during the early period ofthe Old Republic and by the Caf au lait political system; the alternation of political power between prominentgroups/families from only two states (Sao Paulo economic power due to coffee production and Minas Gerais largest political poll in the country and producer of milk).


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While dissident movements taking place throughout the 1920s weakened the political alliancebetween Sao Paulo and Minas Gerais2 and the stranglehold of the agricultural oligarchies eased,the U.S. market crash of 1929 pushed the country into financial collapse when the price anddemand for coffee stumbled and foreign credit, together with Brazilian gold and sterling reservesevaporated.

In 1930, important structural changes aimed at transforming the country into a modernindustrialized economy began to take place when Getulio Vargas, a presidential candidate for theliberal opposition with nationalist and populist tendencies led a second coup dtat and assumedthe presidency of Brazil (aka: The Revolution of 1930).

Somewhat like Franklin Roosevelt, Vargas sought to bring Brazil out of the Great Depressionwith an economic stimulus focused on infrastructure and statist-interventionist policies focusedon expanding the domestic industrial base while reducing foreign dependency. State and mixedpublic-private companies dominated infrastructure industries, while private Brazilian capitaldominated manufacturing. In 1937, rumors of a possible communist plan to control the country

triggered a full dictatorship by Vargas; creating the New State, which lasted until 1945 when amilitary movement overthrew him and reestablished democratic rule.

As a dictator who dissolved congress, curtailed presidential elections and established a newconstitution, Vargas gave continuity to the formation of structure and professionalism in the state.He oriented the state to intervene in the economy, promote economic nationalism, invest ininfrastructure and industrialization

3, and establish labor rights and laws. After leaving behind an

economic surplus and a growing industry, Vargas returned to politics in 1950 as thedemocratically elected president with almost 50% of the votes, but could not handle thepressures of a democratic government and committed suicide in 1954.

While the Vargas Era laid the infrastructure, industrial and labor rights4 foundations of Brazil,Juscelino Kubitschek (JK), a democratic president elected in 1955 using the slogan 50 years ofprogress in 5 years, focused on the industrial development of the country through generousincentives to foreign direct investments and large infrastructure projects including theconstruction of Brasilia, the current capital of Brazil. Despite the tremendous economic boom, bythe end of his term in 1961, the strategy had left a legacy of problems and distortions since thegrowth it promoted resulted in a substantial increase in imports while exchange rate controlscurtailed exports. In addition, to finance the negative balance of payment and the construction ofBrasilia, the Federal Government relied heavily on domestic and foreign debt.

Rampant inflation, political and social reforms that were clearly not addressing the economicproblems of the country, together with fears of a revolutionary leftism by then current presidentJoao Goulart, triggered the military coup dtat of 1964, instituting a military regime for the next21 years. At first, there was intense economic growth due to neoliberal economic reforms (aka:Economic Miracle of Brazil), but in the later years of the dictatorship, the reforms had left the

2 As before mentioned, the Caf au lait politics.3 Industrial and infrastructure concerns created: National Oil Advisor, Rio Doce Valley Company, Sao FranciscoHydroelectric Company, National Iron Smelting Company, Petrobras and others.4 Although, argued by some economists and politics as not capitalist friendly.


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economy in a state of chaos, with soaring inequality of income, exorbitant inflation (accentuatedby the oil shock), very high unemployment, and humongous national and foreign debt.

While stagflation sets in during the first half of 1980s, the military regime ends in 1985 with acivil movement that brought together diverse elements of the Brazilian society demanding direct

presidential elections. The movement resulted in the indirect

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election by the Electoral College ofTancredo Neves, the first civilian president to run the country since the coup dtat of 1964.However, with the death of Tancredo Neves right after his election, Jose Sarney, the vicepresident elected, took office on April 21, 1985. In 1988, the government proclaimed a newconstitution that restored civil and public rights such as freedom of speech, independent publicprosecutors, economic freedom, direct and free elections, and universal health care.

However, economically speaking, the country was decimated; since the 1970s, inflation,domestic and foreign debts had been out of control. From 1985 until the first presidentialimpeachment in 1992, there were seven economic plans aimed at fighting inertial inflation6,economic stagnation, unemployment and souring debts. Find below a summary of those plans

and details about their failures.

Date Economic Plan

(Plano)

Problem/Focus Action taken Result

02/1986 to11/1986,

Avg. AIR7

range: 144%to 256%

Plano Cruzado I Hyperinflationand stagnation

Creation of a newcurrency and suspensionof inflation accounting;freeze of prices of goods

& services and salaries;fixing of the exchangerate; creation ofunemployment benefits.

Total decline in the supply oconsumer staples and goods;retail sales crashed.Moreover, the short-lived

restoration of purchasepower led to the return ofinflation.

11/1986 to05/1987,

Avg. AIRrange: 204%to 278%

Plano CruzadoII

Hyperinflation,stagnation, andescalating budgetdeficit.

Unfreeze of prices ofgoods & services;increase in taxes; returnof inflation accounting.

Overvalued currency due tofixed exchange rate led to anincrease in imports, adecrease in exports andeventual evaporation offoreign reserves.

01/1987 to

06/1987

Foreign Debt

Moratorium

Evaporation of

foreign reserves

Suspension of debt

payments to internationalcreditors (moratorium).

Access to foreign debt

market vanishes

5 Here meaning not by the direct vote of citizens of Brazil.6 The tendency of inflation to grow exponentially, reaching hyperinflation, due to a vicious cycle of priceadjustment/forecast of inflation and subsequent price readjustment based on the forecasted forecast of inflation (ie:future expectation of inflation based on future inflation, a subjective estimation of inflation or preemptiveadjustment without cost assessment.)7 Annual inflation rate


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Date Economic Plan

(Plano)

Problem/Focus Action taken Result

06/1987 to01/1989,

Avg. AIRrange: 366%to 425%

Plano Bresser Hyperinflation,stagnation, andescalating budget

deficit.

Freeze of prices again;increase in taxes to helpbalance the budget

deficit; suspension oflarge infrastructureprojects and agriculturalsubsidies; end ofmoratorium.

Real losses in savingsaccounts due to themaladjustment of inflation

and inflation accounting.

01/1989 to03/1990,

Avg.inflation:350% per

year

Plano Verao Hyperinflation,stagnation,escalating budgetdeficit and reallosses in savingsaccounts.

Creation of newcurrency; suspension ofinflation accounting;establishment of parity toUS dollar.

03/1990 to10/1992

Avg.inflation:+500% peryear

Plano Collor I,II and Marcilio

Hyperinflation,stagnation, andescalating budgetdeficit. Planfocused onfreezinggovernmentliabilities (ie:internal debt) andrestricting money

flow in order tohalt inertialinflation.

Creation of newcurrency; holding 80% ofprivate assets hostage for18 months in an effort tocool demand; increase infinancial transactiontaxes, indexation oftaxes, elimination offiscal incentives;adoption of floating

exchange rate; gradualeconomic opening toforeign competition;freeze on prices andwages; dissolution ofseveral governmentagencies and a plan toreduce 300,000employees, whilestimulating privatizationand initiating economic

deregulation.

Approximately 16% decreasin GDP and a decline inannual inflation toapproximately 60% a year.Privatization of a number ofstate owned companiesamong them: Acesita,Embraer (NYSE: ERJ),Telebras, and Vale do RioDoce (NYSE: VALE).


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Today

The Brazil of today started to take shape with the election in 1989 and subsequent impeachmentin 1992 of Fernando Collor, the first democratic president directly chosen by popular vote in 25years. Under a new political and economic team led by Fernando Henrique Cardoso, who would

become the next president of Brazil, the first steps to reign over the lingering economic problemsof the country were taken in 1994 with the launch of the Plano Real (Real Plan).

Realizing that one of the reasons8

for the hyperinflation problem was the psychologicaldisconnect between the current perception of the value of money and future purchasing power,the new plan created a non-indexed unit of monetary value; the URV, a fake currency peggedto three price indices and fixed at a 1-to-1 parity to the U.S. dollar. Later the URV transformedinto the current Brazilian currency, the Real.

Between 1994 and 2002, inflation-targeting policies, privatization of state-owned companies andbanks, renegotiation of domestic public debt, strict fiscal and contractionary monetary policies

such as expense control and high interest rates, and favorable international commerce policies,helped Brazil to attract a large amount of foreign capital and consequent appreciation of the Realvs. the U.S. dollar. The strong Real was fundamental to fight hyperinflation because it assuredthe supply of cheap imported products, forced domestic producers to sell at lower prices in orderto maintain their market share and kept in-check demand-side inflationary pressure from thereestablishment of purchasing power. As a result, after 7 failed economic plans, 6 differentcurrencies and 1,142,332,741,811,850% (1.1 quadrillion%) inflation from 1965 to 1994, thePlano Real succeeded in breaking the hyperinflationary cycle bringing inflation down tosingle digits per year, stabilizing the Brazilian currency, and laying the foundation for asocioeconomic recovery and infrastructure development.

Sample of inflation rates before and after the Real Plan:Jan Feb Mar Apr May Jun Jul Ago Sept Oct Nov Dec

1993 32.3% 30.7% 32.0% 33.5% 37.0% 35.1% 37.0% 36.2%

1994 42.2% 42.4% 44.8% 42.7% 40.1% 46.6% 6.1% 5.5% 1.5% 1.9% 3.3%

In 2003, the country took another step in the journey to political and socioeconomic development,when for the first time since the military regime, a left/socialist leaning candidate won thepresidential election. Luis Inacio Lula da Silva (Lula), the current president of Brazil was notdirectly part of the oligarchies that have dominated the country since its independence andproclamation of republic. His election signaled a change in the balance of political power, a shiftfrom the generational oligarchies to citizens without pedigree. Understandably, financial marketswere rattled because political and economical stability were at stake; but for the surprise of

skepticals, the new president continued on the path towards progress.

8 Fiscal policy, which led to budget deficits, was another influential reason to hyperinflation.


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Tomorrow

The Brazil of tomorrow is shaping to be the leader among the emerging economies. Whilepolitical, economic, and social reforms during the last 20 years enabled recent macroeconomicstability, investment in infrastructure is a crucial part of the capital accumulation required for

sustainable socioeconomic development and growth. In addition, international institutions suchas the World Bank, the International Bank for Reconstruction and Development (IBRD) and theInternational Finance Corporation (IFC) are deeply committed to guide and assist initiatives thatlay the foundation for the future of Brazil.

Recently, the current administration launched a program aimed at catching up for the lostdecades of 1980s and 1990s. The Growth Acceleration Program (aka: PAC) is a strategic planbetween the public and private sector focusing on the development of infrastructure andreestablishment of socioeconomic growth.

Based on an investment of US$360.0 billion9

between 2007 and 2010, the program expects to

achieve an average GDP growth of 5% per year. Investments are taking place in the followingareas:o Infrastructure, including social infrastructure projects in sanitation, housing

construction, energy, public transportation systems and water management resourceso Stimulation of Credit and Financingo Environmental Regulationo Tax Reliefo Long-Term Fiscal Policies

The source and allocation of funds are described below:

Source of funds Amount (USD:BRL 1.80)State owned companies, including Petrobras USD 157.1 billion

Federal Government USD 46.9 billion

Private Sector USD 155.5 billion

Allocation of funds Amount (USD:BRL 1.80)

Energy Projects (includes electricitygeneration & transmission, oil & natural gasand renewable fuels)

USD 164.5 billion

Infrastructure Projects (includes urbanelectricity, basic sanitation, housing and water

management)

USD 142.2 billion

Transportation Projects (includes roadways,railways, hidroways, ports, airports andmerchant ships)

USD 53.2 billion

9 R$648.0 billion reais @ USD:BRL 1.80 and approximately 20% of 2009 est. GDP


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As of the end of 2009, the Growth Acceleration Program invested US$223.9 billion, or 63% ofthe expected total investment. Finished projects totaled US$142.7 billion, or 40% of the totalinvestment and without counting sanitation and housing projects, there are approximately 2,400projects in progress. Find below a summary of developments by areas of allocation:

oEnergy

o US$97.2 billion invested secured the energy needed to grow in the near future;o The electricity grid increased supply by 6,000 megawattso 109 power plants were constructed and 89 are under construction;

transmission lines cover 8,841 miles;o Record production of oil and its byproducts with 13 new exploration

platforms under operation and 5 more under construction;o 1,958 miles of gas pipelines were put in place and 1,254 miles are under

constructiono The Pre-Sal discovery accelerated investment in oil vessels, exploration

platforms, and dry docks.

o Infrastructureo US$97.7 billion invested in sanitation projects, water treatment facilities,

electric utilities, irrigation, housing, etc

o Transportationo US$28.8 billion invested in 1,361 miles of completed roadways, 4,096 miles

under construction and over 44,100 miles inspected and serviced;o 296 miles of completed railways and another 2,200 miles are under

construction.o 18 ports are under expansion and renovation projects

Conclusion

From Colony to Kingdom to Republic to Military Dictatorship and to Republic again, thecountry is ready for its next phase, a phase of leadership among the emerging economies of the21

stcentury. The political system completed its full circle when Lula, a union worker with

humble origins and no connection to oligarchic families from the Old Republic period of coffee,milk and sugar barons, conquered the unimaginable political power that, not so long ago, wasreserved only to a select group of few. On the socioeconomic front, improving job markets andreal gains in the minimum wages have contributed to the reduction of poverty. Furthermore,revolutionary government initiatives and welfare programs 10 attempting to reduce short-termpoverty by direct cash transfers, and long-term poverty by increasing human capital throughconditional cash transfers have proved effective in breaking the vicious circle ofintergenerational11 poverty; thus, decreasing social inequality and child labor while increasingchildrens school attendance.

10 Zero Hunger, Family Stipend (School and Food), My House My Home, and Electricity to All11 From one generational to another.


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Undoubtedly, there are still many problems to be fixed. The country faces importantdevelopment challenges in areas that include the combination of the benefits of agriculturalgrowth, natural resource exploration, and environmental protection. In addition, differencesbetween urban and rural population, north and south, and rich and poor still persist. Nevertheless,innovative social programs and a more inclusive growth in recent years have been gradually

decreasing these inequalities.

In summary, the country is investing in its infrastructure and its people. It is gaining internationaltrust as a candidate for a permanent seat in the U.N. Security Council and it has two more toolsto promote social transformation by hosting the two largest and truly international sports event ofthis decade: the 2014 FIFA World Cup and the 2016 Summer Olympics. The future looks bright.

Quick Facts12

Name: Federative Republic of Brazil

Capital: Brasilia

Language: Portuguese

Area: 3.3 million square miles (5th)

Population (2009 est.): 192.0 million (5th)

Life expectancy: 69 years (men), 76 years (women)

Religion: Roman Catholic (74%)

Currency: Real (R$)

GDP: US$ 1.612 trillion (2008), US$1.984 trillion (2009) (9th)

GDP growth: 5.7% (2004), 3.2% (2005), 4.0% (2006), 5.7% (2007), 5.1% (2008), 0.1%(2009 est.)

GDP by sector: Agriculture (5.5%), industry (28.7%), services (65.8%)

GDP per capita: US$8,295 (2008), US$10,455 (2009)

Annual Inflation: 5.9% (2008), 4.3% (2009)Civilian Labor Force: ~101.0 million (2008)

Unemployment rate: 7.9% (2008)

Exports: US$197.9 billion (2008), US$158.9 billion (2009 est.)

Imports: US$173.2 billion (2008), US$ 136.0 billion (2009 est.)

Major export partners: USA (14.0%), Argentina (8.9%), China (8.3%), Netherlands (5.3%),Germany (4.5%), Japan (3.1%)

Major import partners: USA (14.9%), China (11,6%), Argentina (7.7%) , Germany (6.9%), Japan(3.9%), Nigeria (3.9), South Korea (3.1%)

Main export goods: transport equip., iron ore, soybeans, footwear, coffee, auto & auto parts,machinery

Main import goods: machinery electrical and transport equip., chemical products, oil, auto parts

and electronics

12 Where needed, the exchange rate of USD:BRL 1.8 was used.


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Reference

o Fausto, Boris and Devoto, Fernando J. Brasil e Argentina: Um ensaio de histriacomparada (1850-2002), 2. ed. So Paulo: Editoria 34, 2005, p. 26, 37, e 46

o Sodr, Nelson Werneck. Panorama do Segundo Imprio, 2. ed. Rio de Janeiro:GRAPHIA, 2004, p. 197

o ABRUCIO, Fernando Luiz. Os Bares da Federao: os Governadores e a RedemocratizaoBrasileira. So Paulo: Editora Hucitec, 1998.

o STEPAN, Alfred. Federalism and Democracy: Beyond the US Model. Journal of Democracy 10,n. 4 (1999): 19-34.

o Freire, Paulo; Donaldo Pereira Macedo (1996). Letters to Cristina. p. 251.o Banco Central do Brasil. Disponvel em BCBo http://pt.wikipedia.org/wiki/Hist%C3%B3ria_do_Brasilo http://pt.wikipedia.org/wiki/Hist%C3%B3ria_econ%C3%B4mica_do_Brasilo http://pt.wikipedia.org/wiki/Plano_Realo http://pt.wikipedia.org/wiki/Programa_de_Acelera%C3%A7%C3%A3o_do_Crescimentoo http://www.brasil.gov.bro http://www.brasil.gov.br/pac/balancos/copy_of_copy_of_copy_of_5balanco/o http://democraciapolitica.blogspot.com/2009/02/recursos-do-pac-vao-alem-de-2010-

com.htmlo http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/LACEXT/BRAZILEXT

N/0,,menuPK:322347~pagePK:141159~piPK:141110~theSitePK:322341,00.html

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Brazil's Infrastructure in Perspective - Defiance EIRA