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Brazil: weak investment, a limiting factor to growth
Alongside demographics and productivity, investment is an important determinant of economic growth. It helps to increase an economy’s production capacity and is one avenue through which improvements to productivity can be made. In Brazil, investment rates have been structurally low but have also notably weakened over the past decade. While a number of enabling elements have emerged in recent years to help spur investment, many challenges remain and a recovery of the investment rate to its pre-2014 level is not projected to materialize until the second half of the decade, at the earliest.
Investment in Brazil has been weaker than in peer BRIICS countries
The investment rate in Brazil has been low when compared to other large emerging markets. According to data from the OECD, the ratio of gross fixed capital formation to GDP has averaged 18.8% over the period 2009-2019. This compares unfavorably to other BRIICS, with China leading the way (46%) followed by India (35.4%), Indonesia (33%), Russia (22.9%) and South Africa (19.8%) over the same period.
Since 2013, Brazil’s investment rate has markedly weakened. National statistics show that after reaching a high of around 21% of GDP in 2013, the investment rate fell to a low of 14.7% in 2017. At that point, the investment rate was insufficient to even offset the depreciation of the existing productive capital stock, especially infrastructure. Investment has struggled to recover since (15.4% of GDP at the end of 2019), and the effects of the Covid-19 pandemic will undoubtedly further delay the recovery of both investment and the economy at large.
Why has investment been so weak?
Insufficient savings have been a major structural constraint to higher investment. Domestic savings have consistently been 2 to 3 times lower than those in some of the largest emerging markets in Asia. Brazil’s low investment rate is also due to many longstanding obstacles pertaining to the business environment. Firms have traditionally had limited access to long-term capital and have faced high borrowing costs (real interest rates for corporates have averaged around 20% over the 2012-2019 period). As a result, companies (especially small and medium enterprises) have had a tendency to rely on internally generated funds to expand, limiting their propensity to invest. Short credit maturities have also translated in firms spending a disproportionate amount of resources servicing debt rather than funding productive ventures. The complexity of the tax system, high compliance costs, severe patent backlogs and difficulties opening and closing down businesses have all had stifling effects on entrepreneurship and innovation, impeding investment along the way. High barriers to competition in the form of subsidies as well as trade barriers have meanwhile contributed to a misallocation of capital and propped up the rate of survival of inefficient companies.
Cyclical factors also help explain the trajectory of investment in recent years. The implosion of the Lava Jato corruption scandal in 2014 and Brazil’s ensuing two-year recession in 2015-16 largely contributed to the tumbling investment rate. The disruption caused profound damage to firms’ balance sheet and business confidence. The recession also led to a significant deterioration of public finances.
A series of impediments have weighed heavily on both the public and corporate sectors’ investment functions post-recession. On the corporate side, deleveraging proceeded at a slower pace compared to households while demands for bankruptcy protection soared. The civil construction sector (about half of total capital spending) was still recovering from the involvement of many firms in Lava Jato. The sector also had to cope with high levels of inventories, especially on the commercial segment of the real estate market. This, along with low levels of capacity utilization in manufacturing discouraged investment. Political turmoil around the possible impeachment of President Temer (2016-2018), the ensuing 2018 Presidential election cycle and uncertainty about the structural reform agenda also increased risk aversion and dampened expectations of demand growth – a critical determinant of corporate investment.
Meanwhile, the gradual process of fiscal adjustment initiated under the Temer administration ended up having knock-on effects on both public and private investment. Indeed, in the absence of reforms destined to curb mandatory spending (around 96% of the federal budget), the brunt of the fiscal adjustment fell on public capital expenditures and subsidies. As a result, the activities of state development bank, BNDES – a traditional anchor of capital expenditure in Brazil and the almost exclusive source of long term funding – were scaled back while public banks dramatically cut down their offering of subsidized credit (so-called “earmarked credit”). The public sector, which had become the largest source of funding for private investment, was gradually retreating to make way for market-driven financing solutions. However, this adjustment affected corporates’ access to cheaper capital with a detrimental impact on investment decisions (interest rates charged on earmarked credit supplied by public banks were on average one fourth that on non-earmarked credit.)
What is the outlook for investment amidst Covid-19?
In the short term – due to the effects of the Covid-19 pandemic on the economy – gross fixed capital formation, the most volatile and pro-cyclical component of GDP, will undoubtedly be hard hit. Support from public investment is expected to be very limited going forward as the government will likely turn its attention to fiscal consolidation following large increases in fiscal deficits and debt in the wake of the epidemic.
The government’s large concession and privatization programme should however help to soften the blow to investment, assuming it is able to resume fairly rapidly once the epidemic is under control and uncertainty recedes. Private investment should benefit from favorable transformations throughout the economy: real interest rates are at a historic low, inflation is under control, the framework for concessions has been revamped, credit market distortions are being progressively lifted and local private debt and equity markets are developing. For a long time, the high cost of local financing and the lack of depth in the private debt market meant that larger corporates borrowed abroad. In recent years, however, they have bought back dollars, paid off their debts and instead raised money in the local capital markets.
While some foundational pieces are in place to help spur investment, the road to recovery will be long. Even under optimistic scenarios regarding the path of economic growth, a recovery of investment to its pre-2014 level is not projected to materialize until the second half of the decade, and even that may be optimistic. However, lifting long standing impediments to investment, especially pertaining to the business environment, would go a long way to moderating the damage instilled by the Covid-19 epidemic. It would concurrently help improve the country’s medium-term growth prospects which are already being challenged by the country’s stagnant productivity and ageing population.
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