Can Brazil progress on reform measures despite political uncertainty?

August 14, 2017 – This post was written by Boyang Xue, FSG’s Research Intern for Latin America

Political uncertainty in Brazil remains elevated despite a recent vote by the Chamber of Deputies to block indictment charges against President Michel Temer.

Notwithstanding the victory (which occurred on August 2nd), it is unclear whether Temer will be able to block an anticipated second indictment (speculated to arrive within the next 30 days), or much less reorganize his political coalition in Brasilia in order to move forward with pension reform – the key to correcting Brazil’s growing fiscal deficit and raising investment sentiment.

In the midst of these developments, Brazil has continued to pursue microeconomic reforms, both through legislative action as well as executive authority. While representing only a part of the greater changes Brazil must implement to unleash greater growth potential, these recent changes deserve a brief review, even amid continued elevated economic and political uncertainty.

  • Brazil’s legislature overwhelmingly voted in favor of passing a bill on labor reform:

This bill aims at modernizing Brazil’s outdated labor law for the first time in 70 years, and is expected to reduce the cost for businesses by giving more leeway to collective bargaining and limiting the scope of legal actions in labor disputes. It will also lower the risks for new hiring, allow more room for part-time and temporary jobs, make labor contract more flexible, and eliminate obligatory contributions to unions

  • The government announced a proposal to further liberalize the power sector:

The Ministry of Mines and Energy wants to reduce regulations on electricity prices and facilitate the privatization of heavily indebted Brazilian power companies. The government will also reduce taxes on power generation and transmission assets to incentivize foreign firms to invest in the energy sector. More than a dozen multinationals have shown interest in entering the market or strengthening their presence in Brazil in recent months.  It is estimated that Brazilian energy companies will attract as much as 30 Billion Reals of investment

  • President Michel Temer announced his government’s plan to increase royalties paid by the mining sector and create a new mining regulator agency:

According to the proposal, royalties for gold and diamonds will be increased by a set rate of between 50% to 100%, while the rate for iron ore will be determined by its future price in the international market. Moreover, the ministry also plans to replace the National Department of Mineral Production with a to-be-created National Mining Agency, to increase transparency and reduce bureaucracy

  • The government has moved forward with it’s plan to replace the current TJLP subsidized interest rate with a market-based rate (the TLP) starting on Jan 1st, 2018:

The TJLP rate has been set as a benchmark interest rate for long-term loans from the BNDES, the Brazilian development bank. This discretionary interest rate is not affected by the Selic base rate, and creates incentives for unnecessary borrowing at a subsidized rate. This comes at the expense of Brazilian taxpayers at a cost of 1.5% of Brazil’s GDP, and crowds out financial resources from the private banks. FSG believes the elimination of this mechanism will help boost long term growth potential, though some adjustments will need to be made in the short-term by firms that relied heavily on the subsidized finance (mainly in the manufacturing and services sector)

With these and other reforms being delivered, the current government still has its sights set on pursuing additional measures outside of pension reform, including political reform and tax reform. However, so long as Michel Temer’s mandate is threatened, nothing is guaranteed in the short-term. Multinationals, however, should evaluate how proposed and approved reform measure could affect tax and other obligations, in addition to analyzing how some measures (such as higher royalties in the mining sector or the elimination of the TJLP) could affect demand from end customers or force a change in terms of value-proposition and market positioning.

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