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Brazilian Infrastructure: Is it Still Attractive for International Investors?

6 MIN READ July 14, 2020
The world’s perception of Brazil has been gravely hit in the 1H20 with the impact of the COVID-19 crisis and has changed some international investors’ view on the infrastructure industry.  Although there are some good things coming up in terms of regulation as the Tax Reform is back on the table along with some administrative reforms that would help bring balance to this global-felt predicament. GRI Club Infra members discussed various areas of opportunity, challenges and barriers that are deterring international inventors from placing their bet in Brazil today. The Brazilian industry will have to team up with the government to affirm the country’s position in the world and why it is the right investment destination. 

Brazil is one of the largest economies in the world, nevertheless it has lagged in infrastructure investment in the last years, investing roughly around 2 percent of the GDP on infrastructure. The country has invested at low rates, and must be increased through a strong regulatory framework to bridge its infrastructure gap. The world’s picture of Brazil is not so great at the moment, so how can local and foreign investors help change that perception? 

Political Risk: Brazil’s Achilles Heel

Brazil has made progress in the last years, Pension Reform for instance was encouraging and the measures taken recently have also helped. Brazil was on the right track pre-COVID to push a strong infrastructure agenda forward. Unfortunately, there is always something that happens that derails plans. It is an ongoing, global issue and there is still great uncertainty as to how it will hit Brazil. How will the country be able to push forward its Structural Reform agenda?

The political risk in Brazil is very high, and it has a great impact on construction and operation licenses. Political risk impacts everything and can be seen as the core discussion of investment in Brazil. Some concessions can last 25 years, which means at least 7-8 different governments will be involved in those concessions. Something is very likely to go wrong in those years. Investors shared that they will have to adjust to the best risk-return opportunities for their funds. Brazil has a great secondary market and opportunities, but obtaining the proper risk-adjusted returns has not been easy.

GRI Club members shared that there is much noise generated by the country’s response to the COVID-19 crisis. Brazil is competitive and global inventors have guidelines of investment they must follow, and investments must be more attractive. The country’s market size helps a lot, and despite the noise, Brazil is a democracy with rule of law, which counts greatly. It also has a positive track record of not discriminating against foreigners. Members shared that international investors need legal predictability and certainty, especially when it comes to tax liabilities. 

Brazilian Real Needs Stability

Members agree that the Brazilian Real’s exchange rate is not for the faint-hearted. Nevertheless, for long-term investors, there are very interesting ingredients in the Brazil market to consider. The 35 percent devaluation in 2020 is on the top of every investors’ mind and the fiscal situation is also a great concern as it will show how things will be managed in a post-COVID world. The Brazilian Real exchange rate is quite volatile and risky for investors, particularly long-term investors.  Most projects are financed through tariffs, which are paid in local currency. This leads to problems and makes it difficult for investors to quantify the risk. This may change in the post-COVID scenario with low-interest rates and inflation. It generates barriers for funds that are not interested in taking currency changes. Inflation is high, and the new normal will bring even more changes. Lower interest rates will decrease the cost of hedging and that makes it attractive or competitive in the future. 

Despite the noise and changes the country is undergoing, Brazil continues to give a warm welcome to foreign investors. The privatization programs for its toll road concessions, the framework for renewables, and support packages for power distribution companies have created a very dynamic market. Industry leaders shared that Brazil continues being one of the friendliest markets to foreign investors in Latin America. Some investors are very optimistic, and now even more with lower interest rates making some investments more attractive. 

Increasing Dynamism in the Market

Brazilian’s competition level is different than that in North America and other Latin American countries. North America, Europe and Asia have short-term funds, which have not fully entered the Brazilian market. Some members believe that this is a sign that something is off. This creates a market with a lack of capital and reduces its competitiveness. For some investors, this is a good thing, but for the country overall, not so much as it will not have dynamic investment. Especially since these short-term funds tend to make more aggressive bets in the market. 

Difficulties in Finding the Right Partner

GRI Club members shared that it is not easy to find the right partners and generating a risk-return partnership can be difficult. To make it as a foreign investor you need the right management team and the right partner, and especially refrain if it is in the Wall Street Journal’s risk index. Traditional GPs cannot take those sorts of risks as the degree of responsibility on risk-return and require great long-term work to help them flourish. Investors cannot afford many hiccups, and if it starts to get more difficult, many will question how much premium they will actually get from that return. 

A part of finding that right partner is overcoming the communication and cultural barriers of working in a different country. Members shared that language is a strong barrier as many do not speak english and it generates important information gaps when it comes to contracts and other important documents. Operational levels often have even less people that speak english which increases the challenge. The business culture may also be difficult, particularly for asian investors which can make negotiations more difficult. 

Investment Opportunities in the Brazilian Airport Sector

There are opportunities in the Brazilian airport sector. It is sophisticated and open to foreign investors. Nevertheless, COVID-19 will make changes, and perhaps move around opportunities in the country.  For these new opportunities, members believe it is important to learn from past mistakes to further strengthen investment in the sector. Traffic forecasting for instance will need to change to fit a long-term view. This has been an issue from the 2014 crisis where the traffic various years to recover. The airline industry has also suffered greatly and even though Latin America is 14 times the size of France, there continues to be a demand and offer issue. The lack of offering of airlines and air services is an issue to unlock capital, as the trips for capita are very low still. There need to be incentives to bring more airlines to Brazil and have more activity in demand and offer.  

As administrative changes start to take place, members are weary on the new tax regime and on the uncertainty in the air. The level of returns in the airport sector are aggressive and are mismatched, and are facing bankruptcies of airlines such as Avianca. Brazil will always be a country of the future, there are opportunities and potential but it suffers from volatility and uncertainty often. Nevertheless, it holds great potential and still is attractive to European investors. 

Other members shared that Brazil has all of the resources and great potential to grow as an economy. The airport sector is privatized and has international operators on the ground already. The challenge will be for new entrants and if there is still a chance to actually enter the market. Developers and operators are also still interested in exploring the Brazilian airport sector, but it will be more difficult to make money with the small airports, bundled and separated from each other, which is what is predicted will happen with the sixth round of tenders. 

Investors will be making investments if the opportunities make sense and they are very cautious given the great uncertainty in the current environment. There are many areas of opportunity for the Brazilian infrastructure sector to attract foreign investment to bridge its financing gaps, nevertheless, if it adjusts the risks and shows certainty as a country, there is plenty of capital and dry powder ready to come into Brazil. 

This article is a summary of what was discussed during the GRI Club Infra eMeeting: Local and international investors' perceptions on Brazil's scenario on July 7, 2020. Some of the GRI Members that participated in the discussion were: Carla Ferreira (Banco Bradesco Europa), Denis Jungerman (CDPQ), Eduardo Klepacz (GTIS Partners) François Deveza (ADP International), Gonçalo Bernardo (OMERS Infrastructure), Ralf Gaffal (Munich Airport International), Ricardo Szlejf (CPPIB), Thiago Silva (Ontario Teachers' Pension Plan) and Yu Yong (CCCC South America).
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