23 jan Bolsonaro Visit: It’s Time India Looks At Brazil Beyond BRICS
On 26 January 2004, Brazil’s president Luiz Inacio Lula da Silva met India’s prime minister Atal Bihari Vajpayee in New Delhi. The Brazilian leader was the chief guest at India’s Republic Day parade. The visit to India, symbolised his wish to strengthen relations between the world’s two biggest democracies among developing nations.
Lula brought with him 100 businessmen and women from 78 different companies in an effort to expand bilateral trade, as well as Mercosur’s Eduardo Duhalde, Paraguay’s Foreign Minister, Brazilian ministers and the governors of Parana and Mato Grosso. I was part of the Brazilian delegation to India, representing The Jai Group, a consultancy I had founded.
Both Brazil and India enjoyed considerable international momentum at the time. Their capacity to unite developing countries during the trade negotiations in Cancun in 2003 marked a fundamental change in the overall dynamics of multilateralism.
In what was seen as a crucial step at the time, India signed a Preferential Trade Agreement (PTA) with Mercosur. Lula described the accord as the first step towards future free trade and as the inauguration of a “new era in South-South cooperation”.
As he told Brazilian journalists in Rashtrapati Bhavan immediately after his arrival in New Delhi: “Emerging nations cannot sit and wait for beneficial concessions from the richer nations. Accords such as these should not substitute international relations with developed countries, but complement them.”
Today, however, hopes for free trade between Brazil and India have faded, and negotiations have not advanced much. Trade between Brazil and India has grown (albeit from a low base), but it remains insignificant as a percentage of both countries’ overall trade.
The upcoming visit of President Jair Bolsonaro, on 26 January 2020 once again as a chief guest for the Republic Day, offers India to take a fresh look at Brazil as a business opportunity.
A Lot Has Changed
The Brazil of the last two decades since Lula assumed power until his successor Dilma Rousseff was unceremoniously impeached in 2016, has undergone a major political change. In the first decade of the 2000s, under President Lula, Brazil rode the commodity wave and easy access to capital to achieve significant economic progress.
The economic growth was largely achieved by direct transfer to the underprivileged and facilitating their greater participation as a labour force in the economy. The discovery of large oil resources under the sea and Brazil winning the Olympic bid for 2016 capped the Lula presidency.
However, the ending of the commodity cycle and the impact of the global economic crisis happened at the time when Brazil had reached full employment and had to take the next step towards structural reforms for productivity growth.
The good years had wrongly convinced the left of centre government now run by Lula’s successor, that Brazilian productivity growth could come without painfully reforming the inflated government budget or much needed tax reforms.
Since the 1980s public expenditure as a share of gross domestic product (GDP) had trebled to 42 per cent, a level similar to that of European welfare states mainly funded by an equivalently large and grotesque tax structure. The quality of services is that of much poorer countries.
Dilma instead tried to force interest rates down even while doubling down on fiscal profligacy.
The private sector refused to play ball by withholding investment and the result was stagflation which triggered a major political disruption resulting in the ouster of Dilma and eventual return of centre-right forces at the helm of Brazil in 2019.
In parallel, a major corruption scandal involving the state oil giant Petrobras resulted in half the business elite of Brazil getting indicted.
The fact that president Lula and his political team got muddled up in some of these scandals delegitimised some of the good things that happened under his watch paving the way for a political transition for the center-right.
The political change has also been accompanied by economic reforms, largely due to Paulo Guedes the finance minister of Brazil, who has enjoyed relative autonomy under the new president.
He has proposed to simplify the tax system radically, while reducing rates and expanding the base; to privatise nearly all state companies; and, after cutting red tape to enable businesses to withstand competition, to open the economy to the world.
A pension reform has already been effected. This will save the government 855bn reais ($210bn) over 10 years. As the reform took shape in 2019 confidence grew, leading to a recovery in investment .
The economy grew by 0.6 per cent between the second quarter and the third, more than expected.
Annual growth for 2020 is forecast to be at least 2 per cent.
Mercosur, a bloc dominated by Brazil and Argentina, signed a long-awaited accord with the European Union in June. But European reservations about Brazil’s environmental policies could prevent ratification (as could the recent election of Alberto Fernandez, a left-wing protectionist, as Argentina’s president. Argentina is an important member of the Mercosur trade block).
Brazil also has become closer to the US under Bolsonaro, a significant departure from president Lula’s time.
As pointers to its increasing alignment with US, Brazil has agreed to forgo a special status for developing countries at the World Trade Organisation, dropped visa requirements for visitors from the US, and granted permission for US companies to launch satellites from a Brazilian base.
US military presence in Brazil and defence co-operation is expected to strengthen further as US refocuses on Latin America even as it seeks to withdraw from many other regions
A Lot Has Not
Despite the many apparent changes the structural positives and negatives of Brazil remains from an Indian business standpoint.
Let us look at the positives first. We can classify them in to markets, resources and technologies.
Brazil as a market: Brazil remains the largest single country market in the Western world after the US in terms of population. With 216 million people and a per capita GDP of approximately $9,000, it has a GDP of $2 trillion and among the top 10 economies of the world ( ranked 9).
In terms of specific products, Brazil tops the position in agro-chemicals ( largest market in the world), the fourth among cosmetics markets and sixth largest pharma market.
Indian companies such as United Phosphorous, Coromandel Fertilizers, Torrent and Aurbindo are beneficiaries of the size of these markets. 34 per cent of 2019 consolidated revenues of UPL came from Brazil and insecticides is the single largest Indian export category.
Brazilian resources: Brazil has huge agricultural land with great potential, and is one of the leading producers and largest exporters of soy, sugarcane and corn. India imports half a billion dollar worth vegetable oils, mainly soy from Brazil.
They are also major meat exporters. Brazil also has abundant gems and pearls and exports almost half a billion of gold and silver to India.
Brazil unlike India is a significant oil producer and an oil exporter. In fact, Indian imports from Brazil is approximately 40 per cent crude oil. Brazil is South America’s largest oil producer and the ninth largest global oil producer and the seventh largest oil consumer.
Brazil owns the 15th largest world proven reserves of 12.67 billion barrels of oil and 372 billion cubic metres of gas.
Brazilian technology:One striking difference between Brazil and India is the degree of urbanisation in Brazil. Brazil has the same level of urbanisation as the UK or other European countries, around 80 per cent at a per capita GDP of 20 per cent of the Europeans. Brazil is further along the curve in many of the urbanisation initiatives, be it banking penetration or urban transportation, for instance.
Two relative success stories of Brazil in India have leveraged the development arbitrage curve. Tata Marco Polo buses that ply Delhi roads and Perto ATMs that ICICI Bank deploys are a result of India-based manufacturing done by Brazilian companies.
In fact for the urban bus maker Marcopolo, India and its JV with Tata represents its largest international revenue base.
From the not so positive side, India’s difficulties with Brazil could be categorised as trade conflicts where both nations are competitive producers, protectionism of a large economy where one of them is competitive and another relatively in-efficient and third the universal barrier of bureaucracy and red-tape and complex taxation.
Fortunately, cultural barriers do not hamper trade and investment, while cultural differences certainly do exist.
Trade Competition: Brazil is an exporter and producer of many commodities that India is a large producer of.
In the early 2000s, this author was hired by a large Brazilian exporter of iron ore to China to evaluate the potential threat of India as a competing exporter.
India could compete because of proximity and a fragmented exporter base resulting in competitive prices that under cut giant exporters from Brazil who depended on large carrier capacity.
Cashew is another example, where India , Brazil and Vietnam have formed a loose alliance of cashew processors, accounting for 90 per cent of world capacity.
Mutual Protectionism: Sugar is a classic example of the protectionism where India and Brazil today have a WTO case going on against India’s sugar subsidies. Both are large domestic markets and producers that want to block access.
Frozen chicken exports from Brazil is a classic example. Even if they would not threaten much of the live chicken market, India is very sensitive to any perceived threat to its chicken farmers. Brazil similarly places punitive targets.
Brazil’s huge tariff barriers protect its manufacturing, which is its soft under belly. Service exports to Brazil as many Indian IT service companies discovered to their dismay in last two decades is bad business with its taxation and labour mobility restrictions.
The domestic protectionism in Brazil also is exacerbated by the low export revenue base of Brazilian manufacturing and high levels of market share concentration in every single industry in Brazil.
Bureaucracy And Red-Tape And Taxation
Brazilian bureaucracy and red-tape are, well legendary. Corruption at high levels in Brazil competed for this title as well (petty corruption in Brazil is completely absent unlike in India, despite the best efforts of the prime minister). The recent Lava-Jato scandal which put many prominent Brazilian businessmen behind bars has also made large-scale procurement processes in Brazil relatively corruption free as of now.
Brazilian taxation is a complex system as this recent article from Financial Times articulates well.
Why India Needs To Engage Brazil?
Great momentum existed for India to engage Brazil when BRICS (Brazil, Russia, India, China and South Asia) was a buzzword. Capital was abundant. One of the missed opportunities was to build scale by combining forces and building Indo-Brazilian companies.
Those days of easy global capital have dried up as both economies have struggled to find their feet in the last decade.
However, Indian exports have suffered from the global downturn and given India’s import profile of essential commodities such as crude oil, exports are an important component to balance the current account.
Brazil is a large international market that is currently counter cyclical. While many large markets around the world are getting more protectionist, Brazil is waking up to the merits of a more liberal regime. While it remains to be seen, how far the trade reform process will go, before local industrialists will seek protection again, the macro-economic needs of Brazil will ensure some opening up happens.
Brazil also has a very low import to GDP ratio today, less than half of that of India, which points to both India’s need for exports as well as Brazilian ability to absorb more imports. The current trade scenario is one where Brazil has a surplus. The increased engagement of US as a political ally and China as an investor with Brazil is also expected to result in greater opening up.
One of the ways Brazil sustained less than efficient trade regime was by subsidising its large manufacturing companies by concessional credit from its development bank while maintaining high tariffs. This credit was funded by tax payer money and pension funds of government employees.
The Brazilian BNDES, which is the equivalent of IDBI+ICICI+IFCI combined in their development bank days made more loans than the World Bank in its heydays in the early 2000s, is under a serious funding deficit — thanks to slower growths and smaller pension outlays going forward.
This has accompanied a significant reduction in banking interest rates as some of the crowding out of credit by development funding has reduced and capital returns to market.
As a result, both from the reduced supply of funds as well as reduced demand from industrialists who see a differential advantage to this concessional funding, subsidy to local manufacturing is winding down.
The capital equipment sector is likely to see the impact of these changes. Two early examples of industries where such funding is slowing and consequently a greater opening up is visible is in infrastructure equipment and tractors. These are still very small, but distinct opportunities to build up Indian exports.
Tractors have been largely funded by BNDES credit and tough localisation rules. However, Indian tractor exports to Brazil has jumped from a small base as Sonalika and Mahindra have set up local facilities and the differential of concessional credit has meant less and less, prompting imports of CBU/CKD imports from India, even in small numbers.
Given this is an area which is an input to the competitive agricultural export industry and India has already broken through in agrochemicals, a combination of export promotion as well as select local investments could yield modest but promising results.
Export of automobile vehicles is one area where India has had good results in the region, whether Bajaj and TVS motorcycles in Colombia and Central America, three-wheelers in Peru and Mexico and cars through intra-firm trade in Mexico.
The advent of electrical vehicles and the fact that adoption in Latin America is slower also promise India can retain an edge as it develops its own electric vehicle industry.
Latin America and Brazil lack local original equipment manufacturers (OEMs) and the local auto-component industry has suffered due to the crisis. While India is going through its own crisis, staying power of Indian OEMs may prove to be a competitive advantage.
Infrastructure is another promising area where Brazil is expected to spend billions of dollars in energy as it builds out renewable wind and solar, transmission lines and promotes oil and gas exploration stalled by the Petrobras scandal.
Especially in the area of electricity concessions, Brazil has made significant progress in creating a transparent auction system in which even Indian Sterlite has participated with some degree of success.
Chinese State Grid is a big investor and so are the Spanish. Supplying these projects from India has been difficult in the past as a lot of these projects were funded with BNDES money and many electrical equipment imports were under heavy tariffs.
A few things have happened since. Some of the major construction companies that executed the EPC projects for these concessionaries have been hit by the scandal and new ones have taken their place.
Aluminum smelters have closed down in Brazil as the crisis hit the auto sector demand for value added aluminum parts. So exports of conductors and unwrought aluminum from India has been ticking up. Brazilian manufacturing capacities are getting saturated as demand begins to surge for transmission equipment that could potentially lead to relaxation of imports.
These trends are likely to also be present in oil and gas equipment as multi-national firms participate in auctions in the newly relaxed rules leading to greater global sourcing from India. If Indian exports is accompanied by select investments, it will always help.
The investment of United Phosphorus has been a useful ally to promote its exports. In 2018-2019, imports of Indian agrochemicals doubled to $600 million even as United Phosphorus has visibly committed more investment.
Technology services is another possible area to work with Brazil.
Except in Fintech, Brazil has not advanced as much as India has in the new digital world, also thanks to Silicon Valley’s Indian immigrants. There exists opportunities to build completely new businesses with embedded digital technologies.
Ola is contemplating and Oyo has expanded in Brazil even as Softbank has famously declared Latin America to be its investment destination in this decade and has started a new fund of $5 billion targeting the region. Brazil is among the advanced economies that can receive such an investment meaningfully.
What Can India Offer In Return ?
Agriculture is one area India can offer meaningful concessions to Brazil in return for opening up the industrial markets in Brazil. With the recent tiff with Malaysian palm oil, India can step up vegetable oil imports from Brazil. It can continue to import crude.
To offer relief to its beleaguered auto industry it can add ethanol hybrid as an option to its electric push to reduce dependence on crude. Brazil can be an able partner for setting up and supplying an ethanol fueling eco system, given the vagaries of Indian sugarcane crop.
Importing some chicken from Brazil can allow Brazil to claim victory to allow further deepening engagement in the Indian food processing story.
India and Brazil are large markets that possibly missed an opportunity to deepen strategic collaboration when BRICS was a buzzword.
However, the counter cyclical nature of Brazilian liberalisation in a protectionist world offers India a potentially large export market. India needs to strategically play its cards to ensure the opportunity is not wasted.
Conceding a little strategically should be accompanied by getting meaningful reciprocity in industries. Simple things like standards make it difficult for India and Brazil to trade. Reduced tariffs and greater willingness for Brazil to allow Indian entrepreneurs script success stories in its market even if unaccompanied by Chinese level of capital investments will be a good ask.
Rakesh Vaidyanathan is a strategy and cross border M&A professional with experience in United States, Brazil, Latin America and India.