In contrast to most of the world, Brazil has been in a rather jubilant mood.
At the end of September, the now soon-to-be former president Luiz Inácio Lula da Silva celebrated the news that Petrobras, Brazil’s national oil company, managed to raise US$70bn in the biggest share issue secured to date.
Addressing the São Paulo stock exchange, Lula exclaimed: “It wasn’t in Frankfurt. It wasn’t in London. It wasn’t in New York. It was in São Paulo.”
Lula’s words herald the growing international presence and importance of Brazil, with the country set to move from being an importer of oil to a major oil exporter.
It is a cue for celebration for many in Brazil, but it is a development not without its pitfalls.
Oil reaps rewards
Brazil’s recently discovered pre-salt fields have 25 billion barrels of proven reserves lying below several kilometres of seawater, rock and salt. Such predicted volumes of oil could put Brazil level with oil-producing nations such as Russia.
To exploit this potential, Petrobras is to launch a large-scale investment programme, pumping US$224bn into exploration, production and refining activities.
It is expected that the oil company will be looking to raise significant debt financing over the next few years; good news for bankers and investors eager to capitalise on Brazil’s new-found global prominence.
Petrobras has hinted it will be looking to raise US$60bn in debt over the next five years. Its debt requirements will be increased by the fact the company must pay US$42.5bn of the US$70bn raised in the share issue back to the government for the rights to the pre-salt oil reserves.
“Petrobras is providing a lot of opportunities. They are asking for new investments. Of course there is great potential in this market. And we see more opportunities in the sector as a whole,”
“Petrobras is providing a lot of opportunities. They are asking for new investments. Of course there is great potential in this market. And we see more opportunities in the sector as a whole,” comments Roberto Padovani, emerging markets strategy and local markets, at WestLB, in São Paulo to GTR.
Rodrigo Campos, structured trade finance, at Banco Espirito Santo (BES) in Brazil is equally positive: “Petrobras is in the market now asking for quotes for guarantees and LCs, normally with significant volumes.
“There are also some new players [private companies] – OGX (OGX Petróleo e Gás) and HRT (HRT Participacoes em Petroleo) – who are basically preparing the infrastructure for the exploration and approaching banks for project finance solutions (for example oil platforms).
“On a more mature phase, it will also be requesting trade-related products.”
Marcelo Franco, director of medium and long-term business at the Brazilian credit insurer SBCE (Seguradora Brasileira Crédito à Exportação) sees increased oil exports indirectly increasing demand for cover on export deals.
“The boom in infrastructure spending brought on to enable oil production, refining, distribution and shipment overseas will undoubtedly create expertise and install capacity that can be used for medium and long-term term exports in the future.”
Similarly, the Brazilian development bank BNDES also sees a potential flow of new investment opportunities.
“The pre-salt discoveries represent not only an opportunity for Brazil to become a major oil exporter, but also a chance to develop a chain of suppliers of goods and services which will be required by oil producers,” a spokesperson tells GTR.
To support the companies involved in the pre-salt supply chain, BNDES has created a new department aimed at helping those smaller firms reach international standards.
Enestor dos Santos, senior economist of the emerging markets unit at BBVA recognises further potential outcomes of the pre-salt discoveries.
“Before we start seeing exports expanding as a consequence of the pre-salt reserves, there will probably be a strong expansion of imports, as imports from abroad will be needed to develop the oil fields.”
This, he adds, could have a significant and negative impact on Brazil’s trade balance in the short term.
Markets will also need to note that despite Petrobras’s vast capex requirements, its investment grade rating will mean it will be able to leverage on its balance sheet. In order to uphold its rating, Petrobras will need to maintain a certain debt to equity ratio.
“Nevertheless, the magnitude of their continued capex requirements will mean that Petrobras will inevitably continue to seek structures which will allow them to finance their domestic demands,” explains Paulo Andre Campos, executive director, corporate and investment banking at BBVA.
“One way which Petrobras has achieved this in the past is through certain assignments of a select number of eligible supplier contracts to specific funds which have then been sold to investors,” he adds.
Wider opportunities
Aside from oil, Brazil presents many other investment opportunities. The 2014 World Cup is estimated to require US$30bn-worth of expenditure, while the 2016 Olympic Games will need US$90bn.
This will again open up opportunities for the financial markets.
According to Erika Glorigiano, head of structured trade finance Latin America at BBVA, there will be heightened demand for infrastructure financing, especially now a new president has been voted in.
“Brazil intends to invest US$18.7bn in infrastructure to host the 2014 Fifa World Cup.”
“Brazil intends to invest US$18.7bn in infrastructure to host the 2014 Fifa World Cup. These resources will fund 50 projects in 12 Brazilian host cities.”
Almost 80% of this funding will be provided by the public sector, she says, but the rest with be from private sources.
“Export credit agency (ECA) support will be crucial to support the investments in Brazil,” Glorigiano adds.
Additional key economic indicators also suggest Brazil has something to celebrate.
“Brazil is now clearly poised for moderate or strong growth in the next five to 10 years, and by moderate strong we mean 5 to 6%,” Rafael Amiel, director, Latin America Economics at IHS Global Insight tells GTR.
The country also has falling unemployment, with the workforce having grown by 74% in the last 20 years, and over 2 million jobs are expected to be created in 2010, according to the Brazilian Census Bureau (IBGE).
Furthermore, Brazil’s middle class has seen high levels of growth, with 30 million Brazilians, approximately 10% of the population, emerging from low to mid-income levels over the past five years.
Indeed, even though the country has voted in the new President Rousseff Dilma (to commence her first term in January next year), the financial markets don’t seem to be concerned as yet about any political uncertainty. Most report that they expect Dilma to continue with the popular economic policies of Lula.
“Current economic policies, will broadly speaking, remain unchanged,” predicts BBVA’s dos Santos.This relative confidence in the sustainability of Brazil’s economy despite a change in president marks yet another break from the past.
Andrew Robison, director structured trade finance origination, at BES in London, notes to GTR that the country has managed to “break the link between a political problem and a subsequent immediate impact on Real rate or the economy ”.
He adds: “The major thing about Brazil is that historically, any perceived political instability or major political issue, would immediately translate into an economic problem – this is no longer the case – the two factors would appear to have separated”
Internationalisation of Brazil
As Petrobras increases its international importance, so too do other Brazilian corporates. This trend is catching the eye of some global trade banks.
Robison at BES comments: “What the bank is looking at is the question of large Brazilian companies expanding internationally.
“Vale [mining company] has operations in across Africa in Mozambique and Zambia as well as Mongolia, in relation to mineral exploration and development. So far I haven’t seen a large number of Brazilian bankers on the ground in Africa, but they will arrive – trust me”
To capitalise on this trend, BES, with presence in Angola, South Africa, Cape Verde and more recently Libya and Mozambique, has, via a newly formed subsidiary, called BES Africa, has signed a MoU with Banco do Brasil and Banco Bradesco to define a common development strategy for future business in Africa.
Eddy Leiber, vice-president, commodity structured trade finance at BBVA, views this Brazilian corporate expansion, including cross-border acquisitions, as a positive trend.
“Internationalisation seems to be a driver behind many changes we are seeing, with some Brazilian-based clients requesting financing lines for their recently created or acquired foreign subsidiaries.”
“This is obviously an advantage for international banks, which have better capabilities to accompany Brazilian clients abroad compared to the increasingly aggressive, yet still very local, Brazilian banks.”
Demand for financing intra-company trade flows is also increasing, as Brazilian companies set up subsidiaries abroad.
“Many Brazilian commodity players are setting up their own hubs or distribution platforms in Asia, sometimes even in mainland China, or investing in producing assets or farmland in Africa, mostly Portuguese-speaking countries such as Angola and Mozambique,” Leiber adds.
With the top-tier Brazilian corporates having healthy financials and an ambitious outlook, there should be plenty of opportunities for trade finance banks to support their activities. Yet, some remark that Brazil has seen a relatively low volume of syndicated deals since the crisis.
Recent transactions this year include a US$600mn transaction for paper and pulp company Fibria, a US$1bn syndication for Votorantim (a conglomerate in the mining sector and paper and pulp industry), a US$600mn deal for Samarco (metals and mining), and a US$200mn transaction for Marfrig (a meat company).
During the crisis, in line with the rest of the financial world, financing structures for companies such as these became tighter and ECA financing became more popular. Yet now, for the top-tier companies, the market seems to have bounced back to almost pre-crisis days.
“We have already seen a return to the simplified structures and longer tenors, which so typifies the rapid growth of the Brazilian market, and the banks are seeking to balance good returns with solid fundamentals,” comments Nick Shaw, head of structured trade finance at BBVA.
“In the case of Brazil, the withholding of tax advantages which exist for pre-export finance structures had a financial attraction.”
Shaw notes that pre-export facilities remain popular in Brazil. “In the case of Brazil, the withholding of tax advantages which exist for pre-export finance structures had a financial attraction.”
Yet this renewed strength at the top of the corporate spectrum has inevitably driven down pricing on trade deals.
In contrast, at the lower end of the corporate spectrum, liquidity is still an issue and pricing is still high.
“Most international banks were quite shaken by the highly publicised fall of a few names in the commodity sector, especially on the soybean side, while the sugar world also saw quite a bit of debt restructuring, and are therefore still reluctant to go after the small names again,” explains Leiber at BBVA.
But he notes that eventually, commodity finance banks will have to focus on sub-investment grade companies and this will eventually put pressure on pricing again.
Currency issues
What will hold back top-tier Brazilian corporates in their quest to become an international player is the strength of the country’s currency.
With commodity prices escalating, the Real has been increasing in value against the dollar.
Brazil’s economy is already highly commodity-driven, and there are concerns that once vast quantities of oil and oil-related products are added to the mix, the Real will only further appreciate.
There are worries about the Brazilian economy suffering from the “Dutch disease”.
There are worries about the Brazilian economy suffering from the “Dutch disease”, a term coined in the 1970s, to describe the impact of gas prices on the Dutch economy.
“Commodity prices drive up the value of currency, making other exports and sectors uncompetitive and ensuring greater dependency on commodities,” comments Keith Martin, director of international trade and investment at Aon.
This can cause a current-account deficit and since the mining and hydrocarbon industries are highly capital-intensive, fewer jobs will be be created.
It will also make Brazil an extraordinarily expensive place for tourists to visit.
Franco at SBCE sees the value of Brazil’s currency as a key problem: “The major challenge today is to remain competitive in an environment of global currency depreciation.
“A relatively over-valued currency may have an impact on export performance due to pricing.”
Yet, he also sees a positive side to currency appreciation.
“On the other hand, some of the drivers behind the strong Real, namely the economies of scale provided by the size of the Brazilian market and the favourable risk-adjusted return on capital invested in the country, have transformed Brazil into an attractive platform for exports to its neighbours, given its existing capacity and its solid commercial ties and friendly bilateral relationships with other countries in Latin America.
“Furthermore, the strong currency has allowed for increasing purchases of high-quality imported capital goods that are boosting export competitiveness.”
Franco’s rosy view is not wholly shared by the Brazilian government, with some officials expressing angrily that the reason for Brazil’s currency problems is due to other major currencies drastically weakening.
Back in September, the Brazilian finance minister Guido Mantega warned that there was an “international currency war” in progress, venting his frustration at interventions by foreign governments to weaken their currencies to boost the competitiveness of their exports.
Mantega’s comments came as the Real was at a 10-month high and was said to be the most overvalued major currency in the world.
The increasingly fiery international debate surrounding a potential currency war has led to the ICC issuing a statement in October calling upon the G-20 (ahead of their meeting in Seoul) to tackle the issue of exchange rate manipulation.
“Currency wars could rapidly become overt trade wars. As in the 1930s, that might well lead to a major slump in economic activity worldwide,” stated Rajat Gupta, chairman of the International Chamber of Commerce.
In her early speeches, the newly-elected Dilma has spoken of her wish to avoid currency wars and that exchange rate manipulation is counterproductive.
“Brazilian complaints and talks of a ‘currency war’ are understandable,” comments BBVA’s dos Santos. But he notes the solution to the appreciation problem does partly lie with the government: “The Brazilian government could also be blamed for the appreciation of the currency as fiscal policy remains lax, stimulating an already strong domestic demand, and therefore putting pressure on the exchange rate.
“Entering into a currency war could have some effectiveness in the short-term,” he adds, but advises that the best course of action for the long-term success of Brazilian exports is to cut inefficiencies and logistical costs.
Risk perceptions
Logistical problems are common themes among those observing Brazil’s development.
“Brazil is reaching a point where infrastructure is becoming a major issue,”
“Brazil is reaching a point where infrastructure is becoming a major issue,” comments Robison at BES. If it is harder to load and transport goods, commodity prices will rise.
As yet, such concerns are not translating into heightened risk perceptions of Brazilian corporates among those looking to finance them. Indeed, winning mandates for trade debt financing in Brazil is getting very competitive.
“Price in Brazil has decreased in the last 12 months, especially for the large corporates,” comments Campos at BES.
The continued downward pressure on pricing could result in Brazilian deals becoming unrealistically priced, not correctly reflecting the risks involved, and becoming unprofitable for some banks.
Competition between Brazilian and international banks is getting particularly heated: “With Brazilian banks, they are aggressively offering competitive conditions to companies. And they are actively participating in syndicated transactions with large tickets and accepting longer tenors,” observes Campos at BES.
“The competition is much more intense nowadays compared to the market three years ago”.
Domestic players are also moving into what was considered the domain of the international banks, such as cross-border deals or other transactions closed in US dollars for commodity exporters and large corporates. This is primarily due to the fact it is cheaper for Brazilian banks to fund in US dollars than it is for many US and European entities.
“It is not clear how long this trend will continue though, as many international banks are now adopting an opposite yet symmetric strategy, where they go after the historical reserved business of local banks – such as local currency deals including debentures, onshore commodity or FX derivatives,” comments Leiber at BBVA.
Comments from Angela Martins, director, international department at Banco ABC Brasil, back this up: “In the last two years we are seeing a bigger demand for funding in local currency, and we are forecasting this is a trend that is here to stay.”
Perceptions of Brazilian risk pricing seem to be defined by the commercial market, rather than ratings agencies.
As an example of this, Robison at BES notes the differences between the interest rates of a Brazilian bonds compared to European bonds.
“If I look at the Brazilian 10-year bond today the spread above US treasuries is around 87 basis points, and Brazil is rated BBB- by S&P.
“But if I look at Italy, I see their 10-year bond at 134 basis points above US treasuries and they’re rated A+. What this indicates to me, is that the market views Brazil’s prospects significantly higher than that which the ratings indicate.”
There is an air of confidence about the Brazilian economy, and the growing role of the country on the international stage.
But, the commercial market perceptions may be blinded to some of the underlying pitfalls in the country’s development. For now, most want to take a sunny perspective on Brazil.
