INSIGHT: Brazilian Economy Starting the Engines for a New Take Off

Long years of political and economic instability have gone by since the Economist’s 2009 issue with the iconic image of Christ the Redeemer taking off on its cover. At that time, the most important magazine on economics praised Brazil’s impressive 5% annual growth rate and forecast that its economy could become the world’s fifth largest economy, overtaking Britain and France.

Following the downfall of the left-wing Workers’ Party, with a president impeached, the party’s leader in jail and several politicians and executives sentenced to prison for corruption, a new president took office in 2019 with a liberal, market-oriented agenda.

After a fresh start, President Bolsonaro’s political inability seemed to bring a new wave of pessimism to investors. However, as the Congress takes the lead on important decisions, Brazil is progressively laying the groundwork for a new phase of economic growth on the back of measures proposed by Economy minister and University of Chicago alum, Paulo Guedes.

Long-awaited Pension Reform

The Congress has approved the long-waited pension reform, which will bring savings of up to 800 million reals ($193 million) on public expenditures over a 10-year period and is expected to reduce the current public deficit. A clearer perspective of the Congress’s overwhelming vote to approve the reform led Brazil’s Stock Market Index to hit records over recent weeks. At the same time, the Brazilian Central Bank has cut its benchmark interest rate to a new low of 4.5%, a move in an anticipated easing cycle to inject new life into the economy.

Tax Reform and Creation of Single VAT

A broad tax reform to simplify the complex tax system is also gaining momentum within Congress, with proposals for a simpler, more transparent and neutral system, despite no immediate reduction in the tax burden. The most debated bill would replace five existing consumption-based taxes for a single value-added tax (VAT) over a 10-year transition period for taxpayers. The new VAT would apply to tangible and intangible assets alike, thereby ending the long debate over taxation on tech companies in Brazil. Tax incentives are expected to be abolished in order to address the lack of neutrality, particularly among local and foreign companies.

EU–Mercosur Agreement

In June 2019, after 20 years of negotiations, the Mercosur economic bloc formed by Brazil, Argentina, Uruguay and Paraguay reached a multilateral trade agreement with the EU.

The EU–Mercosur agreement, which is subject to formal approval by both sides, is intended to remove significant tariffs on EU exports to Mercosur, opening new business opportunities in Mercosur for EU companies. The agreement also provides high standards on food safety, consumer, social and environmental protection (including the commitment to enforcing the Paris Climate Agreement), while enhancing political dialogue and increasing multilateral cooperation.

Brazil’s push to be a member of the Organization for Economic Co-operation and Development (OECD) is also gaining traction under Bolsonaro’s administration. The country submitted its formal application for the OECD back in 2017. While there are ongoing discussions to build a regulatory framework in line with OECD standards, a formal committee has been created to monitor Brazil’s admittance.

Fall in Labor Lawsuits

On the legal front, several important measures have been taken over the last years to turn Brazil into a more business-friendly country.

Following the 2017 labor reform, statistics show that the number of new labor lawsuits has fallen by approximately 40%. New regulations are intended to reduce employment costs and bring more flexibility to labor relations, while providing more certainty and minimizing potential legal disputes. The recent Provisional Measure 905/2019, which is viewed as a complement to the 2017 reform, represents a new attempt to reduce employment-related costs and incentivize companies to hire younger workforce. The measure is expected to create additional 4 million jobs, but is still subject to Congress approval.

Venture Capital, Equity Crowdfunding and Fintechs

Other legislative initiatives have helped to create a more attractive environment for entrepreneurs. This includes new regulations on venture capital, equity crowdfunding and Fintechs.

By 2020, Brazil will also have its own general data protection regulations. In addition, a new set of regulations were approved last September to foster economic freedom, protect the free market, and promote entrepreneurship and economic development. The so-called Economic Freedom Law (Law 13,874/2019) is intended to simplify administrative and judicial procedures within the public administration and to guide the relationship with the private sector.

New Tax Treaties

The new federal government has also a clear intention to expand the double tax treaty network and thus provide more legal certainty for cross-border investments.

In 2018 and 2019, Brazil signed several new treaties (Switzerland, Singapore, United Arab Emirates and Uruguay) and updated others already in place (with Denmark, Argentina and Sweden). Furthermore, new anti-abuse and transparency measures enacted in Brazil show the country’s alignment with the OECD’s Base Erosion and Profit Shifting (BEPS) agenda.

Cooperative Compliance

Also on the tax front, cooperative compliance programs have been operating since 2017, following an international trend of changing the relationship between taxpayers and the tax administration in order to restore confidence. Similar projects have been implemented in Australia, Netherlands and the U.S., with a view to incentivizing voluntary compliance with tax obligations. This is particularly significant in Brazil, a country where tax litigation is almost mandatory for companies to be on a level playing field and where tax evasion is a major cultural problem.

The first measures towards cooperative compliance were enacted by the State of São Paulo and were followed by other Brazilian states. The São Paulo program (Programa de Estímulo à Conformidade Tributária) assigns rates to taxpayers and rewards those best ranked with voluntary disclosure benefits, a faster communication channel with tax authorities, facilities on renewals of special tax regimes and transfers of tax credits, among others. São Paulo is being particularly effective in attracting new investments. The State is currently the main hub in Latin America for early-stage tech ventures with close to 10 companies already included within the $1 billion unicorn’s club.

This new scenario creates optimal conditions for the government to offer a more market-friendly agenda to boost business confidence and expedite bold privatization projects and economic growth. A combination of a huge consumer base and an existing culture of early adopters of new technologies has also made Brazil an attractive environment for startups and tech companies. The banking industry has a huge potential for investment opportunities: with high concentration (as the top five players have close to 85% of market share), there is room for growth in the credit, payment process and e-commerce-related segments. Other areas with strong potential are infrastructure, health and education.

Growing Hope

Overall, despite the challenges the Brazilian economy is still facing, legislative reforms are bright spots in a better legal and economic environment. It seems that a political consensus has formed in Congress around a core set of important reforms. There is growing hope that Brazil is recovering its economic dynamism and is now ready to take off.

Ricardo Maitto and Frederico Bocchi are legal advisers with extensive experience in Brazilian corporate and tax matters. They are associated with São Paulo-based firm Rayes & Fagundes Advogados.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.