Brazil

Challenges & Opportunities of an Emerging Country

November, 2011

Brazil Country Profile

Brazil is the largest economy in Latin America and the 7th in the world (nominal GDP), being a continental country that is larger than the contiguous USA and the worlds largest catholic population in the world

Political System: Democratic presidential republic

Population: 192M, worlds 5th (USA: 312M, worlds 3rd) Political Capital: Braslia Financial Capital: So Paulo

Cultural Capital: Rio de Janeiro

Area: 3.3M square miles (larger than contiguous USA) Language: Portuguese Religion: 75% roman catholic, worlds largest Currency: Real (R$ or BRL) Life Expectancy: 72.5 yrs (worlds 123rd, USA 78.3 yrs) 2010 GDP* (nominal): $ 2.090 trillion (7th) 2010 GDP* (nominal per capita): $10,800 (102nd)

Source: http://www.economist.com/content/comparecabana *https://www.cia.gov/library/publications/theworldfactbook/geos/br.html

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A Quick Snapshot: Bovespa (Stock Market)

The last 16 years were decisive for Brazils current position in worlds economy, while the Brazilian stock market evolution shows a more mature reality for the country Brazils Bovespa Evolution*
Brazils economy has reached a new level
Reaction to crisis became faster Elections has lower impact on economy

How did Brazil progress? What are the future challenges?

Source: *Citi Bank Investment Research !Latin America Equity Strategy: Brazil Fact Book June, 2011

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Agenda
The current presentation will be divided in 5 main steps: past, current situation main pillars, the present situation, the main challenges and opportunities for the future and the short-term most probable scenario
5

FUTURE

Challenges

Opportunities

PRESENT

Political Stability

Commodities Boom

External Trade Diversification

Mature Financial System

Mature National Industry

Social Policy Progress

PAST
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Agenda
The first step in the agenda will quickly focus on Brazils past for analysis contextualization

FUTURE

Challenges

Opportunities

PRESENT

Political Stability

Commodities Boom

External Trade Diversification

Mature Financial System

Mature National Industry

Social Policy Progress

PAST
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Past: History Timeline

1500
Pedro Alvares Cabral (1460-1526), Portuguese explorer discovered Brazil

1550
African slaves were shipped to Brazil to work at sugar plantations

1654
23 Jews left Recife and founded "New Amsterdam" on Manhattan Island. The first New York City synagogue was created in lower Manhattan by the founders of the first synagogue in the New World in Recife.

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Past: History Timeline

1822
Brazil declared its independence from Portugal

1888 - 1889 1964 - 1985

Slavery was abolished in Brazil and 4 million slaves were freed
Brazilian monarchy was overthrown and a republic was established
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A military dictatorship ruled over Brazil

Past: History Timeline

1994
Fernando Henrique Cardoso elected president after helping to bring inflation under control

2002
Luiz Inacio Lula da Silva, popularly known as Lula, wins presidential elections

2010
Dilma Rousseff, of President Lula's Workers' Party, wins second round run-off to become Brazil's first female president

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Agenda
The agendas second step focus on the 6 main pillars that support the latest Brazil economy progress, leading to the present scenario

FUTURE

Challenges

Opportunities

PRESENT

Political Stability

Commodities Boom

External Trade Diversification

Mature Financial System

Mature National Industry

Social Policy Progress

PAST
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Political Stability
The first important pillar that sustains the latest economic progress is concerned to the political stability that the country has reached, presenting a mature democratic presidential republic
After re-democratization (1989), population impeached 1 president, vice took over 2 presidents in 16 years (1994-2010) 2010 elections results would not jeopardize recent social/economic progresses Current president, Dilma Rousseff, is the continuation of Lula administration (2002-2010)

Government has the majority in house of representatives

however
It is hard to change status quo for the worse but also for the better: structural reforms are necessary!
Mature democracy demands negotiation and power balance for reforms
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Commodities Boom: Dependency

Although Brazil continued diversification of external trade, the country still depends a lot on Agricultural and Industrial Commodities as much as on Oil and Fuel

Source: *Bradesco Brazil Macroeconomic Trend and Cycle PDF file, March 2011

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Commodities Boom: High Prices

However, global commodity and energy prices have been rising during the last 10 years: current prices are reaching levels prior to 2008 crisis

Source: *Bradesco Brazil Macroeconomic Trend and Cycle PDF file, March 2011

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External Trade Diversification

Besides, the latest governments have focused on external market diversification in order to lower dependency mainly on USA and Europe, focusing on emerging markets and Africa Brazilian External Trade Partners Diversification (2010)

Source: *Bradesco Brazil Macroeconomic Trend and Cycle PDF file, March 2011

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Mature Financial System

During the last 16 years, Brazils central bank gradually conquered political independency, concentrating its decisions on technical parameters; Brazils banking system is considered one of the most advanced in the world

The 3 Major Groups*

Brazil was awarded 1st place for its high regulatory standards at the 2009 Financial Stability Forum' in Basel that "helped it avoid the worst of the global economic crisis" At the close of first decade of the 2000s, Brazil was one of only 4 countries in the world with a wide spread on lending
MV 115.08 billion $ 10th largest bank in the world by market value MV 74.32billion $ Had acquired Brazilian operations of J.P. Morgan Fleming Asset Management and American Express MV 54.89 billion $ Largest Latin American bank by assets Controlled by the government (major instrument to reach middle class)

We are used to dealing with challenging environments at our institutions and our regulations. Everything we have done since the mid-1990s has tended to take a more cautious approach.
Alexandre Tombini, President of Central Bank

Source: * http://www.forbes.com/lists/2008/18/biz_2000global08_TheGlobal2000Brazil_10Rank.html

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Mature Financial System

State banks are the main inducers of credit expansion policy mainly to real state sector
Breakdown in Mortgage Loans in Total Stock of Credit of the Brazilian Financial System*

Government credit stimulation to overcome economic crisis by internal economy stimulation

which stimulates civil construction and creates new job offers for population with different educational levels
Source: Citi Bank/ Bradesco Citis 4th Annual Latam Financials Investor Field Trip

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Mature National Industry

With the stable political situation, economy growth and government support, some national champions are successfully entering international markets **
($ 239B)
Largest company in Latin America by market capitalization and revenue 12th largest company in the world in terms of capitalization One of the worlds top 10 companies investing in research and development

($ 86B)

($ 21B)
Latin America's biggest power utility company 10th largest in the world 4th largest clean energy company in the world

Largest global brewer with nearly 25% global market share Owner of Budweiser brand

($ 18B) ($ 32B*)
Miami/Orlando International Airport I-40 Interchange Seven Oaks Dam World's 3rd-largest commercial aircraft company

($ 16B*)
World's 10th largest food company

($ 185B)

2nd largest mining company in the world Worlds largest producer of iron ore and pellets

($ 23B)
Leader in long steel in the Americas and a leading supplier of special steel Leader in mini-mill steel production and steel recycling in North America

($ 34.9 B*)
World's largest company in the beef sector $ 225m acquisition of U.S. firm Swift & Company in 2007

Source:*All values in parenthesis are market values, except for Odebrecht, BRF and JBS (2010 Revenue) ** http://www.forbes.com/lists/2008/18/biz_2000global08_TheGlobal2000Brazil_10Rank.html

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Mature National Industry

Within this internalization process, the agricultural sector growth is highlighted by sugarcane ethanol business expansion and high international competitiveness level

Brazil is the World's 2nd largest producer of ethanol fuel Brazil is the world's largest exporter Together, Brazil and the United States lead the industrial production of ethanol fuel, accounting together for 87.8% of the world's production in 2010* In 2010 Brazil produced 26.2 billion liters (6.92 billion U.S. liquid gallons), representing 30.1% of the world's total ethanol used as fuel*

Source: *http://en.wikipedia.org/wiki/Ethanol_fuel_in_Brazil

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Mature National Industry

Government programs and positive economic perspectives are encouraging Brazilian companies to create and implement innovative ideas on international market, specially exploring the Brazilian Fashion concept The Brazilian Fashion Concept

In 2003 Havaianas* produced sophisticated models with rubies for the Oscar nominees. After American celebrities were spotted by paparazzi wearing Havaianas flip-flops, it has definitely earned the title of the Brazilian most global fashion brand.

Stern was also the first to create a worldwide warranty certificate. One of his main goals in life was achieved when important international gemological institutes revised the old "semi-precious" definition of colored stones and began referring to them since as "precious colored stones".**

Top earning model in 2010/2011, with an estimated $45 million income, Gisele Bndchen opened the international market to Brazilian models: Adriana Lima ($ 8M) and Alessandra Ambrosio ($ 5M) are also part of top 10 list: Brazil is the best represented country.

Source: *www.havaianas.com **www.hstern.com

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Social Policy Progress

Short-term income transfer programs have positively impacted the economy by creating a middle-class country; however, long-term educational programs are still timid, what can represent a huge social expenditure debt in the future Social Class Breakdown Changes from 2004 to 2010*

Around 33 million people(around 17% of population) left low income class and entered middle class in 6 years, mainly achieved through income transfer (short-term effect)

Source: *Citi Bank/ Bradesco Citis 4th Annual Latam Financials Investor Field Trip

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Agenda
The 6 main progress pillars led the current countrys scenario, while 5 main parameters are presented below before exploring the future challenges and opportunities

Main Positive Impacts

5

FUTURE

GDP Growth

Challenges

Opportunities

Country Rating Progress

Foreign Investments Raise
Mature National Industry
Social Policy Progress

PRESENT

Political Stability

Commodities Boom

External Trade Diversification

Mature Financial System

Formal Jobs Creation

Internal Market Maturity

PAST

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GDP Growth
Brazil seems to reach a more sustainable GDP growth with a positive tendency estimation for the future, while scenario could be better if unlikely tax reforms were approved Brazilian Historic Growth: 1960 2020 (expectation)*
Oil shock, high external debt, country default economic stabilization

very unlikely

the lost decade

economic return & social progress

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Source: *Citi Bank/ Bradesco Citis 4th Annual Latam Financials Investor Field Trip

Country Rating Progress

Brazil credit ratings are being raised recently by major credit rating agencies, such as Standard & Poor's, Fitch and Moody's Description Rating* Outlook* Standard & Poors* BBBPositive Rating Tendency
BBB

Fitch** BBB Stable

Moodys*** Baa2 Positive

BBBBB+

BBBFitch S&P

<2008

2008

2011

*For S&P, a bond is considered investment grade if its credit rating is BBB-or higher. Bonds rated BB+and below are considered to be speculative grade, sometimes also referred to as "junk" bonds. **For Fitch, a bond is considered investment grade if its credit rating is BBB-or higher. Bonds rated BB+and below are considered to be speculative grade, sometimes also referred to as "junk" bonds. ***For Moody's, a bond is considered investment grade if its credit rating is Baa3 or higher. Bonds rated Ba1 and below are considered to be speculative grade, sometimes also referred to as "junk" bonds.

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Foreign Investment Raise

Besides, foreign direct investment are reaching historical records every year: the crisis year valley is comparable to the first economic growth cycle level in the 90s Foreign Direct Investment 1995 2011*

Cycle 2 Cycle 1
Economic Stabilization Economic Return + Social Progresses

Crisis valley value reached the same level as Cycle 1 top investments

Source: *Bradesco Brazil Macroeconomic Trend and Cycle PDF file, March 2011

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Formal Jobs Creation

Brazilian workforce is tending to have more formal jobs, even though legislation is old and extremely inefficient: 30% of current formal jobs were created between 2004 and 2009 Change in the Percentage of Formal Jobs in Brazilian Workforce (2004 2009)*

Around 30% of current formal jobs in Brazil were created during the period: 13 million jobs

Source: *Bradesco Brazil Macroeconomic Trend and Cycle PDF file, March 2011

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Internal Market Maturity

Internal market growth and maturity are presented in chart below, where it show low 2008 crisis impact on household consumption, what was Brazils main solution for the difficult moment Evolution of Household Consumption & Gross Formation of Fixed Capital*
Companies perspectives went down during 2008 crisis, but rapidly rampedup the following semesters Household Consumption and export level (10% of GDP) lowered 2008 crisis impact to Brazilian economy and will probably do the same in 2011 Household Consumption is about 60% of GDP, which indicates its domestic market-oriented economy, in contrast with other emerging economies Income distribution is one of the key drivers of Brazilian growth in recent years

Source: *Citi Bank/ Bradesco Citis 4th Annual Latam Financials Investor Field Trip

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Agenda
However, important challenges will limit countrys future development and growth, being the 6 most important described below and detailed on following slides

Main Present/Future Challenges

Unbalanced Government Fiscal Policy

5

FUTURE

High Social Security Expenditures High Interest Rates Poor Logistics Infrastructure
Mature National Industry
Social Policy Progress

Challenges

Opportunities

PRESENT

Political Stability

Commodities Boom

External Trade Diversification

Mature Financial System

Poor Education
Unpopular Reforms Need Corruption

PAST

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Government Fiscal Policy

Government is spending too much, especially Lula in his later years
Federal Government Expenditures to GDP 1997 2010*

Brazil Inflation Rate** Annual Change on Consumer Price Index

making it difficult to control the inflation

Source: *Bradesco Brazil Macroeconomic Trend and Cycle PDF file, March 2011 **http://www.tradingeconomics.com/brazil/inflationcpi

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Social Security Expenditures

The government high expenditure is also due to social programs expansion and older population demanding larger benefits volumes that overcome GDP growth pace
Income Transfer Program Expenses vs. GDP Evolution
(Baseline 2004 = 1,00) 3,0 2,5 2,0 1,5 1,0 0,5 0,0 2005 2006 2007 2008 2009 GDP 2010* Income Transfer Program Expenses

Demographic Growth 1981-2030*

Population will start decreasing in 2040

Is Brazil ready to pay this bill?

Source: *Citi Bank/ Bradesco Citis 4th Annual Latam Financials Investor Field Trip

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Interest Rates
Brazil has the highest real interest rates in the world, by a very fat margin

BRIC Brazil: 5% China: 2% Russia: -0.15% India: -3.4%

OTHERS Euro zone: -1.5 % USA and UK: -2 % Australia: 2.5 %

The interest rates is the main mechanism used by Brazil Central Bank to fight against inflation rise due to the economy growth and government expenditures: government is not doing its homework
Source: Bradesco Brazil Macroeconomic Trend and Cycle PDF file, March 2011

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Exchange Rate
Exchange rate are decreasing mainly due to commodities price rise and record foreign direct investments, creating a more challenging scenario for exporters R$/US$ Exchange Rate 2003-2011*

R$/US$ exchange rate drop affects Brazils exportations negatively.

However, 2011 crisis will make companies focus on domestic markets, since developed economies are buying less

Source: *Bradesco Brazil Macroeconomic Trend and Cycle PDF file, March 2011

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Infrastructure
Brazil and Russia disputes the last position of infrastructure quality between the BRIC countries, what means a great challenge and also invest opportunity for the country BRIC Infrastructure Quality World Ranking*

Roads Ports Air Rail

Worst

Brazil 105 123 93 87

Russia 125 93 104 31

India 90 83 71 23

China 53 67 79 27

2nd Worst Best

The World Bank and sector specialists believe Brazil needs to invest closer to 5% of GDP in infrastructure: this is more than 2x what the BNDES is currently projecting for 2010-2013
Source: *Citi Bank Corporate Securities Strategy: Brazilian Infrastructure , September 2010

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Education
Although recent progress is clear, Brazil still has a long way to reach education excellence, what brings workforce deficit for technical and high education services, leading to high salaries to few and inflation
Low education levels and economic growth leads to salaries inflation

Country
New Zealand USA Russia Brazil China India

School Life World Expectancy (in Years) Ranking 20,3 1 16,0 22 14,1 56 14,0 58 11,6 123 10,3 150

Cities So Paulo New York London Singapore Hong Kong

http://www.exame.com

CEOs Yearly Earnings US$ 620 mil US$ 574 mil US$ 550 mil US$ 368 mil US$ 242 mil

http://unstats.un.org/unsd/demographic/products/socind/education.htm

The biggest challenge to education progress in Brazil is to overcome political governance that shares responsibility between cities, states and country levels, besides a long term strategic plan.
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Reforms
At last, important reforms, such as the tax reform, are on hold due to political impasse between governmental levels: agreement could lead to at least a 0.5% GDP increase for the next 20 years
World Bank: Brazilian companies spend the most time to calculate and pay its taxes to the government in the world!

8 taxes over goods, services and profit

COFINS IPI IRPJ CSLL ISS PIS ICMS CIDE

Tax Reform

Transform 8 taxes in one whole taxation logic

Tax reform would lead to at least a 0.5% increase in GDP for at least 20 years!
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Corruption
In 2010 Brazil occupied the 69th position* within 178 listed countries in Public Sector Corruption Ranking prepared by ONG International Transparency
Red Zone Yellow Zone
2010
3.7 points The same position as Cuba, Romania, Montenegro

Green Zone
Denmark
(9,3 points)

Argentina Ecuador Venezuela

Brazil Italy Mexico India

New Zealand
(9,3 points)

2009
3.7 points 75th position within 180 countries

Singapore
(9,3 points)

Canada
(8,9 points)

10

Brazil achieved a higher position in 2010, though it gained the same points as in 2009

Source: *http://www.band.com.br/noticias/brasil/noticia/?id=100000361377

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Agenda
Following the main challenges presented, another group of main future opportunities are presented

Main Present/Future Opportunities

World Cup 2014

5

FUTURE

Olympic Games 2016 Pre-Salt Oil & Gas Ethanol

Mature National Industry Social Policy Progress

Challenges

Opportunities

PRESENT

Political Stability

Commodities Boom

External Trade Diversification

Mature Financial System

Real Estate Water Resource & Arable Land

PAST

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2014 Soccer World Cup and 2016 Summer Olympic Games

Brazil will hold the two main sports events in the world: 2014 Soccer World Cup and 2016 Summer Olympic Games in Rio de Janeiro; Soccer World Cup alone should stimulate a 1.0% GDP investment and a 2.0% GDP return. Infrastructure Investments: 0.5%-1.0% GDP
Citigroup estimates that the 2014 World Cup could generate direct infrastructure investments in Brazil of 0.5% to 1% of GDP, with a total of approximately R$16 billion (approximately US $9 billion).

Impact: 1.5%-2.0% GDP

The 2010 World Cup likely had a total impact on South Africas GDP of 1.25% to 1.5% of GDP for an economy 1/5 the size of Brazils. Citigroup believes that 1.5% of GDP is a reasonable higher end estimate for Brazil.

50%: Stadiums & hotels construction/renovation, plus Urban Reconstruction Public Safety Highway Airports IT & Others

Direct infrastructure investments, plus Media Visitors Operations-Related Spending Other Indirect Impacts

Source: Citi Bank Corporate Securities Strategy: Brazilian Infrastructure , September 2010

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Pre-Salt Oil & Gas

Besides, Brazil started exploring oil in deep waters, called the Pre-Salt, what will make Brazil the 7th largest producer in the world

New Oil Finds and the Pre-Salt

Source: Citigroup Global Markets Brazils Oil and Gas Industry Outlook, May 2011

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Ethanol
Still considering energy opportunities, Brazil and USA share an specific one concerning the ethanol potential market, that is still limited by countries mandates
Liquid fuel demand growth will be met by supply growth from OPEC and Biofuels Potential demand resulting from present mandates up to 2020/22

210 billion liters

140BL/Y Potential Repressed Demand

70 billion liters
Current ethanol global supply

USA and Brazil are the biggest producers and exporters of Ethanol (corn and sugarcane), considered the current best biofuel alternative
Sources: BP Energy Outlook, Ethanol Summit: Jos Goldemberg Lecture

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Real Estate Sector

A special focus is necessary for the Brazilian real estate sector, which credit is still very timid considering the huge total deficit of 7.2 million houses
Real Estate Credit vs. Total Credit
37,0%

Real Estate Deficit per Social Group

28,3% 24,3%

SM = Minimum Wage

4,3%

Brazilian Market (*)

English Market

Eropean Market

American Market

Total deficit: 7.2M houses

Compared to other economies, real estate credit still presents large growth potential

90% of real estate deficit is concentrated in lower income social group

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Real Estate Sector

Government programs are stimulating real estate credit as an economic growth mechanism, which should reach 11.1% of GDP in 2014 even with the lower GDP growth expected for the period
Real Estate Credit GDP Participation Growth
12.000

11,1
11,0

10.000
9,0

7,9
8.000

7,5 5,1
6.000

7,0

5,7 4,1

4,5

4,5

4,5

5,0

2,9
4.000
3,0

Real estate credit is expected to reach 11% of GDP participation in 2014.

2.000

1,0

3.547
0

3.927
2011 Proj. PIB

4.293
2012 Proj.

4.675
2013 Proj.

5.076
-1,0

2010 Proj.

2014 Proj.

Crescimento Real PIB

Crdito Imobilirio / PIB

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Renewable Water Resource and Arable Land

At last, Brazil is considered by specialists as the worlds land and water banks, what are considered to be the most strategic resources in the future to attend global consumption and urbanization growth
Arable Land Availability
500 450 400 350 300 250 200 150 100 50 0

The Worlds Largest Renewable Water Resource

In Use

Potential

Brazil has as much spare farmland (over 400 ha) as the next two countries together: Russia and USA
Source: www.agorafinancial.com, FAO http://www.toradv.com.br/en/News%20&%20Events/001%20-%20The%20Miracle%20of%20Cerrado.htm

Brazil represents 15% of total proven renewable water resource, while USA (2nd) represents 8%
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Amazon Rainforest Issue

Brazil is often accused of levelling the Amazon rainforest to create its farms, but hardly any of this new land lies in Amazon, most is cerrado**

Total Area*
851 100%
Available 30%

Native Vegetation*
498 58%

Arable Land*
338 40%

Other
15 2%

Pasture Agriculture

Sugar Cane

Source: **http://www.toradv.com.br/en/News%20&%20Events/001%20-%20The%20Miracle%20of%20Cerrado.htm * million hectares

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Agenda
In order to wrap-up the present document, a last statement is presented concerning the most probable short-term scenario expected by the market
5

FUTURE

Challenges

Opportunities

PRESENT

Political Stability

Commodities Boom

External Trade Diversification

Mature Financial System

Mature National Industry

Social Policy Progress

PAST

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5 Fives Cycles for 5 Years

Market specialists expect a five 5% cycle for the next 5 years in Brazil, while 2011 has been a hard year for the country due to high government expenditure by the last year of Lulas government and global 2011 recession
GDP

3.3%

2.0%

Current Account - GDP

Five 5% Cycle

Inflation

5.8% - 6.5%

7.0%

Unemployment

Real Interests Rate

5.2% - 6.0%

for 5 Years
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* All data collected from Brazil Central Bank 2011 Forecasts

Any Questions?
Thank You!
contato@visagio.com

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