After being sworn in on 1 January 2019, Brazil’s President Bolsonaro has given priority to implementing a series of long-overdue reforms spanning primarily pensions and social security, taxation, and privatization of inefficient and often corruption-plagued government-owned enterprises.

One of the many pro-market moves is the appointment of the veteran investment banker and Chicago-trained free-market economist, Paulo Guedes, as the head of a newly-established super-ministry of the economy. The new ministry has seven special secretariats – finance; federal revenue; foreign trade and international affairs; privatization and disinvestment; productivity, employment and competitiveness; bureaucracy reduction, management and digital government; and social security and work.

Given the greater authority of his position, Guedes wasted no time before spearheading the much-vaunted pension reform, which was passed on 22 October 2019 as the centerpiece of the president’s plans to cut government debt and shore up finances. This has given international traders and investors, including Hong Kong companies, high hopes for a quicker pace of change in the country, especially if other reforms tackling the country’s notorious business environment with respect to taxation and government inefficiency also work out as planned.

A Big Step Forward

In just one year after taking office, the Bolsonaro administration has made remarkable strides in tackling Brazil’s unsustainable social security system. The long-awaited pension reform, which will raise the retirement age for men to 65 and women to 62, is forecast to shore up the state finances by R$800 billion (~US$200 billion) over the coming 10 years. The pension reform to overhaul the social security system, which accounts for the lion’s share of government spending, is widely seen as a key step for Brazil to strengthen its fiscal position, hopefully reducing the country’s deficit to 3.2% of GDP in 2023 from the current five-year average of 8.0%.

[huge_it_slider id=”15″]The improved government deficit is not only essential to boost business confidence, but may also stimulate mid- to long-term investment and big economic decisions against a background of the lower interest rates and reduced inflation that should follow. The reformed finances may empower both the public and private sectors to spend more on projects which can improve the country’s noted deficiency in physical business infrastructure. To this end, The Federation of Industries of the State of Rio de Janeiro (Firjan) is expecting an increase of R$655 billion (~US$160 billion) in public investment and an increase of R$729 billion (~US$180 billion) in private investment in the medium term across housing, sanitation, public safety, health, education and social sectors.

More importantly, the significant victory over pension reform has created high hopes for the successful introduction of other much-anticipated reforms in the pipeline dealing with taxation and privatisation. It is believed that the trust established between the Bolsonaro administration and Congress will be able to deliver more beneficial reform in the years ahead.

Less (Taxes) is More (Business)

With over 80 different taxes at the federal, state and municipal level, governed by some 6,000 laws, Brazil has an unarguably stressful and complex tax system. According to the World Bank’s Ease of doing business 2020, a medium-sized domestic company in Brazil has to set aside over 1,500 hours to settle its tax payments, at the top of the 190 economies surveyed. Hong Kong companies who are looking to dip their toes into the country are likely to find it difficult to understand which tax to pay, what tax rate should be applied and to which authority the tax should be paid.

But thanks to the new reformist government, sweeping changes of the burdensome tax system are already in the offing. After years of discussion, two key proposals have been submitted to the Congress, in the hope of simplifying the country’s tax system by substituting several taxes with a single goods and services tax (Imposto Único sobre Bens e Serviços, IBS).

The first proposal introduced in the House of Representatives in April 2019 suggested substituting federal value-added tax (IPI), social integration program tax (PIS), social security financing contribution (COFINS), state value-added tax (ICMS) and municipal tax on services (ISS) with IBS at a rate equivalent to the sum of the five rates set by the federal, state and municipal authorities.

The second proposal, introduced in the Senate in July 2019, further suggested abolishing the federal tax on financial transactions (IOF) and contributions for intervention in the economic domain for fuels (CIDE-fuels), on top of the five taxes named in the first proposal, by creating a uniform IBS rate throughout the whole country.

Although no tax cuts or exemptions are offered in either proposal, the simplification among federal, state and municipal taxes is expected to generate significant improvements for tax management in normal business activities, especially for those who are new to the Brazilian market, offering a potential gain of more than R$120 billion (~US$30 billion) to the country, according to Firjan.

The Bolsonaro government is believed to be drafting another ambitious proposal to simplify and lower corporate and individual taxes, which will depend upon how the two initial tax reform proposals are received by the Congress.

Rolling out the Red Carpet

Another keynote theme of Bolsonaro’s reforms is the privatisation of inefficient and often corruption-plagued government-owned enterprises which are estimated to have an aggregate value of R$1 trillion (~US$250 billion), with the intention of promoting a more competitive environment and paying off some of the public debt. Accounting for more than one-fourth of the domestic federal public debt (R$3.8 trillion or US$1 trillion) in 2019, the net interest outlays alone represent one-fifth of the government’s primary expenditure. While not necessarily all assets will be put into the market, the planned wave of privatisation will allow the Brazilian government to greatly reduce its debt level, which stood at 88% of GDP in 2018.

Given the massive assets involved, the privatisation process cannot be done without foreign investor participation. As of January 2019, the Brazilian government reportedly had 134 federal-owned companies, spanning all sectors from commodities such as energy, oil and gas to services including finance and insurance.

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The current investment mechanism Investment Partnerships Programme (Programa de Parcerias de Investimentos, PPI) will ensure a level playing field for domestic and foreign investors in the privatisation process. All qualified PPI projects will be treated as a national priority and will be required to go through the following six phases in an efficient manner.

Six Phases for PPI Projects

Source: Investment Partnerships Programme (Programa de Parcerias de Investimentos, PPI)

From its inception in 2016 to end-2018, a total of 124 PPI projects were awarded to the private sector, including 47 foreign companies. In addition to the 100-plus projects in the PPI portfolio as of August 2019, the Bolsonaro administration is determined to continue to expand the portfolio size and coverage to embrace private investment, regardless of domicile, in a bid to jump-start the ailing Brazilian economy.

In the first round of the privatisation plan announced in August 2019, the Bolsonaro administration added a total of nine federally owned companies to the PPI. Although the privatisation of such large federally run companies as Telebras and Correios is unlikely to be completed in the coming two years, many international investors have reportedly shown serious interest. For example, Amazon and Alibaba are reportedly keen on the national postal service provider Correios. In the meantime, many are looking forward to the next batches of privatisation targets.

Nine Federal-Owned Companies Added to PPI in August 2019

Even before the aforesaid reforms, Mainland China has shown intense interest in investment projects in Brazil, which is not only the world’s 9th largest economy in terms of GDP, but a key member of BRICS – a group of leading emerging markets composed of Brazil, India, Mainland China, Russia and South Africa. In 2018, mainland China had an FDI stock of US$3.8 billion in Brazil – the biggest investment aside from the Cayman Islands and British Virgin Islands in Latin America and the Caribbean.

Although recent statistics from the Ministry of the Economy’s Foreign Investment Bulletin have revealed some declines in mainland China’s FDI flows to Brazil, the areas of investment have in fact become more diversified than before. This could mean that a wider spectrum of Chinese investors are looking for opportunities in the Brazilian economy.

One common factor among these mainland investors is that, regardless of whether they are state-owned enterprises (SOEs) or privately-owned enterprises (POEs), many of them have set up operations in Hong Kong to better manage and finance their overseas operations and investments. Examples in the case of Brazil include China Three Gorges (北京中國長江三峽) and Anhui Zhongding (安徽中鼎控股). As mainland investors are expected to invest more in Brazil, the role of their Hong Kong offices will become more crucial, creating in turn a huge demand for Hong Kong professional services.