Supply constraints limit growth potential
Brazil’s growth potential is closely linked to insufficient supply capacity, which can be blamed on the low level of gross investment rate over the past 15 years (less than 22% since 1991). Productivity gains have also been limited over the last four decades by poor quality education and infrastructure.
Public investment has long been constrained by the need to reduce fiscal deficits and cover the needs of an increasingly expensive social security system. In the private sector, investment is still impeded by an unfavourable “business” environment, as defined by the World Bank, including inadequate infrastructure, regulatory uncertainty, complex administrative and legal proceedings, and very heavy taxation. Hefty regulations particularly in the resource sector have added to costs as has the shortage of financing,
Moreover, lending terms are still very tight for private investors even though they have eased since 2003. The cost of lending is still extremely high (averaging 27% for companies and 54% for individuals in September 2007) and long-term domestic financing remains scarce, both by international and regional standards. Capital markets also play a relatively small role in financing private investment (bonds cover less than one fifth of gross investment).
As a result, companies mainly rely on self-financing and, for the largest ones, on foreign financing. Major reasons behind domestic bank credit rationing (low volumes, high costs) include:
- Insufficient national savings, which stood at 23% GDP in 2007 (up from 19% in 2005). Savings are low due the public sector’s failure to generate net positive savings and the low level of household savings (roughly estimated at 10% of GDP in 2007). Consequently, private enterprises are the main contributors to national savings, notably through self-financing.
- Crowding-out effects associated with heavy public sector financing needs, which reduce the pool of bank funds available for lending to the private sector and raise domestic interest rates. Crowding out effects have tended to ease over the last two years (which has contributed to the recent rise in bank lending to the private sector), but are still significant. Net bank claims on the public sector represented 40% of total domestic lending in July 2007 (including deposit-taking banks and the central bank), down from 49% in 2004.
- Specificities of the Brazilian banking market. Through high intermediation margins, banks offset the cost of very heavy taxation, structurally high administrative expenses and the obligation to allocate a significant portion of assets to “earmarked” loans aimed at financing priority sectors. Earmarked loans (with regulated interest rates) currently account for 32% of total bank loans, and consist mainly of loans from the BNDES development bank (19%) and loans for housing and the rural sector (12%).
- High credit risks are still inherent to Brazil’s macroeconomic and institutional environment. They constrain lending activity and drive up intermediation margins and lending rates. Things have recently started to change following legal reforms in the banking sector. Introduction of the new bankruptcy law in late 2004 has tended to improve creditors’ rights when a borrower defaults. According to World Bank data on the business environment, the time needed to complete bankruptcy procedures fell from 10 years in 2004 to 4 years in 2006 (which is still worse than the regional average of 2.6 years). The recovery rate for creditors at the end of bankruptcy proceedings rose from less than 1% of commitments to 12% (which is still lower than the regional average of 13.6%).
In turn, the recent expansion in credit to the private sector, Brazilian banks seem to be willing to lend more to consumers and companies as soon as institutional barriers are removed – and as long as the macro-financial environment remains stable. This may lower capital costs going forward
Increasing Brazil’s growth potential will require additional institutional reforms (to simplify bureaucratic procedures, strengthen regulatory security and encourage private investment), labor market reforms, the development of infrastructure and massive spending on education.