Brazil: Assessing Country Risk: Elizabeth Taylor, Brazil, And The Broad-Brush® Approach

Last Updated: 14 May 2001
Article by Norman Baldwin

Every day I receive investment reports exhorting me to invest in a hot new stock, or country analyses to help make me a wealthy bond trader. Most, however, end up in the trash. If I’m not able to see the company or country for myself, I’m usually reluctant to invest.

Choosing to invest in a particular country or company can require intensive statistical analysis. Companies need solid justification for their decision, no matter how humble or complex the investment. Shareholders demand it, directors need it, so staff number crunchers produce it - by the truckload. Interestingly though, many big decisions usually come down to simple gut feeling. Reams of graphs, charts and tables are helpful, but they don’t make the final decision - people do. If you’ve ever bet on the horses, you know that people often go with what their intuition tells them. The colour of a jockey’s silks or the horse’s name can be just as important as the animal’s track record. In an attempt to show that assessing country risk isn’t much different, I’ve spent the better part of an afternoon developing the Broad-Brush® approach. It’s designed to save you the headaches arising from interpreting analyses, and solve the problem of paying the experts a lot of money to be consistently wrong.

Let’s suppose your multinational company intends to set up a major overseas manufacturing operation. You’re in charge, and you have to give your recommendation to the Board of Directors in just a few days. The USA, Canada, Scandinavia, Western Europe, Australia, New Zealand and Japan are all out due to high costs and taxes. Besides, their domestic markets have limited use for your product. Your risk analysts draw up a list of possible emerging economies for your review, along with a host of statistics for each. Setting the charts and tables aside for a minute, let’s examine the list using the Broad-Brush® approach.

So how does it work exactly? Well, be warned, this methodology is not approved by any leading business school. Empiricists and analysts - both fundamental and technical - may be horrified. There are no heads and shoulders formations to pore over, and no EVA figures to digest. Calculators aren’t allowed. All you need is a map of the world, and to spend no more than thirty seconds assessing the investment possibilities of each country you look at. You can’t dally over your decision. Ruthlessness counts. Only those countries that don’t generate an immediate ‘No’ response can be put on a short list.

The criteria used are the same that executives (and punters) everywhere employ in any gut-feeling decision: personal bias, ignorance, experience, fear and comfort level. These are derived from many sources, including the media, which we’ll look at later.

So spread out your map and let’s get to it.

First off: Russia. Hmmm. Political Risk has improved lately, but Environmental Risk is as bad as ever. Dodgy economic structure. Massive corruption. Language barrier. Poor adoption of western business practices. Lots of foreign companies there, but are any of them actually making money? And didn’t Long Term Capital Management take a bath in Russia? Pass.

How about those other ex-communist countries and the rest of Eastern Europe? Well, a couple look okay, especially Poland and the Czech Republic, and those ones up by Scandinavia, like Estonia. Put all three on the short list. Turkey gets a lot of good press, but you don’t know anyone there. As for the others, it’s still early days yet, and who wants to be a pioneer?

Next comes China. Everybody loves China, but do we really need an exercise in endless cheque writing? Like Russia, plenty of multinationals are there, but again, are they actually earning a profit? Corruption is rampant, and the red tape goes on forever. Human rights are a bit of a problem, and learning to speak Chinese scares you.

India? With its widespread English, the country wants to become the footloose back-office and call centre capital of the world. Well, if you thought corruption and mind numbing bureaucracy were unique to China and Russia, think again. Toss in a tax structure that nobody understands, religious conflict, overcrowded cities, poverty, health problems and a complex social structure and suddenly any investment there seems extremely long term. Just ask Enron. Bangladesh next door advertises a lot, but isn’t half the country always under water? As for Sri Lanka, it’s a war zone.

Pakistan? Please. This is a serious decision we’re making here. So what about the rest of Asia? The Philippines look good at first glance. Plenty of people speak English, but the infrastructure is weak, plus there’s always talk of a coup. Indonesia? Full-scale civil war seems imminent, and the army and the government don’t see eye-to-eye, not surprising as the military has its fingers in a lot of pies. Malaysia? Possibly, but the economy is still reeling from the crash a few years back, and the President has been getting pretty dictatorial lately. And let’s not forget those kidnappings last year. Vietnam? Not yet. Hong Kong? Singapore? Taiwan? All clean and well off, but costs are higher and there’s little land left. Thailand? South Korea? Like most of Southeast Asia, these countries remain popular among multinationals, but without deep connections or the time to develop them, making money is always going to be a risky bet.

The Middle East is a bit of a bright spot, but the perception of limited women’s rights and religious fanaticism/terrorism has turned off more than a few companies over the years. It’ll probably turn yours off as well. If only there were more places like Dubai. You heard Oman was good as well, but decision time beckons.

Africa has a bit of hope, particularly South Africa, but crime and disease are legitimate worries. Zimbabwe looked good for a while, until their President-for-Life lost his marbles and started to dismantle the economy and social fabric. The rest of the continent is a major gamble. Nigeria regularly tops the polls as the world’s most corrupt country, while plenty of others are engaged in some sort of civil war or suffering under a dictatorship. That leaves just Latin America.

Mexico. It’s part of NAFTA. You’ve vacationed there. You love Mexican food. You even speak a bit of Spanish, albeit badly. Lots of American and Japanese firms there. Even though corruption, entrenched politics and regional unrest add to the risk element, Mexico is strong enough to get onto the short list. Geographical location is also a major plus.

Central America and the Caribbean? Possibly, but limited infrastructure and weak domestic markets argue against it. Lots of call centres, but your manufacturing plant is a completely different animal. Costa Rica and Panama are good for future reference. Moving down to South America, Peru is a bit of a sleeper, but a little off the beaten track. Venezuela seems wholly dependent on the price of oil and the whims of their maverick President, while Bolivia and Ecuador are still scrambling to find their feet. Colombia’s ongoing violence continues to claim plenty of lives every year, despite the country’s considerable wealth. Then there’s all those kidnappings of foreign workers. Chile is great, and knows it. Its only drawbacks are a small population base and access routes. Argentina overcomes the latter, but not the former. It’s a pretty organized place with plenty of multinationals operating there, but its economy is in dire straits. Still, you can safely put these last two on the short-list as well. Paraguay remains weak, while Uruguay’s economy, although stable, might be too small for your needs.

All of which brings us to the big boy on the block – Brazil. You’ve heard about its scary debt figures, balance of trade problems, a devaluing currency, rising crime, thirty-foot snakes, the destruction of the Amazon rainforest and WW II criminals still hiding out. Hmmm. Maybe you should just play it safe and go with Argentina, or Chile, or Mexico. Even Estonia. Brazil just seems too big and unknown, and you don’t know a word of Portuguese. On the other hand, the sheer size of the country means the economy must be huge. You know a lot of companies have invested there, but they’ve got to be taking quite a risk. You wish you knew more about Brazil, but there just isn’t time. Interesting? Definitely. A short-list candidate? You’ll think about it.

So there you have it. By applying the Broad-Brush® approach you’ve managed to reduce entire countries to instant stereotypes, offend their citizens, show up your own biases and ignorance, and select just three firm candidates in Latin America, two or three in Eastern Europe plus maybe Estonia.

By comparison, the professional analysts would likely have chosen China and Russia, and certainly Mexico, plus some countries in Southeast Asia and Eastern Europe. These places boast numbers which can point to all sorts of exciting possibilities. Only now it’s decision time. The Board needs an answer next week. So what it’s going to be? Broad-Brush® or statistics? Gut feeling or print-outs? Bewildered by all the information to digest, it might be better to knock off early and sleep on it.

Before heading home though, you remember that a new employee in your department is from Brazil. A quick call confirms she’s got a few minutes to answer some questions about her home country. Turns out she’s a recent MBA from a top American university, and prior to that worked for several years for a number of multinationals in São Paulo, Rio de Janeiro and Porto Alegre (wherever that is). In her top-notch English, she gives you some impressive insights into Brazil’s pros and cons as an expansion possibility. Even with your own MBA from a top school and a healthy international frequent flier account, your lack of Brazilian knowledge makes you feel ignorant and embarrassed. Playing a hunch, you ask her to brief the Board of Directors, as you’re certain their knowledge level about Brazil is no better than yours.

If you think everything in this story so far would never, ever happen in the real world, guess again. Huge investment decisions have been made with far less to go on than is the case here. If you also think it impossible that a Board of Directors of a major multinational corporation could easily overlook a country like Brazil, maybe you need to get out more.

The traditional country risk approach would likely have relegated Brazil to a spot well down the list. The Broad-Brush® approach at least got you to seek more information. The reasons for this may have as much to do with CNN as anything else, but in general our perceived knowledge base of some countries is much greater than that of others. Often, this is due to the effectiveness of that country’s advertising and marketing machinery, and the willingness of the global media to pick up on it, independent of the country’s actual economic performance.

This is where Elizabeth Taylor comes in. Some years ago, a writer complained that his “Lizformation” capacity had reached the saturation point. He speculated that in everyone’s brain, whether we like it or not, is an area specifically reserved for information about Elizabeth Taylor. Her media people kept her name current with the media outlets, who in turn played their part in relaying the information, no matter how unimportant, to the rest of us. And so it is with companies and countries, many of which are compelled to sell themselves constantly to brokers and investment analysts in the hope of revealing some positive news or overshadowing questionable fundamentals. In Brazil’s case, it has either kept too quiet or expensively sent out the wrong message, with the result that most of us know far more about Elizabeth Taylor than we do about investing in Brazil.

Returning to our story, the Board meeting confirms that none of the Directors knew as much about Brazil as they perhaps should have. They had no idea how developed São Paulo was, or how much Latin America’s economy depends on it. They knew nothing about how industrialized southern Brazil was, or how big the tourism industry is becoming in the north. On the plus side, they knew that Brazil exports heaps of coffee and sugar, and that soccer is fairly popular. They were surprised to learn however, that voting is compulsory, and that most years it snows in the state of Santa Catarina.

Part way through the presentation, the Board became confused. After all, they’re educated, well-travelled, experienced business people. How could they have known so little about the place? Had Brazil’s progress really gone unreported? Had plain-speaking qualitative analysis been buried under mountains of charts and tables? Possibly, but the real answer lies not so much with CNN as with Brazil itself. The country has a story to tell, but is it getting told?

Your Brazilian colleague then produced some more detailed information, supplemented with mercifully few statistics.

With over 160 million people, Brazil’s domestic market is indeed large. Foreign trade is made easy by the huge seaports that dot the east coast, supported by adequate road and rail systems connecting the interior. Mines, farms and factories of every description are found nationwide. Its long dormant tourism industry has finally woken up. Over 300 hotels are currently under construction, many of them massive resorts being built by major chains, representing US$2.0 billion in new investment. Tourist visits have tripled in the past six years, as have tourism-generated revenues. As a financial centre, Latin America has no equal, while its agriculture industry and manufacturing base are both immense. The currency is a bit wobbly, but whose isn’t? To top it off, English is rapidly becoming the second language. So why aren’t more companies investing there?

Actually, they are. Foreign reserves, about a quarter of which were burned up by the Central Bank two years ago (plus another US$8.0 billion in early 2000) trying to prop up the real, have since stabilized at around US$35 billion and are starting to nudge upwards again. Interest rates, which were stratospheric in the 1980s, have now come to down to below 16%. Inflation has similarly been drastically reduced. An A.T Kearney survey recently put Brazil in third place in its Foreign Direct Investment Confidence Index, behind only the US and China. Despite this high ranking, the Economist Intelligence Unit only gives Brazil a current Country Risk rating of 52 out of 100, with 100 representing maximum risk. The criteria include political structure, economic policies, sovereign-debt risk and the state of its banking system. To further confuse things, Switzerland’s International Institute for Management Development ranks Brazil ahead of media darlings China and Mexico and well ahead of Russia on its World Competitiveness Index, based on economic performance, private and public sector efficiency, and infrastructure.

How could three such respected agencies arrive at such different conclusions? Part of the problem may lie in marketing-related perception. No analysts have a perfect knowledge of Brazil, and none are immune to the effects of the media or employing the biases they create. Global knowledge of Brazil has been notoriously limited to soccer and Carnaval. Is it possible that the statistics we get don’t tell the whole story? Is it also possible these ratings and rankings, many of which are compiled by foreigners who don’t actually live in Brazil, could be influenced by Brazil’s media image (or lack thereof)? Some of these statistics thus might leave out as much as they reveal. As seen in these three studies, much of the information used and compiled by leading institutional investors and analysts, including that from the Brazilian government itself, is contradictory.

The Directors nodded, but voiced fears about those emerging market bugbears – corruption, crime, poverty, illiteracy and disease, and pointed out that several Brazilian banks went bust a few years back. Your colleague replied that some banks had indeed gone belly up, but with plenty of international banks like HSBC now operating nationwide, the banking sector has become very stable, competitive and profitable. She then turned to address their primary concerns.

First, corruption. Brazil has a long and proud history of corruption dating back to the earliest Portuguese colonial times. Colossal land grabs and tax evasion have been an inextricable part of the cultural landscape. In fact, Latin America’s corruption hall of fame features plenty of characters from Brazil’s past, and is actively accepting new members even today. After all, the country’s ponderous political structure is the ideal vehicle with which to practice graft, and numerous elected officials have taken full advantage of this. Party unity is not a term one readily associates with Brazilian politics; rather, it’s more like everyone out for themselves. Many of those involved often fail to see this as corruption at all. It’s widely accepted that many Brazilian politicians have a value system which prohibits them from telling right from wrong. People also reckon that half the government should be behind bars, only no one can decide which half. Due to the opportunities afforded by the political system, politicians can become extremely wealthy, which is why it attracts so many people to its ranks. The scale of thievery practiced by some is quite impressive. In 2000, a senior judge flew the coop after it was discovered he'd skimmed off a small fortune from the building of the new courthouse in São Paulo - a seven-year project which is still far from complete. At about the same time, a former head of the Central Bank was also on the lam after it was revealed he'd had his hand in the national till. Compared to the stealing that goes on elsewhere though, this is small potatoes.

The current federal government under President Fernando Henrique Cardoso has made great strides to tackle corruption in recent years, a considerable feat given the powerful vested interests seeking to maintain the status quo. A key factor in the reduction of corruption however, has been the unprecedented arrival of multinational companies in the last ten years. They have brought with them their proven international business standards, and introduced two hitherto unknown words into the Brazilian lexicon: accountability and transparency. In a recent study, PricewaterhouseCoopers placed Brazil in the middle of the world “opacity index” table, which weighs the effects of unclear legal systems and regulations, macroeconomic and tax policies, accounting standards and practices, and corruption on the capital markets. In this instance, the ranking is probably justified, and premiums on Brazil bonds reflect a similar standing.

Crime, the next item on the list, is a huge problem in Brazil. The big cities (and several of them are very big indeed) house enormous shanty-towns called favelas, which have become violent centres of drug trafficking. Cash flow, whether to feed a family or a habit, often comes from petty crime perpetrated in better-off parts of the cities. For this reason, urban residences in Brazil typically come with high walls and gates, security patrols and guard dogs. It still can’t compare with Johannesburg, but it’s getting there. Police officers are paid and trained far less than their developed world counterparts. Governments at all levels have been hamstrung to tackle the causes of crime, preferring instead to confront high profile symptoms. Given the recent change in Brazilian law whereby elected officials may now be re-elected for an additional four-year term, there is hope that more substantial anti-crime programs can be developed and implemented.

On the subject of poverty, regardless of your measurement instrument, Brazil has plenty of it. However, it’s difficult to compare Brazil to India or Africa. There, the term “dirt poor” can be applied on a much more widespread basis, exacerbated by overpopulation and disease, and in the case of Africa, the added elements of famine and warfare. While much of Brazil is still Third World, the rural poor seem almost well off by comparison, despite persistent malnourishment. Land ownership is out of the question for many (thanks in part to latifundia), but the land itself is often bountiful, providing sustenance and support for many. The urban poor vary from recent arrivals from the countryside who live in boxes under bridges (a small minority), to the established favela dwellers, some of whom sport computers, mobile phones and cable TV (even if the service is pilfered) in their humble abodes. It’s said that Brazil is a very rich country inhabited primarily by very poor people. Economists point to unequal income distribution and a widening gap between rich and poor, manifested in a shrinking middle class. As the weak real and low inflation keeps the cost of living down, and may thus change the yardsticks on defining “poor”, the reality may be somewhat different. While the very rich constitute only a very small portion of the population, middle-income earners may be much, much larger than we’ve been led to believe. Assuming half of Brazil’s over 160 million people are city dwellers (some estimates place this number at two-thirds), and half of these are poor (a high figure according to several sources), that still leaves rather a lot of middle and upper income consumers. Ignore for the moment the power of the 40 million urban poor, plus those other 80 million rural residents, and Brazil has at least 40 million middle or upper income earners whose lack of access to cheap credit makes them smarter consumers and better savers than many of their first world counterparts.

Brazil’s success rate with illiteracy is fair to middling, with around 15% of the population over the age of 15 still unable to read or write. Teachers, particularly those in rural areas, are paid appalling wages. As well, children are often needed at home to help with the chores, making school an option, rather than a requirement. Recently though, a rise in classroom attendance has been attributed to a new program which pays parents for every day their child spends in school. A growing number of urban Brazilian students now attend the wide number of private schools which are specifically geared to getting their students into Brazil’s few university places, and into the many new private universities. Today’s university graduates are accustomed to intense competition, and have undergone training to prepare them for work in the global market place. Their level of English is generally good, making them ideal candidates to work for multinational corporations.

Disease prevention and control is one area where Brazil can justly be proud. The United Nations recently declared Brazil’s anti-AIDS program as the best in the world. Indeed, in such a sexually open society it has been relatively easy to discuss subjects that would be taboo elsewhere. The other scourges of the developing world, namely tuberculosis, polio and so on, were brought under control some time ago. Malaria is a slight problem, but affects very few locals or visitors. Tap water in all the big cities in drinkable. Health insurance, whether public or private, is readily available, making the price and standard of health care very good indeed.

By now the Directors were almost convinced, but they were concerned about the logistics of setting up an operation on the ground, finding skilled labour, getting their foreign nationals to learn Portuguese, and how long it would take to start making money.

During the military dictatorship era, foreign companies seeking entry into Brazil had a tough time of it. Markets were not only closed, but were protected to allow local firms to grow. Many of these companies became huge, often because the government promised to buy all their goods. Just as this practice has become difficult to maintain elsewhere, notably in India, Brazil too is rapidly letting the market decide things, making environmental risk less and less of a factor. These days, the list of foreign companies with a presence in Brazil, either through joint ventures or wholly-owned subsidiaries, is enormous, and this includes law firms and tax advisers who offer everything anyone needs to know, in the language of your choice, about setting up shop in Brazil. Land prices are still a bargain, and income tax rates remain comparatively low.

Finding skilled labour in Brazil is not the huge chore it might be in other countries. The labour pool is highly skilled and mobile, with unemployment running at about 8%. The problem foreign companies face is more the cultural clash that occurs when the locals are expected to do things the way they’re done back home. These firms soon discover they are battling against a deeply entrenched way of doing business, forcing them to confront the realities of cultural assimilation.

Some foreign nationals adapt easily to their new environment, while others never feel settled and can’t wait to get home. Some pick up a new language easily, while others insist on speaking their native language, no matter what. The solutions to this problem are as varied as the companies involved. Some try to “go native”, meaning that everything is done in Portuguese, while other firms insist on English being spoken at every turn, in addition to practicing values and standards which may be equally foreign to the Brazilian staff. Somewhere in the middle are those firms that allow for the host nationals to be trained in English or some other language, and for the foreign nationals to be trained in Portuguese. The most successful of these companies might not understand or approve of the local way of doing business, but they’ve managed to accept it by creating a participatory environment embodying both business cultures.

This is all well and good, but can a company make money in Brazil? A good company can make money practically anywhere these days. Brazil simply offers the benefits of low wages, low cost of living, a huge domestic market, a devalued export currency, good access to foreign markets, plenty of natural resources and cheap land, a skilled labour force and a good standard of living. Brazil has long been seen as having plenty of potential, if only it could get its own house in order. In fact, the country is modernizing rapidly, if somewhat quietly. Upgraded airports, highways and railways, industrial parks and ports have all grown through privatization, allowing the government to invest in the basics such as schools and hospitals. Even here, the private sector is active. The economy, both formal and informal, is actually moving fast, yet all we hear is that the country is growing inconsistently, and is still susceptible to external events.

Two problems contribute to this: measuring mechanisms and advertising. Taking the standard yardsticks used to measure economic performance, Brazil comes out about middle of the world table, and in the upper third of developing economies. A number of factors keep its credit rating down, while its long history of protectionism still helps to distort performance figures. While no one doubts the veracity of Brazil’s economic indicators, other figures that perhaps could be taken into account include lack of corporate debt, personal savings rates, assets of the poor and the power of the informal economy, and intangibles such as the Brazilian ability to succeed without easy access to capital markets. In truth, this information should be coming from the country itself and disseminated through the international media.

Unlike some countries, which have internationally established brand names like Mercedes Benz and Sony on which to hang their national reputation, Brazil has no such stars. While many Brazilian companies are indeed active around the world, they are somewhat invisible, and aren’t helped by the government’s wayward means of promoting Brazil as a brand itself. Regrettably, Brazil is its own worst enemy.

The old Madison Avenue adage that nothing will kill a poor product faster than a great advertising campaign is perhaps on the minds of the mandarins in Brasília who seek to put Brazil on the global stage. They might be afraid that by telling the world to come to Brazil, people will come and see all that’s wrong with the country. This should be far outweighed however, by the country’s positive points. Unfortunately, the word is rarely getting out, and until it does, prospective investors will continue missing out, regardless of whether they employ pure statistics or a broad brush.

Companies the world over stage dog and pony shows and print lavish annual reports to entice new investors and keep the present ones from jumping ship. Too many of these same companies, however, have little substance underneath. In short, some analysts might not consider them real companies. Brazil needn’t fear anything. It has the fundamentals, the infrastructure and the people. Now it just has to convince the rest of us that it’s a real country. It might start by learning what outsiders want to hear, and by getting more outsiders to do their analyses in-country, rather than at a distance. Then even the Broad-Brush® approach might yield dividends, and our Lizformation can be supplanted with more useful information about one of the world’s largest and most important countries.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

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