At the end of January this year, the joint announcement of a sweeping reindustrialization plan – called New Industry Brazil (NIB) – by Brazil’s ministry of development, industry and foreign trade (MDIC) and the state development bank BNDES hit a few nerves among bankers in the country.
The pronouncement laid out an industrial spending programme of R$300 billion ($61 billion) in government financing up to 2026, or 2.8% of GDP, with the majority to be disbursed through BNDES.
Bankers didn’t need long memories to recall the administrations of president Luiz Inácio Lula da Silva in the early 2010s, when the Brazilian state ramped up BNDES disbursements to nearly 10% of GDP, a huge amount of fiscal stimulus for any country.
However, not only is the spending commitment that is set out in the NIB a long way from the level of fiscal largesse seen last decade but, according to Brazilian economists, most of the plan is repackaging of spending that is already in the BNDES budget.
Instead, it is likely that BNDES will continue in its recently redefined role of facilitating the growth of the country’s capital markets to fund infrastructure development.
The bank has focused on acting as anchor investor on deals, providing guarantees and being an active participant in the secondary market to encourage growth there, rather than simply finance companies through bilateral loans.
Build a base
And now the new infrastructure debenture (Law 14,801) will sit alongside the tax-incentivized debenture – with a similarly catchy name (Law 12,431) – that was the country’s first attempt to build a base of investors for these capital markets transactions.
Law 12,431 has its critics: it provides tax incentives (by removing the withholding tax on investments) for individual investors. This has had the strange effect of leading private-banking clients to become the leading buyers of long-term project-finance credit risk.
The rationale is not only clear-sighted but is consistent with a financing model that will see BNDES foster local capital-market issuance
Whereas in most large markets, many institutional investors don’t feel qualified to assess and price the individual risks of such long-term projects, in Brazil, it was the country’s wealthy individuals who were buying up project debentures as part of optimization strategies.
The government’s decision to introduce another type of tax-incentivised infrastructure bond has been made to try to widen the investor base for the bonds.
The rationale is not only clear-sighted but is consistent with a financing model that will see BNDES foster local capital-market issuance, rather than stepping in to underwrite huge swathes of the country’s infrastructure development needs.
Tax advantage
Law 14,801 switches the tables on the tax savings. Instead of certain types of investors (individuals) being exempt from withholding taxes, issuances that will be made under this new law will see the tax benefits accrue to the issuers.
So, for example, if company issues R$100 million in debt with a 10% coupon, the interest expense that is deductible for tax calculations is R$10 million plus an additional 30% – so R$13 million.
While the issuer will receive the entire tax advantage under Law 14,801, bankers say they expect that, in practice, investors will receive some of this financial benefit through higher coupons.
However, while issuers may initially be expected to pass on some of their tax savings, they will also be able to attract a wider pool of investors into these transactions, and large books that include pension funds, insurance companies and international institutional investors will, theoretically, be able to be tightened more at pricing.
Another benefit of 14,801 is that bond payments can be linked to foreign currencies.
The old 12,431 didn’t have this optionality, and so for companies with dollar revenues the ability to link to hard currencies could help to reach deep pockets of international investor liquidity.
Palpable relief
The proposed Law 14,801 appears to be receiving a warm reception, while the reaction to the news about changes to other tax-incentivized bonds – CRAs and CRIs – can only be described as ‘palpable relief’. Many bankers thought that Brazil’s tax-reform agenda would lead to the end of CRAs and CRIs altogether. With the country’s agricultural sector booming – and real estate a mature industry in Brazil – there were calls from within the administration top abolish these tax-free bonds (which today have a combined outstanding volume of about R$1 trillion). Those voices claimed that CRAs and CRIs are an unnecessary and costly incentive.
Instead, the government has tightened the rules governing who can issue CRAs and CRIs to those operating in the industries in a primary function. For example, cattle farmers can still issue CRIs, but the slaughterhouses cannot.
Any company not deemed to be operating in a primary role will no longer be able to issue these tax-exempt bonds.
Some estimates suggest that this will lead to a fall in issuance of between 20% to 30% (R$200 billion to R$300 billion), which should provide a large source of liquidity for the new bonds, as the CRAs and CRIs run off.
With Brazil’s tax-incentivised bonds in a state of flux, there are open questions about how the reforms to CRAs and CRIs will drive volumes of transactions structured under both the new and old infrastructure laws. Some think the new law will dominate, while others expect that Brazil’s local capital markets will see issuance under both structures.
For now, though, there seems to be a palpable easing of the market anxiety about BNDES reverting to the 2010s and ploughing reckless amounts of money into the economy in the name of development.
