Manufacturing Sector: Argentina, Brazil, Chile

06/28/2006

Author:
KPMG International
Switzerland
www.kpmg.com

Categories:
Economic Development
Industry Regulation
Venture Capital

Preview:
Over the last few decades South America has been a focus of enormous hopes and great disappointments for private equity investors. Yet to the surprise of many forecasters and analysts, Argentina, Brazil and Chile have emerged rapidly from the recent period of economic stress. Overall growth has regained momentum, and trade in particular has revived sharply. Foreign direct investment has increased dramatically, and the resurgence is most evident in manufacturing businesses.

Article:
Manufacturing in Argentina, Brazil and Chile: challenges and opportunities

Growth returns to South America

28/06/2006 -- The ABC economies are now reviving: they have attracted the biggest increases in FDI of any in South America. Argentina's inward FDI flow increased by 125 percent in 2004, while Brazil increased by 79 percent and Chile increased by 73 percent. The revival has been underpinned by more competitive exchange rates and the worldwide boom in demand for commodities, which the ABC countries export.

Policy attitudes have also changed. Import substitution and industrial subsidization have given way to more open attitudes to inward investment: as the former Economy Minister of Chile Mr Jorge Rodriguez puts it: "We don't have an industrial policy any more. We believe it is growth that will bring investment, not incentives."

Argentina

Argentina is a medium-sized economy undergoing a slow process of recovery from a financial debt and currency crisis that engulfed it in 2001. However, the collapse of the Argentine peso in 2002 has dominated economic life in the post-crisis period. Relations between foreign direct investors and government have been severely strained, especially in the case of infrastructure and utility investors, as government has dictated that pre-existing contracts and financial holdings become 'pesofied' at the lower post-crisis rate of exchange.

It is the view of several companies interviewed for this report that Argentina is in some ways a test case for the ability of South American economies to reform and to normalize. Some of the companies interviewed consider the populist rhetoric of the Argentine government to be more threatening than the reality; however, many large companies active in the region say they will remain reluctant to commit further investment to Argentina unless government and policy become more pro-business. Some companies continue to invest in Argentina to maintain a diversified regional manufacturing presence. Companies interviewed say that outstanding policy issues for industrial investors include:

- The introduction of new capital and profit transfer restrictions which continue to limit financial flows and create considerable uncertainty over what financial operations will be approved by the central bank.
- Uncertainty over rules for settlement of disputes such as those relating to 'pesofication' remain unclear: in 2004 the Argentine Supreme Court ruled that 'pesofication' was constitutional, although lower courts are not in every case required to follow that ruling.

Brazil

Brazil is one of the largest and most dynamic economies in South America. Although investment risk is high compared to OECD economies, corporate investors are attracted to Brazil because of its size, its growth rate, and because of the trend of steady improvement on most risk measures. "Brazil is becoming more settled and predictable," is a comment from interviewees.

Many companies remain concerned about Brazil's sharp divisions of wealth. "Brazil has been growing fabulously, but poverty has also been growing," says one large company. "The result is corruption, a large black economy, and a lack of transparency. Those are the problems that investors will face." Companies are also concerned about the rising value of the Brazilian real against the dollar and the euro, which has severely eroded profit margins for exporters. However, many companies say that strong demand and productivity growth outweigh the disadvantage of a rising currency.

Foreign investment in Brazil has been very largely deregulated since 1991. There are few controls on investment capital flows. Funds can be freely transferred between Brazilian and foreign currencies at the market-determined exchange rate, and the procedures for currency exchange transactions were greatly simplified in 2000.

- Most companies express concern at the difficulty of sourcing capital at competitive cost within Brazil, where real interest rates are the highest in the industrialized world.
- Some companies believe that delays in shaping an attractive regulatory framework for public-private partnerships continue to inhibit investment.
- The complexity and total burden of corporate taxation is a prime concern for most businesses; companies say that benefiting from tax-related incentives depends as much on relationships with local authorities as it does on objective eligibility criteria, and is difficult for new investors. Uncertainty over tax liability is also an issue. "The biggest risk factor is that you can have changes in taxation rates at any time," says one large manufacturer.

Chile

Chile is the smallest and by far the most stable and predictable of the ABC economies, considered by many companies to be akin to a European economy in terms of investment risk. Chile is highly dependent on and open to international trade, and is seen by many respondents as a model for economic reform in South America. However, investment opportunities are limited by Chile's small size and geographical isolation.

Foreign investment in Chile is easy to accomplish and largely free of impediments, helping the country to achieve the highest FDI to GDP ratio in South America. There are few controls on FDI in terms of ownership limits or closed sectors; investment law prohibits the state from altering the terms of any FDI contract after it has been signed. There are no controls on the transfer of capital into or out of Chile, other than administrative controls. There are no generalized foreign investment subsidies or tax exemptions available in Chile.

Some companies express interest in Chile's Investment Platform Initiative introduced in 2002, which is designed to attract international corporate headquarters operations to Chile. The Investment Platform operates as a tax shield in cases where companies based in Chile might otherwise become liable for taxation in multiple jurisdictions.

- Protection of intellectual property rights in Chile continues to be an issue of concern to companies: Chilean authorities have made increasingly strenuous attempts to control counterfeit and pirated goods, but sanctions in Chilean courts have proved difficult and slow to obtain, and cases frequently result in light sentences by international standards.
- Companies remark on the willingness of Chilean authorities to update the legal framework for highly regulated industries.

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