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Over the past decade Brazil has experienced stunning economic growth and delivered exceptional investor returns. All of this has attracted increased investor interest and, I believe, seen many investors discount the risks associated with investing in Brazil. It is easy to see why, with Brazil over the last decade averaging annual GDP growth of 4%, reaching 6.1% in 2007, falling to -0.6% in 2009 at the height of the global financial crisis, and peaking at 7.5% in 2010. This is significantly higher on average for the same period, than the leading developed economies of the U.S. and the eurozone. It is this breathtaking rate of economic growth that saw Brazil in 2011 pass the UK to become the world's sixth largest economy. Furthermore, over this period the Brazilian stock index, the Bovespa, has risen by an extraordinary 382%, which represents an average annualized return of around 38%. This is significantly higher than the Dow Jones Industrial Average, which for the same period returned 33% or an average annualized return of around 3%. This extraordinary growth has been fueled by an unparalleled resources boom, coupled with substantial foreign direct investment and rapidly increasing domestic consumption by an increasingly affluent and flourishing middle class.

However, for foreign investors and companies choosing to invest in Brazil there is a darker and more dangerous aspect to this inspirational story of rapid economic development. This is because this growth has been joined by a growing ideological commitment to aggressive economic nationalism manifested through protectionist and interventionist government policies. Overall, this economic nationalist agenda is being driven by a range of economic, political and ideological motives. These include Brazil's pursuit of its national interest through the application of realpolitik both regionally and internationally, as well as the cultural and economic nationalism that has had historically had a substantial following among Latin America's intelligentsia. Also, over a century of U.S. intervention in Latin America has provoked a substantial nationalistic backlash. Finally, Latin America's socialist governments and labor unions have historically identified with economic nationalism because of their anti-capitalist ideological agenda and because foreign-owned businesses make a more popular political target than local enterprises. All of this is substantially lifting the level of risk and uncertainty for investors in Brazil.

This is clearly demonstrated by Brazil's last two governments successively introducing a broad range of protectionist economic measures. The country now has the second highest number of protectionist measures in Latin America after Argentina, as Table 1 below shows.

Table 1: Protectionist Measures in Latin America

Country

Number of Measures

Argentina

170

Brazil

86

Mexico

23

Peru

11

Venezuela

11

Colombia

7

Ecuador

6

Paraguay

6

Uruguay

4

Bolivia

3

Dominican Republic

3

Chile

2

Costa Rica

1

Nicaragua

0

Honduras

0

El Salvador

0

Puerto Rico

0

Panama

0

Guatemala

0

Source: Global Trade Alert.

Brazil's number of protectionist trade measures is almost four times higher than third-place Mexico and a stunning eight times higher than Venezuela, which is popularly perceived as Latin America's most closed economy. These measures have been applied across the length and breadth of the Brazilian economy from the energy and mining sectors to manufacturing, consumer goods and property ownership. Furthermore, as the evidence indicates in many cases they have been implemented with little to no regard for the consequences for foreign direct investment, trade relationships, foreign investors or companies.

The current government's economic platform appears to be nothing more than a reinstatement of import substitution industrialization. This was Brazil's dominant economic model from around 1950 to 1970, which relied heavily upon protectionist economic policies and government intervention to function. This economic model is often credited with the initial development of Brazil's industrial sector until it failed because it created economic inefficiencies, excluded foreign investment and increasingly isolated Brazil from the global economy. However, it now appears that the socialist government of President Rousseff is determined to reinstate this model.

It was only last year when Brazil's Finance Minister Guido Mantega stated that "Brazil is under siege from imports." It was at the time of this statement that the government introduced further protectionist measures to exclude foreign goods and investment. This has seen the government openly engage in a process of rewriting economic and business laws to create a system that protects and favors local companies and locally produced products. These measures include tweaking government procurement rules to favor local products, significantly raising tariffs on a variety of imported products, introducing tax breaks to encourage domestic production and limiting the access of foreign investors to strategic assets such as a land and oil. Some significant examples of these changes include the introduction of a new 30% tariff on any imported motor vehicles that have less than 65% of their value added in Brazil, as well as the implementation of tax breaks that make it cheaper to manufacture than import tablet computers, which has seen Foxconn (OTCPK:FXCNF) -- the manufacturer of Apple's (NASDAQ:AAPL) iPad -- establish a manufacturing plant in Brazil.

The government has also rewritten the laws governing the allocation of oil concessions in favor of the government controlled oil company Petrobras (NYSE:PBR). This legislation effectively forces foreign energy companies seeking to operate in Brazil to do so as junior partners with Petrobras. However, prior to the introduction of this legislation they could bid for oil concessions on equal terms. The legislation has also made Petrobras the sole operator of oil fields where licenses haven't been sold or allocated, thus preventing open exploration by other companies, in particular foreign oil companies. All of this significantly increases government commercial control over the Brazilian energy sector and gives Petrobras a distinct commercial edge over its competitors, especially foreign competitors.

Farmland is also now being treated as a strategic asset by the government on par with oil. The Brazilian government has effectively resurrected a 1971 law restricting the sale of rural land to foreigner investors and Brazilian companies in which foreign investors hold a 50% or more interest. This legislation has set the maximum amount of land that a foreigner can purchase to between 250 and 500 hectares, depending on the region in which the property is located.

It is not only the current government's leftist economic nationalist agenda that is increasing risk and uncertainty for investors. The government's increasing willingness to intervene in the economy, coupled with a less than transparent culture of decision making and an opaque legal system are also contributing to increased investment risk. This lack of transparency is evidenced by the 2011 Transparency International Corruption Perception Index, where Brazil was ranked 73rd out of the 184 countries rated. The higher a country is ranked the lower the degree of institutional, legal and governmental transparency and there is greater potential for institutionalized corruption. As a point of comparison Brazil only came marginally ahead of Colombia, which was rated 80th and well behind the U.S., which was rated 24th. Meanwhile New Zealand was rated as the most transparent and least corrupt while Somalia and North Korea as the most corrupt and opaque.

The increasing degree of the Rousseff government's intervention in the economy can be seen with the government's use of the Banco Nacional de Desenvolvimento Econômico Social to prop up national companies that are failing or inefficient. Since 2000, its loan disbursements have risen by 497% to $72.5 billion in 2011. The government has also increased the role of state owned enterprises in the Brazilian economy, with government investments as a portion of GDP more than doubling since 2004 to be over 2% of GDP in 2010. It is also estimated that by 2015 government investments and state controlled enterprises will account for 4% of Brazil's GDP.

This rising state intervention in the economy has also increased the importance of the market for government procurement. As a result in 2010 the Brazilian government introduced legislation that favors domestic businesses for fulfilling government contracts. This legislation has established preference margins of up to 25% on domestic enterprises, thereby effectively precluding non-Brazilian businesses from the government procurement process.

The lack of transparency and increased government intervention is further exemplified by the civil and criminal cases being pursued by the Brazilian Federal Prosecutors office against Chevron (NYSE:CVX) and Transocean (NYSE:RIG). This case has been brought as a result of two minor oil leaks in November 2011 and March 2012 at an oil concession being operated by Chevron and its driller Transocean. While the prosecutor's office is functionally independent from the government, the heavy handed application of the charges and distinct lack of proportionality in the penalties sought, when compared with prior oil leaks by Petrobras, I believe indicates an ulterior agenda. A more detailed examination of this case is available in my article titled "Brazil's Case Against Chevron Oil Nationalism in Disguise."

For the reasons discussed I believe that it is clear the current Brazilian government is ideologically committed to an aggressive economic nationalist agenda as a means of fostering economic growth and development in Brazil. Over the short term this will stimulate economic growth and protect Brazilian enterprises from foreign competition. It has also sheltered the country from the fallout of the recent global economic ructions that have had such a significant impact on the economies of the U.S. and the eurozone. But over the long term this policy platform will only promote economic inefficiency as sheltered industries become less productive, inventive and flexible than those operating in more liberalized markets. It will also trigger a migration of foreign investment capital to less protectionist and interventionist economies in the region, such as Colombia and Chile, which have more favorable foreign investment climates.

The net result for investors is that we are now seeing a significant rise in the level of investment risk associated with investing in Brazil. While it is certainly not as great as Argentina, it is not as low as many investors believe. As the degree of investment risk rises investors should be aware that this effectively increases the risk of diminished returns and even potential capital losses. Accordingly, investors choosing to invest in Brazil should actively seek to mitigate this risk by conducting a thorough due diligence of their proposed investment and the industry in which it operates.

They should also understand how this risk fits into their overall investment portfolio and adjust their risk-reward equation accordingly. When investing in Brazil investors should account for this risk by seeking a risk premium over and above the traditional equity risk premium of four to five percent on top of the risk free rate of return. Based on the current risk environment and Brazil's international credit rating of BBB I would recommend that investors seek a minimum country risk premium of around 6%. Therefore, assuming that the risk free rate of return is around the 2% yield of 10-year treasuries investors should be seeking an investment with an earnings yield of 12% or greater.

For those investors seeking exposure to Brazil, they can invest directly on the Brazilian stock exchange or through the nine Brazilian ETFs and 27 Brazilian companies listed as American Depositary Receipts (ADRs) on either the Nasdaq or NYSE. The table below lists the Brazilian ETFs and ADRs that are available on U.S. exchanges. This list does not constitute a full analysis or recommendation of any of these investments, but is only a summary to use as a starting point for further research.

Table 2: Brazilian American Depositary Receipts

Company

Earnings Yield

Industry

Exchange

Companhia de Bebidas das Americas (ABV)

4%

Beverages - Brewers

NYSE

Banco Bradesco S.A. (NYSE:BBD)

11%

Foreign Regional Banks

NYSE

Banco Santander Brasil S.A. (NYSE:BSBR)

5%

Foreign Regional Banks

NYSE

Braskem S.A. (NYSE:BAK)

-5%

Specialty Chemicals

NYSE

BRF-Brasil Foods S.A. (NYSE:BRFS)

4%

Meat Products

NYSE

Centrais Eletricas Brasileiras S.A. (NYSE:EBR)

17%

Electric Utilities

NYSE

Companhia Brasileira de Distribuição (NYSE:CBD)

3%

Grocery Stores

NYSE

Companhia de Saneamento Basico do Estado de Sao Paulo-SABESP (NYSE:SBS)

7%

Foreign Utilities

NYSE

Companhia Energética de Minas Gerais (NYSE:CIG)

6%

Electric Utilities

NYSE

Companhia Paranaense de Energia (NYSE:ELP)

9%

Electric Utilities

NYSE

Companhia Siderurgica Nacional (NYSE:SID)

16%

Steel and Iron

NYSE

Cosan Limited (NYSE:CZZ)

19%

Confectioners

NYSE

CPFL Energia S.A (NYSE:CPL)

6%

Foreign Utilities

NYSE

Embraer S.A. (NYSE:ERJ)

1%

Aerospace/Defense Products & Services

NYSE

Fibria Celulose S.A. (NYSE:FBR)

-12%

Paper & Paper Products

NYSE

Gafisa S.A. (NYSE:GFA)

-58%

Residential Construction

NYSE

Gerdau S.A. (NYSE:GGB)

7%

Steel & Iron

NYSE

GOL Linhas Aéreas Inteligentes S.A. (NYSE:GOL)

-30%

Regional Airlines

NYSE

Itau Unibanco Banco S.A. (ITU)

12%

Foreign Money Centre Banks

NYSE

Petroleo Brasileiro S.A.

12%

Oil and Gas Drilling and Exploration

NYSE

NET Servicos de Comunicacao S.A. (NASDAQ:NETC)

4%

CATV Systems

NASDAQ

Oi S.A. (NYSE:OIBR)

N/A

Diversified Communication Services

NYSE

TAM S.A. (NYSE:TAM)

-4%

Major Airlines

NYSE

Telefonica Brasil, S.A. (NYSE:VIV)

9%

Wireless Communications

NYSE

Tim Participações S.A. (NYSE:TSU)

6%

Wireless Communications

NYSE

Ultrapar Participacoes S.A. (NYSE:UGP)

4%

Oil & Gas Refining & Marketing

NYSE

Vale (NYSE:VALE)

20%

Industrial Metals and Minerals

NYSE

Each of the ETFs listed below are focused specifically on Brazil and give investors access to a specific industry or investment theme.

Table 3: Brazilian Exchange Traded Funds

Exchange Traded Funds

iShares MSCI Brazil Index Fund (NYSEARCA:EWZ)

EGS INDXX Brazil Infrastructure ETF (NYSEARCA:BRXX)

Global X Brazil Consumer ETF (NYSEARCA:BRAQ)

Global X Brazil Financials ETF (NYSEARCA:BRAF)

Global X Brazil Mid Cap ETF (NYSEARCA:BRAZ)

Market Vectors Brazil Small-Cap ETF (NYSEARCA:BRF)

MSCI Brazil Small Cap Index Fund

ProShares Ultra MSCI Brazil ETF (NYSEARCA:UBR)

ProShares UltraShort MSCI Brazil Index Fund (NYSEARCA:BZQ)

Source: The Return Of Economic Nationalism And Rising Investment Risk In Brazil