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Brazilian government's plan to privatise country's largest utility likely to face strong opposition by Congress, political allies

31 Aug 17

The decision to privatise state-run electricity firm Eletrobras confirmed the government's pro-business stance and also highlights its urgent need to raise revenue with the objective of trimming the budget deficit.



IHS Markit perspective

Outlook and implications

  • President Michel Temer and his economic team are desperately searching for additional revenue to reduce the large and growing fiscal deficit.
  • The move to privatise Eletrobras pleased the markets, but lack of specifics on how the divestment will be implemented has generated subsequent uncertainty.
  • The government's main political allies are questioning the plan to privatise Eletrobras, with legal and regulatory constraints likely to exacerbate the difficulty of completing the planned sale.

Risks

Regulatory; Contract alteration; Labour strikes; Government instability

Sectors or assets

Electricity

President Michel Temer during a ministerial meeting at Planalto Palace in Brasilía, Brazil, on 28 August 2017.

EVARISTO SA/Contributor/AFP/Getty Images: 840271796

On 22 August, the Brazilian government announced that it intended to privatise Eletrobras (Centrais Elétricas Brasileiras S.A.), Latin America's largest power utility. The next day, it announced plans to privatise other 56 state assets, including the important and profitable Congonhas Airport, in São Paulo, and Casa da Moeda do Brasil – the Brazilian currency mint. The proposed privatisation of Eletrobras is a bold move by President Michel Temer's highly unpopular government and is taking place while the president continues to face opposition attempts to remove him for alleged corruption.

Eletrobras has 13 subsidiaries and generates a third of Brazil's electricity. The government recognises that in the private sector Eletrobras would enjoy a fresh injection of capital and become more efficient. The privatisation announcement signals a policy shift. When Temer took office in 2016, he favoured Eletrobras' restructuring, cutting the numbers of employees, and reducing corporate debt by asset sales, but with the company remaining state-owned.

Government critics have expressed concerns about the sudden policy change, arguing that it was conducted hastily and most probably in desperation to reduce the country's growing fiscal deficit, which now stands close to 10% of GDP. The Electrobras announcement lacked important detail. The finance minister, Henrique Meirelles, said the government will only now start to evaluate the different options to sell the company and refused to specify target proceeds. However, he confirmed that the government will keep a golden share allowing the state to have a final say on strategic issues.

It is still unclear which parts of the company would be sold. However, two important subsidiaries specifically will be excluded: Eletronuclear, which runs two nuclear plants in Angra dos Reis (in the state of Rio de Janeiro), and Itaipu, the hydroelectric dam at the Paraguayan border. The first subsidiary cannot be privatised because the constitution says only the Union can run nuclear plants while Itaipu is half-owned by the Paraguayan government and is therefore strategic for Brazil to maintain a powerful leverage tool with Paraguay, which generates most of its required electricity from this plant.

Privatisation driver

Brazil's primary fiscal deficit target is being increased to USD50 billion this year, despite Temer's promises on taking office to narrow it. Meeting the diluted fiscal deficit target has become a top priority for the weakened and unpopular government. In August, the president survived a congressional vote proposing his removal on corruption grounds, but needed to make big concessions and expenditure commitments to the Lower House deputies to attract support. Such tactics compounded budgetary problems despite the need to cut public expenditure and raise taxes. However, Congress is in no mood to support such unpopular measures. This leaves privatisation as one of the few residual options to raise extra cash. Temer is also anxious to maintain market confidence and private-sector support, addressing both objectives through the privatisation announcement. Despite the lack of details, the markets reacted very positively, with Eletrobras' shares soaring after the announcement.

To use the sale proceeds to reduce the fiscal deficit will require creative thinking. Current legislation does not allow privatisation proceeds to be used for financing current budgetary costs. However according to media reports, the government's economic team is working on a process that may entail a capital increase by the company, diluting government control into private hands while bringing Electrobras much-needed extra capital. This money, in turn, would be used by Eletrobras to pay the government for the right to exploit some of its hydroelectric generation plants, rather than selling these directly as previously considered by the government. These new royalties could then be used to lower the fiscal deficit.

Outlook and implications

In a best-case scenario, Electrobras' privatisation would take place in mid-2018, but this sounds over-optimistic. The main problem is the government's eroding political support in Congress. Several members of Congress from political parties that support the government have flagged that they will not accept full privatisation. Deputies from the north-eastern states are already lobbying the government to exclude CHESF (the Companhia Hidroelétrica do São Francisco) from the package. The same is being done by deputies interested in keeping Furnas (one of Eletrobras' strongest assets, supplying energy to 63% of all Brazilian homes) in state hands. Deputies from the northern states also appear likely to try to limit the privatisation of Eletronorte, the regional subsidiary. Congressional members are aware that privatisations are unpopular in Brazil with unions and left-wing parties soon to start campaigns against the planned sale, claiming among other factors that electricity would be more expensive under private ownership.

Another problem relates to Cemig (Companhia Energética de Minas Gerais S.A.). This energy company, from the state of Minas Gerais, is struggling financially, prompting plans to sell four of its largest hydroelectric plants. Those were supposed to be auctioned in September – with the proceeds going to the federal government. However, a legal challenge resulted in the suspension of the auction by a Brazilian court. Ominously for Temer, all 53 deputies from Minas Gerais are threatening to vote against the government if the company is not saved.

A champion of this movement is Senator Áecio Neves of the Brazilian Social Democracy Party (Partido da Social Democracia Brasileira: PSDB), a major supporter of Temer. Representing Minas Gerais, he is aware of the social consequences of the unpopular privatisation of the hydroelectric plants and the possible break up of Cemig. He has proposed to Temer the use of the Brazilian Development Bank to inject public money to save Cemig and keep it state-owned. The items above highlight the multiple political constraints for any privatisation process in Brazil. Indicators to watch are whether Temer will have to agree to help Cemig, and potential civil unrest by labour unions and other pressure groups against the Eletrobras privatisation.

 
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