BRAZIL INVESTMENT CLIMATE STATEMENT 2005

UNCLAS SECTION 01 OF 11 BRASILIA 000119

SIPDIS

STATE PASS TO USTR
STATE FOR EB/IFD/OIA

E.O. 12958: N/A
TAGS: EINV KTDB BR OPIC USTR
SUBJECT: BRAZIL INVESTMENT CLIMATE STATEMENT 2005

REF: 04 STATE 250356


1. This cable transmits Mission Brazil's submission
of the 2005 Investment Climate Statement.

Introduction - Openness to Foreign Investment
--------------


2. Openness to Foreign Investment. Brazil knows that
achieving sustained, rapid growth depends on foreign
investment and has lifted many restrictions in recent
years to encourage such investment. The 1962 Foreign
Capital law and subsequent amendments govern most
foreign investment. Foreign investors have been
permitted to invest in the Brazilian stock market since

1991. The Brazilian Congress approved constitutional
amendments in 1995 to eliminate the distinction between
foreign and national capital. New rules, which
liberalized considerably foreign investment in equities
and put foreign investors essentially on an equal
footing with Brazilians, took effect in 2000. During
the high point of the privatization program, Brazil was
the second largest destination for foreign investment
among emerging markets, with a peak inflow of $32.8
billion in 2000; the country remains a leading
investment destination.


3. Constitutional amendments passed in 1995 opened
formerly closed sectors, such as petroleum,
telecommunications, mining, power generation, and
internal transport to foreign investors. In 2002,
Congress approved a constitutional amendment permitting
foreign investors to own up to 30% of media companies.
Restrictions remain on foreign investment in a limited
number of sectors: nuclear energy, health services,
media, rural property, fishing, mail and telegraph,
aviation and aerospace. In December 2004, the Congress
approved and the President signed, the Public-Private
Investment (PPP) bill that promotes joint ventures in
infrastructure investment. The law creates a federal
guarantee fund to protect investors in federal PPPs.
In almost all cases, at least 30% of project must be
private investment funds.


4. New or expanded foreign investment in the banking
sector is technically forbidden by the Constitution of

1988. However, since 1995 entry or expansion has been
approved on a case-by-case basis; the vast majority of
requests for entry or expansion have been granted.
Foreign banks currently account for one third of the
total net worth of the banking system and 27% of total
banking system assets. Since 1996, the insurance sector
has been open to foreign investors, and most major US
firms are already represented, mainly via joint venture
arrangements. Brazil maintains a government-owned
reinsurance monopoly, the Brazil Reinsurance Institute
(IRB). Plans to privatize the IRB were delayed by
court challenges. While the Supreme Court decided in
September 2004 that the privatization was
constitutional, the Lula administration has not decided
to resubmit to Congress a bill privatizing IRB. A 2003
Constitutional amendment allows the regulation of the
reinsurance sector, and permits new market entrants.
Implementing these provisions would require passage of
a complementary law, which is not yet on the
Congressional agenda.


5. In 1991, Brazil embarked on the world's largest
privatization drive, selling off more than US$ 100
billion worth of assets. Since 2002, however,
privatization has virtually stopped. Through 2004,
Brazil realized $87.5 billion in sales revenue and
another $18.1 billion in debt transfer as a result of
the national privatization program. Foreign investment
accounted for $42 billion, or 48% of the total. One
third of the foreign investment was from the US ($14
billion). With the exception of power-generation
sector, most of the largest state enterprises have been
sold, and privatization activity has died down since
2001: in 2002, it totaled only US$ 2 billion; in 2003
there were no privatizations; and through the first
half of 2004 the sole new privatization was that of the
State Bank of Maranhao, for US$ 26.6 million.

6. The privatization of the energy sector also was
halted. In December 2004, Brazil conducted its first
auction of long term energy supply contracts under a
new energy regulatory framework advanced by the Lula
administration in which the federal government now
plays a more central role in establishing energy demand
forecasts and energy prices. Analysts, companies and
regulators have expressed concern that the more
centralized government role and low auction prices will
inhibit private investments.


7. During the early 1990s, foreign direct investment
(FDI) was a crucial source of financing for Brazil's
balance of payments. However, since 2001 the trade
balance has improved sharply, helping produce actual
current-account surpluses in 2003 and 2004. This
trend has enabled Brazil easily to weather the steep
continuing decline of FDI, from $ 22.5 billion in 2001
to $16.6 billion in 2002 and just $10.1 billion in

2003. FDI in 2004 is estimated to have increased to
about $16 billion.


8. Brazil has undertaken a significant reduction in
trade barriers in recent years. In 2004, Brazil's
average Normal Trade Relations (NTR) tariff was 10.8%,
versus 32% percent in 1990, according to the Foreign
Trade Secretariat of the Ministry of Development,
Industry and Foreign Trade.

Conversion and Transfer Policies
--------------


9. There are few restrictions on converting or
transferring funds associated with an investment.
Foreign investors may freely convert Brazilian currency
in the unified foreign exchange market wherein buy-sell
rates are determined by market forces. All foreign
exchange transactions, including identifying data, must
be reported to the Central Bank. Foreign-exchange
transactions on the current account have been fully
liberalized in practice, and in 2000 the Central Bank
greatly simplified requirements for capital-account
transactions.


10. Foreigners investing in Brazil must register their
investment with the Central Bank within 30 days of the
inflow of resources to Brazil. Registration is done
electronically. Investments involving royalties and
technology transfer must be registered with the patent
office (INPI) as well. Investors must have a
representative in Brazil and register with the
Brazilian securities commission (CVM). Subsequent
transactions, such as reinvestment of profits, may also
have to be registered with the Central Bank.


11. Foreign investors, upon registering their
investment with the Central Bank, are able to remit
dividends, capital (including capital gains),and, if
applicable, royalties. Remittances must also be
registered with the Central Bank. Dividends cannot
exceed corporate profits. The remittance transaction
may be carried out at any bank by documenting the
source of the transaction (evidence of profit or sale
of assets) and showing that applicable taxes have been
paid.


12. Foreign loans obtained abroad no longer require
advance approval by the Central Bank, provided the
recipient is not a government entity (loans to
government entities still require prior approval).
Upon concluding the transaction, the loan must be
registered electronically with the Central Bank. In
most instances, the registration is completed
automatically. Automatic registration is not issued
when the costs of the operation are "not compatible
with normal market conditions and practices." In such
instances, the loan is reviewed by the Central Bank; if
the Central Bank does not respond within five working
days, the registration is considered complete.


13. Interest and amortization payments specified in
the loan contract can be made without additional
approval from the Central Bank. That also applies to
early payments, if there is a provision in the contract
for early payment. If the contract does not have such
a provision, early payment requires prior approval by
the Central Bank. According to Central Bank officials,
this requirement is to ensure accurate records of
Brazil's stock of debt, and all requests have been
approved since the new guidelines were issued in 2000.


14. In addition to payments associated with registered
loans and investments, there are other approved
procedures for transferring funds abroad that in
practice can be used for a wide range of purposes.


15. Capital-gain remittances are subject to a 15
percent income withholding tax. Repatriation of an
initial investment is exempt from income tax.
Beginning in 2000, lease payments were assessed a 15
percent withholding tax. Remittances related to
technology transfers are not subject to the tax on
credit, foreign exchange, and insurance (IOF),although
they are subject to a 15% withholding tax and an extra
10% Contribution of Intervention in the Economic Domain
(CIDE). Loans with terms of 90 days or less must pay
the IOF (5%),while those of longer maturity do not.
In 2002, Brazil eliminated the application of the
financial transaction tax (CPMF),which is currently
0.38%, to stock market transactions. Brazil has no
double taxation treaty with the US, but does have such
treaties with a number of other countries, including,
among others, Germany, Japan, France, Italy, the
Netherlands, Canada and Argentina.

Expropriation and Compensation
--------------


16. There have been no expropriatory actions in Brazil
in the recent past nor any signs that the current
Government is contemplating such actions. In 1999, a
state government sought and obtained a court ruling
canceling contractual obligations, signed by the prior
state government, associated with the partial
privatization of a state electricity company. The U.S.
investors are appealing the court ruling. In 2003, a
newly inaugurated government in another state refused
to honor a number of contracts the previous state
government had signed with a range of Brazilian and
foreign investors; the parties involved continue to
negotiate these contract disputes and have had recourse
to local courts. Some claims regarding land
expropriations by state agencies many years ago have
been judged by courts in US citizens' favor. There
remain individuals who have not yet been compensated
because the states have appealed these decisions.

Dispute Settlement
--------------


17. Brazil is not a member of the International Center
for the Settlement of Investment Disputes (ICSID - also
known as the Washington Convention),but it is a party
to the New York Convention of 1958 on the recognition
and enforcement of foreign arbitration awards. In
August 1995, Brazil ratified the 1975 Interamerican
Convention on International Commercial Arbitration, as
well as the 1979 Interamerican Convention on
Extraterritorial Validity of Foreign Judgments and
Arbitral Awards.


18. Arbitration clauses in contracts are not
automatically enforceable. Foreign arbitral awards
require confirmation by a court of the country in which
the award was rendered and by the Brazilian Supreme
Court. This confirmation is procedural in nature, and
not meant to consider the merits of the case.
Confirmation by the Supreme Court allows the claimant
to enforce the arbitral award through Brazilian courts.
The Supreme Court has confirmed foreign arbitral awards
between two private parties in multiple cases.


19. There is some legal controversy in Brazil over
binding foreign arbitration between foreign investors
and state entities. Some Brazilian legal
interpretations claim this is prohibited under
Brazilian law on the grounds that it infringes the
sovereign rights of the state. The Federal Government
nevertheless maintains, in the absence of a definitive
judicial ruling on the issue, that it can agree to
binding foreign arbitration and routinely enters into
contracts that allow for such arbitration.


20. This legal uncertainty, as well as congressional
politics, has held up ratification of Bilateral
Investment Agreements that Brazil has signed with about
fourteen countries (not including the US),which call
for arbitration by either ICSID or a panel set up under
the United Nations Rules for International Commercial
Law. Given the doubts about the applicability under
Brazilian law of these international arbitration
provisions to Brazilian government entities, the
government in December 2003 withdrew the agreements
from consideration for Senate ratification.


21. Brazil has a functional commercial code that
governs most aspects of commercial association, except
for corporations formed for the provision of
professional services, which are governed by the civil
code. In December 2004, Congress approved an overhaul
of the bankruptcy code. The reforms create a system,
modeled on Chapter 11 of the U.S. bankruptcy code,
which allows a company in financial straits to
negotiate a restructuring with its creditors outside of
the courts. In the event a company does fail despite
restructuring efforts, the reforms give creditors a
better chance at recovering their debts. An
overburdened court system is available for enforcing
property rights but decisions can take years. Judicial
reform measures enacted in December 2004 streamline
administrative procedures, and, by introducing the
concept of binding precedent, should, over time, make
judicial decisions more predictable.

Political Violence (As It May Affect Investments)
-------------- --------------


22. Brazil's major urban centers suffer from
significant drug trafficking-related and organized
crime-related violence. Poverty, gangs, drugs and a
lack of government resources have combined to erode
state authority in some urban slums (favelas). There
have been episodes of drug-related violence prompting
major police crackdowns, particularly in Rio de
Janeiro. Police have been implicated in significant
human rights violations, including extra-judicial
killings, abuse of prisoners, and other criminal
activity. Since mid-2003 the Landless Workers'
Movement (MST) has continued its aggressive invasions
of a variety of agricultural interests, both domestic
and foreign, in its campaign to force redistribution of
land. In rural areas, powerful landowners, sometimes
aided by police or private security agents, have used
violence to settle land disputes, including but not
limited to those with the MST or indigenous peoples,
and to influence the local judiciary.

Performance Requirements and Incentives
--------------


23. Geographic preferences consist of tax benefits for
investment in less developed parts of the country, such
as the Northeast and the Amazon, with equal application
to foreign and domestic investors. These benefits have
succeeded in attracting some major foreign plants to,
for example, the Manaus Free Trade Zone, but most
foreign investment remains concentrated in the more
industrialized southern part of Brazil. Individual
states have sought to attract investment by offering ad
hoc tax benefits and infrastructure support to specific
companies. Some municipalities provide land on
favorable terms for industrial development.


24. In firms employing three or more persons,
Brazilian nationals must constitute at least two-thirds
of all employees and receive at least two-thirds of
total payroll. Foreign specialists in fields where
Brazilians are unavailable are not counted in
calculating the one-third permitted for non-Brazilians.


25. The Special Agency for Industrial Financing
(FINAME) of the National Bank for Economic and Social
Development (BNDES) provides financing for purchases by
Brazilian firms of Brazilian-made machinery and
equipment -- capital goods with a high level of
domestic content. The government also has a series of
smaller programs designed to assist small and medium
sized businesses export.

Right to Private Ownership and Establishment
--------------


26. Foreign and domestic private entities may
establish, own, and dispose of business enterprises.

Protection of Intellectual Property Rights (IPR)
-------------- ---


27. Brazil is a signatory to the GATT Uruguay Round
Accords, including the Trade Related Aspects of
Intellectual Property (TRIPS) Agreement, signed in
April 1994. Brazil is a member of the World
Intellectual Property Organization (WIPO) and a
signatory of the Bern Convention on artistic property,
the Washington Patent Cooperation Treaty, and the Paris
Convention on Protection of Intellectual Property. In
August 1992, Brazil removed its reservations and fully
accepted the Stockholm revision of the Paris
Convention. Brazil has not yet ratified the WIPO
Treaties on Copyright and Performances and Phonograms.
As a result of continuing problems regarding protection
of intellectual property rights, principally in
enforcement, Brazil remains on the Special 301 priority
watch list following the early 2004 review.


28. Patents. In most respects, Brazil's 1996
Industrial Property law brings its patent and trademark
regime up to the international standards specified in
the TRIPS Agreement. However, the law includes
compulsory licensing and local working requirements
which may be TRIPS-inconsistent. The law would
theoretically permit the grant of a compulsory license
if a patent owner has failed to "work" (i.e. locally
manufacture) the patented invention in Brazil within
three years of issuance. Brazil has agreed to consult
with the US before any potential invocation of the
local working requirement; to date, Brazil has yet to
grant a compulsory license.


29. Trademarks. The fraudulent use of internationally
"famous" marks has been a problem in Brazil. However,
the Industrial Property Law has provided improvements
in Brazil's trademark regime, including better
protection for internationally known trademarks. Some
foreign firms have been successful in court actions
against trademark infringement. Trademark licensing
agreements must be registered with the National
Institute of Industrial Property (INPI) to be
enforceable; however, the failure to register licensing
agreements will no longer result in cancellation of
trademark registration for non-use.


30. Copyrights. Brazil's copyright law generally
conforms to world-class standards. Likewise, its
software copyright protection law contains provisions
that introduce a rental right and an increase in the
term of protection to 50 years. Despite passage of
these copyright laws in 1998, widespread piracy of
copyright and trademark material remains a problem.
Government efforts to stem the flow of pirated goods
through its ports and across the border with Paraguay
have, to date, been largely unsuccessful. The US
private sector estimates that trade losses from
copyright infringements (including from piracy of
videocassettes sound recordings and musical
compositions, books and computer software) were $907
million in 2003.

31. In May 2001, the Government created an inter-
ministerial committee to address copyright piracy, but
a national strategy for combating piracy on a
comprehensive scale has yet to emerge. A sting
operation at a border crossing in Foz do Iguacu in
early 2003 also resulted in the arrest of a number of
government officials involved with smuggling
operations. A significant number of raids and seizures
were carried out in 2004 in the same border region, as
well as in Sao Paulo and Rio de Janeiro. The judicial
system, however, remains an ineffective deterrent.


32. To enhance enforcement efforts, the Brazilian
Congress passed a law in July 2003 that establishes
prison terms of two to four years for copyright
violations, not only for those selling pirated
products, but also for those convicted of renting,
smuggling, hiding or acquiring counterfeit copyright
products. The new law also establishes procedures for
making arrests and destroying confiscated products. A
much-publicized Special Congressional Inquiry into IPR
piracy completed its report in June 2004, amidst
considerable sensation after a reputed piracy kingpin
was arrested on charges of trying to bribe the chairman
of the inquiry commission.


33. Integrated Circuit Layout Designs. A government-
drafted bill to provide protection for the layout
design of integrated circuits (computer mask works) was
introduced in the Brazilian Congress in April 1996.
The draft law was still under discussion in 2004.
However, the Government's Industrial Policy measures
announced in early 2004 prioritize passage of this bill
to stimulate innovation in local production.

Regulatory System (as it pertains to investments)
-------------- --------------


34. Although some improvements have been made, the
Brazilian legal and procedural system is complex and
overburdened. State courts in particular can be
subject to political influence. The central government
has historically exercised considerable control over
private business through extensive and frequently
changing regulations. The bureaucracy has broad
discretionary authority.


35. Taxes are numerous and burdensome, but do not
discriminate between foreign and domestic firms,
although in a few instances there have been complaints
that the value-added tax collected by individual states
(ICMS) is set to favor local companies. Taxes on
commercial and financial transactions are particularly
burdensome, and businesses complain that these taxes
hinder international competitiveness of Brazilian
products. Brazil has separate value-added tax systems
run by the federal and state governments, and also
imposes several invoice taxes that are cumulative. In
2002, one of the invoice taxes was converted to a value-
added tax. In 2003, the administration presented tax
reform legislation to congress that would simplify the
value-added tax collected by the states and convert
another invoice tax to a value-added tax, but this
draft legislation was subsequently deferred until at
least 2005.


36. Regulatory agencies for sectors such as
telecommunications, energy and transportation are a
relatively young phenomenon in Brazil. ANATEL, the
country's telecommunication agency, handles licensing
and assigns bandwidth. The National Petroleum Agency
(ANP) is commended by the industry for its fair
handling of auctions of oil exploration blocks and its
willingness to assist industry in seeking to simplify
regulatory procedures such as environmental licensing.
Conversely, in the electric power sector, many
companies have complained about the high level of
regulatory risk, for example the tariff review process
and the implementation of the Brazil's new energy
policy. The federal government in 2003 passed
legislation setting fixed three-year terms for
directors of the regulatory agencies. New legislation
to further clarify the roles and responsibilities of
the regulatory agencies and consolidate into one the
multiple laws governing each separate regulator
currently is being considered by the Congress.

Bilateral Investment Agreements (BITs)
--------------


37. Brazil has signed Bilateral Investment Agreements
(BITs) with fourteen countries. There are two Mercosul
investment-related agreements: the Buenos Aires
Protocol ("extra-bloc") and the Colonia Protocol
("intra-bloc"); the latter has not been signed by
Brazil. Seven of the bilateral investment treaties
have been sent to the Brazilian Congress, but have not
been ratified. All of these treaties pending
ratification were withdrawn from Senate consideration
by the Executive in late 2003. The Executive cited the
need for further review of the treaties so as to avoid
potential juridical conflicts. At issue are the
international arbitration clauses of these treaties,
which may not be binding on Brazilian government
agencies under Brazilian law. The US signed an
Investment Warranty Treaty with Brazil in 1965 (OPIC).
The US and Brazil currently have no plans to discuss a
BIT.

OPIC and Other Investment Insurance Programs
--------------


38. Programs of the Overseas Private Investment
Corporation (OPIC) are fully available, and activity
has increased in recent years. The size of OPIC's
exposure in Brazil may occasionally limit its capacity
for new coverage. For more information on OPIC, please
go to http://www.opic.gov.


39. Brazil became a member of the Multilateral
Investment Guarantee Agency in 1992.

Capital Outflow Policy
--------------


40. There are few restrictions on converting or
transferring funds associated with an investment.
However, the Central Bank has broad administrative
discretion in regulating remittances, which in the past
has created problems for foreign investors. At this
time, foreign investors may freely convert Brazilian
currency at the "commercial" rate. The Central Bank is
working on a new regulatory regime for capital flows to
simplify bureaucratic requirements while retaining
necessary reporting requirements.


41. There has been a relaxation since 1991 of the
restrictions on the remittances of royalty payments for
patent and trademark use between subsidiaries
established in Brazil and the parent office
headquartered overseas and on remittances of franchise
contract royalties. A 1992 INPI resolution simplified
procedures and, in particular, eliminated a number of
requirements (but not all) concerning technology
transfer agreements. No royalties or other fees may be
transferred between related companies for the use of
software.

Labor
--------------


42. The Brazilian labor force comprises nearly 84
million workers in a wide range of occupations and
industries. Nearly half of the labor force is employed
in the service sector, roughly a quarter in
agriculture, and the retail and manufacturing sectors
combine to employ another quarter. The participation
of women, who now account for over 40 percent of the
labor force, continues to grow. The labor market has a
high rate of informal sector employment; most sources
estimate that at least half of all workers are not
formally registered, pay no income taxes, and do not
enjoy full protection under the law. About a quarter
of all workers are self-employed.


43. Unemployment - Significant. The Brazilian
Institute of Geography and Statistics (IBGE) calculates
an average unemployment rate for the country based on
data collected monthly in Brazil's six largest
metropolitan areas. According to this survey, the
unemployment rate in November 2004 was 10.6%. This
average masks some significant variation, from a high
of 15.9% in Salvador to a low of 7.8% in Porto Alegre.


44. Real Wages Halt Decline, Disparities Significant.
Real wages in 2004 halted an almost decade long slide.
Real wages were up 2.6% in November 2004 over November

2003. The average monthly wage in Brazil's six largest
cities was approximately 905 Reals (approximately $332)
in November 2004, and the minimum monthly wage was
raised from 240 Reals ($80) to 260 Reals ($87) in April

2004. These averages gloss over some stark wage
inequalities, as the wealthiest 50% of the Brazilian
population earn nearly 90 percent of the total income.
Earnings also vary significantly by region and
industry. The typical industrial worker in Sao Paulo,
for example, earns about three times as much as the
average retail worker in the northeastern state of
Bahia.


45. Differences in earnings are caused in part by the
regional disparity in educational attainment and in the
availability of skilled workers. According to a 2002
survey by IBGE, 60 percent of the population has fewer
than 8 years of schooling, with this number reaching 45
percent in the Southeast (including Rio and Sao Paulo)
and 70 percent in the Northeast (including Recife and
Salvador). Illiteracy rates also exhibit regional
disparities. The IBGE reports that about 11 percent of
the population is illiterate, with 7 percent illiteracy
in the Southeast and 21 percent in the Northeast.


46. Unions Play a Significant Role. Labor unions,
especially in sectors such as metalworking and banking,
tend to be well-organized and aggressive in defending
wages and working conditions. In more remote areas
with smaller local unions, however, unions tend to be
less effective. Union members account for
approximately 12 percent of the workforce, but unions
represent more than twice this number in collective
bargaining. Unions, which are funded largely by a
mandatory tax equivalent to one day's wages per year,
are obliged to represent all formal sector workers in a
professional category and geographical area, regardless
of membership status.


47. The Ministry of Labor estimates that there are
over 16,000 labor unions in Brazil, but Ministry
officials note that these figures are inexact. Local
unions often associate with state federations and
national confederations in their professional category.
In addition, four major labor federations, known as
"centrals," have emerged: the Workers' Unitary Central
(CUT),the Union Force (Forca Sindical - FS),the
Workers' General Confederation (CGT),and the Social
Democratic Union (SDS). Labor unions channel much of
the political activity of the labor movement. They
also organize strikes and salary campaigns involving
multiple professional categories and represent workers
in many governmental and tripartite councils. While
some labor organizations and their leadership operate
independently of the government and of political
parties, others are viewed as closely associated with
political parties.


48. Extensive Regulation, Slow Legal System. The
labor code is highly detailed and relatively generous;
formal sector workers are guaranteed 30 days of annual
leave, an annual bonus equal to one month's salary, and
severance pay in the case of dismissal without cause.
Brazil also has a system of labor courts that are
charged with resolving routine cases involving unfair
dismissal, working conditions, salary disputes, and
other grievances. Currently, over 2.5 million cases
languish in the labor court system, where they may
remain unresolved for four or five years. The
Brazilian government is attempting to reduce this
backlog and increase the efficiency of the labor courts
through recent initiatives to expedite legal procedures
and increase the number of claims that are resolved
before reaching the courts.

49. Labor courts have the power to impose an agreement
on employers and unions if negotiations break down and
either side appeals to the court system. As a result,
labor courts routinely are called upon to determine
wages and working conditions in industries across the
country. The system is tantamount to compulsory
arbitration and does not encourage collective
bargaining. In recent years, however, both labor and
management have become more flexible and collective
bargaining has assumed greater relevance. The Inter-
Union Department of Socioeconomic Studies and
Statistics (DIEESE) no longer collects data on the
number of strikes each month. Strikes have been a
frequent occurrence, however, particularly among public
sector unions. During 2004, federal police, health
workers, social security workers, university staff, and
customs officers were out on strike.

Major Foreign Investors
--------------


50. According to the Central Bank's most recent
foreign-capital census (December 2000),the US was the
largest single foreign investor in Brazil followed by
Spain, Netherlands, France, Germany and Portugal.
Investment from the Cayman Islands began growing
rapidly in 1995 and is thought to represent mainly
repatriation of Brazilian capital entering the country
as foreign investment and, to a lesser extent,
investment activity by other national groups.
Investment from Spain and Portugal surged beginning in
1998 due to involvement in telecom privatizations and
greatly increased investment in the banking sector by
Spain.


51. The stock of direct foreign investment in Brazil
stood at $103 billion as of December 2000, the most
recent year for which detailed data is available. Of
this, the US had the largest share at about $24.5
billion (24%). Spain had 11.9% of the total ($12.2
billion) and The Netherlands 10.7% ($11.0 billion).
Investment inflows since 2000 (not net of capital
repatriation or depreciation) have amounted to about
$65 billion.


52. Four US companies - GM, Bunge, Cargill and IBM -
are among the top twenty domestic firms. Six of the
top ten importing firms in 2003 were foreign: Nokia,
Motorola, Bunge, Volkswagen, Ford Motor Co. and
DaimlerChrysler. Five of the top ten exporters --
Bunge, Volkswagen, Cargill, General Motors and Ford --
represented foreign investment.

Efficient Capital Markets and Portfolio Investment
-------------- --


53. Banking Shakeout Results in Improved System. The
Brazilian financial sector is large and sophisticated,
in part a legacy of the high inflation period when good
financial management was critical to financial
survival. Despite current moderate inflation rates,
bank-lending spreads remain extremely high due to
taxation, repayment risk, lack of judicial enforcement
of contracts, high mandatory reserve requirements and
administrative overhead.


54. Brazilian banks have weathered a difficult period
of consolidation and streamlining over the last decade.
The elimination of high inflation in the mid-1990s, and
with it the disappearance of so-called "float income,"
led to liquidity problems among many banks. A series
of failures, mergers, and acquisitions took place in
1996 and 1997; three of the country's ten largest banks
failed and were taken over by other banks, and some 20
smaller banks were liquidated. Today, the financial
sector is fairly concentrated, with the 10 largest
institutions accounting for over 65% of financial
sector assets. Lending by these institutions is
likewise focused on the largest companies, leaving
small and medium-sized companies underserved. The
surviving banks have returned to profitability; the
largest banks attained record profits in 2002 and 2003
despite the weak economy.


55. Most government-owned banks, in particular those
that were owned by state governments, have been
privatized. These insolvent institutions were taken
over by the federal government, liquidated, privatized,
or transformed into development agencies. Three
federally owned banks, the largest in the country,
still play a prominent role in the financial system.
These federal banks, while in better shape than their
state-level counterparts, were also undercapitalized
and carrying poorly performing loans, many the result
of the loss-making "social" lending. These banks have,
to an extent, recapitalized by selling back government
bonds. Extraordinary bank profits in 2002 and 2003
also have improved the health of their balance sheets.
As part of an effort to prevent the need for future
recapitalizations of these federal banks, the
government now requires that loss-making social lending
programs by any government-owned bank be supported with
an explicit government subsidy.


56. Dealing with the bank failures and consolidations
of the last several years has led the Central Bank to
strengthen bank audits, implement more stringent
internal control requirements, and tighten capital
adequacy rules to better reflect risk. It also
established loan classification and provisioning
requirements. These measures are applied to private
and publicly owned banks alike.


57. Stock Markets Not an Option For Most Companies.
Only a few, primarily large, corporations raise capital
through the Brazilian stock exchanges. In 2003, two
new issues in the primary market raised $174.3 million.
In June 2004, Brazilian airline Gol executed an initial
public share offering simultaneously on the Sao Paulo
and New York stock exchanges. Nevertheless, the total
number of companies listed on the Sao Paulo stock
market (BOVESPA) fell to 361 as of June 2004, compared
to 399 in 2002 and 428 in 2001. Some companies find
the benefits of maintaining a listing on the stock
exchange do not justify the cost. Total turnover in
the secondary market was $68.1 billion in 2003.
Trading is highly concentrated, with the top 10 stocks
accounting for over 50 percent of turnover. Some 71
Brazilian firms, including Petrobras, Embraer, Banco
Itau, CVRD, Brasil Telecom and Ambev, are also listed
on the NYSE via American Depository Receipts (ADR's).


58. In 2000, with the intent of promoting the stock
market and improving liquidity, the numerous regional
stock markets agreed to consolidate. All stock trading
is now done on the Sao Paulo stock market, while
trading of public securities is conducted on the Rio de
Janeiro market. The Sao Paulo stock market also
launched a "New Market," in which the listed companies
would comply with strict corporate governance
requirements. As of June 2004, the new market has 31
listed companies.


59. Until recently, up to two-thirds of a
corporation's capital could be preferred (non-voting)
shares, so that it was possible to achieve majority
control of voting shares, in some cases, by holding
only 17 percent of total capital. In 2001, the
Congress approved a law that limits preferred shares
for new issuances to 50 percent. The same proposal
strengthens rights for minority shareholders.


60. The Brazilian Securities Exchange Commission (CVM)
directly regulates the stock exchanges, brokers,
distributors, pension funds, mutual funds, and leasing
companies. In 2001, new legislation granted the CVM
independence and established stronger penalties against
insider trading.


61. In January 2000, Brazilian regulators removed a
number of remaining restrictions on foreign portfolio
investment. As a result, foreign investors - both
institutions and individuals - can directly invest in
equities, securities and derivatives. The foreign
investors are required to trade derivatives and stocks
of publicly held companies on established markets.


62. Export Credit Availability. BNDES, the government
national development bank, is the primary Brazilian
source of longer-term credit, and also provides export
credits. FINAME (Special Agency for Industrial
Financing) provides foreign and domestic companies
operating in Brazil financing for the manufacturing and
marketing of capital goods. FINAMEX (Export Financing)
is a part of FINAME, which finances capital good
exports for both foreign and domestic companies. An
export credit program for capital and some consumer
durable goods, known as PROEX, was established in 1991.
PROEX receives funds from the National Treasury to
offer assistance in the areas of interest rate
equalization, capital and other goods exports, and
service exports.


63. Other Issues: Accounting and Mergers. Wholly
owned subsidiaries of multinational accounting firms,
including the major US firms, are present in Brazil.
The failure of major banks and large businesses during
1995, notwithstanding positive financial statements
prepared by the major accounting firms, raised doubts
about the credibility of these financial statements.
Beginning in 1996, auditors have been personally liable
for the accuracy of accounting statements prepared for
banks.


64. Brazilian law recognizes mergers, in which one
company loses its separate identity by being merged
into another, and consolidations, in which the pre-
existing companies are extinguished and a new entity
emerges. The procedures for both are essentially the
same. Sales of Brazilian companies usually result from
private negotiations, rather than stock exchange
activities. Acquisitions resulting in market
concentration in excess of 20 percent are subject to
review by the Administrative Council for Economic
Defense (CADE) under Brazil's 1994 Anti-trust Law.

DANILOVICH