IDC takes lessons from Brazil

23 May 2011

Brazil is a country more likely to conjure up images of beaches, samba and soccer than of people hard at work. Yet the tropical nation’s development bank has become an inspiring model to South Africa in its quest to boost industrial development.

The idea that South Africa would look to a development bank in Brazil is even more significant when one considers that for years economists repeatedly wrote off the South American country as one of all talk and no action.

But in the last decade or more, things have begun to change. Last year, Brazil grew 7.5% and this year it overtook Italy to become the world’s seventh-largest economy.

Much of this growth is being driven by loans to businesses and infrastructure projects by Brazil’s development bank, BNDES. The bank has more than tripled its lending over the last five years, so much so that it is now one of the biggest development banks in the world – exceeding even the mighty World Bank.

Last year, the Brazilian development bank lent out 168.4-billion reals (R733-billion) – more than double the World Bank’s US$44.2-billion (R306-billion) in disbursements for 2010. This has taken place while the Brazilian development bank last year posted a record profit of 9.9-million reals and a default rate of a mere 0.15%.

IDC starts scaling up

BNDES lending dwarves that of South Africa’s Industrial Development Corporation (IDC), which in the 2010 financial year disbursed R6.2-billion, posting a profit of R2.2-billion with a 16.3% impairments ratio.

But the IDC too, is scaling up. Last month, Economic Development Minister Ebrahim Patel announced that the IDC would invest R102-billion in funding over the next five years – a 160% increase on the IDC’s loan approvals in the past five years.

The IDC is now considering selling off some of its holdings – which include shares in major firms such as ArcelorMittal, Sasol and Kumba Iron Ore, among others – to finance the expected R36-billion shortfall in investment spending.

It also hopes to inject more capital into small business lending – with the planned merger of Khula Enterprise Finance and the South African Micro Finance Apex Fund (Samaf) with the IDC’s small business funding portfolio to create a wholly-owned subsidiary under the IDC dedicated to funding small enterprises.

A more powerful, strategic funding agency

Brazil’s development bank has provided the IDC with several important lessons in how to create a more powerful and strategic funding agency – with Patel noting in June last year that his department is looking at emulating the success of BNDES.

The Brazilian development bank’s use of funding from its Worker’s Assistance Fund – the equivalent of South Africa’s Workmen’s Compensation Fund – led the IDC to form a joint R2-billion funding scheme with the Unemployment Insurance Fund (UIF) launched last year.

Shakeel Meer, the IDC’s divisional executive of corporate strategy, says the IDC is particularly interested in BNDES’ application of local content development – where the Brazilian development bank insists on a certain percentage of local suppliers or content when it hands out funding.

Meer says insight into BNDES’ model had also led to the exposure to various industry specific financing schemes and methods, which has helped the IDC to formulate various financing schemes in recent years.

International linkages

The IDC has over the years, built strong links with a number of development banks around the world – such as the European Investment Bank, Germany’s KFW/DEG, France’s AFD/Proparco, Japan’s JBIC and the China Development Bank.

The IDC first became interested in BNDES in 2005, after an IDC delegation visited its Brazilian counterpart to conduct an institutional benchmarking exercise.

In a 2005 study by the IDC’s Jorge Maia and Lumkile Mondi, and economist Simon Roberts, found that BNDES was heavily involved in financing the Brazilian economy such that not a single major undertaking, involving private Brazilian capital after 1950, had taken place in Brazil without BNDES support.

The authors also found that despite higher real interest rates in Brazil, BNDES had maintained better rates of investment than South Africa – partly because of the larger role that it plays in Brazil’s economy.

They also found that financing at BNDES is closely linked to the bank’s strategic view of the economy and its practice of linking financing requirements to the promotion of local industrialisation.

With relations between the IDC and BNDES growing closer, the two, in 2009, signed a technical co-operation agreement aimed at exchanging ideas on industrial strategy, financial products and co-operating in financing projects in Africa.

Different operating environments

However, Meer cautions that despite the similarity between the corporate mandates and origins, the operating environments and institutional funding models of each institution has evolved in a very different manner.

For example, while BNDES has a near monopoly in Brazil’s long-term funding market, the IDC has to compete along side private-sector banks in South Africa.

Another difference is that while the IDC has an almost exclusively direct funding approach, BNDES utilises an enormous network of financial intermediaries for indirect funding purposes, largely due to the specific characteristics of the Brazilian financial system.

Meer says BNDES use of financial intermediaries accounts for its substantially lower defaults, since this is largely carried by the intermediaries. The IDC’s project development initiatives and its large equity portfolio also means the IDC is forced to assume a “substantially” higher degree of risk than BNDES, he said.

Beyond the differences between the two banks, critics have questioned whether BNDES massive scaling up of finance is sustainable, pointing out that the bank’s funding is massively subsidised by Brazil’s treasury, which risks driving up inflation by releasing too much cheap money into the market.

Meer however believes the expected increase in IDC financing would not have a negative effect on the South African economy, pointing out that the IDC’s funding activities complement those of the private financial sector.

He says IDC also has cooperative funding arrangements with various domestic financiers.

The IDC uses a pricing approach that considers both risk and development impact, he says.

“In addition, from time to time, IDC introduces specific subsidised funds to promote targeted objectives,” he explains, adding that this was a similar approach to BNDES. The IDC also launched a lower interest rate offering this year which offers prime less three percent for projects with a high employment effect.

Meer says the offer of lower interest rates within certain funding schemes is made possible by cross-subsidisation internally, as well as due to specific external funding arrangements with for example the UIF.

Too much state control?

Speaking to BuaNews recently, BNDES president Luciano Coutinho, disagrees with critics that believe the massive increase in funding by BNDES risks putting the state in too much control of the economy.

“In our case there is no danger at all because our bank has a highly professional management and our non-performing loans are much lower than the private banking system,” Coutinho said.

“We have a very competent bank and we understand that in order to have an efficient development bank we have got to be absolutely professional in terms of credit rating and independent decision making and we have to be accountable and transparent.

“Those are pillars of good governance, because if you don’t have good governance you can’t be a good development bank, because we manage public money so we have to be efficient in managing money.”

Coutinho says developing funding priorities was an important step to boosting the role of any developing finance bank and notes that the IDC has already developed priorities such as funding infrastructure development, food security (through loans to agro-processing companies) and the green economy.

Last year about 93%, or 568 000, of BNDES funding disbursements were to micro, small and medium-sized companies as well as individuals – with 320 000, or half of all its funding operations were through the BNDES Card – which is a hybrid of an e-commerce and credit card financing system. About R$4.3-billion was disbursed through the card to SMEs – 74% up on 2009.

He believes the card might be a product that South Africa could learn from BNDES and that the bank could make available in its technical co-operation agreement with the IDC.

Source: BuaNews