Investment Grade Leverages Power Sector - Nuca

Investment Grade Leverages Power Sector1
Nivalde José de Castro2
Roberto Brandão3
Brazil’s obtaining an “investment grade” credit rating against a backdrop of international
financial crisis is a milestone in its economic development. This significant event should produce
medium-term impact on three variables: (i) conditions of financing; (ii) flow of – especially longterm – lending capital; and (iii) rates of return required by risk capital investors, all of which are
of strategic importance to Brazil’s economy and will be examined here.
Investment Grade refers specifically to how credit rating agencies classify the risk of Brazil’s
public foreign debt. It is reflected most directly in the interest rates the federal government pays
on bonds issued abroad. However, the risk classification of government foreign debt also acts
as a ceiling on ratings for private companies’ foreign borrowing. That is because companies are
usually rated, and interest charged on their foreign currency borrowing, on the assumption that it
is always less risky to lend to a country than to one of its companies. In that regard, Brazil’s
investment grade builds a perception on the international market that Brazilian companies
generally have become less of a risk, making it easier for them to access foreign financing.
The second strategic variable influenced by the new rating is the flow of long-term capital to
Brazil’s economy. Institutional investors from developed countries, notably pension and
insurance funds, are always looking for alternative long-term applications that offer better rates
of return than those available in their own countries. Statutory or regulatory restrictions prevent
these funds from investing in applications rated as speculative. As a result, many developing
economies only have access to short-term capital.
1 Published in Revista Brasil Energy, Ed. 409 - pg. 44 - July/August, Rio de Janeiro ISSN 0100-882x.
2 Nivalde José de Castro is a professor at the Economics Institute (UFRJ) and coordinator of the Power Sector
Study Group (Gesel). ([email protected]).
3 Roberto Brandão is a senior researcher at Gesel ([email protected]).
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With the awarding of investment grade, all capital-intensive businesses and those that – like
the power sector – depend on long-term financing can expect to benefit from a steadily swelling
flow of funding. Mexico and Chile, for example, have enjoyed remarkable growth in the
availability of long-term loans for infrastructure since gaining investment grade rating some
years ago. The same should occur here in Brazil. This is a new and unaccustomed situation for
the Brazilian economy, which was always heavily dependent for long-term loans on Brazil’s own
National Economic and Social Development Bank (BNDES). Above all though, this is a great
opportunity for Brazil, whose development hinges crucially on expanding its infrastructure.
The third strategic variable is the rates of return demanded by risk capital investors. These
should diminish, because the financial market uses “country risk” to calculate required rates of
return on risk assets. The reasoning is that returns on investments in new projects or in stocks
are related to yield from fixed-income assets. These latter include a country-risk premium
reflecting the level of risk in the macroeconomic environment as perceived by foreign investors
and, thus, the country’s rating. The investment grade rating brings with it the expectation that
Brazil’s country risk will decrease, ushering in a trend for earnings on all assets in the economy
to diminish. The country risk and interest rates will tend to remain lower and less volatile, which
should substantially reduce the premiums that investors demand in order to put their money into
risk assets. This is particularly good for capital-intensive businesses, where the cost of their own
and third-party capital strongly determines how attractive an investment is.
The power sector is the most attractive capital-intensive sector for new investments, because
it has a solid regulatory framework, medium- and long-term planning tools and a sound pattern
of financing. Brazil’s economic growth prospects guarantee growing demand for electric power.
That, in turn, entails expanding installed capacity, which will require further investments.
The model of power system expansion, which has become firmly established over recent
years, is well suited to attracting capital and assuring continued system expansion. The
successful use of auctions, which grant long-term contracts for new generation and
transmission projects and thus enable entrepreneurs to secure investment financing, has
fostered a fertile environment in which the power sector can benefit directly from the influx of
funding and the diminishing costs that will follow in the wake of the investment grade credit
rating conferred on Brazil.
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