Published On: August 28, 2015

Brazil: Too Big to Fail

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Brazil v Croatia: Group A - 2014 FIFA World Cup Brazil

Protestors in Brazil are certain of one thing – they want better government. International economic experts agree, but now they are most concerned about the country’s stability. Political upheaval fosters economic instability, weakening investors’ faith in the country.

The Brazilian economy is stagnating at recession levels while inflation and unemployment are simultaneously rising rapidly. Nobel Prize-winning economist Milton Friedman invented a term for this dilemma, “stagflation”, which means inflation is rising counter-intuitively, i.e. despite slow growth.

Besides the economic obstacles to stability, Brazil needs to re-invent its legal system, eliminating impunity and the decades of court backlog that keep justice from becoming a reality. Interestingly, the strongest force for justice in Brazil these days is coming from nine little-known prosecutors who are taking on the most powerful forces in the country in Operation Car Wash, as the Petrobras scandal is known.

Deltan Dallagnol

Deltan Dallagnol

Many of the nine prosecutors studied abroad, and they are using strategies relatively new in Brazil, such as the plea bargain. The Brazilian media are calling them the Nine Horsemen of the Apocalypse. The Nine Horseman were assembled by Deltan Dallagnol, 34 years old, a Harvard Law graduate who is a federal prosecutor in Curitiba, and Carlos Fernando dos Santos Lima, a 50-year-old who received his law degree from Cornell University in the US. They put together the Nine Horsemen team and picked colleagues they considered trustworthy who were willing to relocate to Curitiba.

Most members of the team, whose median age is 36, attended top law schools in the US, Europe, and Brazil, but they aren’t widely known in Brazilian legal circles. “Fear of the law was something that did not exist in Brazil for white-collar criminals and politicians,” said Paulo Roberto Galvão de Carvalho, one of the nine prosecutors. “This needs to change, and is changing.”

However, the task ahead for the prosecutors will not be an easy one. Even the clearly criminal behavior evident in the Petrobras scandal is complicated, and the scandal will not be soon resolved. The hundred or so indictments already issued in the scandal will take years to settle in court, as happened in the last large political scandal, Mensalão.

Paulo Roberto Galvão de Carvalho

Paulo Roberto Galvão de Carvalho

Additionally, Petrobras and its construction contracts account for tens of thousands of jobs, some of which have already been lost. PT cannot afford to lose support among the working class and is attempting to convince federal prosecutors to strike leniency deals with the big construction firms embroiled in the scandal to forestall their collapse, and with it that of many infrastructure projects around the country.

Last week, Petrobras finally released its 2014 financial report. Petrobras’s decision to take a massive U$17 billion write-down to account for overvalued assets and corruption-related costs may only be the start of a broad overhaul needed to revive Brazil’s troubled state-owned oil company. While many have focused on the U$2.1 billion, or 12 percent of the write-down, related to money siphoned off in a price-fixing, bribery, and political-kickback scheme, it is the remaining U$15 billion that calls for greater attention.

After years of rising spending and project delays, Petrobras is the world’s most-indebted oil major, a burden that limits its ability to complete investments needed to boost oil and gas output. For years the government forced Petrobras to subsidize domestic fuel prices, causing billions in refining losses. This also prevented Petrobras from attracting refining partners, adding to this week’s write-downs.

platform 16x9

Petrobras platform

Cheaper oil also forced Petrobras to write down 9.8 billion reais (U$3.30 billion) of exploration and production assets, an area where the company is overstretched. Under a 2010 law that increased the state’s role in the oil sector, Petrobras must own at least 30 percent of all new exploration projects in the country’s most prolific offshore region whether it wants to or not. Because Petrobras must also run the areas, Brazil may face the choice of forcing the company to make investments it can’t afford or forego new exploration to protect Petrobras finances.

Meanwhile, the rest of the world is waiting to see how Petrobras will survive. “The Latin American left is coming up against an enemy that it has never prepared itself for,” said Federico Neiburg, a professor of social anthropology at the University of Rio de Janeiro. “It’s an alliance between shifting geopolitical interests, economic and financial elites trying to impose politics that are beneficial to them, and political action on behalf of the media. The media is one of the most important players in this game. If we follow what they say, then the days of the progressive governments of Latin America are coming to an end.”

In an effort to assist their broken finances, Petrobras announced that it signed a U$3.5 billion financing deal with the China Development Bank. China has extended more than U$100 billion in credit to Latin America since 2005, according to figures from Boston University’s Global Economic Governance Initiative. News of the latest Chinese loan comes just days after President Dilma Rousseff announced that Brazil would become a founding member of the Asian Infrastructure Investment Bank, a new China-based institution seen as a rival to the US-dominated World Bank.china-development-bank_0

As in the financial crisis in the US and Europe in 2007-8, when some US-based, multinational corporations like Citibank and General Motors received assistance from the US government because they were termed “too big to fail”, the same can be said of companies like Brazilian conglomerate Odebrecht and other firms who have Petrobras as their main client. Petrobras accounts for 90 percent of the country’s oil and gas business.

Goldman Sachs estimates that Brazilian banks have investments in the oil sector of about U$40 billion, mostly with Petrobras. The company accounts for 10 percent of the country’s investment, and Petrobras and its suppliers account for between 15-20 percent of Brazil’s GDP.

Last week, OAS, a large engineering and construction firm, became the fourth Petrobras subcontractor to request a bankruptcy court’s protection, after Alumini Engenharia, which defaulted on 1 billion reais in January; and Galvão Engenharia, which defaulted on about 1.6 billion reais in March. The fourth, Schahin Group, requested a bankruptcy court’s protection for 28 of its subsidiaries on April 17.

Meanwhile, the courts have kept 11 executives from six of the companies — among them OAS’s chief executive, José Aldemário Pinheiro Filho — in jail since November. OAS has taken advantage of the Brazilian law that permits companies to make generous donations to political campaigns.

According to figures from the national electoral tribunal, OAS donated over 20 million reais to Dilma in 2014 — nearly 6 percent of her re-election campaign’s official budget. OAS also donated 4 million reais to Dilma’s opponent, Aécio Neves. The federal prosecutor’s office is also suing six companies, including OAS, for damages caused by corruption.

Scandal

So where is Brazil headed? Will replacing Dilma automatically create a better government, or is political corruption endemic throughout the country? Certainly those who profited from the Petrobras scandal must be held accountable. Guidelines should be set in place to prevent large-scale bribery scandals going unnoticed for decades. While Brazil will benefit from greater scrutiny by law enforcement officials such as the Nine Horsemen, the country has come too far to go backwards into a military takeover.

Everyone in Brazil is demanding justice and the injection of integrity into the workings of the ruling class. However, no one profits if the economy collapses. When the economy was strong, as it was a few years ago, there were no street protests. Dilma and Petrobras may be too big to fail.

B. Michael Rubin is an American living in Curitiba.

[Research for this article comes from Folha de S. Paulo; the Wall St. Journal; Reuters news agency, and Dealbook, The New York Times financial website.]

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  1. Nicholas says:

    “Goldman Sachs estimates that Brazilian banks have investments in the oil sector of about U$40 billion, mostly with Petrobras.”

    Uhmm, seems like the justice system in Brazil is working. What about the US (paradise/less corruption as you claimed), Michael? The same Goldman Sachs (that targets Brazil’s crown jewel, Petrobras) that looted and still loot the US taxpayer and nobody in US is on the streets demanding those criminals on top, to be in jail.

    Does the justice system in the US also needs to be reformed?

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