Today's Letter IEDI goes back to the theme of long-term financing and private investment in Brazil, based on work by URFJ professor and former BNDES Vice-President João Carlos Ferraz, whose full version is available on the IEDI website (in Portuguese).

This is the fifth study of our recent series on the topic, which includes the document "The BNDES at a Crossroads: How to Avoid Its Dismantling" (Letter IEDI No. 828 of Jan 30, 2018) written by economist Ernani Teixeira; "For a new development, a new BNDES" (Letter No. 834 of March 5, 2018) carried out by IEDI consultant João Furtado; "Relieving credit restrictions in emerging countries: the impact of BNDES financing on the productivity of Brazilian industrial firms" (study published on June 1, 2018, in Portuguese), by Filipe Sousa and Gianmarco Ottaviano; "Investment funding in Brazil and the role of the capital market" (Letter IEDI No. 850 of June 6, 2018) by Carlos Rocca.

As known, the country is going through a moment of investment contraction, while changes in production patterns, competition, business models, consumption and lifestyles are underway. In this moment of uncertainty, it is of great importance to discuss how to prepare the BNDES so that it can still have a relevant role for the future of the country.

This is the starting point of João Carlos Ferraz's work. What should the BNDES' contribution be to the country's future development, considering its stage of development and amidst major transformations in the real economy, both in Brazil and worldwide?

The first point raised by the author is that the volume of BNDES operations should increase and new sources of resources will be needed. The argument is based on the fact that, throughout its history, BNDES' mission has been to support investment and, on average, from 1952 to 2017 this support corresponded to 1.45% of GDP.

Assuming GDP to be approximately US$ 2 trillion, this would mean a disbursement of US$ 30 billion per year nowadays. BNDES current disbursements are below this amount. Should the investment rate of Brazilian economy grow to, for example, 18% of GDP in the next 3 years, then even if other sources of financing promptly and forcefully appear a more active BNDES participation will be necessary, above and beyond its current timid stance.

The second aspect highlighted by Ferraz emerges as a counterpoint to the consensus that seems to have been formed about what BNDES priorities should be: infrastructure, smaller companies, innovation and the environment. If, in fact, these are the priorities, the Bank should be more willing to take on the risks of development, that is, the institution must be prepared to take the risks (protecting itself) and rewards (profiting and financing the expansion of its capital) associated with these objectives.

This means that the authorities must evaluate whether the nature and extent of the benefits granted to the Bank are adequate and, moreover, should assess whether the scope of the institution's actions should focus only on these missions. On this regard, the author points out that the benefits that the Brazilian authorities confer to our main development agent are very limited, contrary to what is happening worldwide on average. The German KfW, for example, does not distribute dividends nor pays taxes, has automatic sovereign guarantee and access to parafiscal resources.

Another suggestion is that the BNDES ought to preserve the diversified scope of its operations to dilute risks, participating in safe, low risk operations and profitable operations. This includes dealing with some large companies too, those with good governance, sustainability, etc.

The author recalls that most of the existing development banks are not specialized but diversified in terms of instruments and segments served. The logic of diversification is very straightforward and not unlike other financial institutions that seek a distribution of risk and rewards through portfolio management: low rates and long contract terms can be offset by lower term and higher rate operations; high-risk operations can be offset by segments with predictable and safe returns.

The BNDES must also preserve a countercyclical role, as follows: in the ascending phase of the business cycle, the institution needs to be attentive and give way to the financial industry. However, when growth rates cool down and the financial industry acts to protect its balance sheets and when markets reduce or stop providing funds, the importance of public institutions grows. To be effective, the countercyclical role of a development bank should be appropriate and specific to the timing and needs of economic agents.

Ferraz argues that, following the vast majority of development banks in other countries, the BNDES should act not in opposition, but in partnership with the local financial industry. The experience of the institution in establishing partnerships with commercial banks and the capital market (through funds intermediation or not) and in promoting secondary markets should be deepened.

Finally, developing policy assessment tools is paramount. When to start and when to end a policy intervention? Or, how to circumscribe a policy initiative to the limits of its effectiveness? The theme is not trivial when the parameters involved include structural change, innovation, the environment, long-term investments and the duration of economic cycles, which are difficult to estimate.

It will be important, as the author suggests, to institutionalize systematic and permanent search processes and to experiment and implement innovative solutions related to methodologies for identifying tangible and intangible assets of projects and beneficiaries. Also, the institution needs to seek methods to: carry out ex ante assessments of impacts, follow-up processes, and perform ex post evaluations. These are essential ingredients for a constant internal process of learning and for accountability to society.

The full text is available in Portuguese.