Making sense of Brazil's Lava Jato scandal - By Thomas Kamm, Partner, Brunswick São Paulo
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Making sense of Brazil’s Lava Jato scandal By Thomas Kamm, Partner, Brunswick São Paulo April, 2015
Executive Summary
impeachment of President Dilma
• Brazil’s Lava Jato scandal is more than just a mere corruption Rousseff (still a remote possibility
scandal involving alleged kickbacks at oil giant Petrobras. It has at this stage) less than four months
snowballed into at least three other crises that amount to a giant into her second term. And this could
stress test for Brazil: a corporate crisis for many of the country’s be just the start: “The greatest share
biggest companies, whose business has dried up; an economic crisis of accusations is still in front of us,”
says Deltan Dallagnol, the public
as the scandal’s impact on investment drags Brazil deeper into
prosecutor who is coordinating
stagflation; and a political crisis for President Dilma Rousseff the Lava Jato task force. “We’re
only four months into her new term, as the alleged involvement of discovering crimes every week,”
many politicians from the ruling coalition raises questions over the he said recently as he unveiled new
country’s governability. revelations.
• The economy is likely to get worse before it gets better as the In fact, Lava Jato goes far beyond a mere
government imposes tough austerity measures and investment in oil corruption scandal. It exposes not just
& gas and infrastructure feels the impact of the scandal. the outsized importance of Petrobras
• While polls show support for the opening of an impeachment for the Brazilian economy, but also the
procedure against Ms. Rousseff, that probability remains low, as she dynamics of Brazil’s political system.
has not been personally implicated in the scandal. Its ramifications and implications are
such that it has snowballed into at
• The greater risk is that Ms. Rousseff becomes a lame-duck President, least three other crises: a corporate
beholden to Congress, and the country muddles through for the crisis for many of the country’s
next few years, once again disappointing those who believed the biggest companies, whose business
proverbial land of the future was finally living up to its potential. has dried up; an economic crisis as the
Brazil’s presidential system still gives Ms. Rousseff some breathing scandal’s impact on investment drags
space, but to save her presidency, she needs to change her style and Brazil deeper into stagflation; and a
show the deft political touch and leadership that she has so far political crisis for President Rousseff,
failed to display. as the alleged involvement of many
politicians from the ruling coalition
• While the consumption boom that drove the Brazilian economy’s (including the speakers of the House
growth has come to an end, the low value of the Real, which has and the Senate) raises questions over
depreciated by close to 30% vs the US Dollar and attractive the country’s governability. In short,
valuations could offer opportunities for foreign investors. the interlocked crises are a massive
stress test for Brazil that pose a huge
credibility issue for Ms. Rousseff and
Brazil is the land of telenovelas, and duration, volume of money and reach her government – and underscore the
with the Lava Jato scandal, it has into the highest political echelons in domino effect a corruption scandal
created a real-life soap opera whose the country, maybe one of the biggest can have even on a major economy
plot defies the imagination of even the in the world.” like Brazil’s.
most creative script-writers. As the investigation enters its second
What began as a local investigation
into money-laundering at gas stations
year, the scandal has already snared
in its nets Brazil’s biggest company, The facts: Lava
and laundries (hence the name state-controlled oil giant Petrobras, Jato in a nutshell
Operação Lava Jato, or Operation many of the country’s biggest private
Car Wash) in the southern state of construction companies, a handful How did Brazil reach this point?
Parana has mushroomed into what the of multinationals, more than 50 First, the facts. While investigating a
weekly magazine Veja has called “one politicians, the treasurer of the ruling money laundering case in Southern
of the biggest corruption schemes Workers’ Party and has triggered Brazil (itself the result of a previous
ever revealed in Brazil – and, for its a nascent movement seeking the landmark political corruption scandal
2 | 2015 | BRUNSWICK ©which sent to jail Jose Dirceu, a
former government minister and
from seven parties, all but one from
the coalition that supports Ms.
Three key
chief of staff to ex-President Luiz Rousseff. Those implicated include challenges
Inacio Lula da Silva), the Federal Renan Calheiros, President of the
Police came across an intriguing Senate, Eduardo Cunha, President This leaves Brazil facing a triple
connection: a money dealer involved of the Chamber of Deputies, João challenge:
in the laundering scheme, Alberto Vaccari Neto, treasurer of the ruling
Youssef, had purchased a Range Rover Workers’ Party (PT) and Senator 1) Break the corporate
Evoque for Paulo Roberto Costa, the Fernando Collor de Mello, a former paralysis:
Director of Supplies of Petrobras from President of Brazil who resigned in The corruption scandal has left
2004 to 2012. On March 17, 2014, disgrace in 1992 in a corruption Brazil’s corporate world in limbo,
the Federal Police launched a wave of scandal just before an impeachment with a number of companies lacking
arrests, including that of Mr. Youssef, vote. To date, investigators have cash to invest or banned from bidding
followed shortly thereafter by that of identified illegal transactions totalling for Petrobras contracts because of
Mr. Costa. Building on the seemingly 2.1 billion Reais, which, says daily O their alleged involvement in the
tenuous Range Rover connection, Globo, “already makes it the country’s scandal. The obvious biggest victim of
investigators uncovered what appears biggest-ever corruption scandal.” the scandal is Petrobras itself. Once
to be a highly organized “club” that By some estimates, up to 10 billion the world’s fourth biggest stock-
included top Petrobras executives, Reais may have been embezzled in the market capitalization following its
construction companies, Petrobras case. The investigations are ongoing 2010 share offering, Petrobras has
suppliers, independent agents and there could be more to come. lost two-thirds of its market value.
and politicians. In what one of the Investigators believe similar schemes With gross debts of $135 billion, the
suspects has called “institutionalized may have been in place in other state- company is the world’s most-indebted
corruption,” the cartel of Brazilian controlled companies, and other oil major, and Moody’s recently
companies conspired over several construction companies including downgraded Petrobras’s credit to
years to deliberately overcharge Andrade Gutierrez and Odebrecht, junk status, warning that it faces
Petrobras by between 1% and 3% may be involved in yet more tainted “serious near-term liquidity pressure.”
on a number of contracts with third- contracts. The names of several Such is the uncertainty surrounding
parties. (Mr. Costa has since changed foreign companies or their agents the cost of the corruption scandal
his testimony and said that Petrobras have also emerged. And in recent that the company has been unable
was not overcharged, it’s the suppliers testimony, former Petrobras official to publish audited accounts since
who cut into their profit margins). Pedro Barusco told the recently- November, when it was slated to issue
The excess funds were used in part installed Parliamentary Investigation its third-quarter numbers (though
to finance the political campaigns Committee that is conducting an press reports say Petrobras is hoping
of politicians linked to the ruling enquiry into the case that a bribe to finally unveil its accounts next
coalition (sometimes in the form of of $300,000 was paid by Dutch week.) Petrobras has come up with
legitmate contributions to political company SBM Offshore to finance two vastly-differing estimates: the
parties) and in part for bribes to Ms. Rousseff’s 2010 presidential first takes into account the 3% cut on
Petrobras officials. As one of the jailed campaign. Ms. Rousseff has not been suspicious contracts that Mr. Costa
businessmen, Engevix’s Gerson de directly implicated in the scandal, but has mentioned: this would have cost
Mello Almada, put it in his testimony: many of the facts under investigation Petrobras an estimated 4 billion Reais.
“We drove down a highway called occurred under her watch, at a time The second estimate attempts to put a
Petrobras on which we had to pay when she was chairman of the Board of mark-to-market value on Petrobras’s
tolls.” Petrobras while serving as Minister of assets, discounting the inflated
Using a Brazilian plea-bargaining Mines and Energy and, subsequently, value of contracts and construction
scheme called delação premiada, chief of staff to President Luiz Inacio projects, mainly for refineries; by
investigators have used testimony by Lula da Silva. this count, Petrobras should take a
Messrs. Youssef, Costa and others to write-down of a staggering 89 billion
arrest 11 senior executives from four Reais. In the absence of a credible
construction companies (Engevix, number, Petrobras’s auditor, PwC,
OAS, UTC and Queiroz Galvão), has refused to approve the accounts.
three top Petrobras executives and This, in turn, impedes Petrobras from
implicate more than 50 politicians accessing credit markets to finance its
© BRUNSWICK | 2015 | 3huge investment program (though it 2) Relaunch the economy: of a primary budget surplus of 1.2%
recently signed a $3.5 billion financing of GDP and stabilize gross debt,
Even without the Lava Jato scandal,
deal with the China Development including cutting some subsidies and
Brazil’s economy is “a mess,” as
Bank). Folha de Sao Paulo wrote spending programs. Nor has he shied
The Economist put it recently with
recently that CFO Ivan Monteiro away from polemical statements,
characteristic British understatement.
has “the worst job in the world.” Mr. calling a measure backed by Ms.
The economy is in recession, with
Monteiro joined the company on the Rousseff that allowed companies to
economists expecting GDP to fall
coat-tails of CEO Aldemir Bendine, reduce social security contributions “a
by anywhere between 0.5% and
who was appointed by Ms. Rousseff joke that cost 25 billion Reais per year
2% this year. Inflation is running
after her protégé, Maria Das Graças and did not create or even protect
at an annualized clip of about 8%,
Foster resigned as CEO, along with jobs.” But the problem is that Mr.
significantly above the range set by
five top executives. Mr. Bendine, who Levy “is very isolated,” in the words
the government of 2.5% to 6.5%.
previously ran Banco do Brasil, is of former Central Bank governor
Unemployment, at 6.8%, is rising,
now seeking to slash costs, shed $13.7 Arminio Fraga, and the government
and the economy is creating fewer
billion worth of assets and downsize does not have a full growth agenda
jobs. Consumption, the engine of
Petrobras’s $206 billion investment beyond pushing a fiscal adjustment,
Brazil’s growth in the past decade, is
plan. which is viewed as a necessary, but
falling, and investment is expected to
Given Petrobras’s weight – its invest- insufficient, pre-condition. And this
fall by 0.7% this year. The Real is at
ments represent 10% of Brazil’s total, is where Lava Jato does not help: Mr.
its weakest level against the dollar in
its operating expenses are higher than Levy’s bet was that the recessionary
12 years, having depreciated by 30%
the government’s annual expenditures effect of his fiscal measures would
vs the dollar since Ms. Rousseff’s re-
on its Bolsa Familia social program be offset by a confidence shock that
election.The government is in a policy
and the taxes it pays amount to 5% would stimulate investment. But with
bind: to control inflationary pressures
of Brazil’s total tax take-its woes have Petrobras and construction companies
(partly the result of the government
set off a chain reaction throughout the facing liquidity issues, the country’s
lifting a pre-election price freeze on
Brazilian economy. Suppliers such as investment engines are stuck, and
gas, electricity and transportation
Sete Brasil, which makes platforms confidence in the government’s ability
prices), the Central Bank has pushed
and probes, is close to bankruptcy. to boost growth in the short-term is
through a series of interest rate hikes,
Construction company OAS has low. Says economist Mario Mesquita
and the base Selic rate is at 12.75%,
suspended payments on its 2021 of Banco Plural: “The Petrobras
one of the highest rates in the world.
debt in order to preserve liquidity topic has become a macro issue this
But these successive hikes risk further
after being banned from bidding year, because of the risk factors, the
strangling the economy.
for contracts with Petrobras and has company’s decelerating investment
Ms. Rousseff has repeatedly tried to lay plan and its significant macro-
sought protection from creditors.
the blame for the country’s stagflation economic implications.”
News reports have suggested that a
on a challenging international envir-
number of construction companies
onment. But to many economists,
are considering seeking protection
from creditors as their liquidity dries
the problems are home-grown, the 3) Regain political
result of Ms. Rousseff abandoning in credibility:
up. Banks face the risk of defaults
her first term the country’s “tripod”
and large provisions on outstanding Rarely has a government lost
policy – inflation targeting, budget
debts and are requiring guarantees momentum so fast: Less than
surpluses and a floating currency – in
from the 25 construction companies four months after her re-election
favour of a so-called “new economic
that are effectively prohibitive. As a (admittedly by 51.64% to 48.86%
matrix,” a mix of stimulative measures
result, many are unable to honor their for Aécio Neves, the slimmest margin
including tax cuts on a broad number
commitments on other projects such of any president since Brazil’s return
of sectors and subsidized credit. In a
as roads or airports – just at a time to direct democracy in 1989) Ms.
stunning policy reversal, Ms. Rousseff
when the government is hoping to Rousseff is already facing calls for her
appointed Joaquim Levy, a notorious
relaunch infrastructure investments impeachment (which is improbable
fiscal hawk, as Finance Minister in
to jump-start the economy. as Brazil’s constitution says a standing
her second term. With Brazil at risk
of losing its investment grade, Mr. president can only be impeached for
Levy has not shied away from tough acts committed during the current
measures in order to achieve his aim term in office) and massive street
protests against her government. An
4 | 2015 | BRUNSWICK ©estimated 2 million people marched the government, even though both the government’s fiscal adjustment
against her government throughout men are part of the PMDB, the largest makes its way through the economy.
the country in March and another party in Congress and a key ally of Most economists believe at least
660,000 marched again last Sunday. the government. Sensing a weak part of the adjustment program will
Her popularity level has fallen to an government, the PMDB appears to be approved, and Ms. Rousseff has
all-time low of 23% in February from be trying to increase its influence by started defending it more vigorously
42% in December, coinciding with playing hardball and impose its agenda. as a necessary step, but it’s likely to be
what Estado de Sao Paulo calls “the Last month, after a public squabble watered down somewhat as it goes to
most intense reversal of economic with Mr. Cunha in a Congress session, Congress.
expectations in the past two decades.” the PMDB forced the resignation of But to her credit, Ms. Rousseff has
A new poll by Datafolha shows that education minister Cid Gomes. “The said the investigation will continue,
60% of Brazilians characterize her PT and the PMD seem opponents, treat whatever its consequences. The fact
management as bad, while 27% say themselves like opponents and have a that the investigation is proceeding
it is “OK” and 13% say it is good. level of dialogue typical of the most unimpeded and Brazilians are taking
The poll also showed that 63% ferocious opponents,” wrote Veja. This to the street en masse but peacefully
believe Congress should open an lack of support has raised fears that to demand change attests to the
impeachment procedure against Ms. he government could have difficulty robustness of Brazil’s democracy.
Rousseff – but 64% also said they passing legislation through Congress, The prospect of an impeachment
believed she would not be removed further complicating implementation procedure at this stage is unlikely.
from office. of the austerity package. Risk consultants Eurasia Group
Her drop in popularity is due in part to Where does all this leave Brazil? It ascribe a 20% probability to that
the fact that she has disappointed her would be easy, given the converging scenario. In fact, Brazil has a tradition
own electorate by implementing the challenges and pressure from the of expressing anger or frustration,
economic policies that she attacked streets, to believe that the government and then moving on (as was the case
during her campaign, leading some is on its last legs. And indeed, Ms. with the protests that rocked Brazil
to speak of “electoral fraud.” Like Rousseff faces two big constraints: in 2013). The greater risk is that
the 2013 protest movement, it is also 1) The Lava Jato scandal is clearly not Ms. Rousseff becomes a lame-duck
partly due to general exasperation going away quickly – if only because President, beholden to Congress,
with corruption and poor public the US Department of Justice and the and the country muddles through
services – cities such as Sao Paulo SEC have also opened investigations, for the next few years, once again
face the risk of water rationing as low as Petrobras trades in New York. disappointing those who believed
rainfall aggravates lack of investment New revelations are expected. While the proverbial land of the future
in infrastructure and poor planning by the recent disclosure of the list of was finally living up to its potential.
the government. beneficiaries is likely to shift the focus Ms. Rousseff needs to quickly show
But Ms. Rousseff has also brought some somewhat away from the corporate she has heard the clamor from the
of the problems onto herself by her world and more towards individuals, streets. She is seeking to regain the
solitary, top-down style of governing. a key question will be whether or initiative through a new package of
Having promised “dialogue” after her not companies will manage to reach anti-corruption measures that would
re-election, she has had a conflictual leniency agreements with authorities, reform campaign financing. She is
relationship even with the leaders accepting to pay fines in order to also seeking to open dialogue with
of the parties who are part of her be removed from Petrobras’s black her allies, relaunch infrastructure
coalition. In a recent setback for the list. Ms. Rousseff says that “people investments through more favourable
government, efforts to push through should be charged, not companies,” concession terms and attempt to
by decree a key part of its austerity for fear that punishing companies improve corporate governance and
package – a partial roll-back in payroll will delay key infrastructure projects compliance at Petrobras. Brazil’s
tax breaks – was shot down by Senate and set off a chain reaction leading presidential system still gives Ms.
President Renan Calheiros, saying to further economic slowdown and Rousseff some breathing space, but
it should go through the normal – higher unemployment, but others are to save her presidency, she needs to
but slower – parliamentary process. pushing for the full force of the law change her style and show the deft
Similarly, the President of the House to apply. political touch and leadership that she
of Representatives, Eduardo Cunha, has so far failed to display.
2) The economy is likely to get worse
has shown signs of rebellion against before it gets better as the impact of
© BRUNSWICK | 2015 | 5Brunswick Group
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Thomas Kamm is co-head of the Contact Brunswick São Paulo
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experience in diverse aspects of corporate
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acts as a senior consultant to clients on
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particular emphasis on retail and consumer
Avenida Dr. Cardoso de Melo,
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1340, Sala 42, Vila Olimpia,
Thomas joined Brunswick in Paris in 2005,
Sao Paulo, SP, Brasil, 04548-004
prior to which he worked for 18 years as
Tel: +55 11 3076 7620
a foreign correspondent and bureau chief
for The Wall Street Journal in Europe, Email: saopaulooffice@brunswickgroup.com
South America – he was based in Rio de
Janeiro from 1989 to 1994 - and Africa. www.BrunswickGroup.com
Subsequently, he was vice-president for
communications and corporate affairs and
a member of the Executive Committee of
PPR (now called Kering), the French luxury
and retail Group.
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