Washing away – ‘carwash’ scandal in Brazil

December 2015  |  FEATURE  |  FRAUD & CORRUPTION

Financier Worldwide Magazine

Latin America has long had a problem with bribery and corruption. For companies operating in the region, corporate malfeasance has been a major issue for years. Though efforts are being redoubled to eradicate bribery and corruption, it may be a slow process. Some of the region’s biggest economies, including Mexico, Argentina, Chile and Brazil, are often embroiled in corruption scandals.

Presently, Brazil finds itself in the grip of its biggest and most shocking scandal to date. The Petrobras scandal, known locally as operação lava jato or operation ‘carwash’, has rocked the country socially, economically and politically. The operation has exposed the extent to which the tendrils of corruption have spread through Brazil’s economy.

Even the country’s incumbent president, Dilma Rousseff, has been linked with the case, given her position as a former board member of Petrobras between 2003 and 2010. A number of opposition parties in Brazil have moved to impeach president Rousseff, filing a request with the Brazilian congress, but this would require the support of two-thirds of the house. “The opposition on its own cannot get impeachment approved in the lower chamber,” said Senator Ronaldo Caiado of the centre-right opposition party, the Democrats. Accordingly, impeachment proceedings in the lower house depend on speaker Eduardo Cunha, who is a particular enemy of the current administration. However, Mr Cunha himself has been investigated under the auspices of operation carwash. Regardless, in early October Ms Rousseff lost a legal battle when the federal audit court rejected her government’s accounts from last year, a decision which would allow the president’s opponents to try to impeach her. In a unanimous vote, the Federal Accounts Court ruled that the government manipulated its accounts in 2014 to disguise a widening fiscal deficit as Ms Rousseff campaigned for re-election.

The scandal initially began as a money laundering investigation in March 2014, but quickly transitioned into a wider exploration of allegations of corruption at state controlled Petrobras and a number of other firms. Some of Petrobras’ directors have been accused of taking bribes from construction companies in return for awarding them lucrative contracts. The elaborate nature of the racket established by Petrobras and its fellow conspirators has shocked many – especially as the company was once considered the world’s ‘most ethical oil & gas company’. Its standing in Brazilian society has tumbled in light of the revelations.

To date, the operation has seen more than 50 arrests across 11 companies and billions of dollars seized by investigators. For many analysts, the scandal at Petrobras is indicative of a larger undercurrent of corruption in Brazil, as Cynthia Catlett, managing director of global risk and investigations at FTI Consulting in São Paulo, explains. “The public perception of corruption in Brazil is that the country is plagued by what appears to be an ‘era of corruption’. Although the public is proud of the prosecutors’ commitment to enforcing anticorruption and money laundering laws, the public is interested to see the final outcome of the investigation,” she says.

Breaking the link

Brazil, like many of the world’s other emerging markets, has endured a significant slowdown in recent years. In late September the Brazilian government revised its 2015 economic recession estimate to 2.44 percent from 1.49 percent. While the country’s GDP barely increased at all in 2014, this year has been particularly damaging. The country saw a decline of 1.6 percent in Q1 2015 and 1.9 percent in Q2, officially putting the economy in recession.

Consumer confidence in Brazil has also fallen, reaching its lowest level since records began in 2005. Given the difficulties in the national economy, the government is unable to boost investment. Petrobras, a significant national employer, is unable to step into the breach due to the depth of the scandal in which it is currently embroiled. Spending by the company has been slashed, which has had a hugely detrimental effect on the national economy. Petrobras is Brazil’s single biggest source of investment, and a large network of companies and suppliers are reliant on it for business.

In June, Petrobras cut its long term spending plan to its lowest level in eight years. Between 2015 and 2019 the company will invest $130.3bn – 41 percent lower than the $221bn projected in its previous five-year plan for the 2014-2018 period. The move is designed to reduce the company’s debt pile and restore some of the eroded investor confidence in the firm. Due to the size of the company and its importance to the Brazilian economy, the drop in Petrobras’ investment into Brazil may reduce national GDP growth this year by a full percentage point. All this at a time when investment is needed to restart growth in the perilous Brazilian economy.

The national economy is in the midst of its worst recession for 25 years. With the real plummeting to historic lows, unemployment rates spiking and the country’s rate of inflation significantly higher than the government’s target, Brazil’s economy is in serious trouble.

The recent dip in crude oil prices has also had a detrimental effect, as crude oil is a significant source of revenue for Brazil. The general volatility in the commodities space contrasts with the boom in the market under president Rousseff’s predecessor, Luiz Inácio Lula da Silva. Mr da Silva’s second spell as Brazilian president saw the country’s economy boom on the back of a vibrant commodities market. Chinese enthusiasm for Brazilian commodities such as iron ore and oil brought enormous benefits. However, those glory days seem a long time ago.

In the first half of 2015, the Brazilian Central Bank noted a reduction in foreign direct investment in Brazil compared to the same period in 2014. Furthermore, back in March 2015 the construction sector had reduced its workforce by 250,000. These and other issues currently permeating the Brazilian economy can be linked to the emergence of the carwash scandal.

Standard & Poor’s decision to downgrade Brazil’s credit rating to ‘junk’ in September exacerbates the situation. Petrobras’s status as the world’s most indebted energy company has not helped, and declining revenues make the company vulnerable. While some tribulations can be blamed on challenges in the commodities space, the corruption scandal has been a major factor.

“The convergence of a major political crisis with a significant economic crisis means that it will be very hard to solve one without solving the other,” says Fernando Luiz Lara, chair of the Brazil Centre at the Lozano Long Institute of Latin American Studies. “Brazil is not in a desperate situation at this point, but given the stalled political process, it might be in for a long economic slump. The political crisis has already produced a set of very conservative laws in congress, reverting the significant progressive gains of the Lula years. This worries me much more than GDP growth or nominal surplus. Indeed, one has to decouple some sectors and regions which are performing very poorly from others that are doing better. Over the last two or three years, the Dilma government seemed to be reacting to sectoral difficulties without a broader plan, and is now paying the price of this fragmented set of policies. The country needs a new set of economic priorities, but this is an impossible negotiation in the current political climate,” he adds.

Change

The investigation of Petrobras is one of a number of similar ongoing enquiries into corporate malfeasance in Brazil. The carwash scandal has been joined this year by operação zelotes, or operation zealots, which is a federal investigation into corruption at the Tax Appeals Board of Directors in Brazil. Over 70 firms have been investigated to date, including RBS, Ford, Mitsubishi and Santander. For some analysts, investigations such as ‘zealot’ and ‘carwash’ point to a renewed appetite to tackle bribery and corruption in Brazil. Indeed, efforts have been made to step up anti-corruption activities in Brazil of late. The question remains, however, given the depth of corruption in the Brazilian economy, will these efforts bear fruit? “I strongly believe that the current investigation has already unveiled real and positive change,” says Ms Catlett. “The progress of the investigation as I see it includes a successful demonstration of coordination by different Brazilian institutions and authorities, increased perception of enforcement generating a decrease in perception of impunity, increased concern by the private sector with regard to compliance programmes and best corporate government practices, engagement by society at large supporting political and cultural change, and increased enforcement of criminal corruption laws, money laundering legislation and corporate crime.”

For others, genuine change seems unlikely. “I don’t see any major political force in Brazil committed to real change,” says Mr Lara. “Everybody is playing with one eye on the next election, which might be in 2018 or earlier. The moral decadence of the PT combined with the right-wing opportunism of PSDB have opened the floodgates to the old quid pro quo parties. Between 1995 and 2010, Brazilians had a clear choice between a neo-liberal project promoting small government and privatisation, and a social-democrat project of welfare state and redistribution. This clarity does no longer exists, and it will take some time for Brazilian political forces to reorganise around this shuffled deck of cards.”

With a number of ongoing high profile investigations, a president under threat of impeachment and an economy teetering on the brink, change is needed. Efforts to reinforce the local economy are underway, with the government launching an austerity package it believes could provide a shot in the arm. It will include freezing public sector salary raises and hiring, entirely eliminating 10 of 39 ministries, cutting 1000 jobs and drastically reducing housing and health-related social spending. Though the package will likely be incredibly unpopular, the government has been compelled to act by the country’s economic plight.

The carwash scandal, much like Brazil’s economic struggles, will continue into 2016 and beyond. Given the scale of the controversy and the players involved, the investigation still has a long way to run. The introduction of new anti-corruption legislation in 2014 was a key step in turning Brazil away from bribery and corruption. “The growing scrutiny and demand for transparency and ethical business practices has certainly played a part in the increasing number of corruption scandals,” says Ms Catlett. “Enforcement and commitment by the public and private sector, as well as instilling the concept of accountability locally, will be the only drivers for change.”

There are positive signs elsewhere in the system – but some believe they only go so far. “The latest decision by the supreme court on prohibiting business donations to political campaigns is a step in the right direction,” says Mr Lara. “However, consider the situation in Brazil compared to the recent VW emissions scandal. Do we think the VW scandal will make automakers more cautious on their emissions test systems? Yes, for a little while – until they find another easy way to maximise profit. The system is deeply broken, and I don’t see many people with courage to tell the truth and start real reform,” he adds. One thing is for certain: lessons must be learned if the country is to ever say that its economy has been cleansed.

© Financier Worldwide

BY

Richard Summerfield