Brazil's Election Outcome Will Negatively Impact Telecom

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1 Research Brief Brazil's Election Outcome Will Negatively Impact Telecom Abstract: Soon-to-be President da Silva s policies will have a negative impact on Brazil s economy and the telecom marketplace. By Marta Kindya and Ron Cowles Recommendations Prepare for clashes with the IMF on economic policy as the composition of the Brazilian government shifts to the liberal left. Expect the new government to indirectly affect the telecom sector; in addition, the sagging economy will continue to affect the sector. The sagging telecom market could be bolstered by broadband deployment, so carriers should continue deployment as recommended by ANATEL, the national regulator. The government should tap the marketplace for increased revenue by adopting policies that stimulate business, not by raising taxes. The government can stimulate infrastructure deployment by increasing the deficient Universal Service Fund. As a result of the new administration, expect increased activity by labor unions and the creation of new labor laws that will restrict the flexibility of employers in the telecom sector as well as inother businesses. Publication Date: October 23, 2002

2 2 Brazil's Election Outcome Will Negatively Impact Telecom A New Era Is Dawning in Brazil Gartner Dataquest Perspective The Social Democrat government in Brazil headed by President Fernando Henrique Cardoso will soon be replaced by the leftist government of Luis Inacio Lula da Silva (known as "Lula"). This is Gartner Dataquest's prediction for the impending 27 October 2002 elections. We are not alone in this prediction. The upcoming elections are a mere formality and are happening only because da Silva failed to achieve a majority vote on the primary elections held on 6 October. So imminent is the outcome that da Silva's opponents are beginning to throw their support his way. Brazil has many serious problems to solve, and the Brazilian people are choosing a change in regime as the solution. da Silva's Policies Will Have an Impact on Brazil's Economy There will be important implications for the economy and the telecommunications markets if da Silva wins, which is a near-certainty. And it's already beginning to happen: Brazil, the world's ninth-largest economy, has seen its currency plunge to record lows over financial market concerns about a possible da Silva administration. Gartner Dataquest predicts the following: da Silva will have to win investor confidence, so he will not introduce any wide-sweeping policy changes, at least initially. For the same reason, da Silva will initially honor the terms of the International Monetary Fund (IMF) loan. It will take at least a year for da Silva to get his new administration and the respective support staffs in place do not expect any major policy changes to be implemented in the first year. If the Brazilian economy takes a turn for the worse or does not rebound to the new administration's satisfaction, expect da Silva to tap big businesses for additional revenue. What About Economic Growth? Gartner Dataquest's third-party source for economic forecasts, Wharton Econometric Forecasting Associates (WEFA), has stated that the short-term prospects for the Brazilian economy remain weak because of the political fallout from a win by a liberal candidate. For the first half of 2002, the economy did better than expected, growing at about 1 percent. WEFA expects growth in the 0.4 percent range for the remainder of the year. No good prospects for large growth exist until Gartner Dataquest agrees with WEFA's assessments and predictions. Here's what we see: The long-term prospects remain positive (see Table 1), despite bumps along the way.

3 3 Table 1 Percentage GDP Growth 2002 to 2005 The government's monetary policies have had questionable results, as evidenced by the continuing decline of the real. The government is trying to prop up its currency by increasing the prime interest rate. This will tighten up credit and will increase the inflation rate. The election of the new administration will bring about additional economic uncertainty. The new administration will attempt to introduce its own version of economic policies. But within two years, the government will realize that many of these initiatives will fail and will be forced to return to policies more akin to the current administration (%) 2003 (%) 2005 (%) Brazil Data for 2004 was not available Source: Gartner Dataquest (October 2002) How Will the Telecom Markets Be Impacted? Gartner Dataquest maintains that the Brazilian telecom marketplace will be impacted both directly and indirectly. Directly Brazil's president has little direct power over the telecommunications regulatory body ANATEL, in its day-to-day operations. However, the president does influence the policies affecting the telecom industry and those to be followed by ANATEL. Consider the following: The president appoints the Minister of Communications. The president will be able to appoint four of the five members of the board of directors of ANATEL during his term. The president will influence policies through laws that are passed by Congress affecting the telecom sector. Indirectly da Silva has not indicated what changes he would make in the telecommunications sector. Gartner Dataquest predicts if the economy declines further or does not rebound quickly enough, the president will impose new taxes on the telecom sector. We do not expect any action along this line for at least a year. However, we maintain that policies that stimulate the telecom sector will generate more revenue for the government and would be a preferred course of action.

4 4 Brazil's Election Outcome Will Negatively Impact Telecom Recommendations for Service Providers Expand service portfolios with minimum investment Smaller providers should realize incumbents will dominate through 2006 and beyond. One possible entry strategy is to find niche markets, especially targeting small and midsize companies. Seek alternatives that can be exploited through third-generation technologies. Tap the market to its potential, which is still underserved, both geographically and by the business sector. During these economically depressed times, fully plan and execute capital expenditure (capex)/operating expenditure (opex) agendas to remain competitive and to meet service targets/government obligations while deferring to other periods as much as possible outside the economic downturn (which we predict will last until 2005). Attempt to renegotiate vendor contracts for the same reason. Expect few new startups (those entering the market). Those that do enter the market will be well-established firms, such as AT&T. Be aware that despite the rhetoric of da Silva, the industry will be tapped harder than ever. Here is what to expect: Even-higher taxes on the most taxed telephone system in the world put in place to help balance the federal budget Fiscal/monetary and economic policies to be imposed that would not be part of the Cardoso administration's policies Recommendations for Vendors The market opening to competition "which under normal circumstances would bolster investment" will be overshadowed by the economic downturn and the election of a liberal president. The new administration will take a different course than that followed by the previous administration. Expect the following: More emphasis on sustaining viability of incumbents The open market for startups will stall competitive inroads for three to four years. The sagging economy will not soon bottom out. Select funding carefully. Operators with insufficient business plans will fall by the wayside in two years. Orders for equipment will continue to be slow until the economy rebounds. da Silva will favor domestic vendors such as Tropico, ASGA, CPqD, Intelbras Gradiente and others, with increasing pressure on international vendors with plants established in Brazil.

5 Recommendations for End Users Enterprise customers should not place all service needs with one operator. Build for redundancy to counter the possibility of service interruptions and service provider failures Seek voice over IP (VoIP) solutions because it is less expensive. The question remains whether clients are willing to give up service reliability in favor of improved cash flows in a sagging economy. Explore the benefits created by broadband access applications such as second-line replacement and voice over Digital Subscriber Line (VoDSL) Expect that the last-mile problems will not go away anytime soon, because of curtailed investment. By this we mean: Non-existent facilities in some areas Low-quality facilities in some areas No competitive choices in most areas, even with other technologies 5 Key Issue What regulatory changes are expected and how will they affect competition?

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