What has happened to Brazil? A sudden slowdown in the country’s economic growth has put a halt to what was to be the irresistible emergence of the LatAm Dragon. Clearly, the Brazilian economy has overheated and the numbers prove it. Gross domestic product (GDP) growth, a robust 7.5% in 2010, went down to 2.7% in 2011 and was less than one percent in 2012. Inflation also has continued to maintain itself in a range around 6% today.
According to the Banco Central do Brasil (BCB), the country’s seasonally adjusted industrial production index fell in 2012 by 4.05% in the state of Sao Paulo and by 5.52% in the state of Rio de Janeiro. In the past year, the government had to take drastic measures to manage this downward spiral by making unprecedentedly sharp cuts in interest rates – from 12.5% in August 2011 to 7.25% by October 2012 – and many say that even this might not be enough. A massive US dollar (USD) inflow created a short-term bubble in the financial markets in 2011-12 and the government again took stringent tax measures to minimise any short term speculative inflows. While the situation seems to have stabilised so far this year, some have been hurt. The most recent BCB meeting on interest rates held by the Comitê de Política Monetária (Copom) on 16 January decided to maintain the current interest rate level, but until when?
Despite these setbacks, it appears that Brazil’s economic engine is still roaring; indeed the macro picture is significantly more positive. A number of indicators are still at green and the country still enjoys relatively strong fundamentals. For example, Brazil continues to build strong foreign exchange (FX) reserves. USD reserves touched a record high of US$377bn this month, up from US$250bn two years ago and a figure equivalent to nearly 16 months of exports.
Foreign direct investment in Brazil, which stood at US$65bn in 2012, remains strong and continues to fuel the economic engine although foreign investment in bond and equities has slowed as a direct consequence of the new tax measures. Both net debt to exports and net debt to GDP continue to be negative and have remained so for five successive years, which are strong fundamentals. Inflation has been relatively restrained, edging lower from 6.5% in 2011 to 5.8% in 2012.
To this can be added improved export diversification with China becoming Brazil’s most important client in 2012-13, representing 17% of total exports against 6.3% as recently as 2006 and putting the Asian giant at the same level as Europe. Brazil’s unemployment rate is at its lowest in 10 years at around 5.4%. Industrial output is still high and robust despite a slowdown since 2010. The supermarket sales index has been regaining strength over the final months of 2012, following a period of weakness in 2011 and earlier last year.
Finally Brazilian banks remain extremely well-capitalised, with an average tier 1 ratio of 16.5% in 2012 according to BCB figures, whereas the Basel rules require no more than 8%. So while 2012 has been a very difficult year, economists as well as the BCB forecast economic growth of 3% or above in 2013. Some economists have alluded to the so-called ‘5-5-5 equation’ for Brazil – for which read a 5% interest rate, 5% inflation and 5% unemployment – as the country’s formula for sustainable growth and it appears that this is progressively being achieved. Consensus on the interest rate outlook is that rates should remain stable at around 7% in 2013 if GDP growth indicates a recovery is underway. On FX, after a readjustment by the real (BRL) of more than 30% against USD over the past year, the general consensus is for a rate of around BRL2 per US$1 for this year.
Acquisitions: Dream, Reality and Costs
For many multinational corporations (MNCs) that completed acquisitions in Brazil over the past four years, the recent slowdown has provided something of a cold shower. At worst they bought overpriced assets at an overvalued exchange rate (over the past 15 months the BRL has effectively lost 32% of its value against the US dollar), spending on costly integration and experiencing unwelcome tax surprises. At best, although they made an expensive purchase it was in a relatively well protected sector that continued to enjoy growth despite the economic slowdown. However, the latter group has been very much in the minority.
For the unlucky ones, it might be some time before the good times return and in the meantime it’s not a question of integrating and streamlining but also a race to make the bottom line look as good so that head office still has a smile on its face when budget time comes around. While the past five years have been focused on acquisitions, market share and customer care, the pressure has now shifted to results. Maybe it is time to look at costs, an area that has been relatively neglected by Brazilian senior management in recent times.
New Challenges for CFOs and Treasurers
The majority of Brazil’s chief financial officers (CFOs) and corporate treasurers have been on the hook over the past months in Brazil. Chief executive officers (CEOs) and CFOs faced a difficult exercise during the months of October and November last year in crafting and defending the 2013 budget. They had to contend with:
- An economy at near-standstill, with less that 1% growth in 2012.
- Stagnation at best in consumption, and in some cases contraction.
- A jump in the cost of goods sold, reflecting local inflation and still-huge import taxes.
- A continuous heavy indirect tax burden.
- Inflation in salary rates; sometime reaching European levels.
Each of these factors created tensions and squeezed budgets and resources.
It is now time to look above the line and consider if and where budget reductions and cost savings can positively balance operating revenues at risk. More aggressive tax planning, wherever possible, is also part of this tactic. All corporate functions including sales, operations, manufacturing, procurement and finance are being asked to watch their costs and contribute savings. CFOs and treasurers must play their part in this exercise. Salaries and staff expenses are being scrutinised and the recruitment market has suffered a near-freeze for certain functions, due to a mismatch between what executives are demanding and what companies are actually prepared to pay. The financial executive market is no exception to this condition.
CFO and corporate treasurers usually have good room for manoeuvre, as in most companies cost-cutting has not been at the top of the agenda. Employees’ expenses, travel, company cars and other benefits are the first to appear on the list of easy savings. Treasurers can definitely look at their financial service providers to reduce costs, starting with banks. Cash management, debt, car leasing, payroll, payment cards or IT providers are good potential areas for savings. Although the Brazilian bank market is relatively concentrated, with three locals (Banco do Brasil, Itau and Bradesco) and three internationals (Citi, HSBC and Santander) competition is nonetheless fierce and banks are still looking to grow their market share.
Banks in Brazil have seen their revenues grow at an unprecedented pace over the past five years. A high interest environment, booming capital markets and record consumer spending have all contributed to the mix. In addition, banks have been able to maximise and concentrate on the short-term part of their balance sheet, achieving excellent return on assets and growing revenues in areas such as consumer loans and cards for instance. They also enjoy the luxury of not having to book too many of their long- term assets. The state development bank, Banco Nacional de Desenvolvimento Econômico e Social (BNDES) uniquely occupies this role with US$76.5bn in corporate loans disbursements in 2012, most of them long-term.
That said, Brazil’s banks hold more long-term positions than in the past, especially in the derivatives area such as interest rate and cross currency swaps particularly, following the recent access of their corporate clients to long-term capital markets. To complete the picture, banks have been fed by a strong flow of merger and acquisition (M&A) and fixed income fees, cross-border M&A deals and bond issuances.
As the Brazilian bank market remains so concentrated, with a notable absence of second-tier banks, only a handful of players can share the growing cake. Aware of the situation, the Brazilian government has been putting pressure on banks to reduce their interest rates on consumer loans and mortgages and to step up their lending to the infrastructure sector.
In response to this environment, treasurers should more than ever look towards optimising their banking relationships and making sure they are getting a best-in-class treatment against their peer group. At the same time they must aim at having a fair and transparent business relationship, where the bank is adequately remunerated for the service and asset commitment it provides.
How CFOs and Treasurers View their Priorities for 2013
As 2013 began, Latina Finance interviewed 10 CFOs and treasurer of major Brazilian corporates from different sectors on their priorities for the year. Three key areas emerged from those consultations:
Tax efficiency: This is more of a recurring issue than a new one for treasurers in Brazil, which still has one of the heaviest and inefficient tax systems on the planet. Treasurers are calling for simplification and stability. The challenge is around improving tax planning and, above all, optimising the burden of Brazil’s tax on financial operations dubbed the IOF. The tax is payable on all financial transactions, including FX hedges for which the usual rate of 0.38% increases to 1%. Improving IOF on international payments is also an important goal for importers and non-exporting companies as they are not permitted to open hard currency accounts offshore.
Process optimisation and control: This year will see a continuous focus on the improvement of companies’ internal controls and procedures, coupled with the re-engineering of processes and systems. This will include improving the usage of electronic banking (e-banking) platforms and new payment systems such as the direct debit authorisation, Débito Direto Autorizado (DDA) and the Boletos payment network. Generally speaking, the aim is to better integrate and maximise technological solutions from financial service providers.
Cost control and savings: There is a clear focus on cost control towards delivering the bottom line, given the volatile general environment, and improving financial providers’ services and related costs. There is also a consensus from treasurers on the need for better monitoring and negotiating of short-term banking facilities, which can be very expensive, as well as reviewing financial agreements and general terms and conditions.
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