The financial crisis and the leather market

 

Flávio Castelo Branco
Executive Manager of the Economic Policy
Unit of the CNI – National Confederation of Industry.

With privileged seat from which he can see and analyze crises and opportunities for the industry, Castelo Branco gives objective opinions about the current moment. In short, he provides an interesting frame within which each company must be included and evaluated.
1. How does the financial crisis started in the U.S. will affect the Brazilian trade balance in 2009? In export and import? Exchange? Credit? Loss of market?
The financial crisis has become a global crisis, with the occurrence of recession in industrial countries and a slump in their demand. This will affect Brazilian foreign trade. We expect reduction in the growth of exports value, as a result of lower export prices and reduction of some specific markets. Imports will show lower growth, with some deceleration in the pace of domestic activity and as a result of the adjustment in the level of exchange. Gains in exports will gradually appear, but in the short and medium term there will be effects of the lack of credit (for exporters) and recession.
2. Will the internal market be lower in 2009, especially for non-durable goods such as footwear? Is it possible to balance external trade losses?
There will be some reduction in the rate of growth, but with less damage to the internal market, which goes on with expansion of employment and income. The lower availability of credit will hamper the demand for durable goods, but the goods that are less dependent on credit, such as footwear, should not be so affected. In addition, the exchange rate may encourage this segment for competition with imports in the domestic market.
3. The estimates of GDP – Gross Domestic Product growth (general and industrial) for 2009 were revised? How much?
We do not have a clear scenario for 2009 yet, so it is difficult to talk about forecasts. Let us imagine, preliminarily, that GDP growth is reduced to something close to 3.5%. Industrial production should follow in a little higher rhythm, around 4%.
4. And for productive investments? How will this affect industrial production? Etc.
Investments may suffer some revision, depending on the segment and the degree of international integration. The larger projects may have extended their horizon, but the projects in development and the production adjustments, such as adjustments and updating of product lines, should not suffer greater impact. The key is to keep more and more financing lines, so that there are no changes in the company's financial schedules.

COUROBUSINESS Analysis

Credit, exchange and market

Credit: Ten out of ten entrepreneurs answered without hesitation that the financial crisis is beginning to affect the leather market through credit. Lack of credit for export and credit more expensive for any activity. Immediate reaction of the entrepreneurs consulted by COUROBUSINESS, the problems arising out of credit have consolidated over the month of October, creating enormous difficulties for the formalization of contracts of ACC – Cash Advance on the Credit Contract.

Exchange: A good portion of respondents talk, in addition to credit, about the exchange rate issue. If on one hand the dollar appreciation could result in higher gains in exports – since it does not reduce in volume, some warn – on the other hand it results in risks for those who have high debts due to investments in foreign currency. From January to September 2008, leather and footwear have already imported about US$ 13.5 million in machinery and equipment. The Brazilian Real devaluation, even through low international liquidity, for many of respondents should be maintained, with the exchange rate determined around R$ 2.20. This is an exclusively opinion from the point of view of the exporter of leather. The exchange rate pressure, says one of respondents, inserting a new element on discussion, ‘can unbalance foreign business continuity because the importer will extend their purchases until we have reached a balance again, that is, it is the end of speculation with the dollar’. Investments in the purchase of machinery and imported equipment should be reduced until a new balance.

Market: Some people believe that the exporter leather industry will face – many people are already facing – a reduction in demand and so the answer is also valid for the internal market, all depending on the brake of repair that the market takes in times of uncertainty and unpredictability. Some people believe that even before the financial crisis the international price of Brazilian leather was already outside the international reality. This assessment coincides with that made by Wolfgang Goerlich in the previous edition of COUROBUSINESS. Exporters of Wet Blue, on the other hand, consider that one of the aspects that should be reviewed by the Federal Government is the removal of the effect of Export Tax, due to the harmful effects that it causes to prices.

Some exporters assess that the effects of the crisis arrived at a time when the foreign market had already started to reduce, and the synthesis is in the answer of an important exporter: ‘The sale to the foreign market had already fallen before the global financial crisis and now it has considerably worsened. Our clients abroad have no demands and no capital financed by banks, because the movement of currencies between banks is restricted. Banks that have money are afraid to lend and not receiving and banks that need to borrow have nowhere to find money, and when they find, the interest are 80% to 100% more expensive than 45 – 60 days ago’.
Many of these comments were made during the most critical moments in the middle of news about financial institutions bankruptcy, state interventions, declared losses of companies and so on. However, many of the entrepreneurs consulted by COUROBUSINESS said that they do not believe in a change of expectations for short term. For them the leather segment will close the year lower than in 2007, exports may be a little less than US$ 2 billion and 2009 is still uncertain.
Reaction of the Federal Government

The Federal Government took a while to react, but it has taken some measures regarding the financing of exports. It edited the Provisional Measure 442, which authorized the Central Bank to make loans in foreign currency with resources of international reserves, since the banks should direct the resources to finance foreign trade only. The first auction of U.S. dollars (about US$ 2 billion) took place on October 20 and it must be applied in ACC – Cash Advance on the Credit Contract and ACE – Cash Advance on Exchanges. Once restored the finance flow for export, the expectation is to resume business.

Effects from outside to inside

In the external front, the higher concern is about the U.S. recession and about how much it will it affect the Chinese demand for shoes. According to ABICALÇADOS, national organization that unites the Brazilian footwear companies, the fear is associated with the possible new destination that China will give to footwear that will no longer go to the U.S. and also to Europe, a victim as well as America, even if in a lower dosage. Some people talk about ‘invasion of Chinese footwear in the domestic market’ and they speculate that the dollar will not be an obstacle. The president of ABICALÇADOS, Milton Cardoso, in a speech to the press said objectively: ‘I know some manufacturers from China that are giving 40% and even 50% off on their products to send to Brazilian market what they cannot sell in there’.

Brazilian import of footwear from China is a phenomenon that grows with consistency in the last years. In 2006 we imported 18.5 million pairs; in 2007, 28.6 million. From January to September 2008 we have already imported 30.8 million pairs, of which 26.7 million were from China. If the forecasts of ABICALÇDOS are confirmed, the crisis is causing trouble for the external and internal footwear markets at the same time, and this is not good for Brazilian economy.

For tannery industry, large supplier of raw material to China, Hong Kong and Italy, the recession of Europe and North America is not a good new, since the demand for leather will certainly decrease. The uncertainties about 2009 are due to that.

COUROBUSINESS suggestion for working capital

One of the demands that the private segment should present to the Federal Government – and should already have done so – in order to alleviate the liquidity crisis, not only for export but also for working capital, is the ability to use tax credits arising from export as a currency for automatic compensation of tax debits, in a federal and state level. It would be an urgent and reasonable response, at a moment of crisis, for an absurdly unfair situation which is the default of the federal and state governments in the case of tax credits. Certainly there are some bureaucrats who will argue that governments will also lose revenue, but it is a small argue in comparison to the positive effects for the economy, and the way of consequence for the collection, which would result from such measure. The segment and national entities which represents the entrepreneurs have the floor.

The crisis according to third parties

From the top of the chain to its end there are problems and each one evaluates according to their business universe. After Sadia’s announcement to the Securities Commission about a financial loss of R$ 760 million, resulting from foreign exchange derivatives, the main economy paper of the country, VALOR, presented the following headline in one of its sections: ‘Sadia causes slump of R$ 2.4 billion in the value os slaughterhouses’. Such headline has to do with devaluations of shares of companies of the segment and with debts in U.S. dollars. In the center of the crisis, and before the MP 442, the president of the Banco do Brasil, Antonio Francisco de Lima Neto, was objective in the same paper: ‘The lines of long-term financing for big exporting companies for the country to pay for new investments are completely dry’. The president of the Banco PNB Paribas in Brazil, Louis Bazire, had no doubts: ‘The credit will remain limited for some time’. In the middle of so many news and reviews, there was still space for the same paper to report that ‘an exporter of footwear segment from the south of the country achieved a temporary injunction on the 4th Civil Court of Porto Alegre, in order to not having to pay HSBC Brazil Bank the damages caused by the exchange rate in a swap contract to a term that by now reaches R$ 418 mil’. From one end to another of the chain it begins to appear some cases of losses arising from exchange swaps, which makes the scenario even more nebulous. Not only big corporations but also medium companies saw in that operation the opportunity of improving their exchange rate position in face of a persistent, effective and worrying appreciation of Brazilian currency. The risk was high, but we cannot blame them for that.

Final comments

From every crisis become new commitments and behaviors, until the financial market get confidence again and feel absolutely free to create new magic mechanisms. This behavior seems to be part of the essence of financial activity. It is up to financial executives of companies that are part of the real economy to distinguish what is reasonable and what is not, what increase or not their insecurity and what in fact can protect from the real risks.

The crisis finds Brazilian economy with stronger fundamentals than in 1998, for example, when the crisis in Asia caused the loss of a series of internal gains. However, Brazil will certainly end the crisis with low results: the projection of the GDP growth for 2009 has already decreased to around 3%; tax revenue will be lower because of the reduction of business and balances affected; employment follows the same line; investments in infrastructure will necessarily be lower and in longer terms; the trade balance will be affected, in both areas. If Brazil wins internationally, it is inconceivable to assume that it will be undamaged with the crisis.

Finally, as summary of the current moment, a simple but didactic expression follows, from one of the interviewed by COUROBUSINESS: ‘the demand is decreasing, our buyers say nothing, businesses are being postponed, it seems that the buyers of leather will adopt the strategy “go hand mouth”, in other words, they buy the raw material only when the sales of the finished product are guaranteed. This is a clear sign of the unpredictability that is around the leather market, internally and externally. If there is unpredictability, there is hope.