Friday, 24 March 2017

Micro Level Trends – Brazil's Automotive Sector – “Brazil 66”...Sixty Six Years of Economic Power Lifting (Part 5.1.2)

This portion of the web-log continues to summarise the prime events that impacted the busts and booms of the national economy in the modern era (the 1980s onward); having already described the major impacts of :

- The Latin American (Sovereign) Debt Crisis
- The Plano Real
- The 'Asian Tiger' Crisis

However, after nearly 2 decades of stagnancy and delayed economic fruition, Brazil did indeed experience what might be termed as its '3rd Golden Age of maintained growth with the arrival of the 21st century.

The Global Commodities Boom -
(1999 – 2013)

As is well appreciated, for investors and the mass-populace alike, the 'psycho-geography' of the country is its prolific connection to the provision of basic agriculturally grown and ground-extraction commodities.

Previous description highlighted how 'the earth' originally provided for aboriginal peoples, but thereafter became an engine of wealth creation for the first European settlers and their successive generations, who satisfied not only local demand for foodstuffs and materials, but to great advantage also financially gained enormously from the exportation of an ever greater spectrum of items to Europe, North America, and thereafter the Middle East, Asia and Africa.

This ability brought the regional land-owners immense wealth and effectively continued the 'Patron' and Subordinate relationship well into the 20th century, as such incomes were re-directed into more and more industrialised activities, on the farm, under the ground and across a plethora of secondary and tertiary commercial activities.

At the national level through-out Brazil's modern history, it has largely been the income made available from that combination of mother nature's bounty coupled with man's technical ingenuity that has provided the national income to create the foundations for further increasingly diversified growth that has promoted ever greater social inclusion. Whether that be industrial subsidisation together with legislatively capped wage-rates to allow SOE companies to employ greater numbers of workers and so spreading the national wealth more evenly (such as 1960s FNM trucks), or the well-considered latter-day social-welfare programmes designed to reach those trapped in the vicious cycle that is poverty (seen in the 2010s with education and child-support for single young mothers).

The re-investment from commodities then help to 'de-commodify' what was once a relatively homogeneous workforce, as the generational off-spring of farm and building labourers themselves became better skilled and so perpetuated Brazil's economic expansion.

However, as well recognised by Brazil's 1930s economists, reliance on commodities was and is a precarious affair, given the typically low volumetric value of many grown crops and mined ores
compared to higher value-added products and services, and the volatility of national and international markets. The only exception that of precious and semi-precious gem-stones, but these obviously only minuscule in terms of volume and offering little to the overall national GDP and regional GRP.

Thus for all the arguments for uncoupling Brazil from its economic roots in commodities, the sheer size of the massive contribution agriculture and extraction makes directly to corporate profits when times are good, and indirectly to those most in need, cannot be ignored or indeed undermined in any objective consideration.

For this reason government after government has – whilst promoting diversification of the economic base - sought to also effectively bolster the critically important commodities sector, also well recognising its contribution to the continued diversification goal.

Between the late 1960s and the mid 1990s the global commodities market – and so Brazilian activity – was in an effective slump.

The period started with the North American recession, its ripples throughout Europe, the impact of the mid 1970s Oil Crisis resulting in high energy prices and so cost-disadvantageous growing and extraction and through the 1980s and early 1990s the Anglo 'trans-Atlantic' investment focus decidedly inward and dedicated to 'de-industrialisation' (including asset-stripping), new “transfomative” IT, the growth of knowledge services and of course the banking and investment profits enabled by the expansion of the housing sector (in new build and redevelopments) assisted by sizeable base-rates and so interest-rates.

Effectively over that long 25 year period the only interest from specialist investors within the general commodities arena was regards oil-price spike speculation in 1974/5 and gold as many specialist and lay investors sought safe-haven allocations through the much-distressed era.

With most of the world in what appeared a slow economic melt-down (excluding the continued rise of Japan), consisting of high inflation, public disquiet, trade-unions' voices, workers strikes, increasing unemployment and so decreased tax-takes to central government and municipal budgets creating further unemployment and so economic malaise, there was seemingly all the reason in the world that the commodities sector would inevitably become as much a 'ghost territory' as the mining 'ghost-towns' of old.

But from the mid 1990s, and most visibly from 1999 onward, a massive change of sentiment would occur as the global economy became stronger thanks to the outcomes of results of previous historical 'Global-Macro' events.

The 1989 collapse of the USSR initiated the 'opening' of Eastern Europe and Russia to Capitalism and economic revival, the 1992 shift in India from an effectively closed 'Raj' operated industrial economy to a more open and competitive one, and the impact of China's increasing internal reforms and more 'open door' policy (aided by the return of the trading hub that is Hong Kong), and the integration of Europe under the 'EU', together all meant that the economic 'techtonic plates' of world had economically shifted massively within a decade.

This socio-political shift would be the precurser to a new globalist growth mentality that spanned from from Wall Street to Warsaw to Wuhan. The adoption of seemingly raw capitalism however was tempered with very necessary inclusion and growth social agendas. That in turn meant truly metamorphic physical alterations to cities, towns and whole regions by way of major infrastructure projects which in turn provided the impetus for incoming private capital to literally and metaphysically rise from the foundational infrastructure provided.
Brazil would experience what became arguably its most meaningful leap into a better future, surpassing its previous golden age represented by Brasilia. Whereas then the same upper-middle class merely relocated to a totemic city, from the 1990s onward a whole new lower-middle class would be created thanks in no small part to the direct and indirect income provided by globally exported basic commodities.

By the early 1990s the economic template of Brazil regards industry and services had broadened considerably, but services and the automotive element of production industry were still somewhat infant, especially regards export earnings.

Although Brazil had long since modernised, at this time there was far greater internal and external income bias towards extractive and agricultural commodities. But an renewed export stance was especially vital given the unserviceable foreign debt load of $122bn, declining internal growth, high inflation and poor policy formation.

The following comparison provides a much simplified picture regards the export split by monetary value, with a 1993 estimated vs 2015 actual.

Sources: OEC and Harvard's Economic Complexity 'Tree Maps'

Comparative Export Earnings....set-out as:
1993 (est) vs 2015

Total Value:
1993 approx $34bn 
2015 approx $195bn


Extractive :
Iron Ore and Concentrates     15% vs 8% ($15.2bn)
(as Granular/Powder)               2% vs 3.2%
Crude Oils                               4% vs 6% ($11.8bn)
Refined Oils                          1.5% vs 4% ($8.04bn)
Gold 2% vs 1.7%

Agricultural :
Arable -
Soyabean                               15% vs 11% ($21.1bn)
Soyabean Oil/Cake                  6% vs 3.9%
Coffee                                     7% vs 2.5%
Maize                                      5% vs 2.3%
Sugar Cane                             6% vs 4% ($7.83bn)
Fruit Juices                              3% vs 1%
Tobacco                                 3% vs 1.5%

Livestock -
Poultry                                  1.5% vs 3.3% ($6.53bn)
Pig Meats                              0.5% vs 1.8%
Skins                                        2% vs 1.4%

Automotive :
Assembled Vehicles               0.5% vs 2.56% ($5.0bn)
Components                          0.9% vs 2.76% (5.4bn)

(All Other Items) (not shown to aid clarity)

This illustrates the re-shaping of the general export-base of goods over two decades. But what is most obvious is the manner in which commodities maintained and indeed grew their importance to Brazil for foreign currency earnings as the notional pie grew 670% between 1993 and 2014, contracting by 14.5% in the following year shown.

An export earnings time-line depicts the impressive impact of the 'commodities super-cycle' on national income.

1993 - $39bn
1995 - $50bn (an initial 25% jump to feed China, Asia and E.Europe)
1996 - $52bn (new flat-line trend over next 3 years - effects of Asian Tiger Crisis)
1997 - $55bn
1998 - $55bn
1999 - $49bn (the beginning of the globalisation 'super-cycle' for the next 13 years)
2000 - $60bn
2001 - $62bn
2002 - $63bn
2003 - $79bn
2004 - $105bn
2005 - $122bn
2006 - $141bn
2007 - $166bn
2008 – 208bn
2009 - $160bn
2010 - $202bn
2011 - $261bn (the 'super-cycle' peak, three years after Western Financial Crisis)
2012 - $250bn (the beginning of the EM slow-down)
2013 - $245bn
2014 - $228bn
2015 - $195bn

As regards export destinations, as is well known, a fundamental re-proportioning shift took place with the rise of China (and SE Asia).

1993 – the EC 27.6%, LatAm 21.8%, USA 17.4%, Japan 6.3%, RoW 26.9%
2015 – China 18.4%, USA 12.56%, the EU (F,D) 14.3%, Argentina 6.6%, RoW 48.14%

With lesser relative imports, in 1993 Brazil had a Balance of Trade surplus of $13.1bn, whilst in 2015 the figure rose to $25.3bn. Given that in 1993 the surplus was one-third of export value, and that in 2015 the surplus amounted to 'only' 13% of export value, it is easy to understand the great degree to which Brazil both opened its borders to higher-value imported goods and services whilst arguably suffering from the exportation of low-value commodities.

Whilst its export income rose five-fold in this period, its surplus only doubled.

This then follows the necessary adherence to follow globalisation policy by better balancing the BoT so as to generate increased international mutuality. Yet Brazil well recognises the possible derogatory long-term impact of lower-grade exports vs higher-grade imports as the standard of living and expectations of the populace grows and commerce demands high-quality foreign capital goods to boost the quality of Brazilian made goods and services.

Thus possibly leading to an increasingly negative BoT if the export dimension is not well managed.

The need to adequately protect the nation's financial standing as commodity exports decline seen in the next item, government recognising a need to deflect the level of foreign imports in B2C and B2B goods and the need to internally re-invest to raise Brazil's industrial and service capabilities.

Whilst the last item of this web-log looks at how corruption around “national commodities for the public good” has recently come to light.

The 'Plano Brasil Maior' -
(2013 onward)

Brazilian economic growth between the early 1990s through to 2013, provided twenty years of improvement for many.

Wherein the old, typically functionary based middle-class (professionals, senior civil servants, etc) became the new Upper-Middle whilst others (teachers, administrators etc) expanded to comprise the new Core-Middle. And critically this new growth era allowed many to rise from the Working Poor to fill a newly emerged category: the New Lower-Middle.

Whilst obviously favourable boom economic conditions for many, the raised standard of living came at the cost of relatively high inflation rates, seen with the strengthening of the Brazilian Real.

The heavily populated urban coastal regions, the cities and tentacle suburbs, saw a vicious circle of spiral of cost and so price inflation, as the sensitivity between input costs and output costs and so ultimate price rose. This ranging across base materials to semi-finished items to physical labour to a new sets of 'professional' disciplines (formulated to propel the 'lower-middle' zeitgeist and compel consumption) to critically IT and associated services.

The ripples of the global economic recession finally hit Brazil in 2013 and even though high value exports such as vehicles are still strong, the country has found itself caught between the after-effects of its expansionary modus operandi and the new need to re-align its national cost-base (and indeed the strength of its currency).

Recognising the predicament, the Roussef government created the 'Plano Brasil Maior', which itself echoes the 'Import Substitution Industrialisation' policy of Vargas and Kubistcheck.

Of primary concern is the emerged pattern of B2C and B2B purchasing behaviour, buying ever more from foreign countries, inevitably much from the USA and so arguably an over-reliance on external entities who have vital core competencies / human resources, elements of which are beyond the domestic industry and services skills-base.

Furthermore, during the expansion of the national Service sector what is now viewed as problematic 'De-Industrialisation' also took place (this historically typical). With this a loss of suitable professionals in various fields and invariably little education and training to fill what were thought to be yesteryear activities and roles. So, just as advanced economies are struggling to re-kindle the 'economic mass' of their old industrial activities, so Brazil has also recognised this problem.

Added to the problems of the advanced skills vacuum, and those lost core skills, is the fact that those twenty years of economic expansion were also assisted by government spending on high cost infrastructure and social programmes, all paid by increasing tax revenues and increasing 'take' and higher foreign capital markets debt.

[NB The inability of the City of Rio to make a recent payment and subsequently 'bailed-out' by national coffers depicts much about the current unsustainable situation for the hosts of the Olympics and Paralympic Games].

“Innovate to Compete” is the slogan which endeavours to nurture a Silicon Valley mindset, but also beneath which a swathe of protectionist measures (in the ISI manner) are designed to provide the necessary defence against global forces (especially so with Autos and IT). So as to allow Brazil to reconfigure itself from a late 20th century 'commercially yesteryear' economic engine into a 21st century 'commercially advanced' economic powerhouse.

Thus more government and private investment is being funnelled into engineering and technological careers, an absence of these skills recognised as severe barriers to continued development.

When presented by Rouseff et al, the 'Plano Brasil Maior' had six prime 'pillars':

1. Re-Integra : tax exemption for exports, the scheme will refund between 0.5% and 4% of the costs of taxes incurred in the creation of industrialised goods.

2. Government Purchases : establishing a “margin of preference” of 25% for domestic good and services in state tendered contracts, relative to specific strictures for national and regional (re)planning regards investment in jobs, industries, locales etc around innovation.

3. Commercial Defence : the scope and depth of investigations into 'anti-dumping' practices by foreign interests strengthened fourfold in associative Ministry headcount, with specific focus on imported goods' true origins and under-pricing.

4. Certification and Research: strengthened product and process standards set by a new Quality Institute. Its prime attention regards any disparity between the quality of foreign made goods and nationally produced goods, and the creation of a network of laboratory centres across the country that formulate and 'incubate' advanced scientific and technological activities to support the initial phases of commercial transfer and exploitation.

5. Payroll Tax Exemption : to create job creation stability no new employee tax burden to those firms operating in sectors exposed to dominant foreign competition (eg clothing, shoes, furniture and software), with taxes paid refunded by a central governmental body.

6. PIS-Cofins, Tax Exemptions and Digital Book-Keeping : vitally to the auto-sector, a reduction in the 'IPI' tax on trucks and light commercial vehicles (aswell as building materials and capital goods) to promote building activities. Also, payments and compensation claims to be paid by government within 60 days to those firms with digital book-keeping.

As always such reforms generate reaction, and so various criticisms have been voiced within Brazil.

Firstly, that the pledges made by national government to take on the fiscal responsibilities of per state bodies that directly interface with commerce and workers will not be upheld, leaving firms and people to ultimately fend for themselves; this seen from a long history of such empty promises (eg the withdrawn 1950s assistance pledge Isotta-Romi).

Secondly, that this manifesto plan is limited to micro-economic issues, and absolves itself of as important macro-economic factors (ie interest rates, exchange rates and salaries).

Thirdly, that of the level of public indebtedness, whereby (as seen with the city of Rio de Janeiro) the National Treasury has taken on the weight of notionally Independent State incurred debt.

Fourthly, the likelihood that such (obvious 'back-door') protectionism seen with “Certification-ism” will compel and invoke similar actions from foreign importing nations of Brazilian exported goods and services.

Operation “Car Wash”...
and the Required Reforms -

There is an old saying that “a Policeman's lot is not a happy one”, precisely because maintaining the civil body of what passes as 'civilised society' is a very hard task. The recent events next to the heart of government in London well illustrate that whilst politicians provide the rhetoric, it is the police-officers on the ground who really 'represent' the people.

[NB it should be noted that whilst politicians are elected, seen and have a modicum of influence, it is the purity and strength of internal institutions (from social services to policing to the law) that are the effective agents of the people and for these to be strong they must be both efficient yet also well supported by a strong national purse].

This notion perhaps best seen in recent years in Brazil, wherein once near broken federal and state
police bodies have themselves gained from Brazil's commodities' driven global rise, so as to crystallise the nation's motto of “Order and Progress”. This so at both the bottom of society and at the top.

At the bottom the world witnessed how, in the run-up to both the World Cup and Olympic Games, para-military style policing was the only way by which the favellas of Rio de Janeiro, Sao Paulo and elsewhere could be cleared of the once entrenched violent drug gangs. This then providing the required home environment in which a new generation could improve itself to inturn improve Brazil.

But more recent years have seen how Brazilian law enforcement has also targeted those at the very top of society in business and politics who – although already extremely comfortably-off – sought to utilise their power for their own material gain.

Most notably by effectively creating collaborative inner-circle cliques by which to 'skim from the top' from the massive revenues and capital expenditures of the national oil giant Petrobras (and other large firms) through the intentionally inflated costs of procured infrastructure contracts.

This cam to light in 2013/14 just as the Brazilian economy started to contract because of global trade conditions caused by both the 2008 western financial crisis and the fact that the EM regions had both not ultimately 'de-coupled' from the west, and because China sought to cool-down its own over-heated economy.

These conditions led to collapse of the global oil price and a new unseen fragility to an over-indebted Petrobras. This would have immense repercussions for the national purse given the enormous contribution to government income the essentially part-privatised state-controlled oil company provided.

However, 'to add insult to injury' for the people of Brazil, thanks to an altered hard stance by judges and better empowered police, it became clear by late 2015 that Petrobras had been used as a 'gravy train' for about two-hundred senior figures

The scandal became popularly known as 'Operacao Lava Jato' (Operation Car Wash), the initial police code-word for the investigations.

[NB the promotion (by the press) and popular adoption of this very phrase itself indicates that today's masses may have greater faith in the idea of a responsible and benevolent authoritarianism, by individuals whose existence is based upon morality and decency, as opposed to the club-like 'high-tower grandiosity' of senior politicians and corporate executives].

The scandal began with an investigation into money-transfer/laundering in early 2014 between a black-market currency dealer and, his 'client' and the present of a new Land Rover Evoque. It was not the car that provided the name of the affair, but the fact that it apparently started at a Petrol-Station/Car-Wash.

[NB the deniers of the allegations will undoubtedly highlight that this location origin appears very convenient – almost unbelievably so -and was used to initially target Petrobras and gain widespread public belief in the story and so topple a powerful cohort of business people and poliicians].

It seems this activity had connections to a police report by Hermes Magnus back in 2008 regards similar attempts to launder money through his electronics parts manufacturing business.

The weight of this case led to wider exploration based upon conspiracy allegations and so possibilities between various Petrobras directors and construction firms regards the allocation of lucrative (overly high-priced) tendered contracts.

Press reports state that by by late 2016 more than R$30bn / US$8.9bn had been potentially illegitimately moves and involved a group of nine construction companies and disparate group of people numbering about 200.

The effect upon Petrobras was nigh-on implosive, delaying its FY2014 results and seeing a write-down of $17bn in 2015, nearly prey to its bond-holders who were on the fringe of seeking full liquidation had the results not been published in time, was forced to suspend its dividend payments, cut capital expenditures by 40% over the 2014-18 timelin, and required to sell $13.7bn worth of assets to reduce its high balance sheet debt.

The political impact was equally large, with enquiries into the seemingly boosted fortunes of the Worker's Party Treasurer, a Former Chief of Staff, the Speaker of the Chamber of Deputies, the Former Minister for Energy and Mines and a Former President indicted.

The gravitas of the matter, indicating its scale, became sharply apparent when the small plane carrying the Supeme Court Justice who was administering the corruption trials crashed into the sea near the tourist town of Paraty in the state of Rio de Janereiro; many believing this hardly a coincidence.

Investigations are ongoing, but the scale of the matter became apparent when the CEO of the Odebrecht conglomerate was given over 19 years because he provided over $30m in bribe payments to Petrobras personnel.

But whilst justice is seen to be done, this will not be of help to those directly affected by the virtual collapse of the oil giant. As a major employer its delicate condition means operational cut-backs so affecting the income of many; which obviously effects regional local economies, from general retailers to municipality incomes.

Petrobras was a major show-case and development vehicle for the over-due Brazilian privatisation drive, but without major change, the few but powerful internal investment institutions, the general public and external investors may be cautious about putting their personal or client monies into a what might be seen as still a questionable entity. Perhaps the only future course being a massive clear-out of top-tier seniors and their immediate lieutenants.

Critically, given the real-world impact of the scandal upon the public and investment community alike, it seems only sensible that to ensure such an episode cannot occur again within Petrobras or a similar corporation, that very necessary commercial reforms are undertaken so as to put a larger slice of the many government-controlled firms into the hands of more prosaic owners, executives and managers.

This means greater exposure to the national and international public bourses; wherein a new round of successive stake-holders – critically with financial and strategic acumen – would be better able to ostensibly 'police' the firm through much improved transparency and executive questioning.

The impact of the Petrobras scandal demonstrates that any possibility regards the overly cosy relationship between Brazilian politicians, those state appointed national champion executives and the seniors of contract-supply firms, must surely be over.

The true scandal would be if the current status quo continued unabated, since it would deter optimism and new allocations of domestic and foreign capital; new capital that would serve the many, not the few.

To Follow -

A summary of the current economic climate, underpinned by the OECD's observations and findings regards Brazil's near and medium term socio-economic picture.