Cablegate: The Surging Real has Exporters Singing the Blues

This record is a partial extract of the original cable. The full text of the original cable is not available.




E.O. 12958: N/A

REF: Brasilia 2477

1. Summary. The Brazilian export sector is pressuring the
Central Bank to curb the slide of the dollar (US$) against
the Real (R$). As of September 29, the dollar was trading
for Real 2.21, its lowest price since May 8, 2001.
Exporters are concerned that if the devaluation of the US$
against the Real continues, the healthy growth in exports
which the country saw in 2004 will come to an end. The Real
has appreciated 15.4% so far this year and 24.8% in the last
12 months. End Summary.

Impact of the Exchange Rate on Exports

2. The Brazilian government's Institute of Applied Economic
Research (IPEA) has just released a study regarding the
current exchange rate. The study, based on information
gathered from 36 industries, shows that most exporters could
withstand an appreciation of the Real of up to 30 percent
from its point of equilibrium (about R$2.90 to the US$) as
their losses would be less than if they abandoned the
overseas market altogether. Subtracting 30 percent from
R$2.90 would yield an inflection point of about R$2.00 -
i.e., the level at which, if breached, Brazilian exports
would begin to drop significantly.

3. While exporters and the private sector are blaming the
declining exchange rate as one of the key reasons Brazil
could lose ground overseas, government policy makers appear
less worried. Minister of Development, Industry and Commerce
Luis Fernando Furlan, (i.e., the principal advocate for the
business community with the government) has noted "Brazil
has room to improve its infra-structure and lower the cost
of exports." In other words, efforts to improve
infrastructure, reduce costs, and increase efficiency might
compensate for the unfavorable exchange rate. To a certain
extent, some of this is already happening. Well-known macro
consultant Carlos Langoni argues that as a result of: 1)
large imports of capital goods, 2) better use of information
technology, and 3) skilled intensive labor, productivity
growth is increasing. Data from the IBGE (Brazil's main
statistical agency) points to 6 percent productivity growth
in the industrial sector in 2004 and 2.7 percent this year
through July.

The Central Bank's Line

4. During his recent visit to Washington for the Bank Fund
meetings, Central Bank President, Mr. Henrique Meirelles,
told investors that the Central Bank is not going to
intervene in the market, noting that under the floating rate
system (which Brazil has had in place since 1999) exchange
rates must float. Inflation, he declared, was still the
number one enemy of the Brazilian economy. Meirelles said
that while Central Bank will continue to buy dollars the
objective of these purchases will be to increase foreign
reserves and not to intervene in the exchange rate market.
As Meirelles will likely remain as Central Bank President,
having desisted from his early stated intention of running
for Governor of Goias State, this hands-off approach could
represent Central Bank policy for the foreseeable future.

Market Fundamentals

5. During the past few weeks three factors have driven the
continuing devaluation of the dollar against the real.
First, has been the emerging perception that the government
will maintain its embrace of sound economic fiscal policy
notwithstanding the threat of presidential impeachment or
departure of Finance Minister Palocci from the cabinet.
Second, the market is expecting Brazilian interest rates to
decline slowly but surely, with GOP growth prospect
improving accordingly. Last but not least, are the signs
that the Fed will continue to tighten monetary policy in the
United States. These developments have raised the country's
profile among emerging markets in the last two weeks and
foreign investors have started looking for Brazilian assets.
Parking money here is tempting as real interest rates are
13%, the highest in the world, and EMBI country risk has
declined to 353 basis points.

6. According to Luiz Sergio Guimaraes, journalist at the
daily financial newspaper "Valor Economico", another factor
behind the devaluation of the dollar against the real is the
speculative operations that are being launched by foreign
arbitrage investors. While the market consensus predicts an
exchange rate of 2.35 by the end of the year, those foreign
investors who believe the dollar will continue to fall are
buying Reais thus further contributing to the dollar's

7. For his part, Afonso Bevilaqua, Director of Economic
Policy at the Brazilian Central Bank, theorizes that the
current appreciation of the Real is due to an increase in
prices of the goods and services the country exports. In a
recent press article, he noted that it was natural that the
Real would strengthen as Brazil is richer now than it was
before. Bevilaqua disagreed with market analysts who think
that the high interest rates are the main reason behind the
strong Real. The balance of payments (BOP) numbers, he
stated, do not show any influx of foreign capital into
Brazil as a result of the high interest rates. Bevilaqua
pointed out that the government's September 2005 BOP report
shows the bulk of the capital inflow was long term. From
January to August 2005, there was US$ 15.5 billion entering
as long-term capital and US$ 5.3 billion as short-term


8. The current situation, with the Brazilian Real steadily
gaining against the dollar at the same time as exports reach
records numbers, is somewhat worrisome and at best awkward
for the Brazilian economy. Notwithstanding the non-
interventionist comments of Central Bank Chief Meirelles,
Brazilian Government authorities surely would like to
identify for certain where the equilibrium point is, that
is, what exchange rate ratio is business-government-market
acceptable while still allowing for continued export growth.
And while the IPEA study contemplates no large drop off in
exports until the dollar hits the 2.0 reais level, it is
clear that some exporters will be hurt long before it
reaches that point. The automakers, for instance, have
repeatedly told us that the breakeven point for their
exports is around the 2.6 level. To date, however, the
exporters who have been hurt the most are small and medium
sized companies (SMEs). It has traditionally been hard for
the SMEs to develop their clientele base and enter the
foreign markets. Now they see their prices going through
the roof as they lose ground to their competitors. All that
said, Brazilian SME exporters won't give up easily. It is
in their interest to keep and maintain their markets
overseas, and that is where the GOB is putting its cards.
The government's message to the exporters is simple. Cut
costs, increase efficiency, and find new and cheaper ways to
do business. The most immediate effect has been that in an
effort to improve their cost structure, SMEs have begun to
lay off employees. However, should the exchange rate remain
at or near the current level for an extended period of time,
they will also need to improve quality and cut margins if
they are to survive.


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