Brazil: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
22 Sep 1999
eISBN:
9781451805895
ISBN:
9781451805895
Language:
English
Keywords:
ISCR; CR; break; inspections department; government; company; central bank report; enterprise bankruptcy; company situation; U.S. dollar; state energy enterprise; privatized utility company; Exports; Real interest rates; Currencies; Small and medium enterprises
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This Selected Issues paper and Statistical Appendix on Brazil looks at price developments following the floating of the Real in mid-January 1999. The paper highlights that the experiences in East Asia—Indonesia, Korea, Malaysia, Philippines, and Thailand—all show that the pass-through from devaluation to inflation has been lower than expected, with the exception of Indonesia. The paper analyzes the competitiveness and export performance of Brazil. Effects of high interest rates and currency depreciation on Brazilian enterprises are also analyzed.

Abstract

This Selected Issues paper and Statistical Appendix on Brazil looks at price developments following the floating of the Real in mid-January 1999. The paper highlights that the experiences in East Asia—Indonesia, Korea, Malaysia, Philippines, and Thailand—all show that the pass-through from devaluation to inflation has been lower than expected, with the exception of Indonesia. The paper analyzes the competitiveness and export performance of Brazil. Effects of high interest rates and currency depreciation on Brazilian enterprises are also analyzed.

III. Effects of High Interest Rates and Currency Depreciation on Brazilian Enterprises1

A. Overview

1. This chapter looks at the effects on Brazilian nonfinancial enterprises of high real interest rates and the depreciation of the Brazilian Real following the abandonment of the crawling peg exchange regime. Its basic premise is that the generally high real interest rates that have prevailed in Brazil for many years now, as well as the two decades of high and variable inflation that preceded the introduction of the Real Plan in mid-1994, encouraged Brazilian enterprises to reduce their reliance on debt financing and to rely more on retained earnings. This reliance on self-financing has been particularly important for small and medium enterprises, which have often lacked access to credit markets.

2. With the overall level of enterprise indebtedness being relatively smaller than in other Latin American countries, so was the indebtedness of Brazilian enterprises in foreign currencies. In general, only larger firms had access to foreign currency financing. Most firms with foreign currency liabilities either had a natural hedge in the form of foreign currency receivables, or hedged themselves in other ways, for example by acquiring U.S. dollar-indexed government securities. Those few enterprises that were unhedged or only partially hedged tended to be Brazilian subsidiaries of foreign conglomerates that may be assumed to provide sufficient financial backing.

3. The consequence of the relatively low gearing of Brazilian companies and their limited exposure to foreign currency risk is that the nonfinancial corporate sector was not seriously affected by the depreciation of the Real since January nor by the continuing relatively high level of interest rates. The impact of the devaluation was further attenuated by a ruling from the Federal Revenue Secretariat that allowed enterprises to write off losses stemming from the devaluation over a period of four years. As a result of these various factors, widespread loan defaults or enterprise bankruptcies are unlikely to occur.

B. High Interest Rates and the Financial Structure of Brazilian Enterprises

4. Brazilian enterprises are generally considered to have much stronger balance sheet positions than companies in other Latin American economies. The high and volatile inflation that prevailed during much of the 1980s and early 1990s made Brazilian managers cautious in taking on debt. As a result, Brazilian companies entered the 1990s with balance sheets that looked fairly underleveraged when compared to companies in other countries. Frequently, balance sheets of Brazilian enterprises showed working capital financed by expensive short-term local currency financing, and fairly large positions in real assets (such as real estate) that were used to hedge against inflation, but were not used in the production process.2

5. The disinflation brought about by the Real Plan has led to considerable corporate restructuring. This entailed two complementary strategies: reducing debt by liquidating unproductive (real) assets; and replacing expensive short-term bank debt with medium-term capital raised in either local, or increasingly, international capital markets. Despite the restructuring that has taken place over the past few years, the level of indebtedness of Brazilian nonfinancial enterprises still compares favorably with those of other Latin American countries. Sample data from over 300 Brazilian (nonfinancial) stock companies for 1998 show that their debt-equity ratios are significantly lower than those of their Argentine, Mexican, and Chilean counterparts.3 Specifically, the sample of Brazilian firms had a ratio of total debt to liquid assets of 0.42, compared with ratios of 0.79 in Argentina, 1.01 in Chile, and 0.59 in Mexico.

6. Although the advent of low inflation under the Real Plan in and of itself probably encouraged an increase in the supply of loanable funds, the demand for borrowing has been discouraged by the high real interest rates that have prevailed over the last several years. Real overnight interest rates, which constitute the floor for interest rates in Brazil, averaged 1.7 percent per month (22.9 percent per year) during mid-1994 to end-1998. With these high real rates, banks were content to invest in government debt instruments, the total stock outstanding of which increased from 25.8 percent of GDP in December 1994 to 38.2 percent of GDP in December 1998.4 At the same time, lending to the private sector has stagnated over the last several years, suggesting a classical case of crowding out: from end-1995 to end-1998 the total volume of loans outstanding to the private sector fell from 29.5 percent of GDP to 27.4 percent of GDP, although it increased slightly during 1996–98.

7. The profitability of Brazilian enterprises has remained low over the last several years.5 In part, this may be due to insufficient investments in light of existing credit constraints. During 1996–98, the return on equity of Brazilian firms has remained significantly below that of their Argentine, Chilean, Mexican, and U.S. counterparts. In 1998, for example, the return on equity of a sample of 260 Brazilian stock companies averaged 5.3 percent, compared to 7.1 percent in Argentina, 7.9 percent in Chile, 7.6 percent in Mexico, and 16.9 percent in the United States. In contrast, even Brazilian savings accounts offered a real return of 12.5 percent in 1998.

8. With the lower level of indebtedness, net interest expenditures affected the profitability of Brazilian enterprises to a slightly lesser extent than they did effect companies in other Latin American countries that had much lower interest rates. In 1998, for example, net interest expenditures reduced the operational result (gross profit minus operational expenditures) of Brazilian enterprises by 24 percent, whereas they reduced the operational result of Argentine firms by 30 percent, of Chilean firms by 29 percent, and of Mexican firms by 31 percent.

9. These results reflect not only the low leverage of Brazilian enterprises, but also the fact that financial revenues of Brazilian enterprises are higher than in other Latin American countries: for example, in 1998, they exceeded the average financial revenues of Mexican companies by about 50 percent. This again reflects the high real interest rates that have prevailed over the last several years: Brazilian companies have often found it more profitable to “invest” in Certificates of Deposit (CDs) than in their own business operations.6

10. In contrast, the pure operating margins of Brazilian enterprises—that is, net production receipts (gross receipts from the sale of products less tax payments) less the cost of production inputs—are already fairly compressed. Whereas in Brazil, production costs amount to 72 percent of net receipts, they were below 70 percent in all other Latin American countries.

11. Their low operational profitability, in turn, has resulted in Brazilian companies to be relatively “cheap buys” compared to companies in other Latin American countries. In the stock market, most Brazilian companies are negotiated at a value of about 50 percent below their total asset value (book value).

C. Foreign Currency Exposure and Effects of the Devaluation on Different Sectors

12. The foreign currency (FX) exposure of Brazilian enterprises has generally remained modest and is mainly concentrated among larger enterprises. Information on the aggregate FX exposure of Brazilian enterprises can be obtained from different sources, but the information is only partial and somewhat conflicting. Nonetheless, the general view is that the existing FX exposure of Brazilian enterprises is usually fully or at least largely hedged.

13. Information provided by the government suggests that the balance sheet FX exposure of the overall private sector in January 1999 amounted to US$95 billion, of which US$71 billion were hedged through various assets, including indexed securities and FX derivatives.7

14. Data obtained from Economática show that only 98 of over 300 Brazilian stock companies in the nonfinancial sector have issued debt in foreign currencies; by far the largest single foreign currency debtors were Petrobrás, the state oil conglomerate, and “Light,” a recently privatized utility company.

15. Data compiled by CSFB/Garantía show the total FX debt of Brazilian enterprises (including in the financial sector) as amounting to US$39.7 billion; most of this matures in 1999 (Figure 3.1).8 Of the total, 38 percent (US$15.1 billion) was owed by the financial sector; another 10.3 percent (US$4.1 billion) was considered “quasi-sovereign” as it either had an explicit official guarantee or was owed by enterprises owned by the states or municipalities (Figure 3.2).

Figure 3.1.
Figure 3.1.

Brazil: Maturities of Non-Sovereign FX Debt 1/

Citation: IMF Staff Country Reports 1999, 097; 10.5089/9781451805895.002.A003

Source: CSFB/Garantia1/ Estimates, on the basis of data availabilities in the first quarter of 1999.
Figure 3.2.
Figure 3.2.

Brazil: Non-Sovereign FX Debt Outstanding By Sector (US$ million)

Citation: IMF Staff Country Reports 1999, 097; 10.5089/9781451805895.002.A003

Source: Estimated by CSFB/Garantia on the basis of Bloomberg, Anbid, and Brazilian newspapers.

16. Still, the immediate recognition of all FX losses that occurred in January would have had a significantly adverse impact on several key financial ratios of Brazilian companies under Brazilian accounting procedures (Brazilian GAAP).9 To reduce this impact, the government announced, on March 25, 1999, Provisional Measure 1818, which allows enterprises to defer, for up to four years (with amortizations of 25 percent per year), the FX losses resulting from the devaluation.10 Supporters of this measure argue that it has the benefit of mitigating a deterioration in risk perception and reducing the likelihood of early forced redemptions of debt as a result of financial covenant noncompliance of Brazilian corporate debt issues.11 Hence, while this measure does not necessarily affect the fundamental financial soundness of Brazilian companies, it has to be kept in mind that substantial expenses from the total recognition of FX losses, even if only in an accounting sense, would have significantly affected the standard accounting ratios for the year 1999 (such as coverage and leverage ratios). However, the deferral of losses tends to distort financial statements and complicate their interpretation.

Table 3.1.

Brazil: Effect of a Depreciation of the Brazilian Real(R$) on the Ratio of (Short-term debt + Net Interest)/(EBITDA + Cash) of Various Enterprises under Different Devaluation Scenarios 1/

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Source: Calculations by CSFB/Garantia on the basis of data for December 1998, except where noted.

Assuming an inflation rate of zero, so as to isolate the effect of the exchange rate; EBITDA refers to earnings before interest, tax, depreciation, and amortization. The data in the table show the estimated increase in the ratio.

The percentages refer to changes in the R$/US$ rate; e.g., a 50 percent devaluation of the R$/US$ rate would imply a change of the exchange rate from R$1.21 (the level prevailing at end-December 1998) to R$1.82.

On the basis of data for September 1998

On the basis of data for December 1997.

17. In the short-run, enterprises with FX debt will feel the impact of the devaluation mostly through interest payments they have to make on this debt. Only about US$8 billion of the total FX debt matures in 1999; although this would increase to about US$12 billion if debt holders were to exercise the put options embedded in some of this debt at the next possible put-date. Of the total FX debt outstanding in January and maturing in 1999, about 57 percent already matured in January-April (45 percent if the put dates are considered the relevant maturity date).

18. Using the data by CSFB/Garantia and Economática, it is possible to analyze the general effects of the devaluation on enterprises in different sectors of the Brazilian economy.12

  • Industrial exporters. Large industrial exporters (e.g., pulp and paper, chemicals, and steel) with ample liquidity should benefit from the devaluation. In particular, these companies should experience an improved operational performance because of localcurrency denominated cost structure, and hard-currency denominated cash flows and inventories. While some industrial exporters reportedly experienced short-term liquidity problems because of relatively high levels of short-term debt, they are likely to finance a shortfall in working capital with export securitization, if needed.

  • Electric utility companies. In general, companies in this sector are thought to be hard hit by the devaluation because many had FX-denominated debt, whereas their revenues are local-currency denominated. As a result of regulatory controls, tariff increases have been somewhat encumbered. Recently utilities that sought external funding to increase their domestic market share by acquiring other electricity distributors are thought to be the ones that are affected most.

  • Telecommunication sector. There are basically two types of companies in this market: the fixed-line (or A-band) operators, i.e., the 13 holding companies that resulted from the split of Telebrás; and the wireless operators, i.e., the seven companies that purchased so-called “B-band” licenses. The impact of the devaluation on the fixed-line operators is thought not to be substantial for three main reasons. First, their FX exposure is minimal when compared to their earnings before interest, taxes, depreciation, and amortization (EBITDA). Second, fixed-line telecommunication use is fairly inelastic to economic swings, although receivables may grow. Third, all 13 companies are owned by strong international companies, like MCI, Telecom Italia, Portugal Telecom, or Telefónica de España. As a result, most of the 13 telecommunication companies have robust balance sheets and are effectively considered “cash cows” by market analysts.

    The seven wireless operators are in a somewhat different position, also because most sought external funding in the form of FX bridge loans. While six of the seven companies are controlled by international companies (such as Bell South, Bell Canada, and Telecom Italia), they have only recently begun operations or are still in a pre-operational phase. Hence, their revenue base is still rather small. The economic slowdown, although not as deep as originally thought, is expected to have an adverse impact on increasing market penetration in the short run. However, with wireless penetration being fairly low in Brazil compared to other countries with a similar percapita GDP, the long-run potential is considered large, and it is unlikely that the consortia that acquired the wireless licenses will simply walk away in light of the devaluation and the economic slowdown.

  • Pay-TV and media companies. Many companies in this sector have substantial FX-denominated debt (although they are considered to have been somewhat better hedged than the electric utilities), and their revenue is strongly dependent on domestic demand, which, in turn, is fairly elastic to the business cycle. With the devaluation and the likely increase in receivables, many companies in this sector are likely to face heavy liquidity pressures; some of the smaller Pay-TV operators may require equity injections or debt restructuring.

  • Consumer goods producers and others. Companies in this sector also had substantial FX-debt exposure, they are sensitive to the business cycle, and their receivables are likely to have increased with the economic slowdown; this could bring about substantial liquidity pressures. Some companies in this sector already experienced financial problems prior to the floating of the Real. While there have been vast productivity improvements in this sector (e.g., through better inventory management at manufacturers and retail levels), the industry is expected to struggle in the near term.

19. These analyses, which were carried out just after the Real was left to float in January, are now being corroborated to a large extent by first quarter results that are being published by various companies. The results show that the devaluation experiences even within a single sector have been very different, as the examples from the energy sector illustrate. Eletrobrás, the state energy enterprise, tripled its profits in the first quarter of 1999 compared to the same period of 1998, as the company had 51 percent of its receivables (créditos) indexed to the U.S. dollar, which had a positive balance impact of R$3.3 billion in the quarter.13 In contrast, Light, a recently privatized electric utility, registered losses of R$1.0 billion due to the devaluation, which are being recognized in the company’s balance sheet over a period of four years; reportedly, the company (which had recently acquired a São Paulo energy distributor) had left its U.S. dollar or U.S. dollar indexed liabilities largely unhedged. These losses forced Light to seek an aggressive restructuring of its cost structure in which it cut personnel expenditures by 18 percent, expenditure on materials by 54 percent, and other costs by 28 percent.14 Another company in the same sector, registered losses of R$65.3 million that were attributable to the January devaluation, and will also be recognized over a period of four years.

D. How Do Brazilian Enterprises Judge Their Near-Term Prospects?

20. With the recent reduction of interest rates and the strengthening of the Real after the pressures that were encountered in early 1999, Brazilian entrepreneurs are cautiously optimistic concerning the short-term economic outlook, as evidenced by a survey that was carried out by the National Industry Confederation (CNI) at end-March.15 The main conclusions of the CNI survey of 807 enterprises (of which 72 were large enterprises) are summarized below.16 Specifically, Brazilian entrepreneurs expect:

  • the exchange rate to stabilize more or less at the actual level, that is in a range between R$1.60 to R$1.80 per U.S. dollar;

  • cost increases to be likely, and be passed on to consumers only in part;

  • the share of imported inputs to decrease, particularly in large enterprises;

  • a reduction in import competition, particularly for large enterprises;

  • favorable developments for exports to materialize over the next during March–September this year.

E. Conclusions

21. Brazilian enterprises have generally coped well with the depreciation of the Real since January and their financial structure is well adapted to operating in an environment of high real interest rates. Widespread loan defaults or enterprise bankruptcies are unlikely to occur.

22. Brazilian enterprises finance themselves less through debt and more through retained earnings than their Latin American counterparts, particularly the small and medium enterprises, which often have lacked access to credit markets. Indebtedness in foreign currencies was also fairly low and, most firms with foreign currency liabilities either had a natural hedge in the form of foreign currency receivables, or had acquired different forms of hedge (for example by acquiring U.S. dollar-indexed government securities) well in advance of the Real was let to float in January. The few unhedged or insufficiently hedged enterprises mostly were Brazilian subsidiaries of foreign conglomerates that may be assumed to provide sufficient financial backing. Also, enterprises have been allowed to write off over four years, losses resulting from the devaluation. These conclusions seem generally in line with the cautiously optimistic assessment enterprises have of their near-term prospects.

Table 3.2.

Brazil: Results of CNI’s March 1999 Survey of Industrial Enterprises

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Source: National Industry Confederation; Sondagem Industrial-Sondagem Trimestral da CNI; Jan.-Mar. 1999.

SME denotes small and medium enterprises; LE denotes large enterprises.

Table 3.3.

Brazil: Results of CNI’s March 1999 Survey of Industrial Enterprises–Large Enterprises

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Table 3.4.

Brazil: Results of CNI’s March 1999 Survey of Industrial Enterprises-Small and Medium Enterprises

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Table 3.5.

Brazil: Results of CNI’s March 1999 Industry Survey on the Impact of Devaluation

(Percent of all Responses)

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Source: National Industry Confederation; Sondagem Industrial-Sondagem Trimestral da CNI; January-March 1999.

SME denotes small and medium enterprises; LE denotes large enterprises.

1

Prepared by Gerd Schwartz.

2

See Jack Glen and Brian Pinto (1994), “Debt or Equity? How Firms in Developing Countries Choose,” Discussion Paper No. 22, International Finance Corporation (Washington, DC).

3

On the basis of data provided by Economática; these data do not include privately held companies or enterprises that are fully state-owned.

4

Not all of this increase was the result of the government deficit; a significant part reflects debt that was issued in the context of restructuring/recapitalizing public banks.

5

While basic theory suggests that a more highly geared enterprise should (on average) have a higher return on equity (where the higher return compensates shareholders for the greater risk of insolvency or low earnings that results from the higher gearing) it could also have been expected that, starting from an initial position of low indebtedness, the improved macroeconomic environment during the initial years of the Real Plan would have helped Brazilian enterprises to improve their profits, particularly when compared to their more highly geared counterparts in other Latin American countries.

6

See “Rentabilidade Baixa, Mesmo Sem o Peso dos Juros” (Low profitability, even without the burden of interest) in Gazeta Mercantile April 23, 1999.

7

See Federal Republic of Brazil, Brazil’s Macroeconomic Stability Program, 1999–200 7; March 1999.

8

These data are thought to represent about 90 percent of the FX debt of the enterprise sector. The data comprise only securitized debt, and exclude some bridge loans and syndicated loans. Both bridge loans and syndicated loans were used heavily to raise large amounts of money during the privatization process; in general, they are difficult to track. Bank commercial papers (CPs), although securitized, are also excluded, since they are difficult to track as well. The CSFB/Garantia data focus on the euro market (euro bonds and notes); they also exclude trade finance and intercompany loans.

9

See Table 3.1 for an illustration for different companies.

10

Also see “Artificio Contábil Esconde Perdas Com Câmbio” (Artificial Accounting Hides Exchange Rate Losses) in Gazeta Mercantíl May 11, 1999.

11

Also see “Brazil—Overcoming the Devaluation Impact on Brazilian Companies’ Financial Statements,” by CSFB/Garantía, April 15, 1999. Also, many corporate debt issues have embedded put options that, if exercised, could substantially reduce maturities.

12

Also see “Private Sector Implications of the Real Devaluation,” by CSFB/Garantía, January 22, 1999.

13

See “Eletrobrás triplica lucro no primeiro trimestre” (Eletrobrás triples profits in first quarter), in Gazeta Mercantile May 21, 1999.

14

See “Light prorroga perda de R$l bilhão” (Light prolongs loss of R$l billion), in Gazeta Mercantile May 19, 1999.

15

Sondagem Industrial-Sondagem Trimestral da Confederação National da Indústria, (Industry Survey-Quarterly CNI Survey); January/March 1999.

16

The detailed results of this survey are shown in Tables 3.2 to 3.5. They are interesting in that they attest to a significant degree of confidence of Brazilian enterprises in an economic environment that, at the time, was characterized by a significantly higher degree of uncertainty than now. They are also in contrast to similar surveys that were carried out in other countries following a significant exchange rate adjustment.

Same Series

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Cover IMF Staff Country Reports
Brazil: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Volume/Issue:
Volume 1999: Issue 097
Publisher:
International Monetary Fund
ISBN:
9781451805895
ISSN:
1934-7685
Pages:
163
DOI:
https://doi.org/10.5089/9781451805895.002

Brazil: Maturities of Non-Sovereign FX Debt 1/

Brazil: Non-Sovereign FX Debt Outstanding By Sector (US$ million)