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### Viewing cable 05BRASILIA2649, THE SURGING REAL HAS EXPORTERS SINGING THE BLUES

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
05BRASILIA2649 | 2005-10-04 15:59 | 2011-07-11 00:00 | UNCLASSIFIED | Embassy Brasilia

`

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

` `

    UNCLAS SECTION 01 OF 02 BRASILIA 002649

    SIPDIS

    NSC FOR CRONIN
    TREASURY FOR OASIA - DAS LEE AND FPARODI
    STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE
    USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D
    USDOC FOR 3134/ITA/USCS/OIO/WH/RD/DDEVITO/DANDERSON/EOL SON
    AID/W FOR LAC/SA

    E.O. 12958: N/A
    TAGS: ECON EFIN ETRD
    SUBJECT: THE SURGING REAL HAS EXPORTERS SINGING THE BLUES

    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
    weakness.

    ¶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
    capital.

    Comment
    -------

    ¶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.

    DANILOVICH

`