Trade and export finance in Brazil: Outlook and challenges

The last two years have been a time of important shifts for Brazilian exporters. After a decade of almost uninterrupted rising commodity export earnings, Brazilian basic materials suppliers saw their sales overseas diminishing considerably from 2013 onwards. At the same time, even though the Brazilian currency depreciated from overvalued levels, capital goods exports from a historically active industrial sector have not yet been able to recover the share in total exports recorded before the commodity boom. Successive increases in manufacturing workers’ earnings, and lagging productivity growth, led to rising unit labour costs since 2011, which were only reversed – and solely in US dollar terms – halfway through 2015. Since most Brazilian industrial firms focus on the domestic market and use exports as an opportunistic adjustment mechanism, it is understandable that an improvement in unit labour costs in foreign currency has not resulted in a large change in their total production and exports. Nevertheless the fact remains that as the favourable terms of trade have reverted back to the long-term mean, Brazilian foreign trade has adjusted more slowly than was hoped.

The economic slowdown that held our attention for almost two years is partly to blame for this delayed reaction, but other structural factors contributed as well. Unlike commodity producers, the manufacturing industry’s engagement, or even rengagement, of export markets is notoriously difficult, especially in an increasingly competitive world economy with established global supply chains that are suffering from demand scarcity and productive overcapacity. The manufacturing sector also tends to concentrate a larger number of smaller companies than the commodity segments of the economy whose producers can also count on the sales facilitation provided by trading companies for their exports. Furthermore, small medium enterprises (SMEs) in Brazil seldom have strong in-house expertise or the experience necessary to deal with the complex process of exporting. As a result, the five hundred largest exporting companies account for 80% of all Brazilian exports, leading to the conclusion that there is a significant untapped potential for SMEs to diversify their client base and contribute to foreign trade volumes.

The challenge, as in other parts of the world, is how to provide, in a cost-effective way, the instruments SMEs need to successfully target overseas markets. Shortterm export finance in Brazil has traditionally been provided by official banks with vast nationwide networks of branches. Yet even with their mandates to finance exports, these institutions cannot always service SMEs wishing to sell abroad to potentially riskier clients because of the combination of operational costs, lack of security and expected losses. Past experience shows that this financing gap will persist even as the return of economic growth brings down interest rates and rekindles banks’ risk appetite, justifying the formulation of a public policy action to correct what can be deemed as a market failure. In this sense, a SME export credit insurance scheme was introduced in 2015. The product met with good acceptance and has gained traction by using the official bank’s extensive network and client knowledge as well as a simplified process based on online interaction between exporters, bank branches, and ABGF. Incidentally, greater contact with SMEs has also led ABGF to begin evaluating the possibility of providing overseas market prospection support.

The experience of rolling out the SME product also uncovered another gap in the Brazilian trade finance market. Given the difficult liquidity conditions in the financial system and worsening global risks, local private short-term export credit insurance providers were forced to turn down cover for some clients’ export markets. An opportunity presented itself for ABGF to grease the wheels of trade finance by sharing risks with local short-term insurers when there is perceived room for official support to fill the gaps that arise in periods of extended stress.

Another financing gap that stymies the participation of some firms in export activity is the difficulty they have to contract bank guarantees or surety bonds when these are demanded by foreign buyers. Some industries are more prone to face this obstacle than others: defence contractors, for instance, due to banks’ compliance policies. Also, some solid soft commodity exporters burdened by foreign currency denominated debt fell victim to the credit crunch and devaluation that hit Brazil in the last two years. Long-term contracts for foreign sales helped to balance cash flow needs of these Brazilian enterprises while their domestic operations manage through a slowdown. The needs of these companies have opened the door to the creation of products to assist new clients from industries up to now unknown to ABGF.

On more familiar ground, larger corporate entities, that have traditionally made use of official support for exports, have faced difficulties stemming from the peculiarities of their access to overseas markets. For many machinery and heavy equipment makers, the path to foreign markets was regularly as a materials supplier to Brazilian engineering firms executing construction projects abroad. The building and civil construction market, however, has experienced a sharp decline in business performance, both domestically and internationally, since the beginning of 2013, primarily due to the commodity cycle downturn. As a result of slowing demand, capital goods manufacturers have had to redirect their sales strategies to reach new buyers directly. This is a slow process, but the

first signs of a successful adaptation have begun to manifest themselves in the applications for cover received by ABGF in the second half of 2016.

In parallel, many of the Brazilian civil engineering firms that led large export contracts have been absent from new cover demand as they are reviewing their compliance frameworks. They have implemented new corporate governance that will likely change their approach to new business, irrespective of whether it is abroad or domestic. For the most part, the companies are moving in the right direction of higher transparency and stronger compliance standards.

Even for the civil aircraft market – ABGF’s other main source of business – changes abound. The last couple of years have been devoted to sales campaigns to renew the US regional fleets. Now that this phase has run its course, the Brazilian manufacturer will focus on perfecting and marketing its new generation aircraft. As with any complex product launch, the company has to maintain revenue sources to bridge the transition period. It is true that there are opportunities in the private jet and defence transport segments, as well as in new geographical markets, especially Asia, and demand for cover is expected to grow gradually in the next few years.

The crisis in Brazil has provided the Brazilian ECA with another opportunity. It has been partnering with the commercial banks in MLT financing. Their interest has come just in time to pick up the slack from the receding official banks. Most of them are foreign banks keen on supporting structured deals in compliance with ECAs best practices. Though the banks have shown some appetite for Latin American and African countries in MLT financing, there is some expectation that insurance can evolve into an unconditional guarantee for some competitive sectors. Such changes would be positive once the required legislative changes have opened the door to reinsurance and similar forms of risk sharing with other export credit agencies.

In conclusion, trade and export finance in Brazil have come upon some unexpected hurdles, but we see the system working and revamping its own policies and products in preparation for higher demand for export credit insurance facilities in the next couple of years. The outlook is positive and ABGF is a firm believer that the Latin American market will bounce back, with project and structured finance re-emerging as an opportunity.

Marcelo Franco

Chief Executive Officer, Agência Brasileira Gestora de Fundos Garantidores e Garantias (ABGF)

Pedro Carriço

Executive Manager, International Credit Assessment