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LATIN AMERICA Boom times are morphing Brazil into its own end market

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RIO DE JANEIRO It may sound bananas to those unfamiliar with Latin America, but Brazil, following in the footsteps of a few of its leading corporations, such as Cia. Vale do Rio Doce (CVRD), Usinas Siderúrgicas de Minas Gerais SA (Usiminas), Votorantim Metais and Grupo Gerdau SA, is close to gaining investment-grade classification from international credit-risk agencies.

The upgrade should reduce the cost of credit for new investments in Brazil's basic industries, mainly steel and metals-using sectors, which are already counting on new spending from home and abroad of more than 1 trillion reais ($520 billion) by 2010, according to Banco Nacional de Desenvolvimento Econômico e Social, Brazil's development bank.

The new classification is expected as early as the first half of 2008, given the country's favorable debt profile, positive balance of payments since 2000 and currency stability since the 1994 introduction of the real. Credit Suisse recently slashed its country risk rating for Brazil to 150 basis points from 250 in one fell swoop-a far cry from the 700-plus figures in the 1990s.

Brazil's economy has again become international news-but on a much more positive note than the last time this happened, in the late 1980s, when it submerged in hyperinflation that caused the crash of four currency systems and a dozen or so finance ministers in a six-year period.

Unabashed by a succession of corruption scandals rippling through the nation's congress, President Luiz Inácio Lula da Silva triumphantly declared mid-June that "Brazil is enjoying its best economic moment since the country was declared a republic in 1889. Finally, we have managed to combine growth (of an expected 4.3 percent this year) with economic stability and inflation control."

The euphoria is further fired by the world's new interest in sugar-cane ethanol of which Brazil, given its suitably sunny and warm climate, is set to become one of the biggest producers. Despite the strengthening of the real, which is hitting the competitiveness of Brazil's manufactured product exports, ethanol is set for an export boom on expectations of leaping demand abroad.

"Brazil will become the Saudi Arabia of ethanol, tripling exports to 9 billion liters (2.38 billion gallons) a year by 2012," said Paulo Roberto Costa, supply director at oil company Petróleo Brasileiro SA (Petrobras), which is set to become a major producer of the fuel.

In metals and steel, an about-turn is already taking place. Brazil is becoming a market in its own right, shaking off its traditional image as a supplier of ores and semi-finished products. However, the producers of these products, including CVRD (iron ore and copper concentrate), CST-Arcelor Brasil (steel slab) and BHP Billiton and Alcoa Inc. (primary aluminum), also are anxious to maintain their export market positions, despite rising local costs that are pressuring margins-the downside of an otherwise positive economic equation.

The real's notable strengthening, coupled with a steady fall in local interest rates that has boosted consumer buying power, means domestic steel and metal markets are now growing fast and with an increasing input of imported goods. Some import tariffs have been reduced or even eliminated to encourage this growth, forcing local producers to sell more competitively.

Domestic market steel sales jumped to 7.92 million tonnes in the first five months of 2007, up 12.2 percent from the same period last year, led by the construction, automotive and oil and gas sectors, according to the Instituto Brasileiro de Siderurgia (IBS), the Brazilian steel institute. This has been further encouraged by Lula's growth acceleration package launched in January a $250-billion investment in basic infrastructure, including transport, housing and energy generation, by the end of 2010.

Associação Brasileira do Alumínio, the Brazilian aluminum association, in June revised upwards its forecast for 2007 domestic market consumption of processed aluminum products to 891,000 tonnes, 6.3 percent above 2006's record 838,000 tonnes and up from previous forecasts of a 5.3-percent increase. Local consumption will soak up more than half of the country's expected primary aluminum production of 1.66 million tonnes this year.

Domestic copper sales rose 10 percent in the first quarter compared with the same 2006 period and similar growth is expected in the second quarter, according to copper producers and trade associations Sindicato da Indústria de Condutores Elétricos, Trefilação e Laminação de Metais Não Ferrosos do Estado de São Paulo and Associação Brasileira do Cobre (Sindicel-ABC).

The local growth means exports are starting to fall in tonnage terms, although not necessarily in value as most market prices have been higher so far this year than last. IBS said that Brazil's steel product exports fell 16.2 percent to 3.83 million tonnes in the first four months of this year due to domestic market growth and exchange rate factors, despite a hefty increase in output during the same period. Several traders have been forced to switch from exporting to the import business in order to survive the about-turn.

And imports look set to snowball. Brazil's industry, development and foreign trade ministry announced that the import value of all products averaged $472 million a day in June, up a startling 34.5 percent compared with the same month last year. Copper and auto parts were singled out as registering the most new import activity.

Brazilian steelmakers are again fighting insinuations that the country is suffering a steel shortage, following a more than doubling of the nation's steel imports in 2006 to 1.88 million tonnes. But their output now barely keeps pace with demand from the booming local automotive sector-vehicle sales were up 24 percent in the first five months of this year-and the oil and gas sectors, also set for a record year. The strong real and weak U.S. dollar also have left Brazilian steelmakers struggling to keep their domestic prices competitive with imports.

The government has played right into the hands of the automakers complaining of local steel shortages by axing import tariffs on 15 widely used steel product types, fueling the atmosphere of near-animosity between the nation's automakers and steelmakers. The chances of the steel sector winning its battle to get the tariffs reinstated are remote, given the new emphasis on trade openness and consumer power.

"Ford (Motor Co.) is now importing U.S. steel into Brazil for cost reasons . . . up to 500 tonnes per month," Rogelio Golfarb, vice president of Associação Nacional dos Fabricantes de Veículos Automotores, Brazil's automotive producers association, said at IBS' congress in Sao Paulo in late May. And they are not isolated purchases. He said the automaker is now seeking to import steel on long-term (three- to four-year) contracts, intensifying the auto industry steel import activity that started around three years ago.

"There has been an ongoing cycle of price increases in steel in Brazil which is now giving imports a competitive edge. There are three factors involved availability of steel with certain specifications, the strength of the Brazilian real and local price levels," Golfarb said. Mill sources confirm that some local flat-rolled and galvanized product prices have risen as much as 14.5 percent so far this year.

Steelmaker Usiminas-with a 52-percent-plus share of Brazil's flat steel market-had surprising news recently it, too, is resorting to imported steel, bringing some 120,000 tonnes of heavy plate from China, the Commonwealth of Independent States and the United States to help meet high demand for gas pipelines and truck manufacture. These imports by a single buyer compare with total heavy plate imports of just 37,404 tonnes in 2006.

According to Brazil-based traders, the cost of locally produced heavy plate in June was around $1,200 per tonne, f.o.b. works, only marginally below the $1,300 per tonne, delivered, for imported material, including freight costs. The prices are at least double the recently listed f.o.b. export prices for this product from Brazil, but exports have dried up because of non-availability, traders and producers said.

Rising local costs, aggravated by exchange rate factors, could indeed turn out to be a problem for the new Brazil operating in global markets. A survey by two independent consultants shows that Brazilian executives now enjoy the highest salaries of the four BRIC nations-Brazil, Russia, India and China-with a company president in Brazil commanding an average total pay package of $849,000 a year. Despite continuing strident wealth distribution problems, Brazil is breeding millionaires, their ranks having swollen 10.1 percent in 2006 to 120,400, according to a study by Merrill Lynch & Co. Inc. and Capgemini.

An investment-grade rating should help curb costs by allowing companies to obtain credit more cheaply for their new investments in the country. Ample and good-quality mineral resources, land purchase opportunities and a growing domestic market should continue to attract new foreign-owned projects. Germany's ThyssenKrupp Stahl AG, which is setting up Brazil's first new integrated steel mill in more than 20 years, reiterated its commitment at the recent Steel Success Strategies XXII conference in New York, saying it would set up a platform in Brazil for its group's global growth.

ArcelorMittal and China's Shanghai Baosteel Group Corp. have plans under wraps for new integrated slabmaking facilities in Brazil. Italy's Danieli & C. SpA and South Korea's Dongkuk Steel Mill Co. Ltd. are working together on a new slab project in the country's northeast. Anglo American Plc is among newcomers on a rapidly expanding iron ore scene. And Brazilian-owned groups Gerdau, Votorantim, Usiminas and Cia. Siderurgica Nacional all have major expansion plans, which should help boost Brazil's crude steel capacity to as much as 70 million tonnes per year by 2015 from 37 million tonnes currently.

In copper, Chile's Corporación Nacional del Cobre de Chile (Codelco) is busy prospecting in Brazil, along with Anglo American; Alcoa is bringing on a major new bauxite mine at Juruti in Para state, which could later be accompanied by new alumina and aluminum production capacity; Anglo American is forging ahead with a major new Brazil ferronickel project; and Yamana Gold Inc. is one of several Canadian companies rapidly expanding the country's gold production. And the Brazilians are not lagging behind-a return to primary lead production has been announced by Votorantim, while the local nickel and copper scenes should be transformed by various new CVRD investments.

Can Brazil's existing infrastructure cope with this influx of new activity? Serious doubts persist, particularly on the country's future electrical energy generation capabilities. Brazil's energy research company, EPE, is probably not exaggerating when it says that $32 billion per year must be invested in hydro, nuclear and thermal power stations and new oil and natural gas refineries between now and 2030 if the country is to maintain annual gross national product growth of 4.1 percent without suffering blackouts like the ones of 2001 to 2002, which hit the aluminum and ferroalloys industries hard.

Investors in a new investment-grade Brazil might be well advised to invest in energy generation-otherwise, the best of the new projects may never get off the ground.


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