The outlook for Brazil's domestic auto market is bright, but the outlook for exports does not look as promising.
BY THOMAS RIDEG
Access to credit, economic stability, and lowered interest rates have increased consumer confidence and boosted car sales in Brazil to the highest levels in the country’s history. Is this growth sustainable?
Until the mid 1990s, Brazil’s automotive industry was composed of four automotive giants: FIAT, Ford, GM and VW. President Cardoso’s “Real Plan,” that lowered inflation and opened opportunities for more inexpensive financing terms, enabled Brazil’s automotive industry to reach its highest peak in history, selling 1.9 million vehicles in 1997. Brazil became the new promise in this industry, and reports forecasted that the market would reach 3 million vehicles per annum in the next few years. This activity encouraged seven new players to enter the market (Renault, Peugeot, Daimler Chrysler, Audi, Citroen, Honda and Toyota), bringing with them investments of about US$16 billion. This investment included the construction of 11 new automotive plants, assuring that Brazil would have enough installed production capacity to serve the estimated 3 million vehicles demanded in next few years.
Car sales plunged from 1.9 in 1997 to 1.5 million vehicles in 1998 and further down to 1.2 million in 1999. This was a result of the global crisis (China and India, 1997 and Russia, 1998) that depreciated the Brazilian real, stalled consumer confidence and sky-rocketed interest rates. To make matters worse, many consumers with earnings in local currency financed their vehicles (and homes, and other big assets) pegged to the USD to access lower interest rates, and when the local currency collapsed, their monthly financing debt doubled. This brought default credit to record-breaking numbers, and also meant that the Brazilian automotive industry created a colossal excess of installed production capacity that would not be utilized.
After 10 painful years of meager growth, the automotive industry has revived and Brazil is once again registering record sales. The country’s currency is worth about 1.9 to the USD (the strongest in nine years), which has made industrialized goods more affordable to high income consumers. Interest rates have fallen and credit access has expanded to the middle and lower income brackets, which has also made industrialized goods very affordable. Brazilians are living a fever of consumption and this is very much reflected in the automotive market. Brazil closed the first semester of 2007 at 1.4 million vehicles and it is estimated that the year will end at 2.3 million units. This represents a growth in sales of 22 percent, and Brazilian Association of Vehicles (ANFAVEA) expects that growth will sustain 10 percent per annum for the next three years.
ECONOMIES OF SCALE
Access to credit among the masses at realistic interest rates and with flexible repayment terms is bringing rewards to many consumer segments, automobiles included. Ten years ago, only 30 percent of car purchases were financed; today this number has leaped to 70%. The rewards aren’t only in the increased sales volume. Access to such credit has enabled consumers to purchase more sophisticated vehicles than they would otherwise be purchasing, and more sophisticated vehicles offer much higher margins to the auto makers. Dealerships are offering extended credit rates that do not demand down payments and can last for up to 84 months. This is vital in an economy where consumers are more concerned with the value of their monthly payments than with the total sum of the investment.
Although the outlook for the domestic market is bright, the outlook for exports does not look as promising. The automotive consumption fever in Brazil brings with it the opportunity cost of having a less inexpensive production platform. Added to the appreciated currency are the local taxes, making the country’s vehicles expensive compared to other markets, hence compromising Brazil’s competitiveness as a hub for regional supply in this particular industry. As an illustration, a Honda Civic starts selling at $30,000 in Brazil, whereas in the U.S. this car starts at $15,000. In Brazil this car is targeted at the executive segment, whereas in the U.S. it is positioned to attract the starters segment.
Two questions remain in the midst of the industry’s current euphoria:
1) Is Brazil living another 1997 fad?
Brazil’s economy is more self-sufficient than it was ten years ago. The country has maintained a surplus in its trade balance for the last four years (even though its currency has appreciated constantly during this period), inflation is low and the global economy is stable.
Furthermore, although seven players entered the Brazilian market in the last 10 years, only one of them pulled out—Chrysler. The only player considering building a plant in Brazil at this moment is Hyundai. Ten years ago, Brazil was seen as the most promising market, whereas today India and China are considered more attractive markets. That said, Brazil’s current upswing will not lead to the aggressive investments seen 10 years ago, which means that the investments in the industry will be more gradual and consistent, hence sustainable.
2) Does the country have enough installed production capacity to serve growing demand?
Brazil will likely face a problem addressing its demand with current installed production capacity, which is currently at 3.2 million units. Several auto makers are already working triple shifts and having employees work on weekends and will soon have to consider expanding capacity. Auto makers with local production are able to invest in this capacity, and we already see this happening with companies like Honda and Toyota. GM is considering an investment of US$1 billion in Brazil and Argentina for its “Viva Project” that will introduce a new compact car to the market.
ARGENTINA: GOOD ALTERNATIVE
As it is 30 percent cheaper to produce vehicles in Argentina than in Brazil, that country is becoming an attractive alternative for auto makers looking for regional supply. Even though Argentina is currently going through an energy crisis, several auto makers are announcing investments. Honda will invest $100 million to construct its first factory in the country to distribute a new car to Argentina, Brazil and Mexico. FIAT, Brazil’s leading producer, will also be reactivating a plant in Argentina (deactivated since 2002) to produce 50,000 vehicles per year. FIAT will also produce pick up trucks in the country through a partnership with Tata (from India). Renault will transfer the production of its most compact model to Argentina and launch a new line in the country in 2008, leaving its more high-end models to be produced in Brazil. These initiatives should help auto manufacturers reduce costs and guarantee production capacity to attend the growing demand.
Potential problems with exceeding production capacity lie with smaller suppliers, not the large players. Not all players in the Brazilian automotive supply chain are able to invest in expanding production capacity. The global auto parts players may be well-structured to make such changes, but the industry is also very dependent on hundreds of smaller local auto parts suppliers that will not be able to keep up with this rhythm without either private financing or government support. Without either public or private support, these companies will not expand their production and will cause a bottleneck in the industry’s growth. According executives in local OEMs, however, “where there is demand, all other members of the value chain will find methods to attend, and in worst case scenarios, OEMs will assist companies at the lower ends of the value chain with financing or subsidies to ensure that demand is not left unattended."
WHERE ARE THE CHINESE?
Chinese cars will be circulating in Brazil for the first time in Q3 2007 with a compact car (Ideal), imported and distributed via Uruguay, where Changhe (Chinese auto maker) has a partnership with Grupo Effa. Even after circulating through three countries (China—Uruguay—Brazil), the Ideal will be the least expensive vehicle in the market, selling at US$12,500. In 2008, this vehicle will begin being produced in Uruguay and may enable an even more aggressive pricing strategy. The group is also investing in a production line in Manaus, Brazil, for small commercial vehicles. Another Chinese model to be introduced in 2008 is Chery, also with a production line in Uruguay. The Chinese entry is a definite threat to the Brazilian manufacturers, especially when it comes to price-sensitive consumers, which correspond to 70 percent of sales. Consumer receptiveness to Chinese vehicles remains a mystery.
Thomas Rideg is director of marketing and sales at InfoAmericas. This article originally appeared in the company's Tendencias magazine. Republished with permission.