Running Head: CLOVER MACHINES Building Derivative Capability

BUILDING DERIVATIVE CAPABILITY

Clover Machines
Katia Almeida Brandman University FINU 615

CLOVER MACHINES Building Derivative Capability

Introduction Brazil is on its way to growing out of its emerging market status and becoming one of the richest and most developed countries on earth. Brazil's vital statistics: Type of government: Federal republic Major industries: Aircraft, cement, chemicals, iron ore, lumber, motor vehicles and parts, other machinery and equipment, shoes, steel, textiles, tin Currency: Real Language: Portuguese Analysis Brazils human, mineral, and agricultural resources are on par with those of the United States and Canada, and it has a few great opportunities to take advantage of in order to continue the growth its been experiencing over the past 20 years. The Brazilian government is trying to simplify its business licensing processes to make it easier for companies to become legitimate. If it succeeds, strong small companies will grow, which will help the Brazilian economy overall. As amazing as the potential is for Brazil, plenty of issues could hold the country back: Crime In 2007, 25.2 out of every 100,000 Brazilians were victims of murder or attempted murder. This is one of the highest rates in the world; the United States had 5.6 murders or attempts per 100,000 the same year. Brazil also has high rates of kidnapping, rape, and theft.

CLOVER MACHINES Building Derivative Capability

Much of the crime is related to the illegal drug trade. The off-the-books culture comes into play, too. And the deep divisions between rich and poor means that resentment sometimes crops up in the form of crime. The Brazilian government is keenly aware that crime will frighten off foreign visitors and has made reducing crime a key priority. Poor infrastructure Most of Brazils roads are unpaved, and many towns in the interior are accessible only by riverboat or by foot, limiting peoples access to markets. Stewardship of the land Its not always clear who owns what land in Brazil, especially in the jungles. One result is squatting and poaching. Loggers to come into a jungle area, clear-cut the trees, sell the lumber, and disappear. The remaining land has thin soil that can be farmed for just a few years. The loss of jungle contributes to climate change and destroys part of Brazils natural heritage. Its also not unusual for the people who actually own the land, or who think they do, to take on the loggers, farmers, and ranchers whom they believe to be poaching. This contributes to Brazils reputation for violence and high rates of crime. When debating the merits of various Nearshore outsourcing locations, the topic of currency fluctuation usually takes a backseat to the discussion of wages, talent availability and tax and investment incentives. Thats the case for Brazils real, whose value spiked in early 2009 and steadily increased throughout the year. While now normalizing to its pre-crisis levels, a number of US companies

CLOVER MACHINES Building Derivative Capability

outsourcing in Brazil report that the high rate is making a dent in their balance sheets. The result is that Nearshoring operations in Brazil are more expensive than they were even a year ago. With a currency risk rating of BBB- according to Standard and Poors, Brazil is the worlds eighth largest economy by GDP, and the largest in South America. That economy has been performing well in recent years, gaining eight positions on other countries in the World Economic Forums 2009 Competitiveness Report. But with these gains comes a currency appreciation that at present has the real at 1.76 to the dollar a blow to companies searching for lower costs who located to Brazil in, say, 2002 when the rate was almost R$ 4 to the US dollar. Its important that we put this situation in context however. US sourcing companies across the board in Brazil are not gravely affected, and in fact there is little evidence that the majority of them are even that concerned. Brazil has a relatively closed economy, with only about 15% dedicated to exports. That strong internal market allowed it to be extremely resilient during the economic crisis, and one of the first Latin America countries to bounce back. Many Indian players like Infosys and Wipro have recently established in Brazil, and they all seem more focused on the domestic market than on exported outsourcing services. The cost of running a sourcing business in Brazil is definitely exacerbated by the high value of the real. The Brazilian Finance Minister Guido Mantega, said that the real will weaken soon because of the countrys current account deficit, estimated by the central bank to be at $5.18 billion. The current account gap should lead to a devaluation of the real. The current account is an important parameter, and we cant ignore that there is a deficit, said Mantega, quoted on

CLOVER MACHINES Building Derivative Capability

Bloomberg. This has all increased speculation that Brazils central bank will soon start buying dollars to slow down the reals gain. Mantega has already said that he favors this strategy, and that a weaker real would boost exports from Brazil. In terms of making costs lighter to bear for sourcing companies in Brazil, its clear that the government does need to come up with new initiatives.
Renewed fears of a disorderly Eurozone break-up have driven a massive emerging market currency selloff over the last few weeks and the Brazilian real (BRL) is no exception. Since March 2012, the local currency has lost 20% of its value against the US dollar. In May 24, it reached 2.08 BRL per USD, a level not recorded since May 2009 amid the global financial crisis.

The government initially displayed a complacent attitude towards the weakening of the BRL but the central bank, concerned about financial stability, finally intervened in the foreign exchange market to stem the currency depreciation. The government has wanted a weaker BRL to improve the competitiveness of ailing domestic industry. However, further weakening would harm the economy in several ways. Different factors such as the reduction in the benchmark SELIC rate, changes to the Financial Transactions Tax (IOF) and foreign exchange intervention contributed to the weakening of the BRL against the US dollar since March. But it was the decline in global risk appetite that drove the currency lower in the last few weeks. On 22 May, the finance minister, Guido Mantega, stated that a weak BRL benefits the Brazilian economy and provides more competitiveness to domestic production. On that day, the BRL/USD exchange rate surpassed the psychologically important 2.0 level.

CLOVER MACHINES Building Derivative Capability

The central bank then swiftly stepped in to clarify that the excessive volatility of the exchange rate was a matter of concern. It began offering exchange rate swaps equivalent to a sale of US dollars in the futures market allowing investors to hedge against further currency weakening. These measures came less than two months after it had purchased US dollar futures in an attempt to stem a revaluation of the local currency. Conclusion Brazilian economy is performing well in recent years this is the good sign for any investors thinking about doing business in Brazil.
Brazil has longed for a weaker exchange rate to improve the competitiveness of its sluggish industry, but with the BRL at these levels, further depreciation may not be desirable.

CLOVER MACHINES Building Derivative Capability

Reference: Robin, J. A. (2011). International corporate finance. (1st Ed.). Columbus, OH: McGraw-Hill. http://www.bloomberg.com/ http://www.nearshoreamericas.com/brazil-currency-appreciation