Worsening exchange and interest rates delay recovery for companies (2024)

Initially, market forecasts in March projected that the Selic, Brazil’s benchmark interest rate, would close the year at 9% and the exchange rate at R$4.95 per dollar. Current expectations have adjusted to a sustained basic interest rate of 10.5% and an exchange rate of R$5.20 per dollar, as indicated in the recent Focus report. Under these revised projections, Brazilian companies are poised to conclude the year with debts totaling R$6.16 trillion—an increase of 5% from March’s predictions. Conversely, had the economic conditions aligned with March’s more optimistic scenario, the debt increment would have been limited to approximately 3.25%, reaching R$6.03 trillion.

The projections from the Economic Research Institute Foundation’s Center for Studies on the Financing of Brazilian Companies (CEFEB-FIPE), led by Carlos Rocca, are based on simulations using financial debt balances of Brazilian companies, both public and private. These simulations incorporated projections for the exchange rate and the Selic rate reported in the Focus survey. The impact on debts was calculated for two scenarios: the forecast from March this year for the end of 2024, and the revised forecast as of the end of June.

According to the study, if the conditions projected in March held until the end of 2024, companies’ financial expenses would stand at R$170 billion, marking the most favorable scenario. However, under the revised forecasts from the end of June, these expenses could soar to R$295 billion, an increase of 73%.

Mr. Rocca underscores that the study illustrates a deterioration in companies’ capacity to recover. In recent years, businesses have grappled with an increased volume of debt and interest rates, exacerbated by credit condition declines following corporate crises like that of Americanas. Furthermore, companies have faced squeezed margins, rising costs, and the dual impacts of default rates and inflation diminishing consumer spending.

Moreover, many businesses have encountered challenges in refinancing their debts—a crucial aspect of sustaining operations. According to Mr. Rocca, this year saw an improvement for those accessing the corporate debt market, overcoming some refinancing hurdles. However, smaller companies have not experienced the same relief. “Companies indebted in the capital market do not face significant difficulties in refinancing their debts. In contrast, those reliant solely on bank credit, which represents the vast majority, continue to struggle,” he explains.

Mr. Rocca adds that as of March, 11% of companies did not generate enough cash to cover their debt obligations. With the ongoing weakening of the real, he anticipates this proportion could increase to 17% by year-end.

Certain assumptions were made for the CEFEB-FIPE study, such as the majority of bank debts being secured at fixed interest rates, debts in the capital market being tied to the CDI (interbank short-term rate), and foreign-currency-denominated debts remaining constant in dollar terms but increasing in Brazilian real terms due to exchange rate fluctuations.

Rosana Pádua, an advisor at the Brazilian Institute of Finance Executives of São Paulo (IBEF-SP), describes the current period as “quite challenging” for companies. She believes that the only way to sustain current profit margins is through continued cost reduction, a strategy already pursued by chief financial officers. “The environment is increasingly adverse. With interest rates staying high, maintaining solid profitability is crucial to comfortably servicing debt,” she notes.

According to an April survey by RK Partners, about 25% of Brazilian publicly traded companies were unable to cover their financial expenses at the end of 2023. Within a sample of over 300 companies, approximately 45% found themselves in a precarious leverage position, with a debt-to-EBITDA (earnings before interest, taxes, fees and depreciation) ratio exceeding three times.

As the survey exclusively covers publicly traded companies, it portrays the conditions of larger firms that generally have better renegotiation capacities, according to Ricardo Knoepfelmacher, founder of RK Partners. “If you consider the broader spectrum of smaller businesses, which face higher interest rates, this 25% could escalate to 30%,” he notes.

Mr. Knoepfelmacher predicts that the struggle to manage debt costs could persist for at least another two years. “Even if the Selic rate decreases, it will take some time for this reduction to positively impact the broader market,” he clarifies.

Furthermore, Marcelo Bacci, Suzano’s chief financial, investor relations, and legal officer, highlights, “The deteriorating economic conditions over the first half of the year are also influencing investment decisions. The shift towards a harsher economic climate affects what we choose to invest in, as capital allocation becomes pricier, particularly concerning new ventures such as acquisitions or expansion projects.”

The pulp company recently expanded its portfolio by acquiring a 15% stake in the Austrian dissolving pulp and tissue manufacturer Lenzing for R$1.3 billion and even considered purchasing American company International Paper and investing in its own expansion. Marcelo Bacci explains that as a dollarized company, the depreciation of the real benefits Suzano. “The increased revenue helps offset some of the additional costs,” he notes. The company’s unchanged hedging policy in recent months also aids in buffering against market volatility.

“We always maintain some flexibility because market dynamics are challenging to predict, yet it’s clear that the situation has deteriorated,” Mr. Bacci, who is also a member of IBEF-SP, states. “For companies more tied to the domestic market, the impact might be more pronounced.”

At Comerc, a company specializing in renewable energy, financial planning for 2024 had already accounted for a degree of volatility, according to Fernando Oliveira, the company’s chief financial officer. “However, like much of the market, we too were anticipating lower interest rates and a more stable exchange rate.”

Mr. Oliveira mentions that, as of now, he has not needed to alter his strategies but remains vigilant, ready to adjust plans based on market developments. “The immediate impact of the real’s depreciation is that it diminishes the appeal of projects like building new parks, as much of the equipment required is imported,” he explains.

Regarding interest rates, Mr. Oliveira notes a direct impact on capital-intensive sectors like the energy industry. “Rising rates also dampen the appeal of launching new projects. We typically secure a substantial portion of our financing in IPCA terms [Brazil’s benchmark inflation index], but aligning some of our funding with the CDI rate is also a strategic move.”

In April, Comerc successfully issued R$2 billion in debentures, allocating R$1.4 billion to corporate bonds pegged to the CDI and R$600 million to incentivized bonds indexed to the IPCA.

For Rosana Avolio, Braskem’s chief investor relations officer, the main influence of lower interest rates impacts the consumption market and demand growth across various client sectors. Despite these shifts, the company’s financial planning remains stable.

“Even focusing solely on the Brazilian interest rate, its impact on our finances is modest, as only about 10% of Braskem’s total debt is in reais,” she explains. Approximately three-quarters of the company’s debt is at fixed rates.

Similar to Suzano, the depreciation of the real benefits Braskem due to the company’s integration into the global market for raw materials and products. “With portions of our costs in Brazilian reais, like maintenance and salaries, we experience some financial gains,” she notes.

The executive clarifies that while the depreciation of the real against the dollar usually adversely affects the company’s reported financial results due to changes in debt valuation and the hedge policy, it positively impacts cash flow. “A portion of our dollar-denominated liabilities serves as a hedge, but these are primarily accounting effects,” she notes.

Recently, the real’s weakening has been stark, with the exchange rate peaking at R$5.66 per dollar, the highest since January 2022, just the other day. It moderated to R$5.57 on Wednesday following statements from President Lula and Finance Minister Fernando Haddad. Ricardo Maluf, head of institutional equities operations at Warren Investimentos, says that the market is currently experiencing intense tension and volatility, making it challenging to forecast the exchange rate trajectory towards the year’s end.

He details that factors contributing to the pressure include the United States’s delay in reducing interest rates, increasing odds of Donald Trump winning the U.S. presidential elections, and domestic political debates about fiscal policy, inflation control, and the succession at the Central Bank. Additionally, the real is feeling the effects of broader emerging market currencies, impacted by election outcomes in Mexico, South Africa, and India, which disappointed the markets due to the fiscal expansion agendas of the elected officials. “It is estimated that R$0.20 of the devaluation of the real, from R$5.20 to R$5.40, can be attributed to the influence of the Mexican peso.”

Mr. Maluf adds that even though the Selic rate cuts ceased before the exchange rate surpassed R$5.60, analysts initially anticipated a potential reduction when the United States commenced its rate cuts. “As the exchange rate can exert pressure on inflation, the market is now forecasting an increase in interest rates by year’s end.” This week, analysts have intensified their predictions of a Selic rate hike later in the year.