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UNCLAS SECTION 01 OF 03 SAO PAULO 000652 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON PGOV EFIN BR ELAB
SUBJECT: BRAZIL'S AUTO SECTOR'S SUCCESS TO BE TESTED 
 
REF: SAO PAULO 630; BRASILIA 141; SAO PAULO 531 
 
¶1. (SBU) SUMMARY: In a largely successful effort to mitigate the 
worst impact of the global financial crisis, the Brazilian 
government provided tax breaks for industrialized products (IPI) at 
the end of 2008 to boost Brazil's auto sector.  As a result, the 
sector has served as one of the engines in Brazil's quick economic 
recovery as tax breaks and extra liquidity in credit market spurred 
record car sales this year.  The auto sector's near-term strength, 
however, will be tested in the next few months as the tax incentive 
phases out and exports remain stagnant.  The outlook over the 
longer term remains bright as demand among Brazil's expanding 
middle class (ref A) increases and international investors focus on 
Brazil as a growth market.  END SUMMARY 
 
 
 
GOVERNMENT INCENTIVE DRIVES DOMESTIC DEMAND 
 
-------------------------------------------- 
 
 
 
¶2. (SBU) With the onset of the global financial crisis, in 
September 2008 Brazil's auto sector suffered its first monthly 
sales decline in five years, as sales nationwide fell 11 percent. 
Production dropped about 32 percent the following month as several 
auto companies instituted mandatory vacations to slow output. 
Concerned that companies' temporary measures could become permanent 
layoffs, the Government of Brazil (GoB) stepped in with a USD 3.5 
billion aid package for the auto industry.  The package included a 
temporary suspension of the industrial products (IPI) tax on small 
cars (from 7 percent to zero) and halving the tax for large cars 
(from 13 percent to 6.5 percent) as well as funding for banks to 
increase car loans (ref B). [NOTE: According to contacts from the 
National Motor Vehicle Manufacturers Association (ANFAVEA) as well 
as General Motors, about 70 percent of domestic vehicle sales are 
funded by banks through car loans. END NOTE]. The GoB incentive 
program generated immediate effects as automobile output rose 92 
percent and sales climbed 1.5 percent in January 2009. 
 
 
 
¶3. (U) As sales increased and stocks of unsold vehicles dwindled to 
manageable levels, the GoB decided to extend the temporary tax cut 
from March to the end of June.  This move along with added 
liquidity in the credit market and improvements in economic 
conditions (ref C) lured consumers to showrooms.  In June car sales 
reached a record-high of 300,174 units--a 17 percent increase from 
June 2008.  Hoping to maintain the car sales momentum, the GoB 
extended the full tax break until September 30, with an incremental 
reduction of the tax over the rest of the year.  Auto companies 
ramped up production in August and September in anticipation of the 
tax break expiration, which fueled a 20 percent increase in 
September sales.  From January-September 2009, Brazil's auto 
industry posted car sales growth of 5.5 percent reaching 2.2 
million units over the same period the previous year. 
 
 
 
----------SHORT TERM TESTS REMAIN 
 
----------------------- 
 
 
 
¶4. (SBU) While the domestic auto sector has recovered in recent 
months, auto exports have remained stagnant with exports still down 
over 40 percent from the previous year.  [NOTE: Brazilian auto 
exports represent only 10 percent of total auto production this 
 
SAO PAULO 00000652  002 OF 003 
 
 
year, compared to 15 percent in 2008. END NOTE]. The lag reflects 
an overall slower recovery in global demand for Brazilian 
manufactured goods.  Trade analyst Frederico Marchiori from the 
Federation of Industries of Sao Paulo (FIESP) told Econoff he 
expects this trend to prevail for the rest of 2009. 
 
 
 
¶5. (SBU) Likewise, despite the government's intent to minimize the 
impact of the tax break expiration, by gradually increasing the tax 
rate on small cars to 1.5 percent for the month of October, 3 
percent for November, and to 5 percent for December, domestic sales 
are likely to slacken in the near-term.  Jackson Schneider, 
president of ANFAVEA, publicly stated that the top three 
international car makers, Volkswagen, Fiat and General Motors, 
expect a slow-down in sales once the tax break ends.  In an October 
9 meeting with Econoff, ANFAVEA Executive Director Paulo Sotero 
dismissed the likelihood of yet another extension of the tax break, 
a view echoed by GOB contacts in Brasilia. 
 
 
 
LONG TERM DOMESTIC GROWTH AHEAD... 
 
-------------------------------- 
 
 
 
¶6. (SBU) Over the longer term, growing domestic prosperity driven 
by high commodity prices and low inflation over the last five years 
has fostered an expanding Brazilian middle class eager to take 
advantage of improving credit terms and buy automobiles.  ANFAVEA 
Technical Director Aurelio Santana told Econoff they expect the 
person-per-car ratio in Brazil of eight to one to fuel growing 
demand for cars for years to come.  General Motors Brazil Vice 
President Pedro Luiz Diaz echoed this view, recently telling the 
Consul General during a visit to the GM plant in Sao Caetano do 
Sul, that Brazil is the auto industry's second most profitable 
operation worldwide after China. 
 
 
 
¶7. (SBU) Small, compact, and relatively inexpensive cars remain the 
top choice amongst Brazilians.  In August 2009 compact car sales 
accounted for 55 percent of total vehicle sales, generating 
interest among international auto firms to boost their investment 
in small vehicle models.  GM Brazil official Pedro Bentancourt told 
us the company just launched its new compact vehicle "Agile" in 
Brazil, a $400 million investment, based on continuing high demand 
in this market segment.  Overall, Foreign Direct Investment (FDI) 
in the auto sector is estimated to reach 24 percent of total 
industry investment in 2009, up from 20 percent last year, 
according to a Morgan Stanley research. 
 
 
 
...Attracting Chinese Investment 
 
------------------------------ 
 
 
 
¶8. (SBU) Chinese auto companies Chery Automobile and Jianghuai 
Automotive (JAC) are contemplating entering the Brazilian auto 
market.  According to ANFAVEA, Chinese firms see Brazil not only as 
an attractive and expanding market, but also as a strategic 
location to supply vehicles to the rest of Latin America.  ANFAVEA 
Executive Director Sotero said the strategy of these Chinese 
companies is to set up factories in Brazil in the next two years to 
avoid paying the 35 percent vehicle import tariff and build 
consumer loyalty for locally produced models. 
 
SAO PAULO 00000652  003 OF 003 
 
 
¶9. (SBU) Chinese companies' lower cost structure makes the 
Brazilian market even more attractive.  For example, JAC produces a 
compact car that sells in China for approximately USD 8,300 (NOTE: 
Calculation based on current exchange rate at USD 1 equivalent to 
R$1.8. END NOTE).  Chery Automobile is planning to produce an even 
smaller vehicle that would cost only USD 4,900 in China.  Our 
ANFAVEA contacts tell us that Chinese companies have been studying 
the Brazilian market for some time.  Given the steady increase in 
Brazilian domestic demand, they suggest now could be an opportune 
time for Chinese firms to enter the Brazilian market. 
 
 
 
COMMENT 
 
------- 
 
 
 
¶10. (SBU) According to data from Brazil's Applied Economic Research 
Institute (IPEA), the GoB's temporary tax break kept the auto 
industry from shedding thousands of high paying jobs, and bolstered 
production of 110,000 additional cars.  On the downside, the tax 
cuts inevitably eroded GoB revenues and may have also helped 
industry avoid some cost-cutting.  The immediate test will be how 
the sector fares once the favorable tax environment disappears. 
Fortunately, the long-term outlook for the sector remains bright as 
domestic demand is expected to increase and more international 
investors view Brazil as a growth market. 
White