Brazil Currency Appreciation: A “Real” Concern?

By Tarun George

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. But what happens when a major outsourcing player’s currency appreciates over a short period of time? That’s the case for Brazil’s 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 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. We take a look here at whether companies are feeling that pricing pressure, and how Brasscom is responding.

Appreciation at a Cost

With a currency risk rating of BBB- according to Standard and Poor’s, Brazil is the world’s 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 Forum’s 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.

Most Affected

It’s 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. “The currency appreciation is something that companies here are learning to live with. Many of those companies are still growing, even at double digit levels”, says João Lencioni, CIO and Sourcing Leader for GE Latin America.

The firms that are feeling the pinch on the other hand are those for whom low costs are the only criteria. “Companies that use Brazil only for call centers, BPO or other maintenance activities….yes those companies are feeling the pricing pressure”, admits Sergio Pessoa, Director of Marketing and International Markets at Brasscom. “But companies focused on ITO or other complex activities are not feeling it as much. They continue to benefit from the amount of domain expertise and capabilities available in cities like Sao Paulo”. Pessoa also mentions the many clients that are now moving their more complex operations to Brazil, while using India for maintenance and support services.

The firms that are feeling the pinch on the other hand are those for whom low costs are the only criteria.

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 LatAm 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.

Taxes and Overhead 

 The cost of running a sourcing business in Brazil is definitely exacerbated by the high value of the real. “If you look at pure salaries, Brazil is not more expensive than other countries”, says Lencioni. “What adds to your expenses is the high tax rate and overhead cost. For example in Chile, the overhead is 10-15%, but in Brazil it can be 60-80% of salary”. Add this to the high restrictions on services exported from Brazil, and now the currency appreciation, and you have a mix that could potentially limit the growth of the outsourcing industry in Brazil.

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However Brasscom is actively working to make things easier for companies, even if a little slowly. “One of the challenges right now is how to reduce the cost of doing business in Brazil”, says Pessoa. “We’ve implemented two initiatives – 1) we reduced the social contribution on payroll by 50%; and 2) for every dollar spent on R&D and training, you can have a two dollar reduction in taxes”. He mentions that Brasscom is also working on other programs, and there will be monetary incentives coming soon on the state and municipal level to smooth the way for interested firms.

Government Response

The most recent update on the currency situation came yesterday from Brazilian Finance Minister Guido Mantega, who said that the real will weaken soon because of the country’s 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 can’t ignore that there is a deficit”, said Mantega, quoted on Bloomberg. This has all increased speculation that Brazil’s central bank will soon start buying dollars to slow down the real’s 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, it’s clear that the government does need to come up with new initiatives. “Brasscom has been working with the government to educate them that growing the outsourcing business in Brazil requires different treatment”, says Lencioni. “There is still not a major move to change the competitiveness of the country as a whole, but there’s a lot more awareness now in government about what actions are needed”.