Brazilian economic and political conditions and perceptions of these conditions in the international market have a direct impact on our business and our access to international equity and debt markets, and could materially adversely affect our results of operations and financial condition
Our operations are primarily conducted in Brazil, and we sell a material portion of our products to customers in Brazil. Accordingly, our financial condition and results of operations are substantially dependent on economic conditions in Brazil, and we cannot assure you that Brazilian gross domestic product, or GDP, will remain stable or grow in the future. Brazilian GDP, in real terms, decreased 3.6% in 2015, decreased 3.3% in 2016 and increased 1.1% and 1.1% in 2017 and 2018, respectively. Future developments in the Brazilian economy may affect Brazil’s growth rates and, consequently, the consumption of our products. As a result, these developments could impair our business strategies, results of operations and financial condition.
The Brazilian government frequently intervenes in the Brazilian economy and occasionally makes material changes in policy and regulations. The Brazilian government’s modifications to laws and regulations according to political, social and economic interests have often involved, among other measures, increases or decreases in interest rates, changes in fiscal and tax policies, wage and price controls, foreign exchange rate controls, blocking access to bank accounts, currency devaluations, capital controls and import restrictions. We have no control over and cannot predict the measures or policies that the Brazilian government may take in the future. Our business, results of operations and financial condition may be adversely affected by changes in government policies as well as general economic factors, including:
Inflation, and the Brazilian government’s measures to combat inflation, may significantly contribute to economic uncertainty in Brazil and may have material adverse effects on our business and results of operations
Brazil has historically experienced high rates of inflation. Inflation, as well as the Brazilian government’s efforts to combat inflation, have had significant negative effects on the Brazilian economy, particularly prior to the introduction of comprehensive currency reform (the Plano Real) in July 1994. In more recent years 2016, 2017 and 2018, rates reached 6.3%, 2.9% and is expected by the Central Bank (according to the Focus Report dated December 28, 2018) to be 3.69%, respectively, measured by the Extended National Consumer Price Index (Índice de Preços ao Consumidor Amplo), or IPCA, according to the IBGE.
Inflationary pressures continue to persist and the Brazilian government’s measures to combat them, as well as speculation about any such future measures, have generated over the last few years a climate of economic uncertainty in Brazil and heightened volatility the Brazilian capital markets. Brazil may experience high levels of inflation in the future.
As of March 31, 2019, 11.3% of our total loans and financing, including indebtedness outstanding and payables for the acquisition of businesses, were subject to varying rates of inflation IGP-M, IPCA and the Consumer Price Index (Índice de Preço ao Consumidor), or IPC. Increases in inflation could therefore adversely affect our financial expenses in the event of an unfavorable change in inflation. Additionally, inflationary pressures could lead to government intervention in the economy, including the introduction of policies that may adversely affect the overall performance of the Brazilian economy, which, in turn, could adversely affect the operations and the market value of the ADSs.
Developments and changes in the investors’ perception of risk in other countries, particularly in the United States, Europe and other emerging markets, may materially and adversely affect the market value of securities, including the market value of the ADSs
The market for securities issued by Brazilian companies is influenced by, to varying degrees, economic and market conditions in other countries, including the United States, Europe and other emerging markets. Although the economic conditions in these countries are significantly different from the economic condition in Brazil, the reaction of investors to developments in these countries may adversely affect the market value of securities issued by Brazilian companies. Crises in other emerging markets may reduce investor interest in shares from Brazilian issuers, including the ADSs. This could materially adversely affect the market price of the ADSs.
In addition, the financial crisis and political instability in the United States, Europe and other countries have affected the global economy, producing several effects that, directly or indirectly, impact the Brazilian capital market and economy, such as fluctuations in the price of securities issued by listed companies, reductions in credit supply, deterioration of the global economy, fluctuation in currency exchange rates and inflation, among others, which may, directly or indirectly, adversely affect us. In June 2016, the United Kingdom called a referendum in which a majority of its population voted for the United Kingdom to exit the European Union. We have no control over and cannot predict the effect of the United Kingdom’s exit from the European Union nor over whether and the extent to which other member states will decide to exit the European Union in the future. On January 20, 2017, Donald Trump became the President of the United States. We have no control over and cannot predict the effect of Donald Trump’s administration or policies. These developments, as well as potential crises and forms of political instability arising therefrom or any other unforeseen development, may adversely affect us and the market value of the ADSs.
Political and economic instability in Brazil may adversely affect our business and results of operations
Brazil’s political environment has historically influenced, and continues to influence, the performance of the country’s economy. Political crises have affected and continue to affect investor confidence and that of the general public, which resulted in economic deceleration and heightened volatility in the securities issued by Brazilian companies.
The recent economic instability in Brazil has contributed to a reduction in market confidence in the Brazilian economy and to the aggravation of the situation of the domestic political environment. Furthermore, several ongoing investigations into accusations of money laundering and corruption being conducted by the Brazilian Federal Public Prosecutor’s Office, including the largest such investigation known as “Car Wash” (Lava Jato), have had a serious negative impact on the Brazilian economy and political landscape.
A number of senior politicians, including current and former members of Congress and the Executive Branch, and high-ranking executive officers of major corporations and state-owned companies in Brazil were arrested, convicted of various charges relating to corruption, entered into plea agreements with federal prosecutors and/or have resigned or been removed from their positions as a result of these Lava Jato investigations. These individuals are alleged to have accepted bribes by means of kickbacks on contracts granted by the government to several infrastructure, oil and gas and construction companies. The profits of these kickbacks allegedly financed the political campaigns of political parties forming the previous government’s coalition that was led by former President Dilma Rousseff, which funds were unaccounted for or not publicly disclosed. These funds were also allegedly destined toward the personal enrichment of certain individuals. The effects of Lava Jato as well as other ongoing corruption-related investigations resulted in an adverse impact on the image and reputation of those companies that have been implicated as well as on the general market perception of the Brazilian economy, political environment and the Brazilian capital markets. We have no control over, and cannot predict, whether such investigations or allegations will lead to further political and economic instability or whether new allegations against government officials will arise in the future.
Amidst this background of recent political uncertainty, in August 2016, the Brazilian Senate approved the removal from office of Brazil’s of then-President Dilma Rousseff, after completion of legal and administrative impeachment proceedings, on the grounds of violation of budgetary laws. Michel Temer, the former Vice President, who had been serving as acting president since Ms. Rousseff’s removal in May 2016 and assumed the presidency for the remainder of the presidential term, which ended in 2018. Throughout Mr. Temer’s presidency, his approval ratings remained historically low and he faced scrutiny over other matters, including allegations of bribery and other corrupt acts, which contributed to the uncertain political and economic environment in Brazil. After a polarized presidential campaign, Jair Bolsonaro, a former member of the military and three-decade congressman, was elected as the president of Brazil on October 28, 2018 and took office on January 1, 2019. We cannot predict if, and for how long, the political divisions in Brazil that emerged before the election will continue and impact his presidency. It is also not clear what effects, if any, such political division will have on the ability of President Bolsonaro to govern Brazil and implement reforms. Any continuation of such division could result in an impasse in Brazil’s Congress, political unrest and massive protests and/or strikes that could adversely affect our operations. Uncertainty regarding the implementation by the new government of related changes in monetary, fiscal and pension policies, as well as pertinent legislation, could contribute to economic instability. These uncertainties and new measures could increase the volatility of Brazilian securities markets, including in relation to our securities.
We cannot foresee whether President Bolsonaro will adopt policies or changes to current policies that may have a material adverse effect on us. Political and economic uncertainty resulting from the presidential elections or otherwise may have a material adverse effect on our business, results of operations and financial condition.
Uncertainty over whether the Brazilian government will implement changes in policy or regulation affecting these or other factors in the future may contribute to economic uncertainty in Brazil and to heightened volatility in the securities issued abroad by Brazilian companies. Historically, the political scenario in Brazil has influenced the performance of the Brazilian economy; in particular, political crises have affected the confidence of investors and the public in general, which adversely affected the economic development in Brazil.
We are subject to fluctuations in interest rates
The Central Bank establishes the basic interest rate for the Brazilian banking system. As of March 31, 2019, 91.4% of our total indebtedness, including outstanding loans and financing and payables for the acquisition of businesses (excluding present value adjustments relating to payables for the acquisition of businesses), were denominated in reais and subject to fluctuations in interest rates. The interest rate risk arises from the portion of our debt referenced to the Brazilian long term interest rate (taxa de juros de longo prazo), or TJLP, and Interbank Certificate of Deposit (Certificado de Depósito Interbancário), or CDI, which may adversely affect revenue or expenses in the event of an unfavorable change in interest rates and inflation. Any increase in interest rates could increase the cost of our borrowings, reduce demand for our products or have a materially adverse impact on our financial expenses and results of operations.
The volatility of the real against the U.S. dollar and other currencies may have a materially adverse effect on our business and the market price of the ADSs
Historically, Brazilian currency has suffered frequent devaluations. The Brazilian government has implemented various economic plans and utilized a number of exchange rate policies, including sudden devaluations, periodic mini-devaluations during which the frequency of adjustments has ranged from daily to monthly, a floating exchange rate, exchange controls and parallel market exchange rates. From time to time, there have been significant fluctuations in the exchange rate between the real, the U.S. dollar and other currencies. According to Central Bank data, at the end of years 2016, 2017 and 2018, the exchange rates between the real and the U.S. dollar were R$3.2591, R$3.3080 and R$3.8748, respectively. As of May 28, 2019, the exchange rate between the real and the U.S. dollar was R$4.0275 per US$1.00.
Uncertainty over whether the Brazilian government will implement changes in policy or regulation affecting these or other factors in the future may contribute to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets and in the securities issued abroad by Brazilian issuers. Therefore, these uncertainties and developments in the Brazilian economy may adversely affect us and the market price of the ADSs.
Many of our customers are either foreign companies or multinational companies operating in Brazil and are exposed to exchange rate variations that could create an adverse effect on these companies. Additionally, the interest rate on our some of loans has been indexed to exchange rates. Any exchange rate fluctuations could therefore result in a materially adverse effect on our operations and financial results.
Depreciation of the real relative to the U.S. dollar could negatively affect the growth of the Brazilian economy as a whole and harm our financial condition and results of operations
Depreciations of the real relative to the U.S. dollar could create additional inflationary pressures in Brazil and cause increases in interest rates, which could negatively affect the growth of the Brazilian economy as a whole and harm our financial condition and results of operations. On the other hand, appreciation of the real relative to the U.S. dollar and other foreign currencies could lead to a deterioration of the Brazilian foreign exchange current accounts, as well as dampen export-driven growth. Depending on the circumstances, either depreciation or appreciation of the real could materially and adversely affect the growth of the Brazilian economy and us.
In addition, we believe that an increase in interest rates may cause an increase in financial expenses, negatively affecting our financial results. Similarly a reduction in interest rates may cause a decrease in financial income, which would also negatively affect our financial results.
Any further downgrading of Brazil’s credit rating could adversely affect the market price of the ADSs
Credit ratings affect investors’ perceptions of risk and, as a result, the yields required on future debt issuance in the capital markets. Rating agencies regularly evaluate Brazil and its sovereign ratings, which are based on a number of factors including macroeconomic trends, fiscal and budgetary conditions, indebtedness metrics and the perspective of changes in any of these factors. Brazil has lost its investment-grade sovereign debt credit rating by the three main U.S. based credit rating agencies, Standard & Poor’s, Moody’s and Fitch.
Any further downgrade of Brazil’s sovereign credit ratings could heighten investors’ perception of risk and, as a result, increase the future cost of debt issuance and adversely affect the market price of the ADSs.