Brazil Hits Major Bump A rocky road in early '98, but wheels won't fall off

Hitting on all cylinders, the Brazilian auto industry this year seemed poised to cruise past the 2.1 million-vehicle output mark. Until, that is, the world stock market hit some rough pavement and sent the economy of the world's seventh largest car market into the wall.

Industry observers say the damage likely will linger through the first quarter of 1998, dropping as much as 18% from like-1997 and affecting automakers' bottom lines next year.

Brazilian vehicle sales this month are expected to be down 37% from November, which has forced automakers to temporarily close plants to trim huge inventories. Asian automakers such as Hyundai Motor Co. Ltd. and Kia Motors Corp., both hit hard by financial troubles in their home markets, likely will change their South American investment plans, economists say.

Volkswagen AG, Brazil's largest automaker, ceased output for six days late last month. Ford Motor Co. shut down its operations for 16 days, while General Motors Corp. says it will cut production by 25% at its two Brazilian plants over about a month's time.

"It is clear sales will decrease, and we need to adjust our production level," says Celio Batalha, director of government affairs at Ford Brazil Ltd. "We don't know the size yet, but it will be different."

The car sales tumble in Brazil began after the government decided to double interest rates as a way to halt speculation against the Brazilian currency and restore confidence in the country's financial system.

That move quickly made credit too expensive for the middle class car buyer and caused companies considering purchasing commercial vehicles to postpone orders in hopes rates would come down early in 1998.

About 70% of all vehicles purchased in Brazil are on credit. The interest hike has forced many automakers to eat the difference between the old and new rates just to move the metal.

The government also raised the new vehicle tax five points, pushing taxes on small cars, the most popular models in Brazil, from 8% to 13%.

"The government chose the less-painful method to save the real (currency)," says Luis Martinez, senior associate for Latin America at Standard & Poor's/DRI. "I think the overall effect of the government's austerity plan will be more competition in the market. This will intensify the price war between automakers."

This will make Brazilian consumers happy, but could hurt manufacturers trying to establish themselves there, Mr. Martinez says.

"Automakers in Brazil have never made a real effort to reduce prices," he says. "This will be the moment when they start looking in that direction. The automakers with good procedures will be fine. The ones that had financial problems may have more problems in the future."

All of this has economists downgrading growth estimates in Brazil next year to about 1.6%, from as high as 4% earlier this year.

"There will be a very sharp, but short, recession," says John H. Welch, chief Latin America economist for Paribas Corp. in New York. "The auto sector and consumer durable goods will get hit the hardest."

Despite the crisis, however, Brazil appears on track to surpass last year's vehicle output, thanks to a very robust first 10 months. Production through October hit 1.8 million vehicles, a 19% increase compared to like-1996, and is expected to end the year 12% ahead of last year. Production is forecast to drop to 1.7 million in 1998 before getting back to the 2 million mark in 1999.

The problems in Brazil could quickly sour Argentina's economy, which relies on its neighbor to take 30% of its exports. Consider that when Sao Paulo's stock market plunged, Buenos Aires' index took a 16% hit.

This has Chrysler Corp., which is just getting its feet wet in Latin America, sounding cautious. Chrysler sold 4,967 vehicles throughout Latin America in October, a 107% gain, and posted triple-digit increases in Venezuela, Brazil and Argentina.

"We're confident (growth) will continue, although there might be a slight softening in the short term as markets in South America react to unsettled economies in other parts of the world," says Edwin H. Brust, general manager for Chrysler's Latin America, Middle East and African operations.

The economic upheavals that have swept both countries, however, won't likely slow automakers' expansion plans in South America, say industry experts who view the current situation as temporary.

"In round numbers, it's projected that between 1995 and 2000 almost $5 billion will pour into Argentina's auto industry, and about $15 billion into Brazil," says Charles N. Busch, president of Chrysler Argentina SA.

General Motors Corp. - already building Silverado pickups and the Chevy Corsa sedan in Argentina - soon will add Blazer and Corsa station wagon production. Ford Motor Co., meanwhile, is continuing with plans to sink $1 billion in its 35-year-old plant in Pacheco, near Buenos Aires.

Even Mr.Welch says he doesn't expect the downturn in Brazil to last much beyond the first two quarters of 1998.

"(The Brazilian government) has done a good job of protecting the real," he says. "Interest rates will start coming down slowly at the end of December, and six months down the road you will have a recovery."

That is unless another shock rocks Asia, changing the whole scenario in Brazil once again. - with Larry Luxner in Cordoba, Argentina