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

As the macroeconomic landscape shifts, with persistently high interest rates and a weakening real, companies are finding their financial forecasts, set at the year’s outset, becoming less tenable. This adjustment in economic parameters is delaying the anticipated recovery of corporate financial health.

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.

Translation: Todd Harkin

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

FAQs

How might business respond to an increase in interest rates? ›

More late payments: When interest rates increase, businesses tend to be under more financial pressure and experience strained cash flow. This can result in them making payments later, affecting the payee business' cash flow in turn.

How do interest rates affect exchange rates? ›

The Effect of Interest Rates

Higher interest rates tend to attract foreign investment, increasing the demand for and value of the home country's currency. Conversely, lower interest rates tend to be unattractive for foreign investment and decrease the currency's relative value.

What are the disadvantages of increasing interest rates? ›

Rising or falling interest rates affect consumer and business psychology. When interest rates are rising, both businesses and consumers will cut back on spending. This will cause earnings to fall and stock prices to drop.

What happens to the stock market when the Fed raises interest rates? ›

A higher interest rate environment can present challenges for the economy, which may slow business activity. This could potentially result in lower revenues and earnings for a corporation, which could be reflected in a lower stock price.

What should companies do when interest rates rise? ›

Increased competition for both equity and debt: When interest rates rise, businesses that need to raise or borrow money must compete with other businesses for a limited supply of capital. This can lead to higher transaction and borrowing costs making it more difficult for businesses to finance their growth.

What happens to businesses when interest rates go up? ›

In an environment with high interest rates, businesses may have to balance rising fixed costs like labour or supplies whilst remaining competitive in a market where customers have less overall money to spend and so become more cost conscious.

What happens when the exchange rate increases? ›

In the goods market, a positive shock to the exchange rate of the domestic currency (an unexpected appreciation) will make exports more expensive and imports less expensive. As a result, the competition from foreign markets will decrease the demand for domestic products, decreasing domestic output and price.

How do exchange rates affect the real economy? ›

The exchange rate affects the real economy most directly through changes in the demand for exports and imports. A real depreciation of the domestic currency makes exports more competitive abroad and imports less competitive domestically, thereby increasing demand for domestically produced goods.

What is the relationship between inflation interest rates and exchange rates? ›

Higher interest rates tend to attract foreign investment, which is likely to increase the demand for a country's currency. It is a fine balance and so is the resulting impact on a country's exchange rate. In general, when inflation is high, this weakens a currency because buying power is reduced.

What are the disadvantages of an increase in interest rates for a business? ›

With an increase in interest rates, businesses with company credit cards and existing loans can have higher interest payments, less disposable income and bigger overheads.

Why raising interest rates is wrong? ›

By increasing borrowing costs, rising interest rates discourage consumer and business spending, especially on commonly financed big-ticket items such as housing and capital equipment.

What problems are caused by high interest rates? ›

Impact on economic growth: High interest rates can negatively affect economic growth by increasing borrowing costs for companies and individuals, reducing spending and investment, thus reducing overall economic growth.

Who benefits from high interest rates? ›

With profit margins that actually expand as rates climb, entities like banks, insurance companies, brokerage firms, and money managers generally benefit from higher interest rates. Central bank monetary policies and the Fed's reserver ratio requirements also impact banking sector performance.

What stocks do well when interest rates fall? ›

Dividend stocks: Dividend stocks typically pay out a quarterly dividend, which can grow over time. This kind of stock tends to do relatively better than an average stock when rates are falling, in part because the payout becomes more attractive.

Should you invest when interest rates are high? ›

Stocks can be a solid hedge against both rising interest rates and rising inflation. Companies that can raise prices without sacrificing demand for their products (for example, food staples or gasoline) have “pricing power” and are most likely to benefit in this type of environment.

What is one way that an increase in interest rates could affect a business? ›

With an increase in interest rates, businesses with company credit cards and existing loans can have higher interest payments, less disposable income and bigger overheads.

How an increase in interest rates might lead to a change of business strategy? ›

In a high-interest-rate environment, their return-on-investment expectations might be more challenging to meet, which can cause them to be more cautious, potentially opting for fewer deals or looking for businesses with robust cash flows to offset higher financing costs.

When interest rates rise How do investors and consumers respond? ›

Higher interest rates can make borrowing money more expensive for consumers and businesses, while also potentially making it harder to get approved for loans. On the positive side, higher interest rates can benefit savers as banks increase yields to attract more deposits.

When interest rates rise how does business investment spending respond? ›

Higher interest rates tend to discourage borrowing and thus reduce both household spending on big-ticket items like houses and cars and investment spending by businesses.

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