March 8, 2016
Political Turmoil in Brazil not Good News for Brazilian Agriculture
After months of investigations and rumors, it looks like the ongoing Petrobras corruption probe is getting closer to former President Luiz Inacio Lula da Silva (Lula) and President Dilma Rousseff. Last Friday, the federal police took Lula in for questioning and executed 33 different search warrants of his home, his son's home, and various offices all in connection with the Lava Jato investigation - "Car Wash" in Portuguese. The long running political crisis now seems to be coming to a head.
In a "backward sort of way" the market views all this as a positive sign. Without a doubt, impeachment proceedings would be disruptive, but the market views this as maybe the beginning of the end of gridlock in Brasilia. Once all this gets behind them, the Brazilian Congress, and possibility a new president, could focus their efforts in getting the Brazilian economy out of the worst recession in a century. I do not know if that is a realistic assumption or not, but that is the market reaction, at least for now.
I am going to focus my comments on how all this might impact the agricultural sector in Brazil going forward. The agricultural sector in Brazil has been an island of prosperity in an otherwise sinking economy, but that may not be the case going forward. There definitely seems to be storm clouds building on the agricultural horizon in Brazil.
Agricultural Gross Domestic Product in Brazil - According to the Brazilian Minister of Agriculture, the Agricultural Gross Domestic Product (GDP) in Brazil for 2015 increased 1.8%, which was the second worst performance during Dilma's tenure as president, only surpassed by a 3% contraction in 2012 caused by dry weather and reduced production. The Agricultural GDP may actually not be as good as it seems because it was propelled forward by a 5.4% increase during the first trimester of 2015 only to lose steam as the year progressed. Even with that, the agricultural sector was the only sector in Brazil to register positive job growth in 2015.
Additionally, the gains in the agricultural sector were mainly the result of the significant devaluation of the Brazilian currency. Soybean receipts in 2015 were up 11.9%, corn was up 7.3%, oranges were down 3.9%, coffee was down 5.7%, and wheat was down 13.4%. The benefits of a devaluation of the currency is not likely to be repeated in 2016. In fact, the Brazilian currency strengthened significantly late last week, which resulted in declining domestic grain prices last week.
The Brazilian economy will probably contract 4% or more in 2016 after contracting 3.8% in 2015. The Brazilian economy is currently one of the worst preforming economies in the world with lots of problems including: high inflation (10.5% officially and mid-teens unofficially), high unemployment (7.6% officially and rising, much higher unofficially), high interest rates (prime rate is 14.25% and typical bank rates in the low 20% range), and declining consumer spending. A shrinking economy and declining consumer spending is certainly not good news for the agricultural sector. Without the stimulation from a devalued currency, the agricultural picture in 2016 does not look good at all.
Devalued Brazilian Real - The devaluation of the Brazilian real over the past year has been a "god send" for the agricultural sector. It allowed Brazilian grain exports to be more competitive in the world market and it resulted in stronger domestic grain prices especially for corn. The combination of strong corn exports and declining full-season corn production has led to record high or near record high domestic corn prices. Domestic soybean prices have also been supported by the weaker currency. As a result, Brazilian farmers are benefiting from these "artificially" high grain prices.
Stronger Brazilian Real - I have said many times in the past that the exchange rate is often times more important to Brazilian farmers than the actual international grain prices and right now is another example of that. The Brazilian currency strengthened late last week when it appeared that the investigation was closing in on Lula and Dilma. This is not good news for Brazilian farmers. The result is falling domestic grain prices and farmer selling drying up. If the currency would continue to strengthen, Brazilian farmers would be confronted with more realistic grain prices instead of the artificially high grain prices that resulted from the devaluation.
As a result, farmers in Brazil could be confronted with higher costs and lower prices for the 2016/17 growing season - not a good combination.
2016/17 Harvest Plan - The Brazilian Farm Program, called the "Harvest Plan" is renewed on a yearly basis and it basically consists of offering low interest subsidized production loans for farmers. In 2015 for example, the amount of money available for these loans was increased for loans that included market interest rates (20-25%), but it was reduced for loans that included the subsidized interest rates (6-8%). Farmers complained last year that they ended up worse off under last year's plan even though there was more credit available. Details of the annual harvest plan is usually announced in April or May and the loans can be obtained starting on June 1st.
The Brazilian economy is in dire straits and the Brazilian Minister of Agriculture has already held meeting with farm groups looking for ways to avoid cutting back on available credit for the first time in decades. Given the dire situation facing the Brazilian economy, I would expect the 2016/17 harvest plan to be even less favorable for farmers than the 2015/16 plan. In the end, Brazilian farmers will probably have less credit available and at a higher cost.
Higher Production Costs - Even though soybean prices are higher in Brazil this year compared to last year, farmers complain that their profit margins are being squeezed due to increased production costs. Farmers survived these higher costs because of improved domestic grain prices, but that may not be true in the future. Inflation in Brazil is officially 10.5%, but most analysts think the real rate of inflation is probably in the mid-teens. The cost of everything is increasing and as a result, farmer's profit margins are going to be squeezed even more.
Possible La Nina - It remains to be seen if El Nino will transition into a strong La Nina or not, but if it does, that would not bode well for the next growing season in Brazil. A strong La Nina generally correlates with hotter and dryer conditions in southern Brazil and Argentina and below trend line yields. There does not appear to be much of a correlation between a strong La Nina and the weather patterns in central Brazil. In general, a strong La Nina could result in declining grain production in Brazil.
Summary - Brazilian farmers have been fortunate in recent years with generally good yields and good prices, but the agricultural sector could face significant headwinds in 2016/17. But, we must always add the caveat that they might get "bailed out" again if we end up having a significant weather scare here in the U.S. during the upcoming growing season. Stay tuned.