Taxing times for tanners

High levels of activity at the Fimec fair in April 2005 led many spectators to describe Brazil as the world's only growing market. Industry performance over the last few years has been very strong and, according to CICB (the Brazilian Tanners' Association) president Amadeu Fernandes, the leather production chain has a turnover of R$50 billion per year (US$20.4 billion), employs more than 500,000 people and exported US$4 billion in 2004. The footwear sector accounted for 45% of exports, leather for 35% and footwear components 20%. However, the continued decline of the dollar against the real has meant that in early 2005, few tanners are working at full capacity. Exports in 2004 According to Fernandes, of the total of 39 million leathers produced in Brazil in 2004, 27 million were exported, representing a 22% increase in relation to 2003. Value of exports increased from US$1.15 billion to 1.4 billion. In terms of volume, exports increased by 28.5%. Of the 27 million hides exported, 16 million were exported as wet-blue. Brazil exports leather to 78 countries. In 2004, exports to China were up by 68% on the previous year, while exports to Malaysia were up 138% (Table 2). The only countries which bought less Brazilian leather in 2004 were Portugal and Canada. Despite the government tax on exports of wet-blue, in 2004 60% of leather was exported as wet-blue (Table 3). Internal market In 2004, 12 million leathers were absorbed by the internal footwear, upholstery and leathergoods market, with a value of R$4.5billion (US$1.83 billion). The list of factors which gave the Brazilian leather sector the prosperity it enjoyed last year is extensive. As the Brazilian industry has gained reputation, and the country has become more politically and economically stable, more and more foreign investment is finding its way into the sector. At the end of 2004 LANXESS opened a leather laboratory in São Leopoldo, near Porto Alegre, which also houses their Leather Business Unit's technical centre for the entire south American region. A leading Italian upholstery producer is planning to open a 150,000 sq ft tannery in Salvador, Bahia, with an investment of €25 million. Other European tanneries are setting up joint ventures with Brazilian companies. According to Ulf Rainer Bogdawa, vice president of Abrameq, the influx of European companies has created a demand for higher levels of technology in the sector. Fernandes told Leather International that the leather and footwear sectors had invested US$300 million in the modernisation of technology and expansion of the machinery park. This has brought with it a need for a better-trained workforce. The PBQC (Brazilian leather quality improvement programme), a joint undertaking by CICB and SEBRAE (small business support service), has seen programme technicians and specialists visiting 19 states to train employees of livestock breeders, meat packing plants, university and agricultural students as well as producers of exotic skins with a view to improving the quality of raw materials. According to Fernandes, companies themselves are developing quality improvement processes including higher payment for better quality leathers (ie no scratches or holes), in addition to strict quality controls at all stages of the leather making process. Training According to Fernandes, 'Brazil has a modern and dynamic industry. The importance of training and technology is underlined by the establishment of a new Leather Technology Centre in the Mato Grosso do Sul region, the location of 35% of the country's cattle. The technology centre will develop new techniques for upgrading raw materials, train a specialised workforce and promote new technology for the production of bovine leather and the processing of exotics such as crocodile, fish and frogs. A further objective of the PBQC has been to increase the supply of raw materials in Brazil. Fernandes told Leather International: 'Last year, Brazil produced 39 million hides, compared with 35.5 million in 2003. Brazil has one of the largest bovine cattle herds in the world, estimated at 195.5 million head. The Ministry of Agriculture projects expansion to 220 million by 2010, representing 19.3% of the world herd. According to Fernandes, the tanning industry is increasing capacity in line with the increase in raw materials. Government To protect the interests of the leather sector, CICB advocates policies which reduce taxes and expand credit at competitive rates, as well as minimising bureaucracy. According to Fernandes, the federal government decision in December 2004 to maintain the tax on the export of wet-blue at 7% will encourage tanners to focus on the export of finished products, with a consequent generation of foreign currency and jobs in the country. For example, in 2004 the leather production chain generated 60,000 new jobs. In addition to improving their production capacity, many companies have also increased the types of leather they produce to reduce dependence on any one area. There is a particularly strong movement towards upholstery leather. According to Fernandes: 'The upholstery sector is going through a process of evolution. There are now companies which produce semi finished, finished and cut leathers for the automotive and furniture industry in the USA and Europe.' Modernisation has also affected the way in which the industry deals with effluent. Fernandes said that there are several initiatives underway, such as the development of technology to recycle chrome, thus reducing impact on the environment. The government, keen to encourage exports, have created a project to bring foreign buyers to Fimec to promote the image and raise awareness of the quality and diversity offered by the country's tanners. With the co-operation of 110 Brazilian companies, the buyer's project brought 17 buyers to Fimec in 2005 (compared with eight in 2004). Cezar Muller, Tanners' Association of Rio Grande do Sul, stated that the buyers programme had been a great success in creating links with new markets. However, industrialists believe that many of the problems that beset the industry in early 2005 can be attributed to government action. The concensus among tanners is that taxation is one of the sector's major obstacles. Edison Guimaraes Kuhn, of vegetable tannin producers Tanac, feels that the government has failed to react to the combination of increased production costs and the high value of the real against the dollar. Many in the industry are calling on the government to do more to alleviate the current problems. Cezar Muller told a press conference at Fimec: 'Today the dollar has gone down even further meaning that tanners have to come together to make the government aware of the exchange rate disaster that we are currently facing.' He stated that exports from the region of footwear and leather by volume had decreased significantly due to the tax and exchange rate problems. The issue has made exports to dollar based economies increasingly difficult. In July 2004, US$1 was worth 3.10 real. As of April 2005, US$1 was worth 2.56 real, a decrease of 18% over ten months. (NB: As we went to press, the situation had worsened to 2.47 reals to the dollar. However the authorities predict that by the end of 2005, US$1 will be back to R2.75. If the decline continues into the next six months, many footwear factories may be forced to close. The footwear sector has been hit particularly hard by the weak dollar as each year the US market absorbs an average of 50-60% of Brazilian footwear exports. As prices of chemicals and components are up, margins are getting smaller for shoemakers. Fernandes states that the exchange rate is already compromising the development of export companies. He continues: 'Various producers, mostly in Rio Grande do Sul, have been forced to cut staff in order to balance their books.' However, he believes that with a realistic exchange rate policy, 2005 could see the sector achieve exports worth US$4.5 billion, a growth of 15%. In this way, the high levels of foreign investment in Brazil is strengthening the real as more dollars come into the economy. This, combined with high interest rates, means more foreign investment - which is bad for exports. Therefore, the industry becomes a victim of its own success. Brazil has always been a high tax country but industrialists are now getting together to lobby government to lower taxes. Relocation There is a trend toward relocation out of the traditional tanning area of Rio Grande do Sul. This shift has been brought about by increasingly stringent environmental regulation (which caused a multinational pesticide producer to move to the state of Rio de Janeiro where there is less environmental control) as well as crippling taxes. On March 1, changes were made to the structure of the Rio Grande do Sul state's ICMS tax, which has worked against the industry. The tax was previously set at 17% (compared with just 7% in other states) but tax paid was transferable as credit on exports. The tax has now been lowered to 12% but credit is no longer transferable. Tanners say that this more than any other factor has resulted in a number of companies leaving Rio Grande do Sul. Tanneries producing wet-blue have led the exodus, aiming for integration with meat packing plants; thus producing fresher, better quality hides and reducing transport costs. According to Tanac's Marco Horn, the state of São Paulo is taking up a large proportion of this relocation. São Paulo is not a traditional tanning zone but in the last 18 months the state has consolidated its position in the Brazilian leather industry. In 2004, for the first time ever, tanneries in the state of São Paulo exported more wet-blue and semi finished leathers than any other state. Marco Horn feels that this relocation stimulates demand for technological advances in terms of both machinery and effluent treatment to meet the standards of their international customers. Polar Couros Polar Couros are tanners of high fashion leathers based in Novo Hamburgo. They finish 2,500 sq m of leather per day and specialise in lacquered finishes and embossed effects such as ostrich and crocodile. Polar pride themselves on their reputation to be fashionable and up to date with the latest trends. They produce a new collection for each fair they attend, always bearing in mind the season and target market. Polar currently export 10% of their production to China, Canada and the USA, but are planning to expand this to 16% in 2005. The majority of Polar leathers are chrome tanned but, in response to client demand, they have begun to produce some chrome free leathers. For their high volume customers, Polar offer exclusivity of a certain design of leather, meaning that the client will be able to offer a unique range of articles to the market. Polar's Vania Rauber told Leather International that January and February 2005 were better than normal, as production was uninterrupted this year; but this was then followed by a recessive market and the fall of the dollar. She prefers not to produce at all than produce lower quality for less money. At the start of 2005, the company were forced to lower production and have reduced their workforce from 160 to130 employees. Rauber says that improved global communication has meant information on developments in machinery and chemicals and new technology is reaching Brazil quicker. However, the government import taxes are very high so this restricts the technology that can actually be adopted by Brazilian companies. Exports are also heavily taxed. Many tanners are calling on the government to lower import/export taxes since they penalise small tanneries more than larger ones. NBN NBN are machinery producers based in Porto Alegre, Rio Grande do Sul. NBN's solutions are designed to be used by the majority of the tannery workforce throughout the world and they require very little specialist knowledge to operate the machinery. This has been a successful area. Currently, their major market is Brazil, where the machinery market is buoyant. NBN's Ulf Rainer Bogdawa states that the increase in European companies setting up joint ventures in Brazil has created a demand for increased standards of technology, which NBN can provide. As the industry moves away from exporting wet-blue and concentrates on finishing, this also creates a need for expansion of the machinery park. As NBN are a Brazilian company, they can provide service, maintenance and solutions targeted at the local labour force. The company's systems are used in tanneries throughout Latin America, Mexico, South Africa and are now present in Africa and Asia. The Brazilian machinery sector Rainer is also vice president of Abrameq, the Brazilian machinery manufacturers association. The leather and footwear sector in Brazil has mainly been involved in production of drums, chemical automation, transport automation, high technology plant design and finishing but not heavy machinery. The decline of the dollar has actually encouraged the development of the Brazilian machinery industry as, unlike ten years ago, it is now cheaper to produce at home than import machinery. Companies such as NBN buy in electronic components, mainly from the USA, so the dollar situation helps in this sense. Rainer believes that this has encouraged the growth of local expertise. This year, the sector has produced its first sammying machines. However, the cost of steel in Brazil increased in cost by 100% in 2004 due to the boom in construction in China. This is not helping the sector. The government have launched some initiatives to support the industry, such as the buyer's project at Fimec. Rainer says that NBN began to work towards exporting their machinery six years ago through the government's Apex programme which helps companies to attend international exhibitions. The programme also includes training for quality control managers as well as Tan Alliance, an umbrella of Brazilian machinery companies which have come together to gain a collective image to boost sales outside of Brazil. However, according to Rainer, for the industry to move forward, the government needs to take decisive action. He describes the 40% local income tax as unreasonable. 'Brazil is not a 3rd world country anymore. Governmental incapacity makes things hard for industry. It often feels as though we have two governments, one which helps the industry with projects such as Apex and another who penalise industry through taxes. One of President Lula's electoral promises was to lower taxes but he has not yet been able to.' There is a government fund for grants towards technological development - but grants are difficult to obtain. Rainer also feels that the country needs a better internal industrial policy, including lower taxes on industrial equipment which make it currently very expensive to build industry in Brazil. Production down Tanac's Edison Guimaraes Kuhn told Leather International that the period January to March 2005 has seen much less leather production in Brazil than in the same period of 2004. He says that supply in Brazil is much higher than demand so the price of leather is at its lowest for three years. Production costs have increased but at the same time the real has been overvalued compared with the US dollar. According to Guimaraes, the government has not been reacting to this. Tanac's sales to the Brazilian market are down 15% in the first quarter of 2005, compared with the same period of 2004, although the world market has remained stable. However, 25% of Tanac's production is non-leather so expansion into this area of the business will help balance the books. The footwear sector According to Adriane Costa of the Brazilian footwear components association Assintecal, overall exports of Brazilian footwear fell in the month of March 2005 after having remained stable for many years. Costa attributes this to the exchange rate situation. She notes, however, that there has been a general increase of 10% in the volume of high quality designer and branded footwear. Brazilian footwear companies have looked for inspiration in Brazilian culture to differentiate themselves in the fashion stakes, taking advantage of the country's cultural richness and identity. Brazil is the only country in the world which has comfort standards for footwear. Kern Mattes This footwear and leathergoods tannery, based in Portão, Rio Grande do Sul, employs 200 people and has a production volume of 800 hides per day working from wet-salted to finished leather. The company have 73 years of experience in the sector and are Brazil's principal manufacturer of patent leathers. With 70% of production being exported, the biggest overseas sellers are nappas, patents and box leathers. They use 100% Brazilian raw materials. Director Paulo Ricardo Hoff has observed a retraction in the industry both on a national and international level since the beginning of 2005, and attributes this to the strength of the real against the dollar. In response, the company have reduced production to 90% of capacity. He also cites recent changes to ICMS tax as the principal reason many tanners have been forced to leave Rio Grande do Sul. Curtume Bannach Based in Mafra, Santa Catarina, southern Brazil, Curtume Bannach have been trusted suppliers to the Brazilian footwear sector since their foundation 34 years ago. Specialising in sole leather, Curtume Bannach are always up-to-date with the latest technological developments, guaranteeing quality which meets the requirements of the most demanding clients. Conclusion Tanac's Marco Horn believes there is room for optimism. He told Leather International that in the last few months, the market has been reborn and a number of tanneries have reopened their doors. The majority of this activity is focused on the export markets. However, the strong euro which has reduced the competitivity of the European industry, leads Amadeu Fernandes to predict an increase in exports this year 'because Brazilian design and creativity are highly appreciated in Europe. Furthermore China, a fierce competitor of Brazil, has not yet been able to reach the standard that our industry offers.' The Brazilian leather sector's increased capacity, recently modernised tanneries, trained workforce and abundant supply of raw materials are advantages which will help it to emerge strong from the current climate. Fimec dates The 2006 edition of Fimec will take place from April 5-8 in the Parque de Exposições Fenac, Novo Hamburgo.