RIO GRANDE DO SUL: AN ECONOMIC SNAPSHOT

UNCLAS SAO PAULO 000071 SIPDIS AMCONSUL RECIFE AMCONSUL RIO DE JANEIRO AMEMBASSY ASUNCION DEPT OF TREASURY WASHDC DEPT OF LABOR WASHDC USDOJ WASH DC SENSITIVE SIPDIS DEPT FOR WHA/BSC, WHA/EPSC, AND EB/TPP/IPE STATE PASS TO USTR FOR SCRONIN/MSULLIVAN STATE PASS EXIMBANK STATE PASS OPIC FOR MORONESE, RIVERA, MERVENNE NSC FOR FEARS USDOC FOR 4332/ITA/MAC/OLAC USDOC FOR 3134/USFCS/OIO USDOC ALSO PASS PTO/OLIA TREASURY FOR OASIA, DAS LEE AND JHOEK DOL FOR ILAB AID/W FOR LAC/AA E.O. 12958: N/A TAGS: EIND EINV EWWT EAGR ELAB KIPR ETRD ECON ECIN SOCI BR SUBJECT: RIO GRANDE DO SUL: AN ECONOMIC SNAPSHOT SENSITIVE BUT UNCLASSIFIED; PLEASE PROTECT ACCORDINGLY Summary -------------- ¶1. (U) Summary: Econoff and Econ Specialist traveled recently to Rio Grande do Sul (RGS),the southernmost state in Brazil located approximately 1100 km south of Sao Paulo. The state, which borders both Argentina and Uruguay, has a population of 10.3 million inhabitants, which represents 5.1 percent of Brazil's population. Covering an area of 282,000 square kilometers (about the size of Nevada),Rio Grande do Sul generates 8.4 percent of Brazil's GDP, or about USD 51 billion. The shoe industry, the largest employer in this region, has been affected in recent years by Chinese competition, resulting in job loss, transfer of technology and skills to China, necessary adaption to changing consumer tastes, and relocation of factories to the less expensive Northeast. However, because of the available skilled labor force and a concerned government, job opportunities have been created, such as the model GM automobile plant, which employs 2,000 and contributes to the economic welfare of the region. End Summary. Background -------------- ¶2. (U) We met with the Federation of Industries (FIERGS); the Trade, Industry and Service Providers' Association of Novo Hamburgo, Campo Bom and Estancia Velha (ACI); the Federal University of RGS, the Ministry of Development and International Affairs; the State Committee to Combat Piracy; and the Bi-National Center. In addition, we took in-depth tours of the state-of-the-art General Motors plant and the facilities of Rio Grande, the largest regional port. The visit offered a good opportunity to see firsthand the industriousness of this region, the challenges facing certain industry sectors, and the potential for continued economic growth. Rio Grande do Sul: Good and Bad Economies 
 -------------- ¶3. (U) Rio Grande Do Sul is Brazil's 4th largest regional economy, representing 8 percent of the national economy. It has a diversified and comprehensive industrial base, combined with good infrastructure and skilled human resources. Micro and small companies are responsible for 46 percent of the state's workforce, medium companies for 15 percent, and large companies for 39 percent. The production, commercialization, export and innovation networks are promoted by the state government and its partners, providing expert technical consultancy services and management training. During a meeting with Luis Roberto Ponte, the Head of the Department of Development and International Affairs, he highlighted one of the state's newer development programs: the "Exporters Information Center," a one-stop shop which offers a wealth of information, orientation, and technical assistance for the future international exporter. ¶4. (U) Accounting for nearly 20 percent of Brazil's total grain production, Rio Grande do Sul has suffered from a drought since 2004, which severely damaged the soy crops, causing tremendous losses in the agricultural sector (estimated at up to 70 percent). Fortunately, this year forecasts show much improved grain crops with good current sales. The relatively appreciated level of the real-dollar exchange rate has also been a major factor hurting the competitiveness of RGS products, particularly the shoe and agricultural equipment industries, both export-reliant sectors. The state suffered negative growth in industrial production from January 2005 until late 2006, affecting the tobacco and shoe industries and the machinery sector. Also, as a result of the state's heavy indebtedness, there has been little recent investment in infrastructure, with the exception of the major port and highway expansion projects. Mercosul -------------- ¶5. (U) Rio Grande do Sul, which borders both Uruguay and Argentina, has had good relations with its Mercosul neighbors and continues to maintain significant commercial activity. Rio Grande is the major port linking Brazil with Mercosul, and is fast becoming known as the "Mercosul port" according to Rio Grande administrators. Federal University of RGS Economics Professor Flavio Fligenspan believes that if RGS maintains the good economic and business relations with Mercosul countries, as well as an integrated economy, this will be very beneficial to the state. He sees two immediate objectives for good commercial relations: 1) greater promotion of RGS products for export, first to the global market and secondarily to Mercosul; and 2) encouraging stabilization of neighboring Mercosul states, which will result in a better regional economic environment and larger profits for Brazil as the largest partner. If, in the process of pursuing these goals, progress could be made in the areas of infrastructure and logistics, this would generate jobs for the unemployed, which ultimately would contribute towards combating Mercosul's present-day instability. FIERGS: A View from the Industrial Sector -------------- ¶6. (U) At the Federation of Industries for the State of Rio Grande do Sul (FIERGS),Kurt Ziegler, Vice President, and Alexandre Barbosa, Director of International Negotiations & Trade Remedies, provided statistical information on the many regional industries. FIERGS, founded in 1930; has 108 affiliated associations with more than 2,000 associates, representing 41,000 factories that directly employ more than 600,000 workers. Located 20 minutes from downtown Porto Alegre in an industrial complex, FIERGS houses an active Economic Department and also works closely with the Economics and Statistics Foundation (FEE),one of the major national economic research institutes. They maintain up-to-date information and supplied us with their most recent publication of social and economic indicators. According to FIERGS, Rio Grande do Sul is among the top three Brazilian states exporting to the U.S.: USD 9.8 billion in goods in 2004, compared to USD 10 billion for Minas Gerais and USD 32 billion for Sao Paulo. Agricultural products account for 15 percent of all exports. The Shoe Industry: Suffering from Chinese competition -------------- -------------- ¶7. (U) The largest industry in this region is the shoe industry (including leather and fur),exporting mostly women's leather shoes to the U.S. and employing 155,000 workers in this very labor intensive activity. The shoe industry is the largest employer in RGS (mainly women),and double the amount employed in any other state industry. Most shoe companies are clustered in the Rio do Sinos Valley, located in the central portion of the state. Recently, this industry has suffered due to strong competition from China, with exports falling every year since 2003. Several companies have already relocated their shoe manufacturing activities to the Northeast, where labor costs are lower. Intriguingly, many skilled shoe technicians have been lured to China to train Chinese labor in the shoe trade. Moreover, the Chinese shoe industry has begun to purchase primary leather from Brazil, which is exported to China and then used to make shoes that are exported to the U.S. in direct competition with Brazilian shoe manufacturers. ¶8. (U) In a meeting with administrators of the Trade, Industry and Service Providers' Association of Novo Hamburgo, Campo Bom and Estancia (ACI),a regional FIERGS-like organization located 45 km north of Porto Alegre, ACI representatives stated that approximately 1,000 Brazilians from RGS are presently working in the shoe business in China, actually teaching the trade. They further commented that the combination of the EU restriction on shoes from China and the weak labor laws in China, which allow for 29 12-14 hour workdays per month with minimum benefits, creates a work production pattern with which Brazil cannot compete. Chinese shoe exports previously destined for Europe but now blocked by this restriction, are instead shipped to other markets, including the U.S., thus competing directly with Brazilian shoes. ACI estimates that sales of 23 million pairs of shoes were lost to China in 2003-4, and 10 million in 2005-6. On the positive side, Brazil can react more quickly to changes in female consumer tastes and offer variety in shoe styles. However, the inability to maintain jobs for those presently working and create jobs for all those entering the job market has contributed to the rising unemployment rate in the shoe industry. ¶9. (U) A visit to the Zenglein Shoe Factory in Novo Hamburgo, known as the "shoe capital," gave a first hand view of the manufacturing process and its importance to the community. This company has been in existence for over 40 years, and has two factories that employ approximately 1800 workers. It is highly intensive manual labor, with each shoe passing through 20 pairs of hands in the manufacturing process. Zenglein is very fortunate, as they have substantial contracts with WalMart, Payless, American Eagle and Naturalizer Shoes. The General Manager was cautiously optimistic, as they have a guaranteed buyer with these contracts; however, he was also very concerned about the strong Chinese shoe industry, which produces cheaper products at a faster pace, and in many cases is producing cheap knockoffs of original brands at a fraction of the cost. Other Industries & Their Concerns -------------- ¶10. (U) The manufacture of transport vehicles (including auto parts and agricultural machinery) is the second largest industry in RGS, supplying 60 percent of Brazil's transport needs. Other important industries are: chemical products (third nationally); agriculture (especially soybean); precious stones; tobacco; cutlery; chicken (mostly exported to the Middle East); metallurgy; arms and munitions, and furniture. Some of the major companies represented in this region are Universal Leaf and Phillip Morris, General Motors, John Deere, International Motors, Gerdau (steel),and Marco Polo (transportation). Major export partners in order of importance are the United States, Europe, and South America. The Port of Rio Grande is located three hours south of the capital Porto Alegre and is considered the major Brazilian shipping port to the Mercosul countries. ¶11. (U) Both FIERGS representatives voiced three major concerns that affect industry in the region: 1) the 39 percent of GDP tax burden (federal, state, and local taxes combined),especially in light of the lack of services received in return; 2) the appreciation of the Real, which has recently pushed over 1,000 RGS companies out of the export market; and, 3) interest rates, "the highest on the planet," as Brazilians often complain. The solutions are very complex, the industrialists stated, and the increased spending of the Lula government only adds to the difficulty in resolving these issues and maintaining production. Rio Grande Port: Largest in Southern Brazil -------------- ¶12. (U) The Rio Grande Port Facility is the largest port in southern Brazil, and the second-largest in terms of movement. Thirty-five percent of all exports are to the U.S., with the port being the second largest container exporter to the U.S. after the port of Santos (Latin America's largest) in Sao Paulo state. Rio Grande employs 650 people in the terminal, not including the stevedores loading and unloading cargo. According to Port Director Vidal Aureo Mendonca, it takes approximately 12 hours to receive and ship products out of the port by containers, provided 48 hours notice of the contents of the shipment is received. Also of note is the high level of security with an electronic surveillance system, substantially reducing theft from containers. Assisting in security efforts is a specially trained maritime police force, equipped with fast boats. The port gave every appearance of being a clean, efficient, and well-run facility. ¶13. (U) In a 2004 study of 374 companies done by the Center of Logistical Studies at the Federal University of Rio de Janeiro (UFRJ),the Rio Grande Port facility was found to be the most efficient in Brazil. Mendonca attributed this efficiency to the following factors: 1) no employee strikes, 2) good security, 3) efficient operation, 4) good depth of the channel, 5) great expansion potential, and, 6) no piracy. Currently, USD 20 million is being invested in improvements to the port, in order to add another berth that will be able to handle three ships at the same time, and to add two more cranes for container movement. After 2008, other projects are planned for dock and equipment improvement. This port is increasingly becoming the feeder port for Mercosul, and is the major importer of GM and Toyota cars from Argentina. In 2004, there was a 15 percent rise in exports over 2003, in the amount of USD 2 billion. Approximately 98 percent of all exports from RGS go out through the Rio Grande port. Major products exported from the port are: 1) shoes; 2) tobacco; 3) furniture, and 4) chicken. The one problematic factor for the port is a 54 km stretch of inadequate highway connecting the port to the rest of the state. However, a large portion of the products arrive via barge on the canal from Porto Alegre (1,000 containers per month) or by train (500-600 containers per month),and there are road construction projects in progress to improve the bottleneck in the highway system. General Motors Facility: A Model Complex -------------- ¶14. (U) The General Motors Gravatai factory is located approximately 45 km from Porto Alegre and is one of the most advanced GM operations in the world, housing 4,000 employees in the complex. GM has 2,000 employees, and the 17 suppliers located on the complex account for the rest. The factory builds 40 cars per hour, or 115 vehicles per man per year. The Gravatai facility is the first in internet sales in the world for GM. Built in 2000, this site was chosen for its proximity to the port, the road system linking it to the port, the lower construction cost, and the lower labor cost as compared to Sao Paulo. According to Roberto Tinoco, Director of Operations, and Marco Antonio Kraemer, Director of Government Relations, GM has very good laborers who are well trained and completely understand the "lean manufacturing" philosophy of GM that makes this factory a model for GM. Total GM investment since 2000 is USD 1 billion. In addition, GM has purchased raw materials, goods, and services in the equivalent of USD 1.5 billion from 486 suppliers in RGS. ¶15. (U) In October 2007, the Gravatai plant began production of the fuel-efficient flexcar Prisma for the national market. Currently four out of 10 GM cars produced in Brazil come from the Gravatai plant. GM Brazil president Ray Young, in the "Gaucho Project" celebration launching the Prisma, anticipates that the Gravatai facility will soon produce 50 percent of all GM's Brazilian production in the future. With the increased production at the Gravatai facility, there will be increased activity in Rio Grande port for the shipment of cars. In order to accommodate the increased transport demand, GM will expand its use of barge transportation from the factory to the port, and has also entered into negotiations with state and federal authorities to assist with funding to enlarge or replace the present highway. Rio Grande port also plans to increase the present capacity for GM car storage, and will have an exclusive space for these vehicles. The port handles approximately 2,000 GM cars monthly, with 10 percent exported to Uruguay and Panama and 90 percent imported from Australia and Argentina. ¶16. (U) GM has a strong corporate social responsibility commitment (CSR) to the region. As part of the "Gaucho Project" (Note: "Gaucho" refers to residents of RGS. End Note.),GM will strengthen its existing CSR programs and will further integrate GM positively into the life of the community. Other CSR activities that the Gravatai GM facility sponsors are: 1) a Suppliers Fair, which prepares potential suppliers to enter the market with a realistic chance of succeeding; and 2) "Projeto Foco," a partnership with the government and the local metallurgy workers' union that trains young people in engineering and technological professions in the automotive industry. As of May 2006, 352 students have participated in this program. IPR Issues in Rio Grande do Sul -------------- ¶17. (U) Rio Grande do Sul formed one of the first state committees to combat piracy, composed of various state offices, including the Attorney General's Office, the Regional Office of the Federal Police, the Justice Department, and the Ministry of Development and International Affairs. According to Assistant District Attorney Mauro Henrique Renner, one of the major difficulties in combating piracy is making others aware that a problem actually does exist. He sees the need for continued education for partnerships between the municipalities and the private sector as well. RGS has a specialized unit for combating IPR crime, but the state has limited funds to fully support them. Presently, the committee is looking for a building located close to the airport where this unit can be placed and is currently searching for a private partner to assist with the funding, as the state government has limited funds. Even though authorities have been successful in deterring some piracy, Renner is aware that until they have a definite physical space and funding to support the anti-piracy unit, there will not be a sustained, structured fight against piracy activities in the state. The port of Montevideo and Foz de Iguacu in the tri-border area are major points of entry for contraband goods originating in China and Paraguay. ¶18. (U) Renner recognized that there needs to be legislative change to strengthen the government's anti-piracy activities. Specifically, the committee is working to obtain classification of piracy as a more serious crime, in the same category as organized crime, money laundering, and possession and use of arms. At present, legislation allows the counterfeiter to merely pay a fine and they are free without losing any of their valuable merchandise. For example, vehicles found carrying contraband goods in their storage compartments may prefer to accept the charges and pay a fine of USD 300, keep the merchandise, and continue on their way. The potential sale value of their merchandise is much greater than the imposed fine, making it more profitable not to contest the charges. ¶19. (U) In 2003, the Trade, Industry and Service Providers' Association (ACI) formed a very active anti-piracy committee specializing in footwear. They have approached piracy from a law enforcement/educational perspective, with the participation of local and federal authorities. They have 14 brands represented on their committee and have recently been successful in the incarceration of nine people and the closure of seven establishments involved in piracy. They are approaching piracy as a crime against the community, causing a loss of jobs in an employment market that is already suffering from increasing unemployment. As part of their educational message, they have prepared an information pamphlet addressing the effect of piracy on the labor market. Comment -------------- ¶20. (U) Comment: Rio Grande do Sul is a state with tremendous potential. It has Brazil's fourth largest state economy, produces a diversified mix of products, has strong export capability with one of the largest and most efficient ports, and has a hardworking, educated workforce poised to enter new industries. In recent years, exchange rate appreciation has affected its export economy, and a three-year drought has severely damaged its grain crops. Nevertheless, the state continues to forge ahead by 1) partnering with private companies on infrastructure projects, such as the USD 2 billion expansion project in Rio Grande Port; 2) investing in their universities to train their future workforce (Note: 98 percent of the state's school-age population is in school, the best ranking in Brazil, and RGS has one of the most comprehensive technical and professional training networks in Brazil, covering every region of the state); and 3) creating investment incentives for large companies such as GM, providing jobs, stimulating other businesses, and generating income for the community. This state illustrates one direction Brazil's economy could move in; unfortunately, too few others are in a position to follow its example. End comment. ¶21. (U) This cable was coordinated with Embassy Brasilia. McMullen