Brazil. Mineral exploration & metal balance. November Group Economics - Sector & Commodity Research - Emerging Markets Research

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1 Brazil Mineral exploration & metal balance Group Economics - Sector & Commodity Research - Emerging Markets Research November 212 Structural weaknesses continue to constrain competitiveness Brazil s economic success has been partly driven by the surge in commodity prices ABN AMRO expects a strong rebound of growth in GDP of 4% in 213 Infrastructural investments should guarantee that iron ore will remain engine of growth for Brazil. GDP growth, consumption & investments % growth (y-o-y) GDP Consumption Investments Source: Thomson Reuters Datastream Industrial production growth % growth (y-o-y) Q197 Q199 Q11 Q13 Q15 Q17 Q19 Q Brazil compared (212) Brazil Chile Colombia Mexico Peru GDP (USD bn) 2, , Population (mln) GDP per capita (USD) 11,885 14,92 7,648 9,713 6,289 GDP growth (%) Inflation (%) Budget balance (% GDP) Government debt (% GDP) Current account (% GDP) Competitiveness (rank WEF) Doing Business (rank World Bank) Corruption (rank) Moody's Baa2 Aa3 Baa3 Baa1 Baa2 S&P BBB A+ BBB- BBB BBB Fitch BBB A+ BBB- BBB BBB Source: ABN AMRO Emerging Markets Research, EIU Brazil macro views In recent decades, Brazil has been plagued by episodes of boom and bust. Overall, since the start of the 198s, average growth in Brazil has been just 2.5% a year, only slightly higher than growth in the G7 and even lower than world growth (2.8%). As a consequence, Brazil's share in global output has hardly changed and hovers around 3% of global GDP. Over the last ten years, however, this pattern appears to have changed. Average growth in Brazil reached 3.7% between 23 and 212, compared to only 1.3% for the G7 and 2.6% worldwide. The impact of the financial crisis in 29 seemed to have only temporarily interrupted the episode of strong growth. After slightly negative growth in that year, growth rebounded strongly to 7.6% in 21, but this was not long-lived and growth fell to just 2.7% in 211. For 212 we expect the economy to grow by only 1.5%, making Brazil one the region's worst performers. However economic prospects still look rather good. Growth is expected to pick up, initially underpinned by consumer demand, but ultimately also by an upsurge in investments. Ultimately we expect economic growth to reach around 4% again next year. Structural impediments to growth Despite brighter prospects, Brazilian growth comes nowhere near the levels seen in Asia and some other commodity exporting countries in the region, such as Chile and Peru. Structural weaknesses, known as Costo Brazil, continue to constrain competitiveness and hamper the country's efforts to achieve sustained GDP growth rates above 4%. Despite the fact that Brazil's ranking in the global competitiveness report of the World Economic Forum rose from 58 to 48 out of 114 countries in , it scores extremely poorly in some important areas. The most problematic issues are considered to be tax regulation, tax rates, infrastructure and bureaucracy. For example, in the area of government regulation, Brazil has the weakest score of all 144 countries in the survey. In the World Bank's Ease of Doing Business 213 survey, the picture is even bleaker. From an already low ranking of 128 out of 185 countries n the 212 survey, Brazil fell back to 13. If we only consider the 33 Latin American countries, Brazil comes in at an unimpressive 28th place and only outranks countries like Bolivia, Ecuador and Venezuela. The survey pointed to factors like the rigidity of its labour laws, the time it takes to start a business, the costs of exporting and importing and the high corporate tax burden. In fact, the survey said corporate taxes can absorb up to 69% of companies' gross profits. On a positive note, the country scores relatively well in the area of protecting investors. Other encouraging factors that in our view partly mitigate the above-mentioned structural weaknesses, are Brazil's relatively high level of GDP per capita, its rather strong middle class, the size of the

2 2 Brazil - Mineral exploration & metal balance - November 212 External position % GDP Strong loosening of monetary policy % Selic minus inflation Inflation Selic Selic = The SELIC rate is the Brazilian Central Bank's overnight rate Exchange rate Current account Foreign investment Nov-11 May-12 Nov-12 USD lhs Source: Thomson Reuters Datastream EUR rhs Key macro-economic figures for Brazil Real GDP growth -.3% 7.6% 2.7% 1.5% 4.% Inflation (avg*) 4.9% 5.% 6.6% 5.5% 4.2% Inflation (eop*) 4.3% 5.9% 6.5% 4.5% 4.5% BRL/USD (eop) Govt debt/gdp 61% 53% 54% 55% 54% Govt balance/gdp -3.2% -2.1% -2.6% -2.8% -2.6% CA* balance/gdp -1.5% -2.2% -2.1% -2.4% -3.2% Foreign debt/exp 1.4% 1.4% 1.2% 1.1% 1.1% * avg = average; eop = end of period; CA = current account Source: EIU, ABN AMRO Group Economics economy, its well-regulated financial sector, ample availability of all kinds of natural resources and a diversified export base, both with respect to products and markets. Brazil not only exports all kinds of commodities, but also a wide range of manufacturing products. Furthermore, despite the significant increase in the importance of China over the last decade, the US and Europe remain important trading and investment partners, making the country less vulnerable to adverse developments in a particular region. This, in combination with a strongly improved macro-economic stability, led all rating agencies to grant Brazil the lowest investment grade status in the course of 28/29, which was further upgraded last year by one notch. Economic prospects are rather good Most indicators suggest that the economic slowdown bottomed out in the first half and will slowly pick up towards the end of the year. A less gloomy global picture, together with a very accommodative monetary policy, will help to stimulate domestic demand. Since August 211, interest rates were cut by 525 bp to a current historic low of 7.25%. Investment opportunities continue to be bright, especially in the field of mining and infrastructure. The outlook for economic growth in China still looks promising and this will result in favourable prospects for both the hard and soft commodities export sector. Meanwhile, increasing employment and higher wages will underpin consumer demand. And inflation does not appear to present much of an obstacle in the short term. But in the longer run as well, there is little risk that inflation will get out of control. Given the huge investment projects in the pipeline, production capacity will rise and there are still ample opportunities to increase the workforce. Brazil s commitment to primary fiscal surpluses will also help contain inflation and stem exchange rate volatility. Still, even though the fiscal position is much healthier compared to the 199s, this was mainly achieved by increasing taxes rather than reducing spending. To raise growth above the average of recent decades, a lot still needs to be done to improve Brazil's competitiveness, starting with reducing overall government expenditure and lowering the tax burden. Exchange rate outlook Due to increased risk aversion, most emerging markets currencies, including the real, experienced a sharp depreciation in the beginning of 212. The Brazilian currency depreciated from a high of BRL 1.7 against the USD in February to a level around BRL 2. from May. Contrary to other emerging markets currencies, the real did not materially recover in recent months. This is partly due to the country's negative economic growth figures. But a more important reason is probably that the central bank does not seem terribly unhappy with current exchange rate levels. Hence, as long as inflation remains within the inflation target band (4.5% +/- 2 %-point), the central bank will not feel compelled to reverse monetary policy. Still, while the currency has remained rather weak against the USD since May, we expect it will eventually start to appreciate once the global picture looks less gloomy and risk appetite recovers, reaching a level of 1.8 at year-end 213. Less risk aversion will stimulate the inflow of portfolio investment searching for higher yields, while at the same time Foreign Direct Investment (FDI) inflows will continue to outpace the current account deficit.

3 3 Brazil - Mineral exploration & metal balance - November 212 Brazil mineral sector at a glance export to US: 11% share export to China: export to 13% share Netherlands and Germany: 9% share Brazil is global player in:,, Tantalum, Manganese, Brazil is externally dependent of: Metallurgical coal, Potassium, Sulphur, Rare earths export to Argentina: 8% share Sources: IBRAM, WTO, UNCTAD Brazil mineral exports and imports 3% 4% 5% Sources: IBRAM, UNCTAD, WTO Brazil: mineral output and proven reserves 1% 8% 6% 4% 2% % Source: USGS, UNCTAD, Metal Bulletin facts & figures 211 Major mining region 45% of mining companies located here Source: USGS, UNCTAD, Metal Bulletin Iron Quadrangle : of iron ore production Brazil is selfsufficient in: Limestone, Industrial diamonds, Titanium, Tungsten and Talc Exports 211 Imports 211 Silicon 1% Others 3% 84% Tantalum Manganese 211 Nickel Phosphate % of world output % of world reserves Australia Brazil China India production (Mt) * y-o-y % growth in output 13% 5% 2% -8% - share of world output (%) 25% 21% 17% 1% Domestic consumption (Mt) ,8 141 Export (Mt) share of production (%) 94% 84% % 29% Import (Mt) share of total imports (%).5% % 59%.2% reserves (Bln tonnes) share of world reserves (%) 21% 17% 14% 4% * volume converted to equal world average Fe content Sulphur 4% 1% Phosphate 2% Potassium 31% Others 7% Coal 46% Brazil s minerals & metals overview Brazil s mineral sector which includes as many as 8 different mineral commodities is an important supplier of minerals to the world. Brazil is Latin America s leading producer of aluminium, bauxite, cement, ferroalloys, iron ore, manganese, nickel, niobium, phosphate rock and steel. On global scale Brazil s most important mineral resources are iron ore, manganese, bauxite, niobium and tantalum. Of these five resources together, Brazil has a share of 14% in world production and 18% share in world proven reserves. The majority of the mineral resources are exported. Domestic use of the mineral resources is limited. Brazil is mainly a services oriented economy (which has a share of 67% in GDP), while the manufacturing sector has a share of only 28% in GDP. Iron Ore (steelmaking raw material) The iron ore mining industry is the most important mineral sector in Brazil, with a high export share of 84%. Brazil has vast iron ore assets (17% of world crude ore reserves) and is also home of the largest iron ore producer in the world (Vale). The majority of the iron ore basins are located in the eastern part of the country. The quality of Brazilian iron ore is high and the country accounts roughly for 3% of global seaborne supply. It is the second largest exporter in the world (after Australia). (aluminium ore) On a yearly basis, Brazil s mined bauxite accounts for 14% of world mine output. After Australia and Guinea, Brazil has the largest reserves (mostly located in the Oriximiná region in the northern part of Brazil), with an estimated 12% share in world reserves. More then 98% of mined bauxite in Brazil is domestically consumed. The bauxite is used for manufacturing of alumina. The majority of the remaining bauxite is exported to the US and Canada. Recently export increased strongly due to an export quota and imposed tax in Indonesia. (alloying element used in steel for more strength) Although Brazil is world s No. 1 in niobium (in both production and reserves with world shares of respectively 92% and 97%), yearly consumed volumes are small in comparison to other minerals. The world's largest deposit is located in Brazil (in the Araxá region in the eastern part of Brazil) and is owned by Companhia Brasileira de Metalurgia e Mineração (CBMM). Tantalum (metal powder, for the production of electronic components) has similar properties as niobium and is therefore difficult to distinguish. Other - In much smaller quantities Brazil also extracts limestone, industrial diamonds, titanium, tungsten and talc. For these minerals Brazil is self sufficient. Brazil is externally dependent on minerals such as coking (or metallurgical) coal, potassium, sulphur and rare earths for domestic use. Brazil s iron ore market: engine of growth? According to UNCTAD, the world iron ore project pipeline until 214 consists of 796 Mt of new capacity. The majority of these new projects are located in Australia. Expectations are that Australia will remain the top producer of iron ore for the next decade. However, growth of Brazil s output is also expected to remain high. Brazil continues to invest in the iron ore market and new capacity. The Brazilian Mining Association (Ibram) estimates that iron ore output from Brazil will increase by 17% from 211 levels until 215. This represents an investment of approximately USD 45 billion. Apparently mining companies and investors are still optimistic on the future of the Brazilian iron ore industry, despite current weak sentiment and lackluster global economic growth perspectives. When we take the structural problem of overcapacity in

4 4 Brazil - Mineral exploration & metal balance - November 212 GDP per capita (USD) Mineral production growth estimates (IBRAM) Phosphates Source: Ibram, Mining Journal Iron content of crude ore reserves Fe content reserves (in % of crude ore) Zinc Nickel Source: USGS 17% 5% 41% 57% 84% 17% 159% Freight cost advantage Australia vs. Brazil USD/t Freight cost advantage Australia vs Brazil Source: Clarkson SIN 14, 12, 1, Steel consumption & GDP per capita BRICS 8, 6, 4, 2, 8% 7% 6% 5% 4% 3% 2% 1% % South Africa (2) Source: IISI, ABN AMRO Group Economics 211% % 5% 1% 15% 2% 25% 39% South Africa (211) India (211) Production growth % 56% Brazil (211) Brazil (2) 49% Russia (2) Russia (211) China (211) China (2) India (2) Apparent steel use per capita (kg) 59% 55% 61% 64% 37% China Australia Brazil India Russia % the world steel industry into account (especially in China and Europe, important Brazilian iron ore consumers) the investment decision of mining companies seems to be hazardous. Current investment initiatives in iron ore will eventually boost iron ore supply, making the market even more oversupplied then it already is. In the end this will translate into lower iron ore prices, which will increase the problems for especially high cost miners. Therefore, the question is what the drivers are for these buoyant Brazilian investment initiatives. We think there are several reasons. First of all, in the long run iron ore demand is expected to stay buoyant, mainly driven by Chinese economic development. Second, in iron ore, Brazil will remain a competitive country. The costs of mining are relatively low, the ore quality is high and what also helps is that the Brazilian economy is expected to grow relatively strong going forward. Also, during the economic turmoil miners took drastic measures, such as cost-cutting and closing down loss-making mines. By doing this, Brazilian miners became cost efficient, and thus more resistant to decreasing iron ore prices. This way there is room for further exploration of promising mining projects. Another reason is that the Brazilian reserve base in iron ore provides a solid global position. Although the iron ore content (Fe) of the crude ore reserves in Brazil decreased in 21, in comparison to other major producing areas the Fe-content remains high. Indian Fe-content is higher and its crude ore is of good quality, but on the long run India will need most of this ore for domestic use. India will slowly withdraw from the international iron ore market. The quality of iron ore in China is low (and keeps declining) and in Russia vertical integration of the steel industry is high and more then 8% of the iron ore output is used domestically. In Australia, Brazil s biggest competitor, capital costs and wages have increased strongly. Next to that, government will impose a new tax (mineral resources rent tax, MRRT) of 3% on mining companies, leveraging competitiveness. And finally, the cost of shipping has plummeted. With the decrease, the gap between shipping cost from Australia to China and Brazil to China diminished also. Due to large overcapacity in shipping, tariffs for shipping are expected to remain on relative low levels. And this will reduce the freight cost advantage of Australia. But despite the narrowing gap between freight costs, the amount of time it takes to ship iron ore will remain a major handicap for Brazil. A ship from Australia takes about nine days to get to China, while a ship with iron ore from Brazil takes almost six weeks. Brazil s economic success has been partly driven by the surge in commodity prices and external demand of commodities. On a global scale, it is expected that Brazil will maintain its dominant position in minerals such as niobium, iron ore, tantalum, manganese and bauxite. Domestic demand for commodities has been moderate (especially iron ore), while GDP per capita increased by 24% in 1 years time. The surge in demand has put higher stress on existing infrastructure (rail, road, port facilities and power availability). Infrastructure remains a critical issue. Although the current governmental investment initiatives until 214 in infrastructural development are encouraging (described in Growth Acceleration Program), expectations are that it will take some time before all existing hurdles have been taken completely. In order to tackle all the bottlenecks and reduce existing logistic inefficiencies, investment in and strengthening of Brazil s infrastructure should be the single most important strategic issue for government to address. Going forward, this should guarantee that iron ore will remain an important engine of growth for Brazil.

5 5 Brazil - Mineral exploration & metal balance - November 212 Authors Group Economics: - Emerging Markets Research MACRO ANALYSIS: Marijke Zewuster (Head of Emerging Markets Research) tel: marijke.zewuster@nl.abnamro.com - Sector & Commodity Research SECTOR ANALYSIS: Casper Burgering (Senior sector economist Hard Commodities) tel: casper.burgering@nl.abnamro.com Disclaimer Important information The views and opinions expressed above may be subject to change at any given time. Individuals are advised to seek professional guidance prior to making any investments. This material is provided to you for information purposes only and should not be construed as an advice nor as an invitation or offer to buy or sell securities or other financial instruments. Before investing in any product of ABN AMRO Bank N.V., you should obtain information on various financial and other risks and any possible restrictions that you and your investments activities may encounter under applicable laws and regulations. If, after reading the brochure, you consider investing in this product, you are advised to discuss such an investment with your relationship manager or personal advisor and check whether this product considering the risks involved- is appropriate within your investment activities. The value of your investments may fluctuate. Past performance is no guarantee for future returns. ABN AMRO Bank N.V. has taken all reasonable care to ensure that the information contained in this document is correct but does not accept liability for any misprints. ABN AMRO Bank N.V. reserves the right to make amendments to this material. Publication closed on 12th of November 212 ABN AMRO, November 212