NOTICES

DEPARTMENT OF COMMERCE

[C-351-021]

Certain Carbon Steel Products From Brazil; Final Results of Countervailing Duty Administrative Review

Friday, January 9, 1987

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AGENCY: International Trade Administration/Import Administration, Department of Commerce.

ACTION: Notice of final results of countervailing duty administrative review.

SUMMARY: On October 31, 1986, the Department of Commerce published the preliminary results of its administrative review of the countervailing duty order on certain carbon steel products from Brazil. The review covers the period February 10, 1984 through September 30, 1984 and 22 programs.

We gave interested parties an opportunity to comment on the preliminary results. After reviewing all of the comments received, the Department has determined the net subsidy to be 9.14 percent ad valorem for COSIPA, 39.98 percent ad valorem for CSN, zero for USIMINAS, 38.45 percent for Maxitrade, and 21.13 percent ad valorem for all other firms.

EFFECTIVE DATE: January 9, 1987.

FOR FURTHER INFORMATION CONTACT:Richard C. Henderson or Lorenza Olivas, Office of Compliance, International Trade Administration, U.S. Department of Commerce, Washington, DC 20230; telephone: (202) 377-2786.

SUPPLEMENTARY INFORMATION:

Background

On October 31, 1986, the Department of Commerce ("the Department") published in the Federal Register (51 FR 39774) the preliminary results of its administrative review of the countervailing duty order on certain carbon steel products from Brazil (49 FR 25655, June 22, 1984). We have now completed the administrative review in accordance with section 751 of the Tariff Act of 1930 ("the Tariff Act").

Scope of Review

Imports covered by the review are shipments of Brazilian certain carbon steel products. Such merchandise is currently classifiable under items 607.6610, 607.6710, 607.6720, 607.6730, 607.6740, 607.6742, 607.8320, 607.8342, 607.8350, 607.8355, and 607.8360, of the Tariff Schedules of the United States Annotated.
The review covers the period February 10, 1984 through September 30, 1984 and 22 programs: (1) CACEX export financing; (2) an income tax exemption for export earnings; (3) the export credit premium for the IPI; (4) CIC-CREGE 14- 11 financing; (5) incentives for trading companies (Resolution 643); (6) duty-free treatment and tax exemption on equipment used in export production ("CDI"); (7) FINEX (Resolutions 68 and 509); (8) government provision of equity; (9) funding for expansion through IPI tax rebates; (10) FINEP; (11) accelerated depreciation for Brazilian-made capital goods; (12) BEFIEX; (13) CIEX; (14) financing for the storage of merchandise destined for export (Resolution 330); (15) FUNPAR; (16) PROSIM; (17) loan guarantees; (18) loan assumptions; (19) labor subsidies for employees of state enterprises; (20) subsidized electricity used in steel production; (21) subsidized port facilities; and (22) PROEX.

The review covers seven firms, comprising three producers and four trading companies. The three producers, Companhia Siderurgica Paulista ("COSIPA"), Companhia Siderurgica Nacional ("CSN"), and Usinas Siderurgicas de Minas Gerais, S.A. ("USIMINAS"), as well as one trading company, Maxitrade, received benefits that are significantly different, as provided for in section 706(a)(2) of the Tariff Act of 1930, from the weighted-average benefit for all firms. We have, therefore, set company-specific rates for those four firms.

Analysis of Comments Received

We gave interested parties an opportunity to comment on the preliminary results. We received comments from an importer, Voest-

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Alpine Trading USA Corporation, and the Brazilian government.

Comment 1: The Brazilian government argues that the Department should use for its short-term loan benchmark the annualized interest rate in effect on the date that each loan was obtained instead of the average annual rate in effect during the review period. In a high-inflation economy, such as exists in Brazil, and average rate calculated over the review period distorts the actual interest differentials. Further, since the number of loans in this case is small, this approach will not create an unworkable administrative burden.

Department's position: We disagree. An average benchmark over the review period may understate or overstate the benefit on individual loans, but it will accurately reflect the aggregate benefit from preferential loans over the review period because each company borrows at a more or less constant rate throughout the year.

Comment 2. The Brazilian government contends that the Department should use as its short-term loan benchmark the average commercial bank lending rates published by Morgan Guaranty Trust Company in its World Financial Markets instead of the average of weekly trade bill discount figures published in Analise/Business Trends. Commercial bank lending practices are most similar to Resolution 674/882 financing, the source of Morgan Guaranty's figures.

Department's position: We disagree. The commercial bank lending rates published by Morgan Guaranty Trust Company are lending rates to prime borrowers. As stated in the Subsidies Appendix to the notice of final affirmative countervailing duty determination and order on certain cold-rolled carbon steel flat-rolled products from Argentina (49 FR 18006, April 26, 1984) ("the Subsidies Appendix"), we use a national average benchmark based on short- term financing available to all firms, not just to prime borrowers. We have found that trade bill discounting more accurately reflects the actual borrowing practice of most Brazilian firms.

Comment 3: The Brazilian government argues that the Department overstated the short-term loan benchmark by compounding monthly rates. If the Department continues to use the annual average for discounts of accounts receivable, it should calculate a daily rate, compound it for a 30-day period and then multiply this rate by 12 to annualize the benchmark. This calculation would take into account the monthly rollover of the principal.

Department's position: We disagree. We have found that commercial lending in Brazil generally does not exceed 30 days and that most loans are rolled over monthly. It is inappropriate to use compounded daily rates, even if such rates were available, because loans are rolled over monthly, not daily.

Comment 4: The Brazilian government believes that the Department should use the guideline interest rates established by the resolutions regarding the short-term preferential export financing programs instead of the actual interest rates on each loan contract. Although the actual lending experience of certain firms may result in interest rates that are lower than the guideline interest rates, the lower rates are the result of commercial practices, such as the large volume of business conducted between certain firms and banks, and not any government action. Furthermore, since a higher lending volume generates higher costs for the firm, the Department should include these costs in calculating the effective preferential interest rate.

Department's position: We disagree. Regardless of whether the costs of these loans are higher or lower than the guideline rates, the benefit received by the companies' borrowing under this program is the difference between what they are paying and what they otherwise would pay. Further, the Brazilian government has provided no evidence that an increased volume of loan causes higher effective costs.

Comment 5: The Brazilian government claims that, in calculating the short-term interest rate benchmark, the Department should not include the tax on financing transactions ("the IOF"). The IOF is an indirect tax on the financing of physically incorporated inputs. Considering the IOF tax to be an integral part of the commercially-available rate (i.e., considering exemption from the tax to be a subsidy) is contrary to the General Agreement on Tariffs and Trade and U.S. law, both of which permit the non-excessive rebate of indirect taxes.

Department's position: We have considered and rejected this argument in other Brazilian countervailing duty cases. See, e.g., Certain Castor Oil Products from Brazil (48 FR 40534, September 8, 1983).

Comment 6: The Brazilian government claims that the Department incorrectly allocated the benefits from the income tax exemption for export earnings program over export sales instead of total sales. Since the program rebates direct taxes, it is a domestic subsidy, which requires the department to allocate the benefit over total sales.

Department's position: We disagree. When the amount of benefit received under a program is tied directly or indirectly to a company's level of exports, that program is an export subsidy. Under this program, exports are necessary to receive a benefit, and the level of exports determines the level of benefit. Therefore, we will continue to allocate benefits from this program over export sales instead of total sales.

Comment 7: The Brazilian government argues that CIC-CREGE 14-11 loans are not countervailable because they are non-government loans granted in accordance with commercial considerations. Although the nominal interest rates on these loans during the review period were somewhat below the commercial interest rates, commission costs, collateral and foreign exchange requirements effectively increased nominal rates to the range of commercial rates. Further, the Department should not calculate a cash deposit rate for this program because the nominal rates on these loans now approximate commercial rates.

Department's position: The Brazilian government has not provided adequate information to allow us to consider this loan program to be provided without government direction or to be provided on terms consistent with commerical loans.

Comment 8: The Brazilian government believes that the Industrial Development Council's ("CDI") Decree Law 1428, which allows import duty exemptions on Brazilian-made capital equipment, is not limited to an industry or group of industries, and is therefore not countervailable.

Department's position: We disagree. We have found that CDI benefits are provided by the government to specific industries. See, Certain Carbon Steel Products from Brazil (49 FR 17988, April 26, 1984).

Comment 9: The Brazilian government believes that FINEX financing under Resolution 68 and 509 is not countervailable because the program is consistent with the Arrangement on Guidelines for Officially Supported Export Credits ("the Arrangement"), which is not considered an illegal export subsidy under item (k) of the Illustrative List of Export Subsidies annexed to the Agreement on Interpretation and Application of Articles VI, XVI, and XXIII of the General Agreement on Tariffs and Trade ("the Subsidies Code").

Department's Position: We disagee. Since the FINEX loans in this case are short-term loans, they are not covered by the Arrangement and, hence, do not

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fall within the second paragraph of item (k).

Comment 10: The Brazilian government contends that U.S. importers would normally obtain import financing at LIBOR or the U.S. prime rate, not at the rates reported in the U.S. Federal Reserve Bulletin. Therefore, the Department should change the benchmark for FINEX importer financing. If the Department continues to use the Federal Reserve rate as a benchmark, the Brazilian government believes that the benchmark should not be based on the upper limit of the interquartile range, but rather on the average of the upper and lower limits.

Department's Position: We disagree. The Federal Reserve rates are an appropriate measure of the national average commercial rates available to U.S. importers. The Brazilian government has not provided any proof that an average importer in the United States would have access to either trade or working capital financing at LIBOR or U.S. prime rates. In calculating the benchmark, we used the weighted-average interest rates on loans of less than one million dollars, not the upper limit of the interquartile range.

Comment 11: The Brazilian government contends that the Department should have used discounting operations under Communication 331, rather than Resolution 63 loans, as the basis for the FINEX export financing benchmark. The terms and commitments associated with Communication 331 discount operations more closely approximate the FINEX export financing discounting operations.

Department's Position: We disagree. Communication 331 discount operations generally have a duration of much less than 180 days. In contrast, Resolution 63 loans, with 180-day terms, more closely approximate the terms, commitments, and duration of FINEX export financing.

Comment 12: The Brazilian government argues that the Department, in its calculation of benefits from importer and exporter FINEX financing, should not have included the commission, which is paid to the lending bank by CACEX. The Brazilian government believes that, since the commission is negotiated between the lender and borrower at arm's length, it is governed by commercial considerations, and is, therefore, not countervailable.

Department's Position: We disagree. The benefit received by the companies' borrowing under this program is the difference between what they are paying and what they otherwise would pay. Therefore, we have included the portion of the commission that is passed on to borrowers.

Comment 13: The Brazilian government argues that the IPI rebate program under Decree Law 1547 is not countervailable. As originally enacted, the value-added tax applied to all domestic sales transactions, but it now applies to only fourteen industries, including steel. Because these industries are subject to the IPI while others are not, the reduction of the IPI for any of those industries cannot be considered a subsidy.

Department's Position: We disagree. The IPI rebates do not directly reduce taxes paid by steel producers. Instead, the same amount of IPI tax is applied to all steel products, but only companies that produce certain priority products and companies whose expansion projects are government-approved may receive the rebates. For example, manufacturers of steel products such as welded pipe and tube are not eligible for the rebates. Therefore, there is no one-to-one correspondence between taxes paid and the IPI rebate. Moreover, we do not have information on the amount of rebates in other industries or on the exceptions within those industries.

Comment 14: The Brazilian government believes that, having incorrectly found IPI rebates under Decree Law 1547 countervailable, the Department then incorrectly calculated the benefit for the companies found to be uncreditworthy by adding a risk premium to the maximum discount rate. The maximum discount rate already includes a risk premium and is based on compensating balances, which the Department has determined are not required in Brazil.

Department's Position: We disagree. In accordance with the Subsidies Appendix, we have calculated a discount rate for uncreditworthy companies by adding a risk premium to the highest commercial interest rate that a creditworthy borrower would have to pay. The maximum rate for discounting accounts receivable, which includes compensating balances, is the highest commercial interest rate applicable to creditworthy borrowers. The addition of a risk premium to this rate reflects the additional risk in lending to an uncreditworthy firm.

Comment 15: The Brazilian government contends that the Department has sufficient evidence to find the FINEP long-term loan program generally available and, therefore, not countervailable. If the Department continues to find these loans countervailable, the benchmark should be the company-specific long-term interest rate in effect when the loans were taken out. In addition, the Department should not calculate a subsidy for any funds received under this program from the International Bank for Reconstruction and Development ("IBRD").

Department's position: We disagree with the first point. During verification, we requested industry-specific FINEP loan information, including data on the relative economic size of, and amounts received by, each industry for the past six years. Although we obtained information on various industries that received FINEP loans, the Brazilian government did not break down the amounts provided for those industries. Therefore, we do not have sufficient information to find the FINEP long-term loans are not specifically provided to more than a specific enterprise or industry or group of enterprises or industries.
We agree that a company-specific loan benchmark is appropriate. We have recalculated the benefit and find no change in the subsidy rate. Finally, we did not include any IBRD funds received in calculating the benefit for this program.

Comment 16: The Brazilian government believes that, since sales from producers to trading companies are made at arm's length, the Department inappropriately assumed that the subsidies given to producers also confer subsidies on trading companies and service centers. If the Department believes that subsidies on this merchandise were passed through from the producers to the trading companies and service centers, it should have used an upstream subsidy test to determine the benefit. If the Department continues to assume that subsidies given to producers also confer subsidies on trading companies and service centers, it should weight the benefits received by each trading company and service center by the amount purchased from each producer.

Department's position: The upstream subsidy provision of the Act, 19 U.S.C. section 1677-1, only applies to situations involving an input product. (See, final affirmative countervailing duty determination on live swine and fresh chilled and frozen pork products from Canada (50 FR 25097, June 17, 1985)). The products which are sold to the trading companies or the service center in this case are not inputs, rather they are products which are at or near the final stage of processing. All the trading companies or the service centers do is prepare these products for the next customer. The amount of value added by the trading company or the service

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center is minimal. Thus, since we determine that this situation is not one involving inputs, we determine that the upstream subsidy provision of the Act is not applicable. Nor does the fact that the sale from the producer to the trading company is an arm's length transaction alter this conclusion.

Comment 17: The Brazilian government argues that the Department incorrectly determined that COSIPA and CSN were not equityworthy from 1977-1984 and that USIMINAS was not equityworthy from 1980-1984 because the Department evaluated government investments by SIDERBRAS from the point of view of a private outside investor instead of a private owner-investor. The Brazilian government argues that its motive, as an owner-investor, is to maximize average returns on its past and future investments in each company, not to maximize marginal returns on investments as an outside investor would. Therefore, it is unreasonable to expect SIDERBRAS to treat past equity infusions as sunk costs.
The Brazilian government contends that the equity infusions in these years are directly tied to the massive long-term Stage III expansion projects undertaken by each firm. The government's decision to invest in Stage III was made in 1975. The decision relied on favorable long-term domestic and international market projections and World Bank appraisals which showed favorable financial returns for the projects. The Brazilian government contends that if it no longer provided equity, consequently forcing the stage III projects to a halt, it would forego the future benefits from the expansion project, and therefore, realize no return on its past investments.

Department's position: We disagree. Both a rational outside investor and a rational owner-investor make investment decisions at the margin. The relevant question for both investors is: What is the marginal rate of return on each cruzeiro invested An investor in the Brazilian steel companies does not ignore the potential return from the assets that the companies have already acquired. The potential for a favorable return from those assets is an integral part of the investment calculus. However, a rational investor does not let the value of past investments affect present or future investment decisions. The decision to invest is only dependent on the marginal return expected from each additional equity infusion. Therefore, new equity infusions contemplated by investors such as the Brazilian government should not be affected by past investments or sunk costs.
We do not dispute the findings of the long-term market projections or World Bank project reports made in 1975. The Brazilian government designed the Stage III expansion projects as a keystone in its Second National Development Plan (1971-1979). The plan explicitly called for steel investments with the objective of national self-sufficiency by 1979. With an anticipated completion date of 1979, Stage III was designed to supply steel for the Development Plan's large public sector investment program. The decision to sign the contracts for Stage III was based on the national goal of public welfare maximization and not necessarily on commercial considerations.
Although the decision to invest was made in 1975, actual construction began in the late 1970s. By that time, the investment climate had deteriorated, international markets for steel began to decline, and public sector investment dried up. Stage III may still have yielded positive financial returns despite the financial and economic conditions at the time. However, because a sufficient rate of return on equity depends on the performance of the firm as a whole, an investor will invest based on the rate of return for the entire firm, not the rate of return for an individual project such as Stage III. Current and anticipated future economic conditions and the effects of massive expansion projects on the steel companies are just as important as projected long-term markets in an investor's prediction of each company's long-term viability, and therefore, the decision to invest in the companies. Consistent with the desire to maximize overall profits, a rational owner-investor must constantly reevaluate projects such as Stage III in light of other investment opportunities before determining whether those projects should be continued, delayed or abandoned.

Comment 18: The Bazilian government argues that the Department's evaluation of the performance of COSIPA, CSN and USIMINAS during the Stage III expansion program was short-sighted in that it incorrectly focused on financial performance instead of current operating performance. The Department's reliance on both short-term static financial ratios and overall operating performance is an insufficient measure of long-run investment potential and future company performance.
If the Department continues to depend on short-term indicators, it should adjust each company's overall operating performance by eliminating non- productive assets (i.e., assets under construction) and related liabilities from the calculation of the financial ratios. When made, these adjustments reveal a healthy current operating performance for the three companies during the periods the Department found the companies not equityworthy. More importantly, such adjustments show strong profit margins and asset turnover, current operating performance measures which are fundamental determinants in the rate of return on equity.
The Brazilian government contends that the economic constraints existing in the late 1970s and early 1980s, such as government price controls on steel, supplier price increases, high real domestic and international interest rates, a temporary cyclical downturn in the steel market, and lower-than-expected government equity infusions were unanticipated transient problems that were insufficient to cause SIDERBRAS to abandon its long-term investment plans. These transient problems and their effects on the companies are relatively unimportant because they do not have a direct bearing on the companies long- term prospects.
The Brazilian government believes that the logical conclusion from the equityworthiness evaluation is that the only problem faced by the firms was undercapitalization, or a lack of equity infusions. Therefore, the Brazilian government believes that SIDERBRAS should have infused more, not less, equity into the companies.

Department's position: We disagree. the most significant factor in determining the required rate of return on an investment is the degree of risk. The greater the risk of the investment, the higher the expected rate of return must be. The decision to invest balances risk against the expected rate of return. From the point of view of an investor, the purchase of equity is highly risky compared to other types of investments.
In contemplating an equity purchase, an investor will evaluate past and present company performance, anticipated future economic conditions, and overall investment climate. Important determinants in the evaluation include the financial stability of the company (e.g., asset structure, funding sources, and risk of insolvency), past earnings, and the amount of financial leverage in the company's capital structure. Therefore, we disagree with the Brazilian government that present and past performance indicators

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are relatively unimportant in an investment decision.
Investors will also assess the potential future performance of the company. In this case, the Brazilian government undertook a massive expansion program designed to exploit the projected increase in the demand for steel. In evaluating the equityworthiness of the three companies, we do not rely exclusively on the future prospects of the expansion projects. We also cannot ignore, just as an investor would not have ignored, the effects of such an expansion on each company's present operations and future viability. An investor purchases equity based on the rate of return of the firm as a whole, not on the financial returns from a specific project.
From an investor's point of view, there is no relevant distinction between financial and operating results. To see clearly the relationship between operating and financial results, we look to the rate of return on equity, which is primarily a function of three variables: profit margin (income/sales), asset turnover (sales/assets), and financial leverage (assets/equity).
Evaluation on the basis of current operating results (profit margin and asset turnover), without considering non-operational assets and accompanying liabilities, may be an appropriate approach for managing or analyzing profit centers within a company. An investor, however, is concerned with the company's overall performance. To do otherwise, an investor would be ignoring the effects of the Stage III expansion program on the company. Non-performing assets not only drag down overall operating performance, but the chance that they might never come on-stream creates additional uncertainty for future earnings and therefore increases the risk of the investment.
The rate of return on equity equation shows the fundamental interrelationship between financial performance (financial leverage) and operating performance (profit margin and asset turnover). The decision to continue Stage III in the face of inadequate equity infusions from the Brazilian government leads to substantial increases in each company's financial leverage. There is a direct relationship between financial leverage and earnings variability. Therefore, both are also directly related to investment risk.

In the late 1970s and early 1980s, the Brazilian steel industry was characterized by Stage III construction delays, marginal or negative earnings, and a mounting economic and financial crisis. The lack of funding in the industry became critical. (The Brazilian government had a history of underfunding steel expansion projects.) By 1982, the three companies would have required 3 billion dollars in equity to correct their financial positions. Although it is now clear that the companies were severely undercapitalized, we cannot base our equityworthiness decision on what the financial standing of the companies might have been if this were not the case.
The three companies had a uniform response to the conditions in the late 1970s: they contracted variable-rate debt at a time of high real interest rates, and they used increasing amounts of short-term debt. Not only were the companies undercapitalized, but they mismatched long-term assets with expensive short-term debt.
During this time, an investor would have found that the steel companies were incapable of covering the additional debt expense with internally generated funds. The steel companies had a low probability of increasing earnings over the short- and medium-term from domestic sales because of the squeeze between supplier price increases and the government's policy of steel price suppression. Further, it became increasingly evident that there was a long- term decline in the world-wide demand for steel, continuing the depression of steel prices in the international market.
A project such as Stage III can have future positive returns only if the company does not become insolvent. In this case, the continuation of Stage III severely jeopardized the companies' financial standing. Even if we disregard profit margins and asset turnover, we cannot disregard the adverse effects of increased financial leverage on the companies' equity standing. The additional risk in the three highly leveraged companies would have dissuaded any private investor from purchasing equity in these Brazilian steel firms during the periods we consider them not to be equityworthy.

Final Results of Review

After reviewing all of the comments received, we determine the net subsidy to be 9.14 percent ad valorem for COSIPA, 39.98 percent ad valorem for CSN, zero for USIMINAS, 38.45 percent for Maxitrade, and 21.13 percent ad valorem for all other firms for the period of review, the same as in the preliminary results.
The Department will, therefore, instruct the Customs Service to assess countervailing duties of 9.14 percent ad valorem for COSIPA, 39.98 percent ad valorem for CSN, zero for UNIMINAS, 38.45 percent for Maxitrade, and 21.13 percent ad valorem for all other firms of the f.o.b. invoice price on all shipments of this merchandise entered, or withdrawn from warehouse, for consumption on or after February 10, 1984 and on or before September 30, 1984.
This administrative review and notice are in accordance with section 751(a)(1) of the Tariff Act (19 U.S.C. 1675(a)(1)) and § 355.10 of the Commerce Regulations (19 CFR 355.10).
Dated: December 31, 1986.

Gilbert B. Kaplan,
Deputy Assistant Secretary, Import Administration.