January 25, 1999
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Brazil's Currency Defense
Speeds Drain of Dollars
By PETER FRITSCH
Staff Reporter of THE WALL STREET JOURNAL
SAO PAULO, Brazil -- The pace of dollars leaving Brazil intensified Friday as the central bank dipped into its hard currency reserves to break a free fall in the Brazilian currency.
With the Brazilian real falling sharply early in Friday's session, the central bank sold more of its dwindling dollar war chest to buy reals, traders said. The action added liquidity to the market and helped prop up the currency. The real finished Friday at 1.71 reals to the dollar, weakened from Thursday's close of 1.695 reals. The real has lost 29% of its value against the dollar since the central bank first moved to devalue Jan. 13.
About $500 million in hard currency appeared to leave Brazil Friday, up from a drain of $406 million Thursday and $333 million Wednesday. Brazilian newspaper editors meeting Friday with central-bank President Francisco Lopes said Mr. Lopes informed them that Brazil's foreign reserves stood at $36 billion, including the $9.3 billion initial tranche of a $41.5 billion bailout package from the International Monetary Fund and others. Brazil has lost nearly $7.5 billion in dollar reserves this month. Mr. Lopes, according to an editor at the meeting, acknowledged outflows have been "exceptionally high."
Reassuring Markets
Confidence in Brazil's economy appears to be leaving with the dollars. That suggests to many observers that the government will have to do something beyond winning long-delayed fiscal reforms in Congress to demonstrate its commitment to taming a huge budget deficit. Daniel Dantas, president of the Opportunity SA fund-management firm in Rio de Janeiro, said "a more aggressive privatization policy that puts more on the table would help" reassure markets the administration is serious about reform.
The near-term worry is that Brazil's 28 billion reals ($16.37 billion) of taxes and spending cuts planned for this year may not be enough to meet IMF targets established in November. That's because Brazil has lifted interest rates to encourage people to keep their savings in reals, a move to protect its currency that has the side effect of causing its own domestic debt to rise.
IMF officials postponed a weekend trip to Brasilia because officials feel they need more time to prepare for direct negotiations with the Brazilians. Teresa Ter-Minassian, deputy director of the IMF's Western Hemisphere Department, will probably lead the team to Brazil and expects to go there in the near future, an IMF spokesman said. Brazilian officials have said their agreement with the IMF will need to be revised in light of the new foreign-exchange policy, which allows the real to trade freely against major currencies.
Most economists think things here could get worse before they get better. Consider the central bank's effort Friday to sell $175 million in real-denominated notes. Even though those notes pay 12% to 14% and are tied to the dollar exchange rate -- and are therefore unaffected by currency fluctuations -- the government sold only $120 million of those notes.
More Cold Water
Interest rates, too, are more likely to climb in a stepped-up defense of the real, throwing even more cold water on an economy in deep recession. On local futures markets, the rate at which the central bank lends overnight funds to other banks is seen climbing from 32.5% at present to over 34% next month and 58.41% in March before falling to 52.51% in April. Present overnight rates translate into rates of over 200% on many small consumer loans. In Brasilia, congressmen are threatening retribution against President Fernando Henrique Cardoso and his economic team if rates don't begin to fall in the next three months.
In the meantime, market observers said it appears the central bank is hoping to keep the real trading somewhere around its present level. Were it to fall much further, they said, prices could begin a precipitous climb. "Inflation will increase a little from last year's 1% to 1.5%, but it all depends at which exchange rate the real will bottom out," Finance Minister Pedro Malan said in a television interview Friday. Most economists point to inflation of 10% this year, though prices for some goods have already risen more than that.
Friday, Brazil's Bovespa stock-market index fell 1.8%, helping to roil trading overseas and marking its second decline after four sessions of spectacular gains in local currency terms. Markets Monday should be relatively quiet owing to a state holiday in Sao Paulo.
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