Brazil in real trouble
The sharp drop of the real will soon drive up inflation in Brazil
The Brazilian government has been struggling to prevent
a further dramatic collapse in the value of its currency,
the real.
On Tuesday the real plunged to a
record low for the second day running,
forcing the central bank to intervene
by selling foreign exchange reserves.
It now takes 2.17 real to buy one US
dollar. Without the central bank
intervention, the drop could have been steeper. During
the day the real had slipped as low as 2.22 to the dollar.
Brazil's troubles are likely to have a dramatic impact on
the economies of the whole of Latin America and could
trigger new volatility on Wall Street and other stock
markets around the world.
On Monday the Brazilian currency had tumbled 5% to
close at the then-record low of 2.15 to the dollar.
Central bank intervention
The central bank had intervened for the first time shortly
after Brazil's foreign exchange markets opened for
business on Tuesday. The bank pumped dollars into the
market and bought up real, but despite this the currency
continued to slip.
When the real hit the 2.22 level, the bank intervened
again, this time with more success.
In an official statement, the bank acknowledged that it
had been active on the markets by selling dollars during
most of last week. According to the central bank's web
site, the country's currency reserves have now shrunk to
$35bn.
Joaquim Kokudae at Lloyds Bank in Sao Paulo said:
"The Central Bank is going to have to act quickly to
stabilise the dollar below 2 reals this month, or we're
going to have problems with inflation."
On Wednesday, Brazil's
Senate is due to confirm
Arminio Fraga as the new
head of the country's central
bank. Mr Fraga's
appointment had met fierce
criticism because of his
previous job, working for the
speculator and hedge fund
guru George Soros.
Mr Fraga's confident
performance during the
Senate hearings last week
had actually led many
investors to believe that the
real would strengthen this week.
Real setback
The government and central bank were forced to stop
defending the currency's peg to the dollar in
mid-January. Since then the real has lost more than
45% of its value.
The real had first come under pressure when
speculators, hedge funds and both Brazilian and foreign
investors began to move massive amounts of dollars out
of the country. At one point more than $1bn a day was
taken out of Brazil.
Defending the real's peg to the dollar became so
expensive that the central bank decided to let the real
float on the exchange markets.
This was a bitter blow for the government. The
introduction of the real in 1993 had squashed
hyper-inflation running at 2,500% a year and its parity
with the US dollar was at the heart of the government's
economic policy.
IMF help
The economic squeeze is increasing the need for the
government to strike a quick deal with the International
Monetary Fund (IMF). Both sides are currently
negotiating a new loan in yet another bid to save Latin
America's largest economy.
The IMF has already agreed to help the country with a
$41.5bn rescue package, but both sides still have to
agree the conditions for the release of the second $9bn
tranche of that money.
The real's flotation had forced IMF and the government to
renegotiate the terms of the deal.
The IMF's managing director Michel Camdessus said on
Monday that he expected "good news" from the talks in
the next few days. He praised the Brazilian government's
efforts to "put their house in order" by implementing
budget cuts designed to reduce the overwhelming public
sector deficit.
"We're playing with fire," said Augusto Lopez-Claros, an
economist at Lehman Brothers in London. "If confidence
doesn't return to Brazil following the approval of the IMF
programme there will be serious implications for the
economies of the region and the whole continent", he
said.
Latin American impact
Many economists worry that the whole of Latin America
could experience an economic slump if the crisis in
Brazil cannot be contained. This in turn could hurt the
profits of US companies, and inflict heavy damage on
Wall Street and the world's stock markets.
Until now company earnings in the US have proved to be
surprisingly resilient to the turmoil in Latin America and
Asia.
Alice Rivlin, vice chair of the US Federal Reserve told
international bankers in Washington: "Brazil is walking a
precarious path through a minefield. And it is not yet
clear what its immediate economic future holds."
news.bbc.co.uk
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