stopped being the last fat xmas turkey: Traders retreat as Brasília steers real.
By Samantha Pearson in São Paulo
Looming inflation means Brazil’s government is unlikely to step back
Ayear ago foreign exchange traders in Brazil would happily provide six-month forecasts for the country’s currency to the nearest cent. Ask the same question now, though, and most will fall silent or laugh at the absurdity of the request.
Brazil’s real, once one of the most traded emerging market currencies, this month sank to its weakest level against the dollar in three and a half years following a barrage of intervention by the government and the central bank.
The currency of Latin America’s biggest economy is no longer largely dictated by market conditions but by official policy, analysts and traders say.
Even the central bank’s watershed decision on Wednesday night to end the country’s 14-month easing cycle is expected to do little to boost the real, which has weakened nearly 30 per cent against the dollar since July last year.
“It’s a really different thing in terms of forecasting when you have a currency that is an endogenously determined result of fundamentals and policy, and when that currency becomes a policy instrument in itself,” says Tony Volpon, an economist at Nomura. “It’s the same kind of exercise as trying to forecast the Selic (Brazil’s benchmark interest rate) and work out what the central bank is trying to target,” he says.
Ever since Guido Mantega, Brazil’s finance minister, coined the term “currency war” in late 2010, the government has battled to protect the real from what it sees as competitive devaluations by others, namely the US.
At stake are key industries such as automotive production, which represents more than 20 per cent of Brazil’s manufacturing base and has suffered from a flood of imports as the real surged to a 12-year high against the dollar last year.
While the central bank has stepped up dollar purchases in the market, buying about $89bn since the beginning of 2011, the government has also introduced capital controls to weaken the real and boost economic growth.
“This market is now completely manipulated by the government,” says André Ferreira, director of the Futura brokerage, who believes the sharpest attack came in the form of last July’s 1 per cent tax on currency derivatives.
However, over the past few months the authorities have adopted a more gradual approach.
The real had weakened so rapidly at points over the past year that the central bank was forced to reverse its policy and prop up the real via sales of currency swaps.
Even so, companies with large amounts of unhedged debt in dollars, such as state-run oil company Petrobras and Vale, have still suffered multibillion-dollar currency losses as a result.
Recently, the authorities have targeted much tighter bands, currently about R$2-R$2.10 to the dollar. Mr Ferreira says the central bank could look to target a weaker band of R$2.10-R$2.15 in the medium term.
Seasonal outflows in December, the month when Brazilian subsidiaries typically send money home, could give the authorities a helping hand.
“The central bank seems to be keeping the currency cheaper than the fundamentals,” says Mr Volpon, who believes the real’s fair value is about R$2 to the US dollar. Officially, the government still maintains that the real is a free-floating currency.
Increasing government intervention in other areas of the economy, such as the recent overhaul of electricity concessions, has also inadvertently weakened the real by frightening off investment, analysts say.
“In 2013 we will see less inflows?.?.?.?the economy will only grow a little and there is a great deal of government intervention in the economy,” says Sidnei Nehme, the head of Brazil’s NGO brokerage.
“Nowadays the world is full of alternative emerging market opportunities, such as Mexico, Colombia, Turkey to an extent, and Indonesia.”
After $65.3bn flooded into Brazil last year via commercial and financial flows, only $22.2bn has entered the country so far this year, according to central bank data.
Smaller inflows, resulting in less liquidity in Brazil’s currency market, in turn also make it easier for the central bank to control the real’s value through intervention, says Nomura’s Mr Volpon.
However, the extent to which the government is willing to weaken the real over coming months will largely depend on next year’s inflation data.
Analysts expect consumer inflation to hit an annual rate of about 5.4 per cent in 2013 – well above the midpoint of the government’s inflation target range of 2.5 to 6.5 per cent.
A stronger real would be one way to keep rising prices in check, says Jankiel Santos, chief economist of Espírito Santo Investment bank in São Paulo.
“If the international scenario becomes less negative and risk aversion decreases, we could see the possibility of the real being used as an instrument of monetary policy to contain inflationary pressures,” he says.
While the real has been one of Brazil’s top concerns, keeping inflation under control is likely to take priority during the next couple of years, especially as presidential elections loom in 2014.
“At the end of the day, we do not have an official currency target in Brazil but we do have one for inflation,” says Mr Santos.
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