Why is Brazilian Central Bank selling dollars after ten years?

. Aug 15, 2019
Why is Brazilian Central Bank selling dollars after ten years?

One of the biggest boasts of Brazil’s Central Bank in recent years is its vast international reserves. That’s why it came as a surprise when economist Roberto Campos Neto, head of the Central Bank, announced the sale of U.S. Dollars on the spot currency market for the first time since the 2009 crisis. The move comes as an attempt to avoid major losses for Brazil’s currency, but there is some doubt over whether this indicates a change in the way the country will deal with its international reserves, or if it is just a way to calm markets down. 

</p> <p>On Wednesday, August 14, the Central Bank said it <a href=";numero=34005">would hold multiple USD-550 million</a> auctions on the spot market between August 21 and 29, considering “the increase in demand for liquidity on the spot currency market.” In order to protect the USD 388 billion Brazil has put away for emergencies, the Central Bank also announced the spot sale would be coupled with traditional and reverse currency swap auctions.</p> <p>The announcement came amid a global financial slump, as investors seek protection against the <a href="">effects of the U.S.-China trade war</a>, coupled with spill-over effects from the massive crisis in Argentina. But going against a global move is atypical behavior for the Central Bank, which led investors to wonder what might have changed this time.&nbsp;</p> <p>“It seems the Central Bank may have detected an imminent necessity to provide coverage for the market. Because if they only meant to hold the rise, it would be an inopportune moment, as the move was global,” wrote Sérgio Machado, a Brazilian fund manager, <a href="">on Twitter</a>.</p> <p>The reason for the sudden demand could be that Brazilian companies are trading debts in foreign currency for contracts in Brazilian Reais. In order to do that, they need dollars. A report by newspaper <em>Estadão</em> revealed that “Central Bank data shows that in the 12 months before June, the balance of bonds issued by companies abroad fell 34.5 percent. In the same period, bonds issued on the local market jumped 34.4 percent.”</p> <div class="flourish-embed" data-src="visualisation/597983"></div><script src=""></script> <h2>Trade-offs</h2> <p>Though company purchases explain the spike in the demand for the American currency, it definitely wouldn’t be the first time Brazil faces such a move. Normally, the Central Bank manages such situations with currency swaps or line auctions—which don’t have such an impact on reserves. Therefore, the decision to simply sell USD on the spot market came as a shock.</p> <p>Brazil’s international reserves are the country’s suit of armor against speculative attacks. By using them, the Central Bank can provide more liquidity to the market in times of stress and relieve the pressure on the BRL, protecting the currency&#8217;s purchasing power. For Brazilians’ daily lives, a sudden and steep devaluation can inflate prices of staple products such as medicines and fuels.</p> <p>In the 1990s, when Brazil did not have reserves as a cushion, the fall was much harder. In 1999, the country went to the International Monetary Fund (IMF) for help. To overcome a confidence crisis in emerging markets, the Brazilian Central Bank increased interest rates to 45 percent a year, after spending a big chunk of the country&#8217;s reserves to promote a <a href="">new currency, the Brazilian Real</a>, in 1994. Since then, the Brazilian government has worked hard to increase international reserves as much as possible—and many economists are adamantly against overusing them.</p> <div class="flourish-embed" data-src="visualisation/597570"></div><script src=""></script> <p>But with the perspective of more balanced public accounts and thus a more stable economy, some have started to consider whether the country should keep a hold of that money.&nbsp;</p> <p>That’s because maintaining the <a href="">reserves comes at a cost</a>. Brazil’s reserves are invested in assets such as U.S. government bonds (assets with high liquidity, which could be quickly sold to generate cash in case of need). But the return the Brazilian Central bank gets for those assets is lower than Brazilian interest rates, which are the base of the interest Brazil pays to finance its debt. In other words, Brazil pays more to finance its debt and gets a smaller return from its investments abroad.</p> <p>During the electoral campaign, now-Economy Minister Paulo Guedes had already addressed the issue. At the time, he <a href="">said</a> that in the case of a speculative attack pushing the USD closer to BRL 5, the country could sell up to USD 100 billion and use the cash to pay off debts—providing liquidity to markets and reducing the largest expense of the government with a single blow.</p> <p>Although the idea makes sense, it is far from a consensus among economists, who fear the move could make Brazil more vulnerable again.</p> <div class="flourish-embed" data-src="visualisation/597774"></div><script src=""></script> <h2>How to make foreign reserves</h2> <p>By definition, foreign reserves are the assets held by a Central Bank, such as strong foreign currency (U.S. dollars or euros, for instance), bonds, or even gold. The stronger the economy (high GDP growth and primary surpluses) the better the conditions for the country to purchase reserves.</p> <p>They are also impacted by the total amount of money that comes in an out of a country due to the purchase of goods and services, as well as investments. In a <a href="">commodity-exporting country</a> such as Brazil, the cycle of these goods also interferes with how much money comes in, which helps explain how Brazil managed to grow its reserves so fast in the 2000s.</p> <p>It is important to highlight that the Central Bank chose to invest the money, always looking for the safest assets, through <a href="">strict governance and compliance measures</a>.</p> <hr class="wp-block-separator"/> <p><em>This content has been updated on August 22, 2019. </em>

Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Before joining The Brazilian Report, she worked as an editor for Trading News, the information division from the TradersClub investor community.

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