Fall of Brazilian Real is ‘no reason to panic’

. Nov 21, 2019
Fall of Brazilian currency, the Real, is 'no reason to panic' Image: Rafastock/Shutterstock

As the Brazilian currency, the Real, reached its all-time lowest nominal value against the U.S Dollar this week, the government has been battered with criticism. Often held up by the liberal right as a sign of inept governance, the weakened Real has come back to bite many pundits on the rear end. But while the currency devaluation has an impact on inflation and investments, the slide of the BRL may not be nearly as bad as it seems.

</p> <p>So far in 2019, the Brazilian currency is 15 percent down against the U.S Dollar, making it the second-worst performing coin in Latin America, only behind the 60 percent dive of the Argentinian Peso. The BRL&#8217;s slide accelerated after November 6, when the government&#8217;s pre-salt <a href="">oil auction</a> ended up frustrating market expectations of a large influx of foreign investment. Only two of the four pre-salt oil fields on offer received any bids, with the vast majority going to Brazil&#8217;s state-owned oil firm Petrobras.&nbsp;</p> <p>According to Alfonso Esparza, a financial market analyst at brokerage Oanda, the internal situation is less to blame for the struggles of the Brazilian Real—the main culprits come from outside.</p> <p>“I see [the BRL&#8217;s devaluation] as a combination of factors. The trade war is a big one. It has triggered risk aversion, big investors are going to safe havens like the Swiss Franc or Japanese Yen,” he told <strong>The Brazilian Report</strong>. “The other part is regional, with protests breaking out all over Latin America. There’s a lot of resentment from the population and we are seeing protests in Ecuador, Chile, Bolivia, Peru. It feels a little contagious.&#8221;</p> <p>&#8220;And then there is [the release of former president] Lula rallying the opposition. There’s fear of further political polarization which could slow down reforms. That sort of triggered a reaction in investors,” he explained.</p> <h2>“Guilty by association”</h2> <p>For Mr. Esparza, political issues such as the debates on whether <a href="">financial intelligence reports can be used in criminal matters without court orders</a> add extra noise to the current moment, but the standing of the Brazilian Real is 80 percent dependent on events happening outside the country’s borders.</p> <p>In his view, the U.S.-China trade war has brought volatility to emerging currencies, including the BRL. As both countries prepare for the so-called &#8220;phase one&#8221; of a treaty to end the trade war, Mr. Esparza sees two possible scenarios having an impact on foreign currency.&nbsp;</p> <div class="flourish-embed" data-src="visualisation/975494"></div><script src=""></script> <p>“If the deal passes, there will be a renewed appetite for risk, then the Brazilian Real would recover. But there is another scenario, which is starting to seem more likely because we are seeing a bit of back and forth. If they delay the deal until next year—or don’t sign it at all—it will be negative for emerging market currencies and could push the Real even further down,” he said, adding that the date to watch is December 15, when <a href="">tariffs worth USD 156 billion</a> on Chinese goods are set to come into force.</p> <p>Regarding potential side effects, while Brazil is far more peaceful at the moment than its neighbors, it still suffers from local instability. But it is not necessarily a fear of political unrest or economic problems that are causing havoc on the local markets.&nbsp;</p> <p>“Brazil is definitely not in the same situation as Argentina, for instance. But if anything is happening in the region and you want to speculate, you go to Brazil or Mexico, because there is more liquidity. They are just guilty by association.”&nbsp;</p> <h2>Technicalities</h2> <p>As <a href="">Brazil’s benchmark interest rate</a> dropped from 14.25 percent in 2016 to its lowest all-time level of 5 percent as of November, many investors started to wonder whether the country would continue to be a destination for speculative investments, as it now offers less return than other emerging economies, such as Mexico.</p> <p>An article from newspaper <a href=""><em>Valor Econômico</em></a> shows that the influx of dollars to Brazil is already at its lowest level since 1999, when Brazil allowed the market to dictate its foreign exchange rate. Since October, USD 21.2 billion were taken out of the country. This number is set to increase further, as the end of the year is traditionally a time with less liquidity, with multinational companies sending profits to their headquarters abroad.&nbsp;</p> <p>As the report explains, this dollar flight is caused by the global economic slowdown reducing exports, and by companies&#8217; debt management—with many exchanging their foreign liabilities for local, cheaper sources, for which they need to pay in USD.&nbsp;</p> <p>In Mr. Esparza’s opinion, the Brazilian currency has lost a bit of its appeal to foreign investors, yet remains attractive given the low or even negative interest rates in the U.S. and Europe. However, it is lacking the stability foreign investors are looking for at the moment.&nbsp;</p> <p>On the corporate front, the search for dollars is set to continue, as companies must determine their hedging strategies for the following year. “Everything is quite uncertain and emerging market currencies are on a downward slide, so they will look for stability,” he said.&nbsp;</p> <h2>Brazilian currency in the long term</h2> <p><a href="">Speaking before</a> the Senate’s Economic Affairs Committee this week, the president of Brazil’s Central Bank, Roberto Campos Neto, said that the rise in the USD only causes trouble when it begins to put pressure on inflation, making imported goods more expensive and increasing internationally-oriented fuel costs. Considering that the official inflation index hit its <a href="">lowest level for October since 1998</a>, that is not the case at the moment.&nbsp;</p> <p>Mr. Esparza believes that the monetary authority&#8217;s willingness to let the market adjust exchange rates shows they are unfussed. Furthermore, with inflation in check, there is a clear path to continue lowering interest rates. As the measure’s ultimate goal is to foster economic growth, a devalued currency could be useful.</p> <p>“Lower interest rates allow consumers to spend more. There’s more money circulating in the economy and therefore, it grows. The exchange rate limits the consumption of imported goods, so it boosts the internal economy,” he explained.&nbsp;

Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Most recently, she worked as an Editor for Trading News, the information division from the TradersClub investor community.

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