Is coronavirus the only one to blame for Brazilian Real’s rout?

Five Brazilian Reais for each U.S. Dollar. The Brazilian currency touched its lowest nominal level ever in its 25-year history amid the global panic and market routs caused by the Covid-19 pandemic. But is the coronavirus the only factor at play? 

Of course, in a moment of stress when investors are in panic mode, risk aversion takes over and it becomes hard to define what trends are caused by this hysteria, and what is down to local economic factors. At this point, it appears to be a mix of global panic with fears over Brazil’s growth and a bit of portfolio management, says Camila Abdelmalack, an economist at Veedha Investimentos.  

As she told The Brazilian Report, the foreign exchange rate has been feeling the international pessimism caused by the coronavirus outbreak since early February. But this wasn’t related to the country’s default risk, measured by the so-called “credit default swaps” (CDS), which touched their lowest level in a decade on February 18, propelled by signals from Congress that there would be a willingness to move forward with reforms. 

In Ms. Abdelmalack’s view, the gamechanger for this relationship came after the Carnival break, when President Jair Bolsonaro became at odds with Congress. 

“From that point on, the situation has aggravated and that added fuel to the devaluation while diminishing the room to recover. The CDS is back to high levels, with signals that the reforms are not moving forward, which means less trust in the domestic economy and investment influx to Brazil.”

The political news cycle of the day is not one of the best. As we explained in our March 12 Daily Briefing, Congress decided to strike down a presidential veto reducing expenditure on pension benefits for lower-income elderly citizens. Lawmakers doubled the maximum monthly income to qualify for the Continuous Payment Benefit (BPC), from BRL 261 to 522—creating BRL 20 billion in additional annual expenses for the federal administration. 

For the research team at Itaú BBA, “the expenditure increase makes it difficult to comply with the spending ceiling and may increase pressure to loosen it.” The analysts also added that, as a consequence, the government will probably have to reduce discretionary spending from BRL 67 billion to about BRL 55 billion—the lowest value on record.

Adding to the panic, the Brazilian government’s Press Secretary Fábio Wajngarten tested positive for the coronavirus on Thursday. As he was part of the presidential entourage on an official visit to the U.S. this week, President Bolsonaro is undergoing tests to determine whether he has also been infected.

Pablo Spyer, director at Mirae Asset, agrees with the view that a mix of panic and reaction to Congress has dictated the currency’s movements on Thursday. But he also adds that as bad as it seems; it is not as distressed as other assets, such as stocks. “The dollar opened the day reaching its high, but then it has retreated and did not hit the high point again. Even though it is stressed, it is not the worst asset today. Obviously, what is causing the panic is [U.S.] President Trump’s decision to ban travel [from Europe]; Congress’s decision is also contributing to it,” he told The Brazilian Report.  

Mr. Spyer also highlighted that Central Bank’s currency interventions during the day helped to counteract the charge of the U.S. Dollar. In the late afternoon, the announcement of a new spot currency auction helped the Brazilian currency reverse the trend and briefly touch negative territory. 

Money flows

The improved fiscal scenario and low inflation environment allowed the Central Bank to slash the benchmark interest rate to 4.25 percent, its lowest level ever. But the monetary easing process—which started in 2016—also chased away speculative capital, who are the investors that put their money in a country’s market looking for higher interest rates.

As we explained in our March 4 story, this kind of money flow might help to balance the foreign exchange rate, but it is unclear whether the Central Bank will keep the interest rate steady, or if it will follow the U.S. Federal Reserve in slashing interest rates to fight the economic impacts of Covid-19.

In the long term, economists are gambling that stronger growth and better confidence levels, spurred by productive reforms such as the overhaul of the tax system, are key to bring foreign investments into the country and take the forex rate to more balanced levels.  

Expectations for the Brazilian economy and currency

Speaking of the domestic economy, the growth expectations for 2020 are increasingly lower, culminating in the government slashing the GDP projections from 2.4 percent to 2.1 percent this week. That is even more optimistic than the market’s predictions, which are already around the 1 percent mark. 

For Ms. Abdelmalack, this also helps to explain the rout in stocks from the point of view of portfolio rotation, as moves beyond risk aversion. For the past months, foreign investors—which make up 40 percent of B3’s total trading volume—have been taking profits from Brazilian stocks. As  O Globo newspaper reports, up to March 4, foreigners had taken BRL 44.8 billion from the São Paulo stock exchange—the biggest volume ever, surpassing withdrawals from the entirety of 2019.

Focused on commodities, banks, and retail, the Ibovespa benchmark stock index is deeply reliant on economic performance.

“There has been an adjustment in growth expectations at the beginning of the year when investors reassess their portfolios. It looks like other emerging markets are making more sense now, offering tech companies, for instance. (…) We need to bring confidence levels on the local economy back.  And how do we do it? With reforms,” said Ms. Abdelmalack.

On Tuesday, Ibovespa fell over 18 percent in a day, having trading interrupted after having trades interrupted for two circuit breaks — bringing the total to four stops in the same week, a historical mark.

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