Twenty years ago, Brazil’s embattled economy was crawling back from a difficult period, right after a new election, dealing with the mistrust of investors and international turmoil involving emerging markets. Sounds familiar, right?

Although the current situation has many differences, the solutions being sought to boost Brazil’s economy once again closely refer to a structure fully adopted to stop the crisis: the so-called “macroeconomic tripod”. In January of 1999, its last pillar, a floating exchange rate, joined the inflation target regime and fiscal responsibility in an attempt to “stop the bleeding” caused by a capital flight sparked by several crises in fellow emerging markets, and maintain the then-fragile stability provided by the Plano Real.

</span></p> <p><span style="font-weight: 400;">Established in July 1994, the plan helped to control Brazil&#8217;s exponential inflation by introducing a new currency, the Real. By that time, to make sure the plan would work, the foreign exchange rate was controlled by the government and pegged to the U.S. Dollar. In order to maintain this, the country spent its international reserves and, penniless, had to ask the IMF for help. In 1998, this system reached its lowest point and investor’s mistrust in developing countries—particularly Brazil—made it all unsustainable.</span></p> <h2>No more forced control</h2> <p><span style="font-weight: 400;">In January 1999, the authorities decided to adopt a fluctuating exchange rate, which allowed the BRL to float freely against the USD, following market movements. Obviously, this led to a lot more oscillation than a fixed exchange regime but, on the other hand, it made it a lot cheaper to manage the external debt, as Brazil no longer had to make up for a devalued currency on the market or make large increases to its benchmark interest rate to attract investments.</span></p> <p><span style="font-weight: 400;">“The floating exchange rate has to be seen as part of the [macroeconomic] tripod. It was extremely good for the Brazillian economy as it did not have to use interest rates to protect the currency. I cannot see a comeback to the fixed exchange rate we’ve used before, there’s no reason to do it. What we need is more fiscal responsibility,” said Mr. Sergio Vale, economist-in-chief of consultancy MB Associados.</span></p> <hr /> <p><img class="alignnone size-large wp-image-13360" src="" alt="brazil currency BRL against the US dollar" width="1024" height="683" srcset=" 1024w, 300w, 768w, 610w, 1200w" sizes="(max-width: 1024px) 100vw, 1024px" /></p> <hr /> <p><span style="font-weight: 400;">This has also helped Brazil accumulate almost USD 375 billion in international reserves, giving enough room for the Central Bank to intervene in stressful periods, such as last year, </span><a href=""><span style="font-weight: 400;">when the greenback reached its historic peak against the Real</span></a><span style="font-weight: 400;">, at BRL 4.20, reflecting the tension surrounding the election runoff. The monetary authority may use these resources to provide liquidity to the market through tools such as swap auctions, avoiding steep currency devaluation. Those, however, are not a way to fix the exchange rate. </span></p> <p><span style="font-weight: 400;">For financial markets, the exchange rate is more of a symptom than a cause in itself. USD is considered a safe asset; it is normal to see a bigger demand and, therefore, higher prices, in moments of tension. That being said, it is important to analyze the factors that make investors cautious about the economy; right now, none of them is more serious than the government’s fiscal responsibility, or lack thereof.   </span></p> <hr /> <p><img class="alignnone size-large wp-image-13249" src="" alt="brazil inflation rate economy paulo guedes jair bolsonaro president" width="1024" height="683" srcset=" 1024w, 300w, 768w, 610w, 1200w" sizes="(max-width: 1024px) 100vw, 1024px" /></p> <hr /> <p><span style="font-weight: 400;">It’s been six years since Brazil has generated a primary surplus. Gross public debt has increased in recent years and now hovers around 77 percent of GDP. This prompted the worst economic crisis in the country’s history, taking both inflation and unemployment back to double-digit figures.  </span></p> <p><span style="font-weight: 400;">The political instability that followed culminated with the impeachment of President Dilma Rousseff, in 2016. Her replacement, President Michel Temer, </span><a href=""><span style="font-weight: 400;">managed to control inflation</span></a><span style="font-weight: 400;">—also held by the lack of economic growth—but failed in accomplishing the biggest challenge to the public accounts: an overhaul of the pension system. </span></p> <p><span style="font-weight: 400;">Right now, that’s the major concern for both investors and the new government. As expected, this is reflected on the price of USD. So far this year, BRL has been one of the </span><a href=""><span style="font-weight: 400;">best-performing currencies in the world</span></a><span style="font-weight: 400;">, while investors are mainly optimistic about the success of the new president Jair Bolsonaro and his Minister of Economy, Paulo Guedes, </span><a href=""><span style="font-weight: 400;">in approving a sweeping pension reform.  </span></a></p> <p><span style="font-weight: 400;">“The fiscal regime is crucial to finding out the path our currency will take in years to follow. If the reform is approved, [the Real] will certainly rise. Otherwise, we will be back on the road to recession. I hope our Congress will be sensitive to such a brutal alternative,” adds Mr. Vale.

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MoneyJan 19, 2019

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BY Natália Tomé Scalzaretto

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