SCENARIOS-Brazil weighs options to halt real's rise
Tue Aug 24, 2010 4:30pm IST
By Samantha Pearson and Silvio Cascione
SAO PAULO Aug 24 (Reuters) - Compared to the rest of Latin America, Brazil is an old pro at currency intervention.
Haunted by memories of rampant inflation in the 1980s and 90s, Brazil's authorities have continued to play an active role in the currency market, primarily through U.S. dollar purchases.
But the real soared 34 percent against the greenback last year, putting a huge pressure on the country's exporters. Investors flocked to Brazil in the aftermath of the financial crisis since it was one of the few places offering high interest rates and returns, and thus big profits.
While the currency has weakened so far this year, fund-raising plans by local companies and renewed interest in Brazilian bonds has caused the real to firm 2 percent since June, prompting the government to consider getting tougher.
Following are measures which Brazil's authorities have used before and could use again to curb the real's appreciation:
* VERBAL WARNINGS
Brazil's central bank is adamant that it is not trying to secure the real at a specific level.
But that has not stopped economists and traders from fixating on 1.75 as the maximum value the real could be allowed to strengthen against the U.S. dollar before the government takes more aggressive action.
Brazil's finance minister, Guido Mantega, has frequently issued cautionary comments about the currency's appreciation. Further warnings should be expected whenever this level is broken for more than a few days, analysts say.
* BIGGER OR MULTIPLE DOLLAR AUCTIONS
The central bank has already been increasing its dollar purchases in the spot market via daily auctions, which it resumed on a regular basis in May 2009.
But despite almost doubling its purchases so far this month, the currency has continued to test the 1.75 level.
Analysts argue that the auctions are also creating a guaranteed market for dollars in Brazil which could actually cause the real to strengthen in the long-term.
One temporary option would be to call more than one auction on the same day, as the central bank last did in May this year.
By changing their routine, the central bank would "wrong-foot" the market, sending a stronger signal to traders without necessarily buying more dollars, said Mike Moran, senior currency strategist at Standard Chartered in New York.
* SOVEREIGN WEALTH FUND PURCHASES
Brazil's Treasury has also been buying more dollars, making the most of cheap greenbacks to pay off foreign debt, but the effect on the currency has been minimal.
Brazil's sovereign wealth fund, which was authorized last December to buy dollars but has yet to do so, could also be used to slow the currency's rise.
However, after the initial shock to the market, this strategy faces the same pitfalls as the central bank's daily auctions, analysts say.
* REVERSE CURRENCY SWAP AUCTIONS
"Below 1.70 they would probably pull out the big guns, such as reverse swaps," says Kathryn Rooney Vera, an emerging markets strategist at Bulltick Capital Markets.
Reverse currency swaps are derivatives which, when auctioned to the market, would have the same effect as buying U.S. dollars in the futures market.
The central bank used them regularly between February 2005 and September 2008, and has recently considered reintroducing them, ringing up dealers last month to gauge demand.
While the auctions represent a warning to the market about the currency's strength, they do not actually weaken the real on a technical level. Under the swap contract, the central bank pays out the interbank lending rate on a set amount of reais in exchange for a fixed rate in dollars.
Their use did not stop the real strengthening to 1.56 in July 2008 from 2.60 reais in February.
JPMorgan analysts argue that the government is also reluctant to use derivatives because, unlike dollar purchases which are ostensibly made to accumulate reserves or pay off debts, swaps would be seen as a direct attempt to manipulate the market.
* CAPITAL INFLOWS TAX INCREASE
The currency's surge last year prompted the government in October to slap a 2 percent tax on foreign purchases of stocks and bonds to curb inflows and contain the real's appreciation.
This tax could be increased if the real decisively breaks below the 1.70 level, say analysts at RBC Capital Markets.
But such a policy change could be more tricky in the next few months given the country's upcoming presidential elections.
Aggressive intervention may be even more unlikely if Brazil's ruling party candidate and election favorite, Dilma Rousseff, wins, says Miriam Tavares, a currency director at the AGK brokerage in Sao Paulo. She believes opposition candidate Jose Serra would make more of an effort to curb the real's rise in an effort to boost exports.
However, the scope and scale of these various measures will ultimately depend on events abroad, says Win Thin, senior currency strategist at Brown Brothers Harriman.
"If we continue to get weak numbers of out of the United States and continue to see emerging markets weaken, then these policymakers are off the hook." (Editing by Kenneth Barry)
Tue Aug 24, 2010 4:30pm IST
By Samantha Pearson and Silvio Cascione
SAO PAULO Aug 24 (Reuters) - Compared to the rest of Latin America, Brazil is an old pro at currency intervention.
Haunted by memories of rampant inflation in the 1980s and 90s, Brazil's authorities have continued to play an active role in the currency market, primarily through U.S. dollar purchases.
But the real soared 34 percent against the greenback last year, putting a huge pressure on the country's exporters. Investors flocked to Brazil in the aftermath of the financial crisis since it was one of the few places offering high interest rates and returns, and thus big profits.
While the currency has weakened so far this year, fund-raising plans by local companies and renewed interest in Brazilian bonds has caused the real to firm 2 percent since June, prompting the government to consider getting tougher.
Following are measures which Brazil's authorities have used before and could use again to curb the real's appreciation:
* VERBAL WARNINGS
Brazil's central bank is adamant that it is not trying to secure the real at a specific level.
But that has not stopped economists and traders from fixating on 1.75 as the maximum value the real could be allowed to strengthen against the U.S. dollar before the government takes more aggressive action.
Brazil's finance minister, Guido Mantega, has frequently issued cautionary comments about the currency's appreciation. Further warnings should be expected whenever this level is broken for more than a few days, analysts say.
* BIGGER OR MULTIPLE DOLLAR AUCTIONS
The central bank has already been increasing its dollar purchases in the spot market via daily auctions, which it resumed on a regular basis in May 2009.
But despite almost doubling its purchases so far this month, the currency has continued to test the 1.75 level.
Analysts argue that the auctions are also creating a guaranteed market for dollars in Brazil which could actually cause the real to strengthen in the long-term.
One temporary option would be to call more than one auction on the same day, as the central bank last did in May this year.
By changing their routine, the central bank would "wrong-foot" the market, sending a stronger signal to traders without necessarily buying more dollars, said Mike Moran, senior currency strategist at Standard Chartered in New York.
* SOVEREIGN WEALTH FUND PURCHASES
Brazil's Treasury has also been buying more dollars, making the most of cheap greenbacks to pay off foreign debt, but the effect on the currency has been minimal.
Brazil's sovereign wealth fund, which was authorized last December to buy dollars but has yet to do so, could also be used to slow the currency's rise.
However, after the initial shock to the market, this strategy faces the same pitfalls as the central bank's daily auctions, analysts say.
* REVERSE CURRENCY SWAP AUCTIONS
"Below 1.70 they would probably pull out the big guns, such as reverse swaps," says Kathryn Rooney Vera, an emerging markets strategist at Bulltick Capital Markets.
Reverse currency swaps are derivatives which, when auctioned to the market, would have the same effect as buying U.S. dollars in the futures market.
The central bank used them regularly between February 2005 and September 2008, and has recently considered reintroducing them, ringing up dealers last month to gauge demand.
While the auctions represent a warning to the market about the currency's strength, they do not actually weaken the real on a technical level. Under the swap contract, the central bank pays out the interbank lending rate on a set amount of reais in exchange for a fixed rate in dollars.
Their use did not stop the real strengthening to 1.56 in July 2008 from 2.60 reais in February.
JPMorgan analysts argue that the government is also reluctant to use derivatives because, unlike dollar purchases which are ostensibly made to accumulate reserves or pay off debts, swaps would be seen as a direct attempt to manipulate the market.
* CAPITAL INFLOWS TAX INCREASE
The currency's surge last year prompted the government in October to slap a 2 percent tax on foreign purchases of stocks and bonds to curb inflows and contain the real's appreciation.
This tax could be increased if the real decisively breaks below the 1.70 level, say analysts at RBC Capital Markets.
But such a policy change could be more tricky in the next few months given the country's upcoming presidential elections.
Aggressive intervention may be even more unlikely if Brazil's ruling party candidate and election favorite, Dilma Rousseff, wins, says Miriam Tavares, a currency director at the AGK brokerage in Sao Paulo. She believes opposition candidate Jose Serra would make more of an effort to curb the real's rise in an effort to boost exports.
However, the scope and scale of these various measures will ultimately depend on events abroad, says Win Thin, senior currency strategist at Brown Brothers Harriman.
"If we continue to get weak numbers of out of the United States and continue to see emerging markets weaken, then these policymakers are off the hook." (Editing by Kenneth Barry)