Brazil Mulling Increased Currency Intervention?

Media reports are playing up local press stories that Brazil officials are evaluating additional measures to slow capital inflows which are driving the Brazilian real higher. The 2% tax may have led to some greater volatility in the currency, but net-net the currency remains firm. Other ideas being considered include the government selling a BRL denominated bond issue overseas, though perhaps most important for foreign investors is the talk that officials may change the rules and allow investors to deposit guarantees overseas.

That said, the authenticity of the local press report is not clear and was said not to cite sources. Moreover, on Wednesday Finance Minister Mantega was quoted indicating that the government was not looking at additional measures to curb the real's strength.

The BRL is up about 34% against the US dollar this year, while the Bovespa is up 70% in local terms. Officials are wrestling with a significant challenge--absorbing the capital inflows. Figures from the central bank indicate there was a net $14.6 billion foreign exchange inflow in the month of October, the bulk of which was net investment inflows (~$13.1 billion) and a bit from net trade flows (~$1.5 billion).

Two points to make about the net investment inflows. First the net reflects incoming investment of almost $40 billion, and about $26.6 billion in outflows. This suggests another way Brazil and other countries experiencing strong inflows can mitigate the impact--encourage capital outflows.

Second, year-to-date Brazil reports a net foreign exchange inflow of almost $23 billion. The same year ago period saw a net inflow of $12.5 billion. The October inflow was flattered by a Spanish bank's IPO that raised more than $6 billion and overseas debt sales by Brazilian companies (who then apparently repatriated the proceeds).

One consequence of Brazil's 2% tax and some of the other measures that it is reportedly considering could be a slowing of the development of local capital market capacity. This is to say its tactical measures may undermine its strategic goals. And, even if it slows the development of its local capital markets, neither its daily intervention nor the tax is seeming to deter upward pressure on the currency.

Brazil is not alone in wrestling with this problem. The challenge in East Asia is also acute. The Hong Kong Monetary Authority is defending its peg by buying US dollars, which has seen its money supply (M1) rise 55% above year ago levels (in September). In South Korea, to cite another example, foreign currency reserves have grown among the fastest in the world, rising roughly $63 billion this year so far.

Lastly, the challenge countries like Brazil face in absorbing capital inflows may put greater pressure on recycling some of those funds and that in turn may point to a source of demand for US Treasuries.

Disclosure: No positions

Comments

[Mad Hedge F...:]

ndr I’ve got to comment on Brazil’s (EWZ) idiotic move last week to impose a 2% tax on real stock and bond purchases to scare off foreign investors. It’s like firing off an emergency flare in the night and saying “Come and get me.” If any portfolio manager was living in a cave for the past ten years and somehow missed the attractions of investing in an emerging market that exports food and energy, has an appreciating currency, and an almost perfect demographic profile, they can see it now, clear as day. This lunacy reminds me of Malaysia prime minster Mohamad Mahathir’s rantings and ravings about George Soros’s selling of his country’s markets during the Asian financial crisis, when in fact, George was buying. I sympathize with Brazil’s dilemma, similar to those of the Swiss during the eighties and nineties, when the whole world wanted to buy their currency, forcing the government in Berne to drive interest rates to zero, pushing domestic prices through the roof. But this is the price of economic success. Everyone wishes they had Brazil’s problems. Better to just let things be.

Nov 05 11:56 PM

[surfgeezer:]

You forget they have been through this before. Hot money can leave very quickly, as was shown last year, when the Real went 1.50's to 2.20's in a very short time. The reason I like Brazil is they are willing to do things like this, taxing a bubble and using the tax to buy treasuries as a hedge is just prudent.


On Nov 05 11:56 PM Mad Hedge Fund Trader wrote:

> ndr I’ve got to comment on Brazil’s (EWZ) idiotic move last week
> to impose a 2% tax on real stock and bond purchases to scare off
> foreign investors. It’s like firing off an emergency flare in the
> night and saying “Come and get me.” If any portfolio manager was
> living in a cave for the past ten years and somehow missed the attractions
> of investing in an emerging market that exports food and energy,
> has an appreciating currency, and an almost perfect demographic profile,
> they can see it now, clear as day. This lunacy reminds me of Malaysia
> prime minster Mohamad Mahathir’s rantings and ravings about George
> Soros’s selling of his country’s markets during the Asian financial
> crisis, when in fact, George was buying. I sympathize with Brazil’s
> dilemma, similar to those of the Swiss during the eighties and nineties,
> when the whole world wanted to buy their currency, forcing the government
> in Berne to drive interest rates to zero, pushing domestic prices
> through the roof. But this is the price of economic success. Everyone
> wishes they had Brazil’s problems. Better to just let things be.

Nov 06 02:12 PM