Brazil’s currency intervention: feeding speculation?

August 28, 2013


Brazil’s decision to offer up to $40 billion in currency swaps by year-end has been widely praised as a smart way to stabilize its foreign exchange market. The bold move announced last week, which doubles the amount of outstanding currency swaps in Brazil, has put a lid on the real’s sharp depreciation without burning a single dollar of the country’s foreign reserves. It also targeted the source of market stress directly: the need for corporate insurance as companies rushed to futures markets to hedge their dollar-denominated debt.

But what if some of these companies are not hedging anything, but speculating instead? A paper published last year by Fernando Oliveira, a central bank official and professor at local institute Ibmec-RJ, showed that in a sample of 93 Brazilian companies, nearly half of them (40) did so in 2002, when the central bank used a similar strategy.

With the real plunging nearly 60 percent to record lows, many companies saw an opportunity of easy gains in times of uncertainty. The situation was much worse then. Investors feared Brazil would adopt unfriendly measures, possibly even a debt default, if Luiz Inacio Lula da Silva won the elections that year. The country had lived with rampant inflation until eight years before, and memories of currency crises in emerging economies were still fresh on everyone’s minds.

Much has changed since those years: companies grew wary of derivatives after big names such as pulp producer Aracruz and food processor Sadia collapsed in 2008, despite their healthy operations. Authorities have also increased oversight of financial derivatives –so the likelihood of risky bets might have decreased as compared to 2002.

Still, the paper, based on confidential central bank data, provides some of the strongest evidence to date that the liquidity offered by official interventions could be used for speculation on a significant scale. Perhaps the benefits of providing a hedge for ailing companies outweigh the risks of fueling speculation. Yet such risks should not be seen as negligible.

Oliveira wrote in his study:

Corporations with revenues from exports or expenses from imports are natural candidates to speculate with foreign exchange derivatives. The nature of their activities, makes these corporations follow regularly the foreign exchange market, maintaining close contact with agents that are probably the first to detect changes in the trends of the nominal exchange rate (dealers of foreign currency, for example). Therefore, they can participate in the foreign exchange market using privileged information.

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