Brazil’s currency outlook may be brighter than politics suggest

September 1, 2016
The rising sun over Copacabana beach is reflected in a window in Rio de Janeiro, Brazil, August 23, 2016. REUTERS/Christian Hartmann - RTX2MO9G

The rising sun over Copacabana beach is reflected in a window in Rio de Janeiro, Brazil, August 23, 2016. REUTERS/Christian Hartmann

Disappointment over the progress of an ambitious reform agenda by Brazil’s new President Michel Temer will probably be insufficient to cause another massive fall in the currency, even though it could rekindle market volatility and kill chances of any credit rating upgrades, a Reuters poll suggested on Thursday.

The daunting task ahead of Temer is no secret to anybody. With popularity rates nearly as low as former President Dilma Rousseff, and seen by many Brazilians as the product of a coup, Temer has vowed to approve pension and labor reforms and freeze government spending growth for 20 years.

There are “significant hurdles” for that agenda to be implemented, ratings agency Moody’s said today, in an apparent understatement of the challenges in dealing with a fragmented Congress with just two years to go before the next elections.

However, currency strategists polled by Reuters are increasingly convinced the Brazilian real is still likely to hold ground in coming months, or even add to its 20-percent gains so far this year against the U.S. dollar.

The implications of a stronger currency are twofold.

On the one hand, it would slow down a much-needed economic recovery by reducing the competitiveness of Brazilian goods and services. The real is already dragging growth down: gross domestic product data on Wednesday showed imports growth outpaced exports in the second quarter and helped keep Latin America’s largest country mired in a brutal recession.

On the other hand, currency gains would help the central bank cut interest rates from the current 14.25 percent, their highest in a decade, by reducing inflation.

Policymakers implicitly acknowledged the importance of the exchange rate for monetary policy in their post-meeting statement on Wednesday by conditioning future rate cuts to the level of market confidence in the implementation of economic reforms in Brazil. Between the lines, the reference to confidence was a reference to the dollar – the classic safe haven that comes to affect prices in Brazil whenever risk perception is up.

What currency strategists are saying is basically that, barring a complete failure by Temer, the exchange rate will probably remain around where it is now, between 3.20 and 3.50 reais per dollar, or even head towards the 3.00 threshold. That is a long way from above 4.00, seen not so long ago.

Gabriel Gersztein, currency and interest rate strategist at BNP Paribas for Latin America, has a long list of reasons to be bullish on the real, most with nothing to do to politics:

  •  High interest rates: even if the central bank cuts the benchmark rate to around 10 percent next year, as most expect, they will still be among the world’s highest, making short positions too expensive to be carried for long;
  • Trade balance: 2016 has seen record monthly surpluses as the recession reduced imports. The market consensus for the year as a whole projects R$50 billion dollars to come to Brazil via trade this year, regardless of market swings;
  • Foreign investment: companies are already stepping up purchases of machinery and equipment to renew their production lines after the recession and prepare for the modest recovery ahead. Many of them are foreign, such as Renault and Albaugh.
  • International reserves: at nearly $400 billion, they proved to be more than sufficient for Brazil to weather severe crises, and will probably help assuage investors fears. Their size has no parallel in the region – Mexico, with a much smaller buffer, has had to resort to an IMF credit line.
  • End of a perfect storm: Brazil faced not only its worst recession in generations in 2015; it also saw commodities prices tumbling, had successive ratings downgrades, suffered along with other emerging currencies with a Chinese devaluation.

“We’re now seeing some elements that lead us to believe that the worst is over and we are close to a turning point,” Gersztein said.

Brazil’s huge economic problems are likely to remain around; but, as things stand, a currency rout should not be another one of them.

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