Traumatized by several currency crises in the past, Brazil has made a dedicated effort in recent years to amass $374 billion in foreign reserves as China bought mountains of its iron ore and soybeans. When the next crisis came, policymakers figured, the reserves would act as Brazil’s first line of defense.
It turns out that those reserves, which jumped from just $50 billion in 2006, may still not be large enough, Bank of America-Merrill Lynch analysts found in a report on the increased volatility in foreign exchange markets as the U.S. Federal Reserve prepares to scale back part of its monetary stimulus.
Using central bank monthly data on the stock of foreign investments in Brazil, David Beker and Claudio Irigoyen estimated that foreigners hold about $1.2 trillion in Brazil. While most ($785 billion) of that amount consists in longer-term direct investments, portfolio investments such as equities and debt still far exceed the central bank’s reserve cushion at $415 billion.
That’s why the monetary authorities have preferred to offer derivative contracts such as currency swaps rather than simply burning through its reserves, the BofA-Merill analysts said. Brazil’s central bank, led by Alexandre Tombini, has already sold over $30 billion in currency swaps in just two months, nearly a record high, and yet the real has traded at four-year lows.
“Our perception is international reserves need to be managed with caution given the high stock of investments in Brazil and the potential for FX hedging, as reserves could decline quickly if global uncertainty increases,” Beker and Irigoyen wrote.