Excuse the obvious pun, but Brazil's in Real trouble .....

Thursday 24th September 2015

Excuse the obvious pun, but Brazil's in Real trouble .....

Ref : "Brazil's Central Bank Moves to Prop Up Real Amid Volatility" , The Wall Street Journal 23/9/15

We know that the Chinese slowdown and the effect it has on her demand for commodities has been pretty disastrous for emerging markets and their currencies. Nowhere is this more the case than in Brazil. Some background :

A new Brazilian currency, the Real, was introduced in 1994 at parity with the US$ to combat hyperinflation.

The US$ has surged to an all-time high of 4.18 to the Real. In doing so it has breached the previous high of just under 4.00 seen in 2003 when the rate spiked after the election of the radical President da Silva.

 The Real has lost about 70% of its value against the US$ in 12 months.

Standard & Poors have downgraded Brazilian debt to "Junk" status. Moody's and Fitch still mark Brazil at the low end of "Investment Grade", but are due to re-assess shortly.

Previously the epitome of a powerhouse emerging nation (Brazil is the "B" in BRICS"), it's not just the pace and extent of her fall from grace that catches the attention. Brazil shares many of the problems faced by other emerging markets but also brings some specific issues into play. Not the least of these is her size..... Brazil is (or has been up to now, at least) the 7th largest economy in the world, ranked by GDP. She runs an enormous budget deficit swollen by growing social security bills and lower tax revenues brought about by falling employment. And then there's corruption.....

A scandal at state-owned oil company Petroleo Brasileiro SA , aka Petrobras, has spread to implicate dozens of prominent politicians. The president, Dilma Rousseff, is not personally implicated but as captain of what is perceived to be a rotten ship her approval ratings have plummeted to below 10%, which of course makes it very difficult for her to get things done.

In fact, and not that you'd know it from the foreign exchange markets, Ms Rousseff had a better day on that front on Wednesday. Congress approved 26 of 32 presidential vetoes on high-spending bills (wage rises for government workers, tax breaks on fuel etc) that would have added 127bn reals to government outlays, roughly US$ 30bn at today's rate. It's a victory of sorts, but Ms Rousseff faces a constant battle to get Congress to buy into the austerity measures vital to maintaining Brazil's debt ratings and its fiscal credibility as a whole.

The central bank has been intervening in FX markets (after a fashion), but currency-swap contracts and dollar-repurchase agreements are temporary measures and won't scare the markets. Whether the bank has the resources (or the will) for more aggressive action must be open to doubt. The dilemma being faced is that while a weak currency is a boon to commodity exports, Brazil imports much else which of course brings inflation into the picture  --  it's already climbing towards 10%.

Fundamentally it's hard to see any good news on the horizon for the Real, and technical analysts will no doubt be highly excited by US$/Br Real making new all-time highs. but with Brazil representing such a bell-weather for emerging markets, many will be hoping for an improvement in fortune, for everybody's sake.