Brazil is back on the currency warpath after a truce with markets.
It’s all about the relentless rise of the real. Over the last three months, it has trended up from the 1.85 mark against the greenback to around 1.72 on March 5 although more stability has been seen over the last weeks. A wave of protectionist from across the Brazilian industrial base is leading to the opening of ever more anti-dumping investigations. Even the Brazilian wine industry is not immune and calling for import taxation to be doubled to over 50%.
The currency rise is leading to a concerted drive to dampen fixed-income investments. Veteran finance minister Guido Mantega and president Dilma Rousseff squarely assign the blame for a ‘flood of foreign currency’ on rich country policies. Rousseff has been on the stump, criticizing what she sees as overly tight fiscal policies coupled with very loose monetary policies in the rich world. At the same time, Brazil has been negotiating hard with the Chinese government to impose restrictions on its exporters to Brazil to stem a relentless hollowing out of Brazilian industries.
What does this mean for investors? This is probably a prelude to more measures to curb fixed-income investment. The March 1 decision to widen the catch of the hated IOF financial transaction tax is designed to curb short-term speculative investments and will see the 6% tax extend from two to three years. Other measures may involve curbs on derivative speculation.
Brazil has the powerful weapon of lower interest rates in its sights too as the Central Bank aggressively pursues its rate cutting policies. Real rates remain some of the highest in the world at some 4%, but that could be slashed by as much as 1% in the next meeting of the rate setting committee, Copom.
The clear risk is an over-zealous rate cutting exercise that allows the inflation genie out the bottle. There are, however, positive signs that inflation is decreasing with an inflation rate of just 0.07% in February recorded in São Paulo (down from 0.66% month over month). It’s a gamble to cut rates too fast but one that Brazil seems poised to win.