Brazilian real is 19% weaker than it should be and will likely remain so – FGV economist

RIO DE JANEIRO, BRAZIL – The Brazilian real (R$) is undervalued by about 19% when measured against fundamentals. By the end of the year, the currency could show another large negative divergence as fears about fiscal policy revive, says Emerson Marçal, coordinator of the Center for Applied Macroeconomics at the FGV School of Economics in São Paulo (FGV EESP).

The data from the latest study referred to the end of June and were made available after a lag of up to two months from primary sources. The calculation is made for the actual effective exchange rate. At the end of last year, this misalignment was around 10%.

The exchange rate has been weaker than signaled by fundamentals since February 2020, just before the pandemic shook the global financial markets. This is one of the longest negative streaks since the 1980s, says FGV.

Marçal explained that as fundamentals improved -trade balance, terms of trade, higher interest rate differentials…- the equilibrium effective rate for the real appreciated (i.e., the equilibrium dollar became weaker).

On the other hand, renewed fiscal concerns and uncertainties about monetary policy in the United States have put upward pressure on the nominal rate. With this gap between the nominal rate and the equilibrium rate, the negative deviation has remained high.

In recent months, political risk has increased again as the government has come under more pressure from the Covid CPI investigations into the administration’s management of the pandemic. As a result, in a nod to the 2022 elections, President Jair Bolsonaro needed to cede more space to the center bloc in Congress, traditionally a demander of more spending, weakening the position of Economy Minister Paulo Guedes.

“More and more, next year’s election will start to get on people’s radar. A lot of things are open. They should continue this up-and-down, the fluctuations,” said Marçal.

In this sense, the negative deviation of the exchange rate should persist until the end of the year, evaluates the scholar.

“The pressure is for more spending next year. The government will not be able to carry out any important reforms this year. We have to keep an eye on the issue of monetary policy.”