Analysis: Why isn’t the U.S. dollar dropping in Brazil like elsewhere in the world?

RIO DE JANEIRO, BRAZIL – The Federal Reserve Bank’s decision to print money was taken to counter the economic recession effects triggered by the covid-19 pandemic. In parallel, the interest rate was lowered and is now close to zero.

When this happens, the country tends to become “less attractive” to foreign investors, who tend to look for other markets with higher returns on their capital. As a result, the dollar lost value against the main global currencies.

But not against the Real.

In fact, the Brazilian currency has proved to be an exception, following a path contrary to the currencies of many other countries, including emerging ones: it depreciated sharply against the dollar last year and has recovered only slightly in recent months.

Henrique Castro and Claudia Yoshinaga, professors at the Getúlio Vargas Foundation (FGV), discuss the behavior of the real against the dollar in three different periods, from January 31st, 2020 to January 29th, 2021, from July 31st, 2020 to January 29th, 2021, and finally from October 30th, 2020 to January 29th, 2021.

In the first period, from January 31st, 2020 to January 29th, 2021, that is, since the start of the coronavirus pandemic, the real depreciated almost 22% against the American currency, abandoning the “psychological” limit of R$4 per dollar. It was the worst performance among the 30 most traded currencies in the world, including the Argentine peso.

The plummet stopped in August, but the Brazilian currency continued to depreciate against the American currency, but at a lower rate of about 5%. Nevertheless, it was still the worst performing currency.

And, finally, in the last three months, since November, the real partially reversed the decline, appreciating by 5.6% against the US currency, albeit over a previously low base.

However, over the past few days, the dollar has once again appreciated against the real.

On Monday, February 21st, the American currency opened high after president Jair Bolsonaro intervened in the command of Petrobras and appointed General Joaquim Silva e Luna to head the state-owned company.

Moreover, Bolsonaro said the day before that he would “intervene in electric power,” and that “if the press is worried about yesterday’s switch, next week there will be more.”

At the close of trading on Wednesday, February 24th, the commercial dollar closed the day trading at around R$5.42. The tourism dollar, at R$5.59.

But what is behind this behavior of the real against the dollar?

According to experts, this disconnect between the real and other countries’ currencies, including emerging countries, was mainly due to internal issues, such as fiscal risk and the uncertainties about the trajectory of Brazilian public debt – while the reforms pledged by the government, particularly those improving the government’s accounts, were not passed.

“There is no doubt that the domestic factor prevailed in driving the exchange rate. If it weren’t for these very significant local problems, because of the fiscal issue, our exchange rate would be well below R$5 per dollar,” said Silvio Campos Neto, economist and partner at Tendência Consultoria, in São Paulo.

Claudia Yoshinaga, from FGV-SP, agrees. She adds that the reforms pledged by president Jair Bolsonaro, with the exception of Social Welfare, did not get off the ground.

“Brazil’s fiscal situation is worrying. There was a perspective of improvement with Bolsonaro’s election, but expected reforms did not materialize, with the exception of Social Welfare, which did not fulfill exactly what was expected of it,” she points out.

” In the recent past, we saw the resignation of the president of Eletrobras, the privatizations that didn’t materialize… The discussion now is about extending the emergency aid, because there is concern that this benefit will open a hole that the government won’t be able to fill,” she adds.

In early February, President Jair Bolsonaro signaled that the federal government and Congress were looking for ways to extend the emergency aid. Negotiations suggest that it will return in four installments to be paid from March or April this year.

The benefit, introduced to assist people in vulnerable situations during the pandemic, ended in late 2020. Through it, 67.9 million beneficiaries received four installments of R$ 600 and then four months at R$300, with a cost of R$293 billion to the public coffers.

Moreover, the government was forced to increase its spending because of the pandemic. The hole in the Treasury’s accounts reached R$743 billion. This deficit helped increase public debt, rising from 74.3% to 89.3% of GDP (Gross Domestic Product) in one year.

USThe government will need to pay 57% of this bill, of R$1.4 trillion, by the first half of this year.

This is not an easy task. According to an analysis by the Senate’s Independent Fiscal Institution (IFI), the public spending cap, passed in 2016 during Michel Temer’s administration, is at high risk of being breached this year.

All this worries investors – and evidently impacts the behavior of the real against the dollar, experts point out.

Future

But what will the dollar behave from now on?

“The collapse of the dollar has just begun,” said Stephen Roach, a professor at Yale University in the US and former president of the investment bank Morgan Stanley in Asia. Roach predicts that the US currency could drop more than 35% by the end of this year, based on three main reasons.

The first is that there is a sharp increase in the US current account deficit, meaning that the country pays more abroad for the exchange of goods, services and transfers than it receives. His projection is that this deficit will continue to drive the currency down.

The second reason is the Euro’s appreciation, after the German and French governments agreed to a fiscal stimulus package, in addition to bond issues.

And the third reason is that Roach expects that the US central bank will do almost nothing to stop the dollar from plummeting.

With the US increasingly dependent on foreign capital to offset its growing domestic savings deficit, he explains, and with the policies adopted by the Fed which create a large excess liquidity, “the argument for a sharp weakening of the dollar seems more compelling than ever,” he argues.

Regarding the impact of a devaluation of the dollar on emerging markets (such as Brazil, Mexico, Argentina, Colombia, Peru or Chile in Latin America), the expert suggests that there may be hikes in some of these countries’ stock markets.

As long as the Federal Reserve does not raise interest rates, which is what Roach assumes will happen, “the weakness of the dollar should lead to increases in foreign equity markets in general and emerging market stocks in particular.”

“No excesses”

However, other economists argue that while the currency is somewhat weak this year, in no case should a “crash” be expected.

“The dollar’s decline should not be blown out of proportion,” wrote Mark Sobel, US president of the Official Monetary and Financial Institutions Forum (OMFIF), in early January on the study center’s website.

In his opinion, there is a “dismal” outlook for the dollar. “The dollar may drop this year, but a very negative outlook is not justified,” Sobel said.

One argument is that the dollar has already dropped significantly (13% in 2020 from its peak in March). Another is that amid global uncertainties, it is not as certain that investors will prefer to take risks and bet on currencies other than the dollar.

Concurrently, Sobel also says he believes that there may be relatively more favorable monetary conditions in the US and that the current strong dollar cycle is simply coming to an end. In other words, if the stimulus measures to boost the economy in the country are successful, the dollar could very likely appreciate again.

In fact, long-term interest rates in the US increased their highest in a year, suggesting the likelihood that this scenario will materialize.

In line with Sobel’s opinion, Campos Neto, from Tendências Consultoria, says he does not believe in a sharp dollar drop.

Talking about Brazil, he notes that “despite the difficulties we have, the perception is that the minimum will be done to solve this (fiscal) problem. As a result, our exchange rate may come closer to what the external factor suggests, a much lower rate,” says the economist, noting “that all this fiscal risk produces great volatility.”

His projection is slightly better than the market’s, which estimates that the dollar will close 2021 quoted at R$5.05.

Yoshinaga, from FGV-SP, recalls that the behavior of the real against the dollar should be influenced by Brazil’s vaccination rate. “If the population is vaccinated more quickly, economic activity tends to rebound faster and the country’s situation will improve,” he says.

Winners and losers

The depreciated real has an impact not only on the pocket of those who want or need to buy dollars or those who buy imported products.

The national industry consumes a range of imported raw materials, as is the case of the electronics segment. And there are a number of items whose price setting is ultimately influenced by international quotes, as is the case of fuels and commodities in general.

The “rice dilemma” is indicative of this. The devaluation – in addition to higher international demand, which tends to raise prices – tends to increase the revenue in reais for those who sell abroad.

Thus, producers often prefer to export rather than sell in the domestic market. Lower supply in the domestic market, in turn, pushes the price up in the domestic market.

The same logic applies to corn, soybeans, sugar… This dynamic helps explain why food prices have risen so much in recent months.

Source: BBC Brasil