Sep 25, 2011

Brazil and Exchange Rate Policy

Source: Central Bank of Brazil

In recent days, the price of local currency, the real (BRL) fell about 18% against the U.S. dollar (USD), and brought up the debate on what the appropriate exchange rate for the Brazilian economy is. The exchange rate undoubtedly has a direct effect on the earnings of exporters and importers. On the other hand, the exchange rate is also related to a series of economic variables, such as industrial input costs, investment cost, and also an effect on consumer welfare, because it can stimulate competition. An exchange rate stable or predictable gives visibility to investments, and can contribute significantly to economic growth.

Let's see what happened to the exchange rate in Brazil in recent years. The first graph below shows the recent evaluation of exchange rate. Between 1994 and 1999, the exchange regime was fixed, where the Central Bank acted to keep the exchange rate. This was a period with high trade deficit and the current account deficit rose to 4.8% of GDP in mid-1999. The sequence of external shocks (Russia and Asia) has forced Brazil to abandon the fixed exchange rate regime, and the exchange rate began to float since from 1999.

Between 1999 and 2002 there were some events that have left the exchange rate more volatile. Among these events, we mention the process of privatization of state enterprises, which increased transfer of resources abroad for at least 2% of GDP, and external financing difficulties related to the electoral process, which culminated in an agreement with the IMF. It was also a period of low commodity prices, which affected Brazil's external financing. It was a period in which nearly doubled the dollar against the BRL.

The period between 2002 and 2008 was a period of strong global growth, trade balances with higher commodity prices high, as can be seen in the second chart below, and also with strong flow of capital. Brazil has taken this time well, receiving part of this flow, which came as a direct investment and also to take advantage of high interest rates. The volume of international reserves rose from USD 22 billion in late 2002 to USD 200 billion in mid-2008. This was a period of continuous appreciation of the BRL, which lost nearly half its value against the dollar.

Source: Brazilian Central Bank
Elaboration: Mellone Jr.,G

From 2009, after sub-prime crisis, commodity prices rebounded and the flow of resources continued positive, pushing back the exchange rate, and valuating the BRL, at least until the present moment.

As described, both domestic economic policy and especially the foreign scenario were responsible for determining the exchange rate in Brazil. The exchange rate was extremely volatile during this period, which is negative to investment enviroment. This is the great challenge of Brazil: adopt an economic policy that allows an appropriate forecastable exchange rate for investments for a healthy economic growth.

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