Brazilian Currency Update

From late May to mid-June the Brazilian real went almost nowhere

. Against the US dollar, its defining counterpart, the midpoint of the real's range over that month and a half was 2.04. The pound wandered between R$3.10 and R$3.25 and bought, on average, 3.17 reais. For both the dollar and the pound, today's levels are close to where they were three years ago.

If the urgency seems to have evaporated from the real, so it has for most currencies. Among the emerging market BRICs the Indian rupee has strengthened by 1% against the pound in six weeks while the real has fallen by a little more than that. The Russian ruble and the Chinese yuan are with sterling in the middle of the field. Over a month and a half these are relatively small changes, implying that investors have no strong opinion as to what happens next.

The highlight of Brazil's month was surely the 50,00 people who attended the United Nations' "Rio +20" conference on sustainable development. It will have been good for foreign currency inflows - not such an unwelcome happening nowadays - but not ultimately influential on the value of the Brazilian currency.

Nor will a downgrade of Brazil's commercial banks' credit ratings have had any impact on the real but it did draw attention to a global pessimism about financial institutions. Moody's took the expected step of bringing Brazilian financial institutions' ratings into line with that of the country from which they operate. The sovereign rating usually sets the ceiling so Brazilian banks cannot do better than the country's Baa2 from Moody's or the equivalent BBB from Standard & Poor's. Those grades are better than Spain, similar to Bulgaria and one step below Mexico.

Brazil's government is conscious of the threats to global and domestic growth, which have hit manufacturing output and dented the trade surplus. It has taken steps to keep the economy moving. Top of the list for Brazil, as it is for almost every other country, is the stimulation of consumer spending. If consumers don't buy things the system does not function. One measure that has already brought results is a reduction in the tax on new cars. Sales in June were the highest ever, with 24% more vehicles being sold than in May and 19% more than in the same month last year. Under consideration now are tax cuts on oil and ethanol as well as domestic electrical goods and furniture.

The biggest threat to global growth - and therefore to the Brazilian economy - is, according to many analysts, the sovereign debt crisis in Euroland. The immediate threat of Greece's departure from the single European currency has been averted by a re-run of May's general election but there are still grave doubts about the country's survival in the euro. Spain and Cyprus have become the fourth and fifth of the euro area's 17 member states to request a bailout. Italy's prime minister refuses to rule out a similar request. Germany's constitutional court could take months to rule on the legality of using taxpayers' money to support other Euroland countries. Finland's prime minister has told journalists that "This situation is dangerous, very dangerous."

It will be months before that dangerous situation is resolved, months during which investors and consumers alike will be reluctant to take the plunge with a new equity purchase or a new washing machine. Recent evidence suggests the euro will edge lower as long as that uncertainty continues and that other exchange rates will stagnate, simply because nobody can guess which of them has the most or least to lose.

To predict that the Brazilian real will be worth as much in a month's time as it is today would be to tempt fate. However, with the northern hemisphere summer sapping activity and liquidity in financial markets it would not be a surprise to see it turn out that way.

by: Marven Caulker

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