On Thursday, September 24th, the Brazilian real hit its weakest point since the currency was introduced in 1994. Trading as low as 4.24 to the dollar, the real has lost over 35% of its value against the dollar so far this year. Brazil enjoyed rapid economic growth over the past decade because of a commodity-price boom that ended this year. Its economy is highly dependent on commodity exports to China, its largest trading partner, whose economy is also suffering. Yields on the nation’s real-denominated government bonds have hit 16% (9% higher than the emerging-markets average) as prices of the bonds fell. Brazilian bonds are among the worst performers in emerging markets this year. Its Central Bank has raised rates five times this year and expects to keep them high in the coming months to combat inflation, which is currently at 9.6%.
Brazil’s rating was downgraded to junk this month by Standard & Poor’s Ratings Services. A major factor behind the downgrade was Brazil’s widened budget deficit caused by lower commodity prices decreasing revenues. The spread on a 5-year Brazil CDS has more than doubled from the beginning of the year, reflecting concerns of a default.
Brazil’s political turmoil has further discouraged investors. The government has proposed cost-cutting and tax-raising plans, but congress has rejected these plans. Furthermore, there was a corruption scandal around state-controlled oil giant Petrobras.
While the currency plummeted on Thursday, it recovered some ground as the central bank announced interventions to prop it up. The central bank will hold a series of auctions of currency swaps, dollar repurchase agreements, and local debt, all of which helped reduce volatility in the local yield curve and the real. Alexandre Tombini, the head of the Central Bank of Brazil, announced that Brazil could dip into its $371 billion in reserves to stem the currency’s bleeding. The real rebounded sharply on his comments and closed at 3.93.
Troubles are not over for Brazil. The problem with weakening government finances amid weak growth and depreciating currencies is that it increases debt burden, lowering their ability to service short-term debt. Brazil’s central bank lowered its 2015 forecast for a second time Thursday and now predicts the economy will shrink 2.7% this year, the worst contraction in 25 years. Unemployment rose to 7.6% in August, the eighth consecutive monthly increase. Also, the administration’s 2014 accounting is the target of a continuing probe by Brazil’s public account monitors, further weakening the government.
In order for investors to regain confidence in Brazil, a catalyst for global growth would have to be seen. The yields will become attractive only when the Brazilian government shows a commitment to do fiscal adjustments or China’s demand for commodities increases dramatically.
By: Semona Skvirsky