By James Bargent
Over the last decade, Brazil’s rapid economic growth has earned it a place at the table with the world’s economic powerhouses – earlier this year it even overtook the UK to become the world’s 6th biggest economy. However, the country’s meteoric rise has not been without its growing pains and in 2010 Nearshore Americas reported how one of these – currency appreciation – was not only acting as a drag on growth but was also hitting outsourced interests in the pocket.
However, with the Brazilian boom still in full swing and relatively few outsourcing companies attracted to Brazil by cost arbitrage alone, nobody seemed too worried. One man, though, was concerned, and was already trying to put the brakes on the Brazilian real’s seemingly endless ascent.
When Finance Minister Guido Mantega first began to call for a currency devaluation in 2010, his was a lonely voice drowned out by the din of economic growth and election year campaigning. The real continued to appreciate until mid-2011 when it hit a high of 1.5 reais to the dollar – a far cry from the almost 4 reais a dollar bought in 2002, when Brazil was on the brink of the “Lula” Da Silva presidency.
But no longer. With the strong real dragging down Brazil’s ailing manufacturing sector, Mantega now has the full backing of Lula’s successor, Dilma Rousseff, and together the two have been waging a full-blooded currency war at home and abroad.
One of their main targets has been developed economies and the president has launched thundering broadsides against rich countries for their loose fiscal policies, including personally complaining to German Chancellor Angela Merkel and U.S. president Barack Obama about a “tsunami” of hot money flooding Brazil.
According to Alfredo Barbutti, an economist at leading Brazilian inter-dealer brokers BGC Liquidez, Rouseff’s claims are legitimate. “The easing policies and consequent reduction in interest rates practiced in developing countries – the rates today are at historical lows in the U.S., Germany, Japan and UK – had direct consequences for the currency,” he said.
However, Brazil’s currency woes run deeper than reactions to the economic crises still raging abroad and some analysts believe blaming foreign governments has been a convenient cover for the government’s own failures. According to market analysts Business Monitor International (BMI), Brazil’s economic growth imbalances are a result of not enough production and too much consumption, fuelled by lax financial regulation and the government’s dominant role in Brazilian credit markets.
“True, ultra-loose monetary policy by developed states since 2009 has certainly exacerbated demand for holding real-denominated assets,” stated BMI, “but had it not been for a rampant consumer growth story and some of the highest rates on offer out of all emerging market economies, currency appreciation would not have been nearly so aggressive.”
And while the government raves against foreign governments, it has also been taking steps to adjust the Brazilian economy for imbalances. “The government committed to a tripod of actions where interest rates, exchange and lower taxation will allow the country to keep the growth at a sustainable level,” explained Barbutti. Currency depreciation has been further supported by the Central Bank, which has been slashing interest rates consistently since August 2011.
“The situation is not comfortable…We don´t know if the tripod will work. If the government revises the interest rate policy for whatever reason, the exchange rate policy will be directly affected.”
Since its 2011 high, the real has dropped more than 20 percent against the dollar and has broken the two for one dollar mark for the first time since the 2008 financial crisis pushed the dollar upwards. It is currently hovering around the 2 mark, where BMI predict it will stay for 2012, before gradually depreciating to 2.5 to the dollar by 2015.
According to the Financial Times, this is the result of both the government’s fiscal policies and external factors. “Brazil cannot claim to be solely responsible for the drop in the real,” read a May article. “Global risk appetite has turned against emerging markets amid political turmoil over the European sovereign debt crisis. Commodities prices have softened from their highs in line with decelerating Chinese growth.”
However, analysts believe the weaker currency could be a mixed-blessing for the Brazilian economy. According to Barbutti, “Industry will be the biggest beneficiary of this new policy, and as a consequence employment will be strengthened. Overall consumption can benefit, however, individual consumers might suffer with price increases.”
In contrast, the outlook predicted by BMI is much bleaker. “A substantial depreciation in the unit would result in a drop in consumers’ purchasing power, sapping demand for imports and dampening private consumption, the country’s main engine of growth,” state the analysts. “This in turn could hit the service sector hard, translating into rising unemployment.”
Nevertheless, according to Benjamin Quadros, CEO at Brazilian ITO company BRQ, the raging currency war and the fluctuating value of the real should make little difference to companies with outsourced interests in Brazil or those thinking of investing in the sector. “Our margins could be higher and our prices could be lower [with a weaker real],” he said, “but this is not enough to bring in big offshore projects because our unit-cost, if you compare it to India is still higher.”
“Your decision [to invest in Brazil] should not be based on the appreciation or the depreciation of the real – it should be [based on] value creation in Brazil,” he added.
Despite Finance Minister Guido Mantega boasts of possessing an “infinite arsenal” of financial measures to manage the real, the currency’s future could well be out of the government’s hands. “In the short term, the biggest worry is Europe,” said Barbutti. “In the event the current crisis gets worse, the real will follow the same risk-averse movement from other currencies relative to the USD.” Barbutti’s predictions for the medium term future are no more optimistic. “The situation is not comfortable, he said. “We don´t know if the tripod will work. If the government revises the interest rate policy for whatever reason, the exchange rate policy will be directly affected.”
However, for Barbutti, U.S. companies concerned about the affects of the real on their outsourced interests may be worrying about the wrong currency. “I would not exchange a real for a U.S. dollar,” he said, “because I believe the American fiscal situation is a disaster waiting to happen.”