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Roula Khalaf, Editor of the Financial Times (FT), shares her top stories in this weekly newsletter.
Brazil’s Currency Crisis: What’s Happening and What’s Next
Brazil is facing a severe currency crisis, with the Brazilian real dropping nearly 2% this week, hitting a record low against the US dollar. This decline comes despite the central bank’s efforts to stabilize the currency by selling over $6 billion in the market. Investors and analysts are urging the central bank to take more decisive actions to prevent further decline and are calling for fiscal reforms from President Luiz Inácio Lula da Silva’s government.
The central bank’s recent interventions have temporarily slowed the real’s fall, but concerns remain about Brazil’s fiscal health. The leftist Lula administration is under pressure as it tries to implement cost-saving measures after its spending policies faced backlash from the business community.
Eduardo Cohn, a portfolio manager in São Paulo, noted the market’s concerns about Brazil’s fiscal accounts and the government’s response. He emphasized that the exchange rate is a way for the market to express its concerns.
Since Donald Trump’s election win last month, emerging market currencies have struggled, but Brazil’s issues are largely due to fears of increased government spending and rising debt under Lula’s leadership. These policies have spurred growth but also raised inflation and fiscal sustainability concerns.
This year, the real’s value has dropped 21%, making it the worst-performing currency in JPMorgan’s emerging market index. The country’s stock market index has fallen 27% in US dollar terms, contrasting with a 7% rise in broader emerging markets.
To combat inflation, the central bank raised interest rates by 1 percentage point last week, with further increases expected. While higher rates might attract foreign investors, they could also slow down Brazil’s economy.
Mark McCormick from TD Securities highlighted the urgency of protecting the currency, suggesting that the government may need to inflict economic pain to stabilize the situation. Ed Al-Hussainy from Columbia Threadneedle Investments agreed, noting that aggressive rate hikes might be necessary, but long-term solutions require credible fiscal commitments.
Brazil’s fiscal deficit is nearing 10% of GDP, raising concerns about unsustainable debt levels. Despite promises to cut spending, traders remain skeptical, especially with simultaneous tax breaks for lower earners.
Economist Paul McNamara noted Brazil’s debt is high but not yet at dangerous levels compared to G7 nations. However, Brazil’s high borrowing costs make its debt less sustainable.
Lula’s government is working on fiscal reforms, but many require congressional approval, which is challenging as Congress is about to recess. Lula has been absent from negotiations due to recent surgery but is expected to return soon.
The central bank’s next policy meeting is in January, but there are calls for interim measures to stabilize the currency. McCormick suggested using rhetoric to prevent further declines, while Al-Hussainy believes an extraordinary rate hike could shock markets into stability.
Additional insights were provided by Beatriz Langella.
