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Wall St Has Its Doubts Over Brazil's Intervention Plan


By: Grainne Mc Carthy
 The Wall Street Journal, July 3, 2002




New York -- According to conventional wisdom in the foreign exchange market, intervention by central banks to manipulate their currencies works best if it's totally unexpected, if speculators have extreme bets on against the currency and if the intervention nudges the currency in the direction the market wants to go anyway.

On the face of it, the Brazilian central bank's plan announced Wednesday - under which it will spend up to $1.5 billion intervening in the currency market every day in July - meets none of those criteria. That's not to say it won't be successful in stabilizing the sliding real, which has lost more than 20% of its value since mid-April.

In fact it's already yielded some element of success, hauling the real back from another all-time low earlier Wednesday around BRL2.940 and arguably injecting an element of doubt into the theory that the real was on a one-way slide.

But if the aim of the intervention strategy is to really turn the Brazilian real around, it probably will have less lasting effect, U.S.-based analysts said.

This is partly due to the fact that Brazilian markets are still dominated by October's presidential elections, with the opposition Worker's Party candidate Lula de Silva continuing to lead the government and market-friendly candidate Jose Serra. Brazilian assets are also under pressure from concerns over Latin America's largest economy's public debt load, which has nearly doubled in recent years to around 56% of gross domestic product. Against these political and economic pressures, the central bank's efforts, no matter how well-considered, can only do so much.

But analysts also argue that the central bank might be stymied by its own transparency. In forewarning currency markets of its strategy, the central bank effectively lost the element of surprise that's key to any intervention policy. "The fact that they are going to do this was a surprise," said Guillermo Estebanez, a currency analyst at Bank of America in San Francisco. "But once it's factored in, it's not a surprise anymore, it becomes a non-issue." 

Ammunition For Speculators 

At the same time, the central bank has potentially handed speculators an ideal opportunity to make money at their expense: "If you still think the real's rate will get worse, you would take the opportunity to buy dollars on the cheap and sell them back to the central bank," said Estebanez.

Even so, the threat from speculators is diminished by the fact that, since early 1999, the real has been floating freely. Hedge funds have had a much easier job in the past of attacking an overvalued pegged currency, which makes a clear target.

And yet, speculators may be of less relevance in this case because they aren't believed to be big participants in the real market these days, a situation which in fact exposes some flaws in the new policy.

"One of the things that increases the likelihood of success is if speculators are very short your currency," said Estebanez. But this isn't really the case in Brazil , where pressure on the real has resulted more from local companies hedging their dollar-denominated debt. "In that sense, intervention has less of an impact which ultimately brings you to the question of how effective this is going to be to stop the weakening of the real. I don't think this is going to do it," he said.

In some ways, determining whether the intervention plan will work is somewhat in the eye of the beholder in any case. While the weakening of the real has certainly been dramatic over recent weeks, there's still the question of how much weaker it might be now if the central bank wasn't using a variety of monetary tools to prop it up?

The monetary authorities have been shortening bond maturities in a bid to ease fears among investors about holding longer-dated debt heading into the October elections, even though this raises further concerns about Brazil's reliance on short-term debt. In addition, the monetary authorities have been intervening during periods of strong pressure on the currency. They have also raised the reserve requirement for bank time deposits to 15-20% from 10-15% previously, in a bid to reduce real liquidity and help support the currency.

In this context, Wednesday's announcement simply adds another element to that cocktail. There's also some precedent in Brazil for the policy: almost exactly a year ago, the central bank began implementing a similar policy, spending roughly $50 million a day on the spot market to lift the real. That did reap some measure of success in helping to stabilize the real.

It's All About Politics

What's more, analysts argue that central banks around the world increasingly use such transparent tools to communicate with the market, as the days of large-scale surprise interventions favored during the 1980s and some of the 1990s fades away, with the exception of at the Bank of Japan. "What is positive is that it gives the market a clear sense of what the central bank is doing and how proactive it will be in preserving the value of the real," said Jose Barrionuevo, head of emerging market strategy at Barclay's Bank in New York. "In that sense it's a positive shot to confidence."

But there are some key reasons why Brazil's current situation could render the intervention plan less likely to work now. For one, the global economic environment is much more uncertain than it was a year ago and the sheer scale of Brazil's debt - gross public debt is estimated at around $275 billion - renders the country extremely vulnerable to shocks. On the plus side, Brazil's current account deficit fell to 3.7% of GDP in the year to May, the lowest in a 12-month period since September 1996. Unlike its neighbor Argentina, which was in recession for years before its debt default, Brazil has posted positive GDP growth on a regular basis and has also weathered the Argentina crisis relatively well.

But with the presidential race set to remain a major factor on investors' minds - as well as questions about how Brazil can continue to finance its debt - many analysts continue to believe it's only a matter of time before the dollar breaches the BRL3.0 level. "We haven't seen the nadir of the crisis yet," said Marc Chandler, chief currency strategist at HSBC in New York. 

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