Brazil sparing foreign reserves, but maybe not for long
RIO DE JANEIRO, Sept 4
RIO DE JANEIRO, Sept 4 (Reuters) - Brazil's central bank has so far kept the door closed on its vault of $370 billion in foreign reserves, but may need to open it in the next few months if investors continue to lose faith in the country's slow-growing economy.
On Aug. 22, Brazil unveiled a $60 billion plan to defend its currency against a broad sell-off of emerging-market assets. The initiative relies on sales of derivatives, meaning the bank can satisfy market demand for dollars without actually having to sell any hard currency from its reserves.
Coming after a roughly 15 percent drop in Brazil's real since May, one of the biggest falls in the world, the plan led many investors to think central bank president Alexandre Tombini is saving firepower in case of even greater market stress ahead.
Emerging markets are bracing for a cut in stimulus by the U.S. Federal Reserve, which could come as early as this month, prompting investors to pull out even more money from riskier emerging market investments.
In a sign of growing unease among key developing countries, India has called for coordinated currency intervention and heavy central bank dollar selling was suspected to be behind a rebound in the battered rupee on Wednesday.
Brazil's caution is probably a good idea for now, Bank of America Merrill Lynch economists David Beker and Claudio Irigoyen wrote in a recent research note.
"Our perception is international reserves need to be managed with caution," they wrote, warning that Brazil's pot of savings is actually "not that big" when compared to other pools of money in Latin America's largest economy.
Although reserves are healthy at around 16 percent of annual economic output, Brazilian companies have about $500 billion in dollar debts. Foreign investors have another $400 billion invested in local markets.
While foreign investors could simply move their money out of the country, companies would need actual dollars to pay their debts abroad if they are unable or unwilling to roll them over.
Central bank data shows companies are already rolling over only about half of their foreign obligations, either because international markets became more restrictive or because the cost of hedging dollar obligations has been on the rise.
Brazil's demand for dollars is no longer fully covered by relatively stable foreign direct investment, leaving the country relying on investment in stocks and bonds to fund its current account deficit -- a source which could easily run dry.
"At (that) point, the central bank has the following decision: it can meet this demand from its reserves, or it can step back and let the real fall until some other private sector agent enters the market and meets this demand," said Tony Volpon, head of emerging markets research for Nomura Securities.
The recent challenges have been a major shock for Brazil, which just two years ago was taking measures to stop dollars from flowing into its fast-growing economy and last dipped into its reserves during the 2007-2009 financial crisis.
However, economic growth of just 0.9 percent last year and the interventionist policies of left-leaning President Dilma Rousseff have caused the country to lose much of its allure.
The central bank initially tried to support the real by auctioning so-called currency swaps, derivatives that provide investors with protection against the real's depreciation. It also injected dollars into the spot market through repurchase agreements that force buyers to sell those dollars back to the central bank at a later date -- with little effect.
The real only seemed to stabilize when the central bank committed to the daily intervention program that, added to earlier actions in 2013, will ensure that at least $100 billion worth of currency swaps and dollar repos will be offered to markets by year-end.
However, the program does not come free, of cost or of risk.
By regularly offering currency swaps, the central bank is able to satisfy speculators who want to bet against the real. When those contracts mature, the bank makes up for a possible currency weakening with payments in reais, adding to public debt but preserving foreign reserves.
In July alone, the current stock of about $40 billion worth of swaps have added 1.7 billion reais ($720 million) to Brazil's debt servicing cost, according to the central bank.
That loss may eventually be wiped off the books, depending on the real's performance before the contracts expire. If the real appreciates over time against the dollar, the central bank will actually make a profit.
But if the real depreciates, the debt grows even more. The stock of swaps is expected to more than double to about $100 billion by year-end, opening Brazil to more losses.
If swaps become ineffective, the central bank could dip into the reserves accumulated during the boom years of the 2000s.
Tombini says the central bank has not touched a war chest which has ballooned from less than $50 billion in 2002 because there has been no demand for dollars on the spot market.
However, that may quickly change if dollar outflows pick up and the real loses more value. Given Brazil's efforts to avoid additional inflation pressures stemming from a weaker currency, analysts bet the central bank will likely choose to spend its foreign reserves when such demand arises.