September 25, 2015 / 9:32 PM / 4 years ago

Brazil ramps up real support, but sees reserves as last resort

SAO PAULO (Reuters) - Brazil’s central bank says it might dip into its dollar reserves to support its tumbling currency but people who work closely with the bank say it will use other tools until it sees dollars leaving the economy.

Brazilian real coins are seen in this picture illustration taken in Rio de Janeiro October 15, 2010. REUTERS/Bruno Domingos

The dizzying drop of the Brazilian real BRL= to all-time lows in recent days has virtually frozen Brazil's foreign exchange and interest rate markets and raised contagion fears across emerging markets.

Brazil’s currency futures market, where volumes are nearly three times bigger than in the spot market, has led the slide and that is where policymakers are focusing their efforts - holding 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.

The central bank has been able to carry out those operations without dipping into $371 billion of foreign reserves, but faces mounting calls to start selling some of those dollar stockpiles.

After repeated questions, central bank chief Alexandre Tombini said on Thursday that reserves were an “insurance policy that may and should be used.” The real rebounded sharply on his comments.

Tombini did not say what would warrant the use of those reserves, however, and a member of President Dilma Rousseff’s economic team said that option was not on the table “right now.”

“There are no outflows, dollars are not fleeing the country,” the source said in explaining the government’s decision to leave the reserves untouched.

Central bank data shows Brazil has recorded inflows of $11.66 billion since the beginning of the year, $900 million of which came in during the week to Sept. 18. No outflows have been seen since then, the head of the central bank’s currency trading desk said on Wednesday.

Yet the real has fallen more than 30 percent this year, making it the worst performer among 152 currencies tracked by Reuters.


With the economy in recession, inflation above 9 percent, a sharp deterioration in government finances, and one ratings agency lowering Brazil’s debt to “junk” status, investors have been heavily betting against the real in the futures market.

Brazil’s futures markets thrived over the past decades as investors, rattled by past domestic currency crises, sought to develop instruments to limit foreign exchange risk.

Futures trading grew so much that it now dictates currency spot prices, a unique configuration in the world, and such trades do not involve dollars actually changing hands.

Brazilians are not allowed to have dollar accounts in the country and the spot currency market is mostly used by companies. Recent inflows into that market have been insufficient to satisfy investors’ appetite for hedging.

Policymakers will try to quell that thirst for hedging by boosting dollar sales through repurchase agreements, according to sources at three banks that deal directly with the central bank.

Dollar repos work as a renewable financing line in dollars that can be used by for companies that are exposed to currency variations, or banks that need to provide foreign currency to its clients, among others. Dollars sold through those lines do not deplete government savings abroad as they return to the reserves at a later date.

Analysts say repos are becoming more appealing for the central bank as currency swaps grow increasingly expensive.

Swaps are derivatives that let investors hedge against currency losses by swapping exchange rate and interest rate variations. But, as local interest rates shoot up, the central bank has been forced to pay a higher premium to roll over those contracts.

Trying to drive interest rates lower, the Treasury unveiled on Thursday a program of daily auctions to sell and buy back fixed-rate notes in the local debt market.


Analysts are calling for more decisive action from the central bank, including more rate hikes, that tend to support the local currency by raising yields on real holdings, but are split on whether the time has come to tap foreign reserves.

“You are in emergency mode now,” said Cristian Maggio, head of emerging markets strategy for TD Securities in London, arguing that the central bank should raise interest rates like Turkey or Russia did when faced with a currency crisis.

“The central bank can do anything but sell its reserves because you can rapidly run out of them without resolving anything,” he said.

Brazil’s foreign reserves soared during the commodities boom of the past decade, which propelled the real to nearly 1.5 per dollar by mid-2011. It traded weaker than 4.2 on Thursday before firming to around 3.97 on Friday.

Ratings agencies frequently cite Brazil’s reserves as one of the few remaining signs of economic strength, but they come at a considerable cost.

To buy dollars, which yield minimal returns abroad, Brazil must issue debt in its local market, where the base interest rate is 14.25 percent.

BNP Paribas strategists said in a research note that Brazil may have “excess international reserves” and should try to break the real’s downward spiral by selling dollars in the spot market.

Reporting by Bruno Federowski and Walter Brandimarte; Additional reporting by Patrícia Duarte in Sao Paulo and Alonso Soto in Brasilia; Editing by Tomasz Janowski

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