Change in the international scenario and increased risks

BRAZIL ECONOMICS - Report 18 Jun 2018 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

The international scenario has changed. The current cycle is marked by appreciation of the dollar and reduced flow of capital to emerging countries, which to a greater or lesser degree has weakened their currencies and raised the quotations of their CDS. The countries with balance of payments issues (like Argentina and Turkey) have suffered the most. But Brazil, due to its fragile fiscal and political situations, has also been suffering, obliging the Central Bank to intervene to smooth out the exchange rate movements.

Neither the depreciation of the real, which last week reached above R$3.75/US$, nor the transitory inflationary “shock” generated by the truckers’ strike, poses a threat to the inflation target of 4.5%. But all the same, the positive slope of the yield curve steepened substantially, and some believe the Central Bank might raise the interest rate at the next COPOM meeting. This would be a mistake, since the economy is depressed and there are no risks of losing control of inflation.

The Central Bank should not intervene in the currency market to pursue an exchange rate target, nor should it use the interest rate to try to influence this variable. The interest rate is the proper instrument to control inflation. All it should do is try to smooth out the movements of the real. With respect to the slope of the yield curve, this is also not an indicator the Bank should try to influence through the interest rate. Happily, the Central Bank and the National Treasury have a pragmatic and realistic vision, and do not have this diagnosis. In the text of this Report we describe one of the measures taken last Friday that caused the longer-term interest rates to fall sharply.

The relative stability of Brazil’s CDS quotations was evidence that until the truckers’ strike international investors still had not started selling off their positions. Since the strike, however, those quotations have risen, accentuating the pressure on the exchange rate and making the Central Bank’s task harder. Unfortunately, the competent leaders of the Central Bank and Treasury have to coexist with a government whose timid efforts have aggravated the situation instead of helping to stabilize it.

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