The 2020 Depreciation, Foreign Exchange Flows and Trade Balance

BRAZIL ECONOMICS - Report 13 Nov 2023 by Affonso Pastore, Cristina Pinotti, Paula Magalhães and Diego Brandao

The minutes of the last COPOM meeting stated that “at upcoming meetings” the easing pace of 50 basis points per meeting will be maintained, so it is certain that the SELIC rate will be lowered to 11.25% at the meeting in January. However, thereafter the Central Bank will have to use the “art in the exercise of monetary policy”, so that the terminal rate will depend on the future data on economic performance.

There are two limits on this rate: (i) the neutral interest rate, which has been rising with Brazil’s expansionary fiscal policy; and (ii) the difference between the interest rates in Brazil and the United States, which has been affected by the impacts of American fiscal policy (more expansionary than Brazil’s) on that country’s neutral interest rate. The minutes also indicated that this is not the only external risk. Rather, the main one is the war in the Middle East, which can trigger an increase of oil prices. If the Central Bank chooses an excessively low terminal rate, or accelerates the easing pace while the fed funds rate remains high, the exchange rate will tend to weaken, with negative effects on Brazilian inflation.

In this report we analyze these problems. After a review of the recent behavior of exchange rate and interest rate differential between Brazil and the US, we analyze two problems in depth. The first is the depreciation that occurred in 2020, when the SELIC rate fell steeply; and the second is the effect on the exchange rate of the expected increase in the trade balance in 2024.

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