By Marcelo Ballve.

Foreign investor cash is not as attracted to Brazil as it has been in the recent past, according to Central Bank data. The new numbers on the flow of foreign exchange or FX in and out of the country reveal investor purchases of the real (or BRL) decelerated markedly in May.

This trend is important because it results from real economic decisions as investors and corporations enter or exit fixed investments like plants and property, or evaluate financial bets like purchases of Brazilian bonds. Before they can take their money out of Brazil, investors must exchange their reais for USD. Conversely, when they enter Brazil they must buy reais. And these transactions are reflected in the financial FX balance. To arrive at the number, the Central Bank simply subtracts sales of BRL from purchases of BRL.

(Importantly, the financial FX balance excludes reais and dollars exchanged to complete export and import transactions. It is a barometer purely of financial flows.)

The chart above reveals Central Bank data released yesterday to show how that has looked over the last 17 months. The extreme zig-zag basically tells the story. When the line’s above the x-axis, it means more money’s coming in and buying reais than buying U.S. dollars on its way out; when the result’s below the line,  BRL sales outweigh purchases. May’s result, at the right edge, is the lowest in the series, at $6.3 billion.

May’s result, according to Valor Ecônomico, was the largest deficit in the financial category since late 2008. What the Valor story does not say is that the May dip occurred not because of an increase in BRL sales (which actually decreased compared to April), but because of the immense drop in the purchase of reais. In other words, the big shift is not due to capital flight (at least not in terms of the last 30 days), but capital staying away.

In any case, it is eye-opening how sudden this negative result is, considering the FX balance was massively positive in early 2011, and again early this year. It’s another example of the FX seesaw Brazil has been on for this entire decade, enduring periods of huge money inflows– 2007, and 2010 and early 2011– and sudden sharp reversals, late 2008 and today.

Swap on, swap off

And here’s another example of what I mean. Brazil’s Central Bank (Bancen), like most emerging market central banks, routinely intervenes in FX markets to “stabilize” them. One method the Bancen uses is to buy and sell reais and dollars directly. Another approach is to auction foreign exchange swaps or reverse swaps. These are auctioned to a syndicate of domestic banks, who must bid on the contracts– a captive market if you will. These derivative contracts either put the Bancen in the position of betting for or against dollar appreciation, the future price of the dollar.

(To be specific, these contracts are called Contrato de Swap Cambial com Ajuste Periódico. And because derivatives are exchange-traded in Brazil, the exposure of the banking sector to these is visible on the BM&F Bovespa website.)

When the Bancen believes the BRL is too cheap (undervalued) it auctions swaps and effectively goes short the USD, when it believes the real is overvalued– as was the case during the euphoric mid-2000s until the financial crisis hit, it auctions reverse swaps and goes long the USD– short its own currency.

A powerpoint presentation given by Alexandre Tombini June 5 at Brazil’s Congress (and available on the Bancen’s website) shows how the Bancen’s position in these derivatives seesawed over the years, in an attempt to control FX variations. That’s the chart below.

The line dips into negative territory in 2006 because the Bancen had begun to accumulate a position effectively betting on an appreciation of the dollar, in order to contain the BRL’s rise. By 2008, the Central Bank had accumulated a long USD position that was worth over $20 billion. Of course, in late 2008 it suddenly had to unwind this position, and take an opposite one, and do so at mach speed after the Lehman Brothers bankruptcy. The havoc in the international markets pulled the rug out from under the BRL.

The near-vertical line in the middle of the chart is evidence of Bancen grinding gears as it raced to reverse its position. In fact, in late 2008 and early 2009 many Brazilian corporation that had over-hedged (read: speculated) against a falling dollar went belly-up.

For a time, after the financial crisis, the Bancen stayed away from the swap auctions (the flat line), but then resumed them– at first to ward off BRL appreciation, and more recently, to fight a quickly-climbing dollar. It looks exhausting, all that betting on one side, and then on another.

The irony, of course, is that Brazil, like many other countries, purports to have a free-floating currency that insulates the country’s economy and helps it adjust to external shocks. When, in reality, Brazil has a managed but volatile currency. One question to be asked, and which I have looked into, is whether the Bancen’s pre-crisis interventions withswaps cambiais actually helped to lead to imbalances in the FX market that spelled trouble once the Lehman Jack-in-the-Box sprung.

*Updated June 7, 2012, 17:58 New York Time*


Marcelo Ballve is a reporter who for over ten years specialized in Latin America. During that time, he worked in about a dozen countries, and wrote about politics, arts and culture, and business. He was a Jorge Paulo Lemann Fellow at Columbia University’s School of International and Public Affairs (SIPA) and the Fundação Getulio Vargas School of Management in São Paulo.

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