Hank Paulson first brought the bazooka metaphor to the public’s attention at the nadir of the banking crisis in 2008, but the Brazilian Central Bank has been applying it in its currency war with speculators.
Since September the BCB has begun twice-daily currency auctions, sometimes holding three in a day; has trebled its tax on foreign investment in Brazilian fixed-income securities; set reserve requirements at 60% on short-dollar positions held by local banks; and reintroduced reverse currency swaps to effectively buy dollars in the currency futures market for the first time since May 2009. It has also authorized the Brazilian sovereign wealth fund, Fundo Soberano do Brasil, to trade in currency derivatives.
Diego Donadio, BNP Paribas’ Latin American FX and interest rate strategist in São Paulo, says the evidence suggests that the bazooka effect is working: “The IOF [a transactions tax] was increased to 6% in late October so the November balance of payments data was our first indication of the tax’s effectiveness,’’ he says. “The data showed that whereas net foreign investment in fixed-income assets had been between $1 billion and $1.5 billion in preceding months, in November the net figure was zero.”
This was corroborated by data from the Brazilian national treasury which showed that the share of foreign holdings of domestic debt, which had been increasing, dropped from 10.35% to 10.03% after the IOF increase. By raising the tax, the central bank was aiming to negate the positive carry advantage of holding long real positions, thereby reducing interest in taking speculative positions.
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“Those that have a funding requirement find that borrowing in dollars, euros or yen can be a lot cheaper than in real” James Kwok, Amundi Asset Management |
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Even though the evidence shows that the BCB’s measures are constraining capital inflows, James Kwok, head of currency management at Amundi Asset Management in London, reckons that foreign-derived inflows are not necessarily the main problem: Kwok believes that although IOF tax is reducing the attractiveness of the foreign carry trade, Brazilian companies are using the same carry trade themselves, by borrowing in foreign currencies at record low interest rates, given their own domestic rates of 5% to 6%. “Those that have a funding requirement find that borrowing in dollars, euros or yen can be a lot cheaper than in real,” he argues. “The central bank does not currently have enough measures to reduce this form of inflow.” Moreover, Donadio says it would be difficult to detect such hedging behaviour if it is occurring.
Brazilian companies are raising funds in foreign capital markets at a record pace. In January, they raised $10.4 billion in offshore bond markets, the busiest month on record, and are on track to surpass last year’s record of $36.5 billion, according to Banco BTG Pactual. Additionally, Brazil is likely to raise $33 billion through IPOs, according to the São Paulo securities exchange.
Last month the central bank raised interest rates 50 basis points to 11.25% to counter the effects of the economy overheating.
Meantime, speculators might already be seeking lower-hanging fruit, says Vincent Craignou, global head of FX derivatives at HSBC, citing the Mexican peso, which has appreciated more than 4% against the dollar since the beginning of December.
