Brazil’s central bank began intervening to support the value of the real in August. It announced a $60 billion programme of FX swaps – $500 million a day Monday to Thursday and $1 billion on Fridays – to run until the end of December. This regular acquisition programme is in addition to other, ad-hoc, sales of swaps over the past few months that have sought to halt the real’s alarming slide, which led to an estimated $40 billion of swaps being sold.
Credit Suisse says that, year to date, net interventions in FX swaps totalled $48.7 billion. By the end of the year, near to $100 billion in these FX contracts might have been sold.
The exchange rate has stabilized on the central bank intervention and the derivatives strategy appears to be working, although the US Federal Reserve decision not to taper has also supported EM currencies generally.
However, in a paper to investors, Alhambra Investment Partners’ chief investment strategist, Jeffrey Snider, draws uncomfortable parallels between Brazil’s current strategy and that employed by the Thai central bank in the currency crisis of 1997. To defend the baht, the central bank sold dollars in the spot market and also sold dollar swaps to protect the currency without directly using the country’s currency reserves – although in Brazil’s case the central bank hasn’t sold in the spot market since 2012, when it sold $11.2 billion, according to Credit Suisse.
Snider says the Thai and Brazilian central banks are doing exactly what rational economics dictates from policymakers in these situations: support for the currency with off-balance-sheet swaps to avoid damaging the local economy from a sharp rise in short-term currency interest rates. But he argues that the Thai central bank made a grave miscalculation because “unfortunately economics and economists rarely understand finance, speculators in particular”.
He says: “If you pair the spot intervention with a swap/forward, you’ve given speculators a huge alternative access point to borrow/short your currency.”
The IMF says Brazil’s central bank has $364 million in reserves, of which $345 billion is in securities. In a relatively short period (possibly when the real is under renewed pressure from a post-tapering markets environment, and possibly even amid heightened speculation about a ratings downgrade) these contracts will need to be paid, requiring dollars (in turn necessitating a big sale of dollar-denominated securities), or rolled over without significantly disrupting the market.
Put bluntly, Snider believes Brazil’s central bank is playing into the speculators’ hands by aiding their ability to short the real. “At best, you’re only attempting to buy time for conditions to normalize. But they won’t because you’ve given speculators the very ammunition they need to attack your currency further ... I don’t see how this can end well,” he concludes.