Is appreciation of the real a sign that we are on the right track? – 05/03/2023 – Solange Srour

In common sense, the behavior of the exchange rate is seen as resulting from the success or failure of the set of economic policies adopted domestically. If the outlook for the economy is positive, the exchange rate tends to appreciate; if there is an increase in country risk, the opposite occurs. The recent appreciation of the real, which dropped to close to R$4.90/US$1, could be seen as a reflection of the reduction in fiscal uncertainties and the confidence that the economy will once again grow at high rates and attract a high flow of foreign investment.

However, the exchange rate –as it is the conversion rate between national and foreign currency– is influenced by international and domestic factors. In the case of the real, the appreciation of the currency this year is largely related to the depreciation of the dollar globally. The real appreciated by around 5% and the Mexican peso by almost 9%, while the Indonesian rupiah appreciated by around 6% and the Chilean peso by 5.3%.

Last year, we had not only the most aggressive of the Fed’s interest rate hike cycles, but also a significant increase in geopolitical risk with the outbreak of war, leading to an appreciation of around 25% of the dollar against the most important global currencies. .

As fears of inflation and military conflict as a global threat eased, the dollar began to weaken, offering a reprieve for emerging economies. This Wednesday (3), the Fed made it clear that it could interrupt the cycle of interest rate hikes as early as the next meeting, while recent events with medium-sized US banks did not bring the risk of a systemic crisis or a run to the dollar due to an increase in risk aversion.

In addition to these factors, a series of shocks that had dented growth in Asia and Europe in 2022 have lost steam this year. Europe, which faced the threat of completely losing access to its main source of energy and the risk of a nuclear event, has shown better-than-expected growth. In Asia, the zero Covid policy applied in China, which led to an extremely negative demand shock for the entire region, gave way to an intense reopening.

Thanks to its energy independence and geographical distance, the US economy was more protected than most developed countries in 2022, but today this is no longer a great advantage.

Meanwhile, the European Central Bank is still expected to raise interest rates by a further three-quarters of a percentage point to 3.75%, as growth and a tight job market in the region fuel fears that the battle against inflation is not fully won.

In England, it has been difficult to envisage exactly the end of the cycle of high interest rates, since inflation has not shown significant retreats. In Japan, the new president of the central bank (BOJ) has already signaled that the extremely expansionary monetary policy –which caused the depreciation of the yen– is close to ending.

Although Brazil will certainly benefit from the weakening of the dollar, we cannot ignore that the real has also reacted positively to the reduced risk of a scenario of uncontrolled spending (the consensus even is that Congress will tighten the framework) and to the high trade surpluses supported by the excellent agricultural harvest of the year. Our high interest rates, anchored by an independent Central Bank, have long been a positive for the currency, particularly during government transitions.

However, the perception that the glass is half full may not be enough to stabilize the debt, threats to the Central Bank’s autonomy and initiatives that undermine the country’s legal security constitute a relevant risk that goes against the grain of the external scenario.

The real has yet to recover from being one of the worst currencies in the world – along with the Turkish lira, the Argentine peso and the Russian ruble – when we consider its performance since the start of the pandemic (January 2020).

Of course, there is always the possibility of new and unexpected shocks, but dollar depreciation is likely to continue as uncertainties surrounding inflation and global monetary policy volatility subside. This is good news, which may even help to reduce inflation and interest rates.

However, if home fundamentals continue to walk a fine line, their benefits will not be reaped.

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