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Tuesday, 07 February 2023
Brazil’s Central Bank Quadruples its Yuan Reserves to Cop the Trump Slump

Brazil’s Central Bank Quadruples its Yuan Reserves to Cop the Trump Slump

2022-10-29

 

The Trump slump has even Brazil worried.

After the U.S. Federal Reserve raised interest rates in December, Brazil accelerated its shift toward a bigger role for the yuan in oil contracts and other transactions. The move toward the Chinese currency and other emerging market currencies reflects the country’s growing discomfort with the consequences of a Fed-driven currency rally. The strengthening of the real against the dollar has hurt Brazil’s exports.

A strengthening currency makes it more expensive for Brazilian companies to trade goods and services in foreign markets. That, in turn, makes Brazilian exports less competitive and makes it harder for Brazil to pull itself out of its worst recession in decades.

Why it matters

Despite its large domestic market, Brazil’s industrial capacity is relatively small as a percentage of the overall economy. That means that the country’s real GDP, which is around $2.9 trillion, is more heavily dependent on foreign trade.

When the value of the real plunges, it becomes more difficult for Brazil to sell its exports. Brazil’s exports, which are hydrocarbons and other agricultural products, cars and components, make up more than 60% of Brazil’s GDP.

A weakened currency also makes it more expensive for Brazil to import consumer goods, including food. That’s a big deal because the country is heavily dependent on imported food. In 2015, nearly half of Brazil’s calories came from imports.

How much the real has strengthened

At the end of 2016, one U.S. dollar bought R$3.80 in the foreign exchange market. That means that the country’s currency has appreciated by more than 20%.

The real had appreciated by 4.6% against the U.S. dollar at the end of 2016. But the pace of appreciation picked up tremendously at the start of 2017 and hit a high of 21.6% on January 18. The currency then plunged 18% over the next three months.

During this episode, the real had rallied by 1,721.1% against the U.S. dollar from 2010 to 2016. The surge in the real’s value against the greenback, which began in 2002, is widely seen as the result of a currency war.

Most emerging market economies, including Brazil, have since joined the fray by targeting their own currencies.

Brazil’s alternative to the U.S. dollar

The Brazilian government has been working to diversify away from the greenback and other traditional sources of financing for years. The most notable development has been the launch of the Petrobras oil company’s Petro tokens, which were introduced in 2017. Petro is a play on the words “petroleum” and “token.”

Petro is backed by a basket of oilseeds and provides a way for Brazilians to buy and sell oil in a decentralized manner. The Petro plan has been applauded by many as a way to wean Brazil off of dependence on the U.S. dollar and the financial system.

To be sure, the Petro is just one example of how emerging markets are trying to diversify away from the greenback and maintain some control over their own currency.

Many more countries, including Russia, Venezuela and Ecuador, are exploring their own versions of cryptocurrency.

 
 

What the central bank is doing about it

In order to support the real, the central bank has been buying up large amounts of the currency. This intervention by the central bank, known as currency intervention, was unprecedented in the history of the modern economy.

As of April, the central bank had purchased more than $20 billion in real assets, according to a statement.

The central bank held an auction of $8.33 billion in real bills and $7.71 billion in cash-settled securities. The auction results indicate that investors were eager to unload their real assets and switch to assets with a higher yield.

The government also announced on April 8 that it would no longer be accepting U.S. dollar payments for gasoline and diesel imports. In addition, the government said it would no longer exchange U.S. dollars for its own currency, the Brazilian real, as part of a plan to reduce the amount of U.S. dollars in the country.

Is it enough?

Brazil’s central bank has beefed up its reserves by more than four times since the beginning of the year. But the reserves have fallen by more than $700 billion since mid-2016, when the value of the real started to rise against the U.S. dollar, as a result of the Fed’s rate hikes.

If the real continues to strengthen and the Fed starts to reduce its $4.2 trillion balance sheet, as many analysts expect, the value of the reserves may fall even further.

At the current pace, it could take the reserves decades to reach pre-slump levels.

Will it work?

As with any currency war, the real’s gains against the U.S. dollar are likely to be fleeting.

It takes a lot of effort to prop up a currency when it’s rising against the dollar, and that could prove to be a major drain on Brazil’s scant foreign exchange reserves.

The only real outcome of the real’s rise so far is that it has become more expensive for Brazil to buy oil and other imported goods. That could prove to be a big problem if the current economic downturn in the U.S. lasts longer than expected.

Key takeaway

Emerging market economies, led by Brazil, are trying to wean themselves off of the U.S. dollar and maintain some degree of monetary sovereignty. But their attempts have so far been half-hearted at best and have failed to match the dollar’s decline in the wake of the 2008 financial crisis.

The long-term trend of growth in the U.S., which is the main consumer of many of these commodity-based exports, is likely to be a far more serious threat to these economies than any short-term fluctuation in the value of their currencies.

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