Brazil: real ails

The global credit crunch may do some long-term damage to the Brazilian economy despite the favourable economic implications of the country's weakening currency.

The real fell below 2.00 to the dollar for the first time in three months on August 16, as a result of continuing volatility in global credit markets. At the time of writing it is just below 2. The weakening exchange rate is welcome in some quarters: the strong real has been cut into the trade surplus and reduced Brazil's competitiveness abroad, and since it passed the psychological barrier of 2.00 to the dollar in mid-May efforts to encourage a more competitive exchange rate have failed. 

With international reserves of over 160 billion dollars and the maintenance of cautious fiscal and monetary policy since President Luiz Inacio Lula da Silva came to office in January 2003, the government has made serious efforts to distinguish Brazil from other emerging markets whose economic policies may appear shaky.  The fact that the fall and rise of the real has responded more to global reaction to 'riskier' assets, rather than Brazil's own fundamentals, suggests that this strategy has been only partially successful, and that benign global conditions, rather than its own stability, have been the key to Brazil's low country risk and rising real.  If this is so, long-term market turbulence could undermine confidence and eat into investment -- and the trade surplus -- faster than expected.