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A lmost exactly six years ago, the International O l y m p i c C o m m i t t e e a w a r d e d R i o d e Janeiro the “privilege” of hosting the 2016

Olympics, and frankly, who could blame them? The Brazilian economy was surging on the back of a commodities boom, driving Brazil’s currency—the real— to its highest level in a decade. Indeed, the country cited its strong economy and political stability as major selling points in its Olympic bid. Now, the situation has com- pletely reversed: Brazil’s economy is in shambles, hit by the brutal combination of a slowing Chinese economy, falling commodity prices and political instability.

Not surprisingly, many of Brazil’s economic issues stem from a slowdown in China, its biggest trading part- ner. Brazil’s (over)reliance on exporting raw materials to the seemingly insatiable Chinese economic dragon contributed to the country’s rapid growth throughout the early 2000s. As China’s economy has downshift- ed, Brazil has fallen into a deep recession, with GDP contracting by 6% during the last five quarters alone.

Beyond trade, China’s slowing economy has also had a negative impact on commodity prices. Key Brazilian exports including iron ore, crude oil and agricultural staples, have all fallen by 50%-60% in the last few years, driving down Brazil’s terms of trade and leading to a persistent current account deficit.

On the political front, President Dilma Rousseff’s approval ratings have fallen into the single digits and a majority of citizens now support her impeachment. Rousseff and her party have also been accused of a massive corruption scandal related to the semi-public energy company Petrobas, where Rousseff previously served as Chair. In early September, Standard & Poor’s downgraded Brazil’s foreign currency debt to junk, citing political turmoil as one of the major catalysts.

Some international observers are hopeful that S&P’s downgrade will serve as a wake-up call to help Brazil get its fiscal house in order. In an effort to restore inves- tors’ confidence, the government recently introduced a $17 billion (66.12 billon real) austerity package for 2016, composed of a mix of tax hikes and spending cuts.

However, the falling currency has driven inflation high- er, putting Brazil’s central bank in a bind. It would like to raise interest rates to support the real and counteract growing price pressures, but tightening on both the mon- etary and fiscal fronts could push the economy into an even deeper recession. If the government’s optimistic fore-

casts play out, the country could return to a budget sur- plus next year and avoid further downgrades. Regardless of how the austerity package goes over, Brazil’s economy will remain fragile as long as China continues to struggle and commodity prices remain subdued.

All of these economic concerns have taken a mas- sive toll on Brazilian assets. The market cap of Brazil’s Bovespa stock exchange, which was previously the largest in Latin America, has now fallen below that of Mexico, and the carnage in the Brazilian real has been even more severe (see “Real problem”). The real recently hit an all-time low against the U.S. dollar. In fact, the value of the USD/BRL has nearly halved in the last year alone. Brazil’s central bank governor has vowed to use “all instruments” at his disposal to stabilize the currency, but it remains to be seen whether that will be sufficient.

The real’s travails could have implications beyond Brazil. As of this writing, the real has become an indicator for emerging market sentiment, meaning that a continued collapse could spill over and cause contagion with other emerging market currencies and stock markets.

The outlook for the real (and many emerging market currencies) will hinge on U.S. monetary policy. If the Fed opts to raise interest rates later this year, capital could flee emerging markets for the safety of the U.S. dollar. If the Fed embarks on a prolonged rate hike cycle, the impact on the real could be even more severe.

Matt Weller (p 78)

the real forex problem

Real pRoblem The Brazilian real has plummeted vs. the dollar for several years, and weakness accelerated in July with China’s stock market woes.

Source: eSignal

0.65

0.6

0.55

0.5

0.45

0.4

0.35

0.3

0.250.2593

2011 Apr Jul Oct 2012 Apr Jul Oct 2013 Apr Jul Oct 2014 Apr Jul Oct 2015 Apr Jul Oct

Brazilian real vs. USD

The market

cap of Brazil’s

Bovespa

stock

exchange,

which was

previously

the largest

in Latin

America, has

now fallen

below that of

Mexico.

MT_BRIC_December.indd 53 10/16/15 12:24 PM

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