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Can Brazil Prop Up the Sinking Real?

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Last week, Brazil’s central bank President Alexandre Tombini announced new monetary policy measures which aim to prop up the domestic currency.  Tombini unveiled a $60 billion program which intends to utilize currency swaps and loans to arrest the fall of the Brazilian real.

The Plan and its Response

Tombini said that from Monday to Thursday the central bank would sell currency swaps worth $500 million. This move aims to provide insurance to investors against the decline of the real. Additionally, every Friday the central bank will make available $1 billion on the spot market via repurchase agreements.

These actions make it clear that the central bank is determined to arrest the decline of the real. Martin Redrado, former President of the Central Bank of Argentina welcomed the move, saying that it illustrated how economies should manage their currencies in periods of uncertainty. He supported the idea that utilizing foreign currency reserves was the best way to go.

The real responded almost immediately to these measures. It gained 3.7%, rising to 2.3488 against the dollar. This is a clear indication that such measures may be effective, at least in the near term. Prior to the announcement, the real had declined dangerously close to a five-year low against the dollar.    

Tapering Concerns

The immediate reason for the dollar’s decline is undoubtedly the concerns emanating from Fed policy. The Federal Reserve has indicated several times that it will begin tapering its long-running stimulus program sooner rather than later. This has already caused massive capital outflows from emerging economies.

The extent to which such flight of capital will take place will become more evident once the Fed firms up on a definite timeline for such measures. Brazil’s new policy measures attempt to address that situation without actually affecting  currency reserves worth $370 billion.

Underlying Factors

But whether such measures would be effective over the longer term remain a matter of concern. The immediate gainers will be domestic investors and companies who hold dollar denominated debt securities. However, debt of this kind has already increased by 2.9% in July, raising the question as to whether such a move should have come into effect earlier.

Ultimately, the long-term strength of the currency will be determined by the direction of both fiscal and monetary policy. A high rate of taxation, inadequate infrastructure and profligate government spending are key issues which need to be addressed. The central bank also needs to introspect about its moves in earlier months where it continued to reduce interest rates even in the face of fiscal indiscipline.

If such issues are addressed, Brazil’s $2.3 trillion economy remains a good bet in the long term. We recommend one excellent addition to your portfolio as well as two other stocks which are also good options

Braskem S.A.

The eight largest producer of thermoplastic resins in the world, Braskem S.A. (BAK - Free Report) has 36 plants across the globe. 29 of these are in Brazil, while the rest are located in the U.S. and Germany. Braskem holds a Zacks Rank #2(Buy) and its sales are expected to grow by 26.83% over the current fiscal. The forward price-to-earnings Ratios (P/E) for the current financial year (F1) is 2.33.

Itau Unibanco Holding S.A.

Itau Unibanco Holding S.A (ITUB - Free Report) is also a good choice. One of the largest banks in the world, Itau is the largest Latin American bank. It is one of the leading brand names in Brazil, valued in excess of $10,765 billion by Interbrand in 2012.  The company has a Zacks Rank #3(Hold) with expected earnings growth of 18.34%. It has a P/E (F1) of 8.82.

Petroleo Brasileiro Petrobras SA

Another good option is Petroleo Brasileiro Petrobras SA (PBR - Free Report) . This is a joint stock company which focusses on the oil and gas sector. It plans to invest around $236.5 billion in the 20012-16 period as per its current business plan. The company has a Zacks Rank #3 (Hold), with expected earnings growth of 7.44% and a P/E (F1) of 6.48.

The coming months will make it clearer as to when the Fed intends to begin tapering monetary stimulus. It is therefore imperative that Brazil begins to urgently address fundamental economic issues with view towards the future. 

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