beyondbrics

No sooner had the FT gone to press on Monday evening with a report that Brazil was likely to use its sovereign wealth fund to fight the appreciation of its currency, the real, than the finance ministry announced it was preparing to do just that.

Here, with no further comment, is what Tony Volpon at Nomura had to say in a note to clients on Tuesday:

Late yesterday, in another round of the by now tiring attempt to talk down BRL, the governing council of Brazil’s Sovereign Wealth Fund (“SWF”) approved its internal regulation and allows the start of its investment activities, specifically the buying of USD in the market. In the post meeting communiqué, the council makes the questionable statements that “there are no limits for the fund to buy foreign exchange”, and that “the investments will not affect the budget, since these are funds of the National treasury, and so do not constitute public spending”, an affirmation that carefully forgets to mention that this fund will have to overcome the huge negative carry of buying USD against the issuance of BRL debt paying rates at or above Selic.

Of course there is no reason for Brazil to have such a fund, which should be better denominated as a “Sovereign Debt Fund”. SWF are instruments to manage the flow of foreign exchange for countries with large current account surplus. Brazil, as everyone knows, has a large and growing current account deficit of around 2.25% of GDP.  It’s SWF then becomes just a mechanism to shift around imaginary fiscal surpluses, which also only exist in the questionable way the so-called primary surplus target is calculated, since the country runs a nominal deficit of 3.3% of GDP. With nominal and current account deficits, the SWF only concrete purpose is to give the Ministry of Finance a way to interfere in the foreign exchange market without having to go through the Central Bank (BCB).

The “no limits” statement is equally dubious, as the huge negative carry faced by the SWF puts clear limit on the amounts of USD the government can buy. With international reserves of US$262 billion and growing, the BCB already saddles the hapless Brazilian taxpayer with, let’s be generous, a  R$44 billion or so bill every year of negative carry, which is heaped to the gross debt stock which is already 65.5% of GDP and growing.  The SWF will do no different, as it will also be just funded not by any “wealth” but by further debt issuance.

How long markets will “forgive” this fiscal deterioration is anyone’s guess, especially as other countries are facing even worse fiscal dynamics. That said, the government must find a more efficient way to manage the inexorable rise of BRL, one that hopefully would involve a more fiscal rectitude to generate more savings and so decrease the pressure on the currency by the need to finance the growing current account deficit.

In the short run the big question is what will the government effectively do after the Petrobras deal and the election. The growing levels of verbal intervention, if not followed soon by more effective measures, will just embolden the market to press BRL even higher.  With technical positions very long BRL, the room for aggressive and effective intervention is large. Let’s see if the dog that barks also knows how to bite.