beyondbrics

It looks like the mighty real is on the march. After being confined in a “dirty float” of between R$2 and R$2.05 against the dollar for some months, Brazil’s currency closed at R$2.0985 on Wednesday, the lowest according to Bloomberg since May 2009.

There is now speculation the government could let the currency drift in a higher band, of say between R$2.05 and R$2.15 to the dollar after Brazilian President Dilma Rousseff told a local newspaper, Valor Econômico, that the real is “over-valued”.

The government’s rationale for such a move would be simple. Brazilian industry is struggling to recuperate after a strong currency, rising labour costs, increased competition from imports and other factors eroded its competitiveness in recent years.

A weaker real would represent, in the government’s view, a shortcut to competitiveness. After all, that is what Brazil believes its trading partners are doing with their currencies. Suspect number one in this respect is the US, with its continuous waves of quantitative easing.

So why not let the real “go” altogether. The answer is of course, inflation, Watson. Brazil’s traditional enemy is never far away, with inflation already flickering towards the upper end of the central bank’s barn-door sized target range of 4.5 per cent plus or minus two percentage points.

Here’s what RBS had to say on whether the central bank will let the real (known as the BRL) shoot off into the clouds.

The bias for a weaker BRL is no surprise given underperformance of industry and investment shortfall in a context of diminishing policy options, but inflation is what keeps the government from engineering more currency weakness via distortive FX measures. We do not buy the view that the government is prepared to let BRL “go”. BRL’s recent move outside its previous tight 2.02-2.04 range reflects a combination of weak fundamentals and poor FX flows in mixed risk environment. We think the government will defend the 2.10 level.

Whatever happens, one thing seems clear: whether the government lets the real go or not, the currency is firmly under its control. The dirty float is here to stay even if the band has moved slightly.