SUNS 4356 Wednesday 20 January 1999

Brazil: Central Bank yields to the Market



Rio de Janeiro, Jan 15 (IPS/Mario Osava) -- Brazil's Central Bank gave in to market pressures Friday and suspended the exchange rate band adopted two days ago, allowing the local currency, the Real, to float free.

Within minutes, the dollar shot up to 1.54 Reals, 22 cents above the upper limit of the new band in which the Real was trading, set Wednesday at 1.32 Reals per dollar. The new drop in the Real meant a further 16.6% depreciation. Brazil's authorities are trying to determine the magnitude of the
devaluation required by the market, and announced new exchange policy rules for Monday.

The Sao Paulo stock exchange rose 19.5% two hours after investors were surprised by the news that the Central Bank would not intervene in the exchange market Friday.

The Sao Paulo index had started out the day with a 5.14% loss, in a continuation of the tendency seen over the past two days.

The stock market rebound was a response to the correction of the value of stocks in Reals, seeking to return to their price in dollars, said Paulo Yokota, a former Central Bank director who was in favour of a devaluation of the Real.

According to that logic, a 25% increase is possible, since the Real has depreciated to that extent since Wednesday, when new Central Bank President Francisco Lopes announced the widened band, which implied an effective devaluation of nine percent.

The dollar was trading at 1.21 Reals Tuesday, when the rate continued to be controlled by a tight mini-band that allowed only 1.16% variations.

Friday's decision, announced after the start of bank and stock exchange operations, was an about-face from the Central Bank's denial Thursday evening that it would allow the real to float free.

The reaction of the stock markets indicated that the new measure was welcomed, because the devaluation approved Wednesday was considered insufficient.

Shortly before Brazil's decision Friday, former Argentine economy minister Domingo Cavallo recommended, in interviews granted to the Brazilian press, either the adoption of Argentina's dollar-pegged currency board, or free flotation.

Such "clear and credible" rules are necessary to re-establish market confidence, in order to lower interest rates and reduce the internal and external financing costs of development, Cavallo maintained.
Argentina's currency board uses the exchange rate to maintain price stability, and forces the Central Bank to carry out its operations with a dollar-pegged currency.

The depreciation of the Real will contribute to reducing Brazil's bulky trade deficit, which totalled 6.3 billion dollars in 1998.

A sharper devaluation than that intended by the government was inevitable, according to economists and traders. Brazil lost around three billion dollars over the past two days, after announcing Wednesday a broadening of the band in which the Real trades, to between 1.20 and 1.32 reals against the dollar.

With that measure, modifying a policy of tight control of exchange rates, in effect since 1995, the Central Bank attempted to limit the devaluation to nine percent, in the face of pressure from a growing outflow of capital.

Brazil's reserves have fallen to around 30 billion dollars, according to economic analysts. In July, prior to the Russian debt moratorium, they stood above 70 billion dollars.

Allowing the Real to float was the right decision, said Jaime Valdivia, director of research in Latin America at the U.S. Morgan Stanley bank. The measure will protect foreign reserves, and once the initial jitters have passed, Brazil's currency will be able to recover part of its lost value, he said.

A rate of 1.50 Reals against the dollar is an "excellent" result, which will allow a recovery of exports and a resumption of economic growth, according to Dany Rappaport, chief economist of the Banco Santander in Brazil, which expects the real to continue to float.

The Central Bank communique, however, said the free flotation was adopted for "this Friday," and announced new measures for Monday.

The Central Bank has decided to let the market define the exchange rate and assess reactions over the weekend, in order to decide on the new rules Monday, said Minister of Development, Industry and Trade Celso Lafer.

Economists expect inflation to rise, as a consequence of the devaluation of 24% with respect to Tuesday's rate of exchange.

The major rise in debts contracted in dollars is expected to cause trouble for companies, as well as a number of state governments, which were already facing serious difficulties in meeting their debt
payments.

The shift in the exchange policy could also force new negotiations with the International Monetary Fund (IMF) and the governments with which Brazil worked out a $41.5 billion rescue package in November.

Finance Minister Pedro Malan and new Central Bank President Francisco Lopes fly to Washington Saturday to explain the latest measures to the IMF and U.S. government, in search of international backing and in a bid to keep the assistance package on schedule.

Amidst the turmoil, the Brazilian government took in some $77 million in revenue Friday through concessions of two areas of telecommunications - confirming the government's decision to continue
forward with its privatisation programme, which is to focus this year on sales of electric companies, and could bring in up to $20 billion.

The Bonari consortium, headed by the U.S. company Sprint, will provide long-distance telecommunications services in Brazil, competing with the Brazilian Telecommunications Company, privatised last July.

The Canbras consortium, comprised of groups from Argentina, Brazil, Canada and the United States, will dispute, with another private company, the fixed telephony market in 16 eastern, northeastern and northern Brazilian states.