Brazil is a fascinating and informative country for investors and public policy analysts. Few, if any, of the world's emerging market economies demonstrated as much political or monetary turmoil in the five years between 2011 and 2016. It's a tale of growth, inflation, recession, corruption, presidential scandals and, ultimately, huge swings in currency markets.
2011: International Concern About an Overvalued Real
During mid-2011, the expert consensus was that the Brazilian real (BRL) ranked among the most overvalued currencies in the world. A United Nations Conference on Trade and Development (UNCTAD) concluded in April 2011 that Brazil's currency was trading 80% higher than its long-term "optimal" level (the term "optimal" here referred to an original market value-based concept introduced by UNCTAD, whereby an efficiently-priced currency should be able to reallocate an economy's resources toward sectors with the highest productivity).
In its published opinion, the UNCTAD argued Brazil's real had been chronically overvalued ever since the end of Brazil's high inflationary period in the 1990s, though the trend escalated following the 2008 international financial crisis. One potential cause was an increased foreign demand for Brazilian assets and domestic products which, because they are priced in real, bid up the cost for Brazil's currency in forex markets. The real hit a high point of R$1.50 per U.S. dollar (USD) in 2011.
Overvaluation matters because, as the UNCTAD pointed out, a mispriced currency creates dis-coordination between spending and investing decisions. It also puts a squeeze on Brazilian fiscal policy, since government debt financing is more expensive in a state of currency overvaluation.
Brazil entered 2012 in a troubling situation. The cost of living for Brazilian families was increasing, forcing the country to adopt high interest rates to put clamps on domestic inflation. However, almost every other major global currency was devaluing in the face of easy monetary policy. The effect was a BRL losing value at home and gaining value in all international markets.
2012-2014: Targeted Devaluation
The period between 2012 and 2014 saw strong devaluation efforts by Brazilian monetary authorities. Finance Minister Guido Mantega had been calling for more inflation for years, but pro-inflation policies were politically unpopular.
Targeted interest rates first started to fall in August 2011, but the BRL really began losing steam in the middle of 2012. The central bank set a policy goal of R$2.50 per USD by 2015, but the pump priming may have been too aggressive. Interest rates fell from 12.5% to a then-record low 7.32% in just 11 months. By October 2012, the real was already around R$2.00 per USD.
International equity investors turned their attention from emerging markets in 2013, largely due to strong stock market growth in the United States. Despite expectations of price stability in 2014, the real showed continued weakness. BRL prices declined against the dollar by 9.5% in the third quarter of 2014, the second-worst performance among emerging markets behind the Russian ruble.
2015: Economic Turmoil
Part of the BRL selloff in late 2014 and early 2015 was in response to strong polling for President Dilma Rousseff. Rousseff was widely considered anti-market by international investors. In fact, many significant runoffs were timed directly after Rousseff polled well against then-rival Marina Silva.
The real was in free fall by the end of 2015. Rampant inflation, which reached approximately 11% according to official measurements, had combined with a perceived failure by the Rousseff-led government to pursue pro-growth policies. In late December, Brazil raised the minimum wage for civil servants despite huge fiscal challenges. Investors responded by dumping real in currency markets, unconvinced the political class was willing to tackle economic problems with any seriousness. The BRL would end the year above R$4.00 per USD, the highest since 2002.
2016: President Lula Detained; Real Soars
On March 4, 2016, Brazil was rocked by political scandal when federal police detained former President Luiz Inacio Lula da Silva ("Lula") for corruption and money laundering. Though striking in its consequence, the news wasn't a complete surprise; President Lula had long been linked to an investigation involving Brazil's semi-public oil powerhouse Petrobras (NYSE: PBR) and billions of dollars in bribes and kickbacks.
The Brazilian real surged upon news of the arrest, presumably out of hope that Brazil's political turmoil would cease to hinder pro-growth policy and restore faith in the country. It remains to be seen if Brazil's politicians have the fortitude to turn things around. If nothing else, the Brazilian real is a fine case study in the intersection of economics and politics.
