FINANCE
IN
IIC210 International Finance
Fall 2019. December. 04
HE Yuqi 2018475032
ZHAO Chunyi 2018475035
LIU Xinyan 2018475038
LI Yutong 2018475039
BILLAH Adip 2018475055
BOYMIRZAEV Temurbek Xusanboy Ogli 2018475067
BRAZIL
CONTENTS
PART 01 Background of Brazil
PART 02 Exchange Rate for the Past Years
PART 03 Exchange Rate for the Long-run Future
PART 04 Exchange Rate for the Next Year: Prediction
PART 05 Possibility of Financial Crisis
01
Background of Brazil
Brazil’s Basic Macroeconomic Features
Introduction of Brazil’s basic macroeconomic features
•
•
•
•
•
•
Economic growth rate
Inflation rate
Unemployment rate
Output gap
Current account
Government deficit & debt
01
Background of Brazil
Brazil’s Basic Macroeconomic Features
Economic growth rate -
The inflation-adjusted market value of the goods and services produced
by an economy over time. It is conventionally measured as the percent rate of increase in real gross
domestic product, or real GDP.
01
Background of Brazil
Brazil’s Basic Macroeconomic Features
Inflation rate -
The inflation-adjusted market value of the goods and services produced by an
economy over time. It is conventionally measured as the percent rate of increase in real gross domestic
product, or real GDP.
01
Background of Brazil
Brazil’s Basic Macroeconomic Features
Unemployment rate -
It is defined as the percentage of unemployed workers in the total labor
force. Workers are considered unemployed if they currently do not work, despite the fact that they are
able and willing to do so.
01
Background of Brazil
Brazil’s Basic Macroeconomic Features
Output Gap -
Output gap is a difference between the actual output of an economy and the maximum
potential output of an economy expressed as a percentage GDP.
01
Background of Brazil
Brazil’s Basic Macroeconomic Features
Current Account - Change in net foreign assets of the country
01
Background of Brazil
Brazil’s Basic Macroeconomic Features
Government/Budget Deficit the money it receives.
The amount by which a government's spending is more than
01
Background of Brazil
Monetary & Fiscal Policies and Financial Crisis
History of Brazil’s Monetary, Fiscal Policy & Currency Crisis
•
•
•
•
Government’s Fiscal & Monetary Policy
Central Bank’s Policy Stance
Credit Rating from Credit Agency
Currency Crisis 1998-1999
01
Background of Brazil
Monetary & Fiscal Policies and Financial Crisis
Brazil’s Monetary & Fiscal Policy
History of Brazil’s Macroeconomic policies:
Fight against high inflation. (before 1994)
Budget Constraint
Passive to Active Monetary Policy
1960–1980: Fast economic growth with high inflation
and moderate deficits.
1981–1994: Slow growth with hyperinflation and high
deficits.
1995–2016: Moderate growth with lower inflation and
lower deficits.
01
Background of Brazil
Monetary & Fiscal Policies and Financial Crisis
PAEG Plan
01
Background of Brazil
Monetary & Fiscal Policies and Financial Crisis
Central Bank’s Policy Stance
• Fundamental Objective of The Central Bank: Keep inflation around the target
KEY WORD：
BCB: Central Bank of Brazil
COPOM: BCB's Monetary
Policy Committee
Selic Interest Rate
Source: Brazil Central Bank
01
Background of Brazil
Monetary & Fiscal Policies and Financial Crisis
Monetary Policy Stance
Benchmark Interest Rate -- Selic
Source: Brazil Central Bank
01
Background of Brazil
Monetary & Fiscal Policies and Financial Crisis
From 1986-2018
Rating Description:
Non-investment
grade speculative
Source: http://www.worldgovernmentbonds.com/credit-rating/brazil/
01
Background of Brazil
Monetary & Fiscal Policies and Financial Crisis
Brazil’s Currency Crisis 1998-1999
• Background：
• Crawling Peg System
• FDI increased by 140% 1997
• Current Account Deficits.
• Russian default and Recent East Asian crisis (1997)
01
Background of Brazil
Monetary & Fiscal Policies and Financial Crisis
Analyze Brazil’s Devaluation:
Balance of Payment Crisis and AA-DD Model
E0 to E1:
Investors will expect the central bank to devalue the domestic currency.
The central bank uses its reserves to meet this demand causing the domestic
money supply to decrease to M2/P.
The country run out of foreign exchange reserves and it will be forced to
devalue its currency.
AA-DD model further explains how a devaluation affects output and real
money supply.
Effects: Improvement in Brazil’s current account.
Exchange Rate for the Past Years
02
The Exchange Rate for the Past 12 Years
Time
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
BRL pre USD
1.94705
1.83376
1.99942
1.75922
1.67282
1.95306
2.15608
2.35295
3.32690
3.49131
3.19138
3.65382
Global Crisis/Subprime Crisis:
⑤
Brazil was affected after the collapse of Lehman Brothers. Its strongest initial effect
was BRL depreciation, which resulted from the global USD liquidity squeeze as well
as from the terms of trade deterioration brought about by falling commodity prices.
Tendency of Global Crisis & Monetary Tightening:
⑥
②
①
③
④
Aimed at aligning the speeds of aggregate demand and supply growth, as well as
reining in inflation expectations, with the ultimate goal of bringing inflation back to
its target.
Appreciation due to higher commodity prices and capital inflow.
Source: International Financial Statistics (IFS), 2019
Control on Foreign Capital Inflow:
The series of measures started with 2% tax on financial transactions on foreign
investments of portfolio debt and equity, collected at the initial currency conversion.
The exchange rate overall shows a rising trend, from 1.9 in 2007 to 3.7
in 2018, indicating a currency depreciation on Brazil’s Real (BRL). The
exchange rates are not stably increasing for many reasons.
(OECD, 2011; Barua, 2016; OECD, 2019; FBS, 2018)
Exchange Rate for the Past Years
02
The Exchange Rate for the Past 12 Years
Time
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
BRL pre USD
1.94705
1.83376
1.99942
1.75922
1.67282
1.95306
2.15608
2.35295
3.32690
3.49131
3.19138
3.65382
Interest Rate Cut and Recession:
⑤
⑥
②
①
③
④
Since 2012, recession in Brazil emerged. From mid-2014 to 2016, Brazil experienced
a severe economic crisis. The economic crisis became coupled with a political crisis
that resulted in the impeachment of president Dilma Rousseff and in widespread
dissatisfaction with the political system.
Tight Monetary Policy:
Tight monetary policy used until mid-2016 helped contain inflation.
Replacement of President in May:
The Vice President became acting president in May. It took time to restore
government order and adjust policies.
Source: International Financial Statistics (IFS), 2019
The exchange rate overall shows a rising trend, from 1.9 in 2007 to 3.7
in 2018, indicating a currency depreciation on Brazil’s Real (BRL). The
exchange rates are not stably increasing for many reasons.
(OECD, 2011; Barua, 2016; OECD, 2019; FBS, 2018)
Presidential Election:
BRL is the third Emerging Market currency showing the biggest depreciation
against the USD. Though the presidential election would take place in October,
it has already started affecting the currency. Elections are always a tight period
for a domestic currency since markets do not like changes.
02
Exchange Rate for the Past Years
The Exchange Rate for Past Months this Year
Time
2019M1
2019M2
2019M3
2019M4
2019M5
2019M6
2019M7
2019M8
2019M9
BRL pre USD
3.74105
3.72302
3.84588
3.89555
4.00091
3.85822
3.77871
4.01938
4.12090
The exchange rate overall increased over the past ten months this
year, indicating a currency depreciation.
Messy Politics and New President
With messy politics slowing the government’s fiscal reform agenda in
Congress, the domestic economy deteriorating and global trade war
tensions rising, the Brazil’s real has plunged.
Many studies show that as the country’s rate has converged with the low
levels of developed markets, it has increased the real’s vulnerability to
sharp sell-offs.
Source: International Financial Statistics (IFS), 2019
Under the governance of new president, President Jair Bolsonaro
submitted a bill to Congress that would allow the Brazilian Central Bank
to make monetary policy independently.
(Dwyer, 2019; EFE, 2019)
Exchange Rate for the Long-run Future
03
Purchasing Power Parity
1. Purchasing Power Parity (PPP)
•
Absolute PPP : 𝐸$/𝑅$=𝑃𝑈𝑆 /𝑃𝐵𝑅
➢ But it always fails to describe nominal exchange rate since every country has its own
unique commodity basket. (×)
Inflation, consumer prices (annual %)
• Relative PPP (10 years) :
➢ (𝐸 $ -𝐸 $
R$
,𝑡
R$
,𝑡−1
)/𝐸 $
R$
,𝑡−1
➢ 𝜋𝐵𝑅,𝑡 ＞𝜋𝑈𝑆,𝑡 → 𝐸 $
R$
10.0
8.0
=𝜋US,𝑡 -𝜋BR,𝑡
,𝑡−1
6.0
＞𝐸 $
R$
,𝑡
→𝐸$
Brazilian Real (R$) depreciation
R$
4.0
2.0
0.0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
-2.0
Brazil
United States
Source: World Bank
Exchange Rate for the Long-run Future
03
Monetary Approach to Exchange Rates
2. Monetary Approach to Exchange Rates
Broad money growth (annual %)
20
(1) Money Supply
15
•
Both Brazil and the US see an increasing money supply
since 2010.
•
In general, Brazil has a higher growth rate than the US
does, which leads to higher inflation rate in Brazil
together with a less valuable currency.
10
5
0
2010
2011
2012
2013
2014
2015
2016
2017
2018
-5
•
Causing depreciation in Brazilian Real (R$).
Brazil
United States
Source: World Bank
𝐸 $ = 𝑃𝑈𝑆 /𝑃𝐵𝑅 =
𝑅$
𝑆
𝑀𝑈𝑆
𝑆
𝑀𝐵𝑅
/
𝐿(𝑅$ ,𝑌𝑈𝑆 ) 𝐿(𝑅𝑅$ , 𝑌𝐵𝑅 )
→ 𝑃𝐵𝑅 →𝐸 $
𝑅$
, Brazilian Real (R$) depreciation
Exchange Rate for the Long-run Future
03
Monetary Approach to Exchange Rates
2. Monetary Approach to Exchange Rates
Interest Rate (monthly %)
(2) Interest rate
•
The Federal Reserve slashed the target range for the
federal funds rate to 1.5%-1.75% during its October
meeting, the third rate cut so far this year.
•
“Brazil’s central bank cut its benchmark interest rate
for a third straight meeting, which hit a new low of 5%
on 30th October, a cut of 50 basis points following their
first cut in over a year in July on the day the US Federal
Reserve also eased its monetary policy.”
16
14
12
10
8
6
4
2
0
Selic Interest Rate
(Schipani, A. 2019)
𝐸 $ = 𝑃𝑈𝑆 /𝑃𝐵𝑅 =
𝑅$
𝑆
𝑀𝑈𝑆
𝑆
𝑀𝐵𝑅
/
𝐿(𝑅$ ,𝑌𝑈𝑆 ) 𝐿(𝑅𝑅$, 𝑌𝐵𝑅 )
Federal Funds Rate
Source: Banco Central do Brasil, The Federal Reserve
→ 𝑃𝑈𝑆 , 𝑃𝐵𝑅 → 𝐸 $ ? , Brazilian Real (R$) ?
𝑅$
03
Exchange Rate for the Long-run Future
Monetary Approach to Exchange Rates
GDP Growth Rate (annual %)
2. Monetary Approach to Exchange Rates
10
8
(3) Output level
6
• Brazil’s economy is recovering gradually. “The
government has increased its projection for
economic growth in 2019. The GDP estimate was
revised from 0.85% to 0.90%. ”
(Mann, 2019)
4
2
0
-2
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
-4
-6
• However, it does not show a stronger growth than
US.
Brazil
US
Source: OECD Data
• Thus, Brazilian Real still faces depreciation
pressure
𝐸 $ = 𝑃𝑈𝑆 /𝑃𝐵𝑅 =
𝑅$
𝑆
𝑀𝑈𝑆
𝐿 𝑅$ ,𝑌𝑈𝑆
/
𝑆
𝑀𝐵𝑅
𝐿(𝑅𝑅$, 𝑌𝐵𝑅 )
→ 𝑃𝑈𝑆 →𝐸 $ , Brazilian Real (R$) depreciation
𝑅$
Exchange Rate for the Long-run Future
03
Consumption (Current US $, trillion, %)
The Real Exchange Rate Approach to Exchange Rates
20
30%
3. The Real Exchange Rate Approach to
Exchange Rates
•
15
𝑅$
= 𝑞𝑈𝑆/𝐵𝑅 ∗
•
𝑆
𝑀𝑈𝑆
𝐿(𝑅$, 𝑌𝑈𝑆 )
/
𝑅$
𝑆
𝑀𝐵𝑅
𝑃𝐵𝑅
-10%
0
𝑃𝑈𝑆
-30%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
𝑃𝐵𝑅
Brazil
𝐿(𝑅𝑅$, 𝑌𝐵𝑅 )
= 𝑞𝑈𝑆/𝐵𝑅 ∗
United States
BR Growth Rate
US Growth Rate
Exports of goods and services (current US$, billion, %)
2500
𝑅$
𝑅$
0%
-20%
➢ Domestic basket demand decrease in Brazil →
𝑞𝑈𝑆/𝐵𝑅 ,Brazilian Real (R$) real depreciation → 𝐸 $
𝑃𝑈𝑆
10%
5
(1) Brazil Basket Demand
𝐸 $ = 𝑞𝑈𝑆/𝐵𝑅 *
20%
10
The rate of exchange for goods and services
across countries
𝑞𝑈𝑆/𝐵𝑅 =(𝐸 $ * 𝑃𝐵𝑅 )/𝑃𝑈𝑆 → 𝐸 $ = 𝑞𝑈𝑆/𝐵𝑅 *
40%
𝑆
𝑀𝑈𝑆
𝐿(𝑅$, 𝑌𝑈𝑆 )
/
𝑆
𝑀𝐵𝑅
𝐿(𝑅𝑅$, 𝑌𝐵𝑅 )
40%
30%
2000
20%
1500
10%
1000
0%
-10%
500
-20%
0
-30%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Brazilian Real (R$) depreciation
Brazil
United States
BR Growth Rate
US Growth Rate
Source: World Bank
Exchange Rate for the Long-run Future
03
The Real Exchange Rate Approach to Exchange Rates
3. The Real Exchange Rate Approach to Exchange Rates
•
The rate of exchange for goods and services across countries
𝑞𝑈𝑆/𝐵𝑅 =(𝐸 $ * 𝑃𝐵𝑅 )/𝑃𝑈𝑆 → 𝐸 $ = 𝑞𝑈𝑆/𝐵𝑅 *
𝑅$
•
𝑅$
𝑃𝑈𝑆
𝑃𝐵𝑅
8
→ 𝐿(𝑅$, 𝑌𝑈𝑆 ） → 𝑃𝑈𝑆 → 𝐸 $ ？
4
𝑅$
𝑆
𝑀𝐵𝑅
𝐿(𝑅𝑅$, 𝑌𝐵𝑅 )
= 𝑞𝑈𝑆/𝐵𝑅 ∗
6
2
𝑅$
𝑃𝐵𝑅
𝐿(𝑅$, 𝑌𝑈𝑆 )
/
10
➢ Output supply increase in US → 𝑞𝑈𝑆/𝐵𝑅 , 𝑌𝑈𝑆
𝐸 $ ?= 𝑞𝑈𝑆/𝐵𝑅 *
𝑆
𝑀𝑈𝑆
GDP Growth Rate (annual %)
(2) US Basket Supply
𝑃𝑈𝑆
= 𝑞𝑈𝑆/𝐵𝑅 ∗
𝑆
𝑀𝑈𝑆
𝐿 𝑅$, 𝑌𝑈𝑆
/
𝑆
𝑀𝐵𝑅
𝐿(𝑅𝑅$, 𝑌𝐵𝑅 )
0
-2
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
-4
-6
Brazil
US
Source: World Bank
Exchange Rate for the Next Year:
04
Prediction
Monetary policy effects on exchange rate: Interest rate
⚫
“We now think that the Copom will continue
reducing the Selic rate until reaching the record
lowest level of 5.0% at year end.”
(Reuters, 2019)
⚫
“Brazil’s swap rate traders have trimmed bets on
a February rate cut that would take the rate to
4%.”
(Bloomberg, 2019)
Exchange Rate for the Next Year:
04
Prediction
Short-Run Equilibrium in Asset Markets: AA curve
⚫
Recent decline and further expected decrease in
interest rate would cause the AA curve shifts
up (right).
⚫
In the short-run, due to the decreased interest
rate, BRL is expected to depreciate.
Exchange Rate for the Next Year:
04
Prediction
US interest rate effects on exchange rate
⚫
We think the Fed will cut rates at least once
early next year, but will mostly adopt a “waitand-see” attitude beyond that.
(Kiplinger, 2019)
⚫
The Federal Reserve cut interest rates is due to
uncertainty from President Trump’s trade war
and slowing global growth continue to pose
risks to the United States economy.
(The New York Times, 2019)
Source: The New York Times
Exchange Rate for the Next Year:
04
Prediction
US interest rate effects on exchange rate
⚫
Due to the several aspects, there is an
expectation of decrease in the US interest rate.
⚫
Accordingly, the expected US return will be
lower that would have appreciation pressure
of Brazil Real.
Exchange Rate for the Next Year:
04
Prediction
Short-Run Equilibrium in Asset Markets: AA curve
⚫
Recent decline and further expected decrease in
US interest rate would cause the AA curve
shifts down (left).
⚫
In the short-run, due to the less USD return
(decreasing pattern of US interest rate), BRL
should face appreciation pressure.
04
Exchange Rate for the Next Year:
Prediction
Government/Budget Deficit the money it receives.
The amount by which a government's spending is more than
Exchange Rate for the Next Year:
04
Prediction
Monetary policy effect on exchange rate: Money supply
⚫
Due to the huge fiscal deficit (around 7% of
GDP), there is an expectation of growth of
money supply.
⚫
Moreover, the broad money supply growth
was recorded at 7.1% increase in 2018 (the
money growth was 4.19% in 2017).
Exchange Rate for the Next Year:
04
Prediction
Short-Run Equilibrium in Asset Markets: AA curve
⚫
An increase in money supply would cause the
interest rate to fall and AA curve shifts up
(right).
⚫
In the short-run, due to the money supply
increase and lower interest rate, BRL will face
depreciation pressure.
Exchange Rate for the Next Year:
04
Prediction
Fiscal Policy Effect on Exchange Rate: Government Purchases
⚫
Contractionary fiscal policy enabled
significantly decrease the government
purchases.
⚫
Output of the country would also decrease.
Source: World Bank Development Indicators
Exchange Rate for the Next Year:
04
Prediction
Short-Run Equilibrium in Output Market: DD curve
⚫
A decrease in government purchases would
cause the output to fall: DD curve shifts up
(left).
⚫
In the short-run, due to the decreased
government purchases BRL will face
depreciation pressure.
05
Possibility of Financial/Currency Crisis
Evaluation
Sluggish Growth
Subject Descriptor
2014
2015
2016
2017
2018
2019
2020
2021
Gross domestic product, constant prices
0.506
-3.551
-3.313
1.056
1.114
0.875
2.039
2.371
Source: IMF, World Economic Outlook Database
Growth has been hurt by a combination of external headwinds and domestic factors
• External: Argentina's economic crisis, the US-China trade war
• Domestic: High unemployment, fiscal policy restraint, and transitory factors like the
Vale dam collapse
Structural factors challenging a rapid growth recovery are still present
• Investment rate fell significantly
• High public debt
• Commodity prices are unlikely to rebound in a significant manner
05
Possibility of Financial/Currency Crisis
Evaluation
Weak Fiscal Profile
Fiscal challenges continue to weigh heavily on the credit profile and make Brazil vulnerable to shocks
Brazil's general government debt burden is high, and is forecast to continue rising over the next few
years, exposing Brazil to debt sustainability risks.
Spending on pensions accounts for a large share of total government expenditure.
→ The social security reform (SSR)
General government gross debt (% of GDP)
Source: IMF, World Economic Outlook Database
Source: IMF, staff calculations
05
Possibility of Financial/Currency Crisis
Evaluation
Uncertain Reform Progress
• Passed the social security reform (SSR)
• Proposed “More Brazil Plan”, a fiscal
package of constitutional reforms
• However, the Bolsonaro administration's
lack of a stable and reliable base in congress
can make reforms difficult and time
consuming.
05
Possibility of Financial/Currency Crisis
Evaluation
Macroeconomic Stability
Low inflation and moderate current account deficits supported Brazil's
macroeconomic stability
• Consumer price inflation has remained below target since 2017
2014
2015
2016
2017
2018
2019
2020
2021
Inflation, average consumer prices (%)
6.329
9.03
8.74
3.446
3.665
3.785
3.467
3.805
Inflation target (%)
4.5
4.5
4.5
4.5
4.5
4.25
4.00
3.75
• Brazil's current account deficit is expected to widen slightly in 2019 but remain
moderate
Current account deficit,
percent of GDP
2014
2015
2016
2017
2018
2019
2020
2021
4.13
3.026
1.337
0.352
0.777
1.208
1.037
1.134
• It would help Brazil's central bank to adopt looser monetary policy to stimulate
growth.
Source: IMF, World Economic Outlook Database
05
Possibility of Financial/Currency Crisis
Evaluation
Relatively strong capacity to absorb external shocks
•
•
•
•
•
flexible exchange rate
low external imbalances
robust international reserves
the third-largest net sovereign external creditor position in the ‘BB’ category (stable).
low share of foreign-currency debt in total general government debt (5.6% in 2019)
2018
Itemization
2016
2019
2017
Jun
Sep
Dec
Mar
Jun
Oct (e)
Gross external debt / GDP (H/N)
18.1
15.5
15.4
16.0
17.2
17.6
17.5
17.9
International reserves / gross external debt (J/H)
111.9
117.9
126.0
123.9
116.9
117.7
120.2
113.2
International reserves / short-term external debt, by
residual
329.3
365.2
378.2
368.8
331.9
341.0
337.3
327.8
Source: Banco Central do Brasil
Agency
Standard & Poor's
Fitch
Moody's
Source: Fitch Ratings
Rating
BBBBBa2
Outlook
Developing
Stable
Stable
Date
11/2019
11/2019
09/2018
05
Possibility of Financial/Currency Crisis
Evaluation
Conclusion
In the short term
Given moderate economic growth and uncertainties in the external environment, as well
as the contagion effects of Argentina's crisis, it is hard to reverse Brazil’s rising public
debt load.
→ The risk of a debt crisis leading to capital flight, currency depreciation and higher
bond rates remain. → Risk of currency crisis remains.
In the long term
It will depend on the performance of the government's subsequent reforms and whether
it can raise productivity with limited fiscal expenditure and controllable macroeconomic
indicators.
References
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https://www.federalreserve.gov/monetarypolicy/openmarket.htm (accessed December 2, 2019).
Banco Central do Brasil (2019). Monetary Policy. [Online] https://www.bcb.gov.br/en/monetarypolicy/historicalpath (accessed December 1, 2019).
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