WEEKLY SELECTION: Brazil’s Central Bank Gives In to Market

By Mario Osava Reprint | | Print |

Mario Osava

RIO DE JANEIRO, Jan 16 1999 (IPS) - 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 depreciation of 16.6 percent.

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 percent 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 percent 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 percent 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 percent 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 reestablish 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.