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Brazil responds to its real problem

Brazil responds to its real problem
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Brazil is the latest country to have to launch drastic measures to shore up its national currency.

After the currency – the real – slipped to near five-year lows against the dollar – down 15 percent this year – the central bank pledged $60 billion (44.8 billion euros) worth of cash and insurance to the foreign-exchange market by the end of the year.

“This shows the firm determination of monetary authorities to keep the exchange rate from slipping further,” said Andre Perfeito, chief economist with Gradual Investments in São Paulo.

The government is trying to defend the currency and at the same time kick-start a stagnating economy.

The finance ministry has repeatedly had to slash its growth forecasts. The latest has GDP this year expanding by 2.5 percent, rather than than 3.0 percent. Next year’s growth prediction was cut from 4.5 to 4.0 percent.

Brazil’s challenge is to keeping the real from sliding while at the same time controlling inflation. Consumer prices in July were up 6.2 percent from a year ago.

Higher interest rates would limit inflation and attract investment to Brazil, helping the real strengthen against the dollar, but higher rates could slow growth by making borrowing more expensive.

While a weaker real can help Brazil’s export of commodities and manufactured goods, it makes raw materials and other imports more expensive, helping drive inflation higher.

Falling for the Fed

The real’s fall in value is linked to the United States’ central bank, the Federal Reserve, moving closer to ending a bond-buying programme that has injected billions into the US economy driving down interest rates there.

As a result investors have been searching for higher-yielding, emerging market securities.

With the end of the Fed’s “quantitative easing” programme expected soon, capital has flowed out of emerging markets – such as Brazil – and back to the US and other developed countries, helping to weaken the real.

“Today, the big problem is there is a structural change (in the world economy),” said Eduardo Velho, chief economist with Miami-based investment bank INVX Global Partner, in São Paulo.

“The (Brazilian) central bank’s move is an important measure to reduce volatility and slow the pressure on the exchange rate. I see this as positive.”

Foreign exchange traders seemed to agree; on Friday Brazil’s real rallied against the dollar.

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