Brazil's Brand New Bag: SWF Currency Intervention

♠ Posted by Emmanuel in , at 9/21/2010 12:45:00 AM
As a follow-up to the roundup I posted only yesterday on currency intervention worldwide, here's more on Brazil talking down its currency in a fairly alarming way. Their authorities say they've given Brazil's brand spanking new sovereign wealth fund carte blanche to buy dollars and keep the value of the Brazilian real down. This, of course, is in addition to central bank intervention on a fairly regular basis (see below).

Of course, a sovereign wealth fund is usually not intended for the purpose holding back the appreciation of one's currency. After all, isn't a sovereign wealth fund supposed to make foreign investments using existing stocks of foreign exchange instead of buying foreign exchange for the sake of currency intervention? Let's just say the Brazilian authorities have come up with alternative, unfunded uses for their SWF:
Brazil's government authorized on Monday the use of its sovereign wealth fund to buy U.S. dollars in the foreign exchange market, as part of an effort aimed at stemming a recent rally in the local currency. The government set no limit on the amount of dollars that can be purchased by the $10.4 billion fund to curb a more than 4 percent rally in Brazil's real since late June, the finance ministry said in a statement.

The fund was created last year to help finance overseas expansion by Brazilian companies, and its use in the currency markets has been considered for months. The move gives the government another tool in its fight against the appreciation of the local currency that threatens to hamper exports and slow economic growth. So far, the central bank has done the bulk of the legwork with daily purchases of dollars in the spot foreign exchange market.

"This is another form of verbal intervention. But the dog has been barking a lot in the last couple of days; it's going to need to bite soon," said Tony Volpon, head of emerging market research for the Americas at Nomura Securities in New York. The real has rallied against the dollar partly as a result of huge interest in the country's [relatively high yielding] debt and expectations of massive inflows related to the upcoming share offering of state-controlled oil company Petrobras. Petrobras is expected to raise up to $79 billion on Thursday, in what could be the largest-ever share offering.

The Brazilian real was 0.6 percent weaker at 1.7323 after the announcement, according to the international reference rate...The impact of any intervention by the wealth fund on the market is unlikely to be permanent, but it could push the national debt higher in the long run, analysts said. Analysts also added that dollar purchases by the sovereign wealth fund are likely to be more random and less transparent than those by the central bank. That could help have a greater effect on the market than the central bank's daily purchases in the spot market.

Diego Donadio, an economist with BNP Paribas in Sao Paulo, said that, in the absence of strong dollar inflows in the coming days, the actions of both the central bank and the fund could push the real down to as low as 1.78 reais within the next two weeks. "The sovereign wealth fund could be a source of surprises. By that I mean that its actions could have more impact than we think," Donadio said.

The National Treasury would not officially comment when the sovereign wealth fund will be used. A government source told Reuters last week that "the sovereign fund will go in without the market knowing."
And speaking of using SWFs for this purpose, there's the seemingly inevitable matter of accounting shenanigans. Ultimately, purchases of dollars are probably funded by the public purse instead of more organic reserve accumulation via export proceeds:
One serious concern stemming from the central bank's actions in the currency market is their apparently high fiscal costs. In the statement, the National Treasury said purchases of dollars carried out by the sovereign fund would not add to the nation's budget deficit--which in July reached an eight-month high. "It's an accounting gimmick," Nomura's Volpon said, adding that the wealth fund purchases "will add massively to the debt of the country."

As the central bank buys dollars from investors, the treasury has to issue local notes that the bank will use to pay those investors. The process is known as sterilization. The central bank has recently increased its purchases on the spot market, calling two auctions rather than just one to buy dollars every day. Last week, it announced it had bought a staggering $815 million in dollars in the month through Sept. 10.

On Sept. 9, the bank bought more than it did during the whole of February. In addition to the central bank's intervention, the National Treasury has been allowed to keep government dollars abroad for a longer period. "The good thing about this is that the need for sterilization should decrease," Donadio noted, saying that the government could prevent its debt from growing by about $1 billion a year if it uses the fund to buy dollars.
Attaboy Brazil? I guess nobody really fears being labelled a currency manipulator by the US Treasury anymore.