By Jamie McGeever
BRASILIA (Reuters) – Brazil’s decision to sell dollars on the spot market for the first time in a decade is a sign the central bank is finally willing to reduce its $385 billion pile of foreign exchange reserves, analysts said.
Officially, the central bank’s announcement on Wednesday that it will sell dollars – along with existing sales of reverse currency swaps – was designed to meet rising demand due to global market volatility and does not reflect a change in the central bank’s floating exchange rate policy.
There is no suggestion the central bank is in any way targeting the exchange rate. And at $3.84 billion, the operation set for the seven trading days over Aug. 21-29 represents just 1% of overall reserves.
But beyond simplifying the central bank’s currency derivatives position, the sale of dollars could mark the first step in longer-term strategy shift by central bank governor Roberto Campos Neto, analysts and investors said.
“This is a change of tactic, as well as signaling that there is no problem with selling FX reserves as long as it is a measured sale,” said Cleber Alessie Machado, broker at H. Commcor in Sao Paulo.
Economy Minister Paulo Guedes on Thursday gave his thumbs up to the move, saying the central bank is making “good use” of its reserves, adding that selling dollars in the spot market – or “giving up reserves” – will help reduce public debt.
He also said that Brazil is “prepared” were the real to weaken past the 4.00 per dollar level to 4.10 or 4.20, an indication that he would have no problem with the central bank reducing reserves further.
10TH LARGEST STOCKPILE
Brazil’s FX reserves were mostly accumulated during the 14 years under leftist Workers Party (PT) presidents Lula Inacio Lula da Silva and Dilma Rousseff between 2003 and 2016, when they rose to more than $350 billion from under $50 billion.
(GRAPHIC – Brazil’s FX reserves: https://fingfx.thomsonreuters.com/gfx/mkt/12/4811/4768/BRRESERVES.png)
This was akin to effectively taking out a large insurance policy against financial and economic turbulence.
The move sought to convince the international investment community that the PT could be trusted with the stewardship of the world’s ninth largest economy: there would be no return to the devaluations and hyperinflation of the past.
And it worked: for most of that time, Brazilian markets rose and interest rates fell, while the insurance policy came in handy when Brazil plunged into one of its longest and deepest recessions ever in 2014.
U.S. Treasury data this week showed that Brazil is the fourth largest foreign holder of U.S. Treasuries in the world with $311 billion.
In recent years, however, under former central bank President Ilan Goldfajn and current incumbent Roberto Campos Neto, the debate around Brazil’s reserves, the 10th largest in the world, has shifted.
Many observers now argue that they are too large. And while the cost of maintaining them has come down as interest rates have fallen to their lowest on record, they are still costly.
The cost of holding international reserves, which are mostly U.S. bonds, is essentially the Brazilian-U.S. interest rate differential. That gap has shrunk as Brazil’s official interest rate has been cut to 6.0%, but even that is still almost 400 basis points more than official U.S. rates.
CROSSING THE RUBICON
There was nothing to suggest this technical change to how the central bank manages its day-to-day currency policy will result in a big or sudden drawdown of reserves. Any drawdown will likely be over a period of years, and very gradual, analysts said.
However, one Sao Paulo-based portfolio manager, who asked not to be identified because of the sensitivity of the debate, said the announcement was significant and that the central bank had crossed the Rubicon.
“Campos Neto tipped his hand, and reserves are fair game now,” he said.
Over time, the move could be broadly supportive for the real currency, other things being equal, but it was unlikely to have a marked exchange rate impact, analysts said.
The move comes as Brazilian companies are paying down dollar debts and reducing their dollar-denominated liabilities.
State-owned oil company Petrobras (SA:), for example, is selling off assets and said this week it has pre-paid a loan of $3 billion with China Development Bank and will pre-pay a second loan worth $5 billion with the same bank later this year.
As companies pay down more dollar debt, Brazilian banks have increased their short dollar position to around $30 billion, according to central bank data, which has been funded in part by central bank loans known as “lines.”
Analysts say the central bank has taken the opportunity to simplify its currency derivatives portfolio by selling spot dollars and buying back dollar swap contracts, but it is no coincidence it is doing this now when there appears to be a diminishing need for such a FX huge reserves buffer.
“The central bank needs to be efficient in the use of its instruments, and this is what it is looking at,” said Carlos Kawall, chief economist at Banco Safra in Sao Paulo.
He hailed the announcement as “flexible and genius” and said that current market and economic conditions in Brazil probably warrant lower reserves overall, even though this is not the primary aim.
“Reserves are in excess of what we need. I wouldn’t see a problem if reserves were around where they were at the time of the global financial crisis, around $230 billion. But this isn’t the central bank’s goal,” he said.