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Dabbling Dilma’s dilemma

23 September 2011 By Rob Cox

Dilma Rousseff, Brazil’s president, is getting the first market beating of her tenure. Adventurous monetary policy, worries of weakening central bank independence, disco-era industrial policy and even scuttlebutt about insider trading have conspired to hammer the real by 17 percent against the U.S. dollar this month, making it the biggest loser among significant emerging market currencies. Some weakness in the currency was desirable, but as Rousseff may soon learn, it’s tough to regain lost credibility.

The primary catalyst for the currency slide was the central bank’s head-scratching decision on Aug. 31 to reduce its benchmark interest rate by 50 basis points to 12 percent. Not only was the cut not telegraphed by central bank boss Alexandre Tombini, its merits aren’t obvious.

Inflation was 7.2 percent in the 12 months through August, above the Brazilian central bank’s own target ceiling of 6.5 percent. Credit growth is robust, even verging on bubble territory. Finally, the labor market remains tight, with unemployment at a historically low 6 percent last month. And that’s before the last-minute scramble as the 2014 soccer World Cup approaches.

The central bank’s rationale, that the cloudy economic picture abroad will weaken future demand, smacks of a directional hunch. That might be fine for a hedge fund, but it’s adventurous for a central bank.

The rate cut should also reduce cross-border speculation by making Brazilian assets less attractive, thereby weakening the currency. That helps domestic manufacturers and exporters. But while this aspect might be a concern for the government, for the central bank it should come second to fighting inflation. So investors have interpreted the move as evidence of a worrying chink in the central bank’s independence.

And that’s not all. Sao Paulo’s financial circles have been buzzing with talk that a select few made billions betting on a rate cut, even though it doesn’t seem that any economists predicted one from their study of publicly available information.

Many emerging market currencies are taking a hit as investors flee risky investments. But add in inexplicable monetary policy that hews a little too closely to political whim, and a whiff – even if no evidence – of corruption, and it’s no wonder Brazil’s real is taking the most punishment.


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