A weaker Real is the “New Normal” of the Brazilian economy

BRAZIL ECONOMICS - Report 27 Jan 2020 by Affonso Pastore, Cristina Pinotti and Marcelo Gazzano

What is keeping the Real from appreciating? The answer requires looking not only at the nominal exchange rate, but also the real exchange rate. Since the end of 2011, commodities prices have been generally falling, causing losses in the terms of trade, and the current account deficits have been raising the country’s external liability. These two movements have been keeping the equilibrium real exchange rate weaker. However, as a type of asset price, the exchange rate is also affected by financial flows. When the difference of the interest rate between Brazil and the United States was large and the real exchange rate was getting stronger, nonresident investors gained from both the interest rate differential and the appreciation of the exchange rate, attracting inflows to the fixed-income market. But with commodity prices now falling and the external liability rising, the appreciation of the real exchange rate is a thing of the past, and the high exchange rate risk (measured by the high volatility of the real) is not offset by the interest rate differential. Therefore, instead of inflows, the pattern now is outflows of portfolio investments. We see no forces to alter this picture, so in our view, a weaker Real has become the “new normal” of the Brazilian economy.

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