Download Brazil`s Currency Crisis

Brazil’s Currency Crisis
By Team IV ( Chris Trick, Austin Weaver, Tim
Moore, Pat Heffernan, Chris Barnes
Why Brazil Matters
• Biggest economy in Latin America
• One of the last big countries to attempt
free trade and privatization; if this fails
international investors discouraged.
• Unified global economy is threatened if
Brazilian currency fails.
History
• Brazil had been through 6 currencies since
the 1960’s
• In 1994 the Real Plan was adopted
• Before it were a series of failed plans (the
Cruzado Plan of 1986, Bresser plan of
1987, and more)
• It worked well to tame inflation and
maintain exchange rate stability for 5
years
History
• The Real was initially indexed one-for-one
with the dollar
• It was quickly allowed to float though
• A policy of high interest rates to
discourage speculation and overborrowing quickly attracted a surge of
capital inflows
• By the mid 1995 the Real Plan evolved
into a crawling peg
History
• Said to be the worst currency crisis in the
western hemisphere to date
• The Real Plan was one of the longest
running exchange rate stabilization
programs
Facts of Life Before Crisis
• 43% of Brazilians – over sixty million people - lack the essentials of
a decent life
• One in three children drop out of school without completing primary
• Drug gangs rule the favelas and the middle class lives behind bolted
doors
• Half a million North-eastern farmers watch crops wither in yet one
more drought
• The urban environment, home to four out of five Brazilians, is
deteriorating fast
• Blacks, over-represented amongst the poor, suffer social
discrimination
• Indians face severe threats to their economic and cultural survival
• The income gap between men and women is the worst in Latin
America
Why Peg to Dollar?
• Needed to convince domestic and
international investors that chronic inflation
would be stopped.
• Before Real Plan, inflation was 3000%.
• Fixing the exchange rate was easier then
reducing government commitments.
The Fall
• It was in a financially fragile state
• It required large capital inflows to build up
the central bank to defend currency
• This built investor confidence and led to
exchange rate appreciation
• This fueled import-driven consumption and
stifles export growth
• In order to attract the inflows the real
interest rate had to rise
The Fall
• The high interest rates lead to a rising debt
burden and a deteriorating fiscal balance
• A rising budget deficit and deteriorating
trade balance inevitably lead to
devaluation
• It just could not finance its current account
deficit due to insufficient long-term
instruments
The Fall
• Investors came to believe the capital
inflows were insufficient to finance its
current account deficit
• Productivity did grow from the imported
capital goods
• The industrial restructuring it caused was
not enough to fight off the deteriorating
trade balance as unemployment rose
The Fall
• Speculative pressure built up and it
became harder and harder for the central
bank to maintain the rate
• Eventually the peg had to break; calling for
a floating rate.
Other Reasons
• The political power of the elite prevented
tax hikes and to encourage exports it
could not impose higher taxes on
manufacturers
• The public sector had won generous
pensions and benefits that the government
could not afford any longer
• Dismantling these programs would have
led to further social instability
Other Reasons
• Given the political paralysis it is difficult to
see how the prolonged overvaluation of
the currency could have been avoided
How Much Was Lost
• During the first 6 months of speculative
attack currency loss totaled $35 billion!!!
• After the first 3 months of 1999, US
reserves went from $70 billion to about
$32.9 billion.
The Fall
Foreign Influences
• The other currency crisis in Asia, Russia,
and Mexico made the peg increasingly
fragile
• Short-term capital flew faster into Brazil
and the government had to sell off 10
billion dollars in reserves and hike interest
rates from 21 to 44 percent
• This worked for a short time until the crisis
hit January of 1999 unexpectedly
Decline of Reserves
Crisis Recovery
• Managed a quick recovery compared to
other major currency crisis to date.
• Due to banking system being ready to
handle both severe economic shocks and
policies.
• Commercial banks able to take extreme
measures to calm and stabilize markets.
A guy who came to International
Finance for the first time, his @$$
was a wad of cookie dough. After a
few weeks, he was carved out of
wood.
-Johnny Stiver