Brazil’s Currency Crisis

1. Brazil’s Currency Crisis By Team IV ( Chris Trick, Austin Weaver, Tim Moore, Pat Heffernan, Chris Barnes

2. 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.

3. 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

4. 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 over-borrowing quickly attracted a surge of capital inflows • By the mid 1995 the Real Plan evolved into a crawling peg

5. 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

6. 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

7. 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.

9. 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

10. 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

11. 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

12. 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.

13. 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

14. Other Reasons • Given the political paralysis it is difficult to see how the prolonged overvaluation of the currency could have been avoided

15. 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.

16. The Fall

17. 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

18. Decline of Reserves

19. 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.

20. 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