The exchange rate closed 2023 at R$4.9 per dollar. Last Wednesday, it closed at R$5.4, a devaluation of 11.5%. This movement can be broken down into three intervals: from December 29, 2023, to May 10, the currency devalued 6.2%, going from R$4.9 to R$5.2; from May 10 to July 2, it devalued 10%, going from R$5.2 to R$5.7; and from July 2 to July 10, last Wednesday, it appreciated 4.6%, from R$5.7 to R$5.4.
We therefore have four dates: 12/29 of last year, 5/10, 7/2 and 7/10; and, respectively, four quotes, R$ 4.9, R$ 5.2, R$ 5.7 and R$ 5.4.
At FGV Ibre, with my colleague Livio Ribeiro, we developed a two-stage model to disaggregate, on the one hand, exchange rate movements due to external fundamentals; and, on the other, exchange rate movements due to the increase in the perception of risk in Brazil, which are not associated with external factors. The model attempts to describe short-term changes in the currency exchange rate.
The objective of the study is to decompose exchange rate changes into external factors and a domestic factor. The domestic factor is the portion of the change in country risk that cannot be explained by external factors.
Thus, the domestic component is obtained by residue. There is an attribution of the residue —that which cannot be explained by observed external factors— to domestic factors.
The breakdown suggests that the first movement, from R$4.9 to R$5.2, was 2/3 caused by external factors. In fact, as reported in this Folha in mid-April, Minister Haddad attributed 2/3 of the currency movement to external factors. The minister’s thermometer is well calibrated!
Market Sheet
The second movement, from R$5.2 to R$5.7, between mid-May and the end of June, was entirely domestic. Since we obtained this result by residual, it is difficult to know what motivated it. Each analyst tells his or her own story.
My narrative involves two factors. First, there was recognition by market operators of the inconsistencies in the fiscal framework. This topic was discussed in this space last May. The worsening of US inflation and, therefore, the prospect of higher interest rates there triggered this process of reviewing the framework’s prospects. The second factor was President Lula’s attacks on monetary policy.
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In recent days, there has been a decline in the currency’s value — as we saw, it closed last Wednesday at R$5.4, a 4.6% decline compared to R$5.7 on July 2. According to our calculations, 1/4 of this movement was due to a decompression of domestic risk.
The change in the president’s discourse regarding the need to organize the public accounts and the strengthening of Minister Haddad probably caused the movement. But 3/4 of the movement was due to the international improvement. There was a fall in international interest rates.
There is, therefore, ample room for a new round of currency appreciation, depending on the government’s actions to comply with the fiscal framework and the building of the reputation of the new Central Bank.
Last week I wrote that Chile used to practice capital account control. Chile stopped this practice a little over twenty years ago. The Chilean capital account is open without controls. I would like to thank Márcio Garcia, a full professor at PUC-RJ, for the correction.
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