Real Problems
Subject Exchange Rates
Topic International Finance
Key Words Currency Union, Exchange Rates, Economic Growth
News Story

Over the past 10 months, the value of the real, Brazil's currency, has fallen significantly relative to the dollar. The real can currently be exchanged at a rate of 2.71 to the dollar, a 28 percent decline compared with December 2000. The real hit a low of 2.835 to the dollar on September 21, 10 days after the terrorist attacks. Since that time, Brazilian policy makers have attempted to stabilize the currency.

Brazilian policy-makers employed a number of measures in an attempt to halt the real's slide. They issued bonds linked to the dollar, tightened reserve requirements for banks and permitted firms to report exchange-rate losses over a number of years, thereby mitigating the impact of these losses. Brazil also used $4.7 billion from an International Monetary Fund credit line to strengthen its financial position should it need to intervene in the exchange rate market.

Concern over Brazil's economic future has caused some of the flight from the real. Brazil is facing an energy crisis that has resulted in substantial rationing. There is considerable uncertainty over the impact of Argentina's economic problems on Brazil and the outcome of Brazil's next presidential election.

Some of the measures that Brazil has adopted to halt the real's decline may be contributing to its problems. Brazil issued bonds linked to the dollar to offer investors a hedge against possible devaluation. As the slide in the real proceeded, the value of these bonds in reals increased, resulting in an increase in government indebtedness. Government debt could rise to 67 percent of gross domestic product (GDP) by the end of the year. Some economists, evaluating Brazil's position, have called for the government either to cut government expenditures, raise taxes, or do both. Opponents argue that the fall in the real has already resulted in layoffs in a number of major industries, fiscal austerity would add to the nation's economic woes.

(Updated November 1, 2001)

1. How would a decrease in the value of the real compared to the dollar, affect an ordinary Brazilian? How would he or she fell the change? How would the real's slide affect a Brazilian business?
2. Part of the problem is the fear that Brazil will devaluate the real. What is a devaluation? How would a devaluation affect an ordinary Brazilian? Business firm?
3. One of the measures adopted by the government was to issue dollar denominated debt. How would these bonds reduce the fear of devaluation?
Source Matt Moffett, "Efforts to Boost Brazil's Currency Could Require More Austerity," The Wall Street Journal, October 3, 2001.

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