On Wednesday, the Brazilian real plummeted sharply, deprecating over 1%. This came a day after the real had reached its highest value against the U.S. dollar in over a decade.
The move may have come as a result of the Brazilian government’s decision to impose a 1% tax on certain foreign exchange derivatives. In effect, the Brazilian government declared that it would make the currency more expensive to trade.
The Brazilian government may have intentionally undertaken the move to weaken the currency, as Bloomberg notes.
The Brazilian economy (the “B” in the BRIC moniker) has been growing strongly in recent years, as millions of Brazilians have seen their standard of living improve.
The Brazilian government may view a weak real as an integral part to ensuring that this trend continues. After all, Brazil is a major exporter, especially of agricultural goods and bio fuels.
A cheaper real may make Brazilians goods appear a better purchase to both domestic and foreign consumers. That may keep demand for Brazilian goods elevated, and the Brazilian economy growing.
Yet, perhaps China highlights the potential peril of following this path.
A weak currency and a growing economy may have a tendency to spike inflation, which could lead to social unrest—which China has experienced in recent months.
The Brazilian inflation rate presently sits at 6.7%, which is up from the rate of roughly 4.5% in the fall of 2010.
If inflation becomes too much of a problem, the Brazilian government may have to reverse course and push for a strong real to fight inflation. A sharp reversal in monetary policy could trigger a recession, negating the very goal the Brazilian government may have been working to prevent.
Of course, Brazil is not a completely a free market. The country may be able to moderate the damaging effects of inflation and guide the economy to a recovery.
Given the tremendous interest in the BRIC economies in recent years, investors should keep a close eye on developments in Brazil.
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